Dunedin Income Growth Investment Trust: Manager update

In this latest episode of the abrdn Investment Trusts podcast, we take a deep dive into ESG with the Trust's co-manager Rebecca Maclean and Andrew Risk, ESG Analyst at abrdn. 

For more information about the Trust: www.dunedinincomegrowth.co.uk 

Transcript

Cherry Reynard: Hello and welcome to today's podcast on the Dunedin Income Growth Investment Trust, where we're going to be taking a deep dive into ESG. I'm Cherry Reynard and with me today are the Trust manager, Rebecca MacLean, and ESG analyst Andrew Risk. So welcome, Andrew, welcome, Rebecca.  

Andy, if we could start with you, there's been some pushback on net zero recently. Do you think we might see governments and corporates roll back ESG targets? 

AR: Well, I suppose in the UK we already are seeing some rollback from the, from the government side, as we've seen in the news lately around EVs and boilers and things like that. I suppose the disappointing part around the news flow is that beyond the bits and pieces of maybe sort of misunderstanding about what was actually required of these policies is that a lot of a lot of the sort of mainstream discussions on the costs.

I mean, any policy that's aiming to sort of advance our chances of reaching net zero, need to carefully consider the costs that a sort of population is going to face, particularly lower income groups. But I suppose, you know, one thing we've noticed a lot of discussion about cost doesn't talk about the cost of doing nothing and we see that more and more from the sort of financial impacts of climate change and what the toll is having on different parts of the world.

And added to that, there's not that much talk about the benefits side, which is definitely going to come through for job creation and investment, and so forth. So, will - do we think that, you know, the governments will continue to roll back, I suppose, what we hope  - what I personally hope really - is that the governments will you know, they'll look at the opinion polls in the UK, things like climate change are very high in widespread support in terms of people's,  how people care about this thing.

And so it's not something restricted to younger groups and, and equally from a corporate perspective, they want, they’re often willing to invest. They're just looking for the policy stability. So I suppose added to that on the corporate side, will they roll back? I think - I mean, there might be a little bit of re-evaluation because there are a lot of very ambitious targets put out in recent years and maybe they’ll take the time to understand how and whether they can reach them or not.

But I think from our side, we're just looking for those companies that can kind of, you know, can just sort of really stick - really sort of grasp the megatrends which are around the issues that are ultimately, you know, the costs of green technologies and so forth. They're falling, the consumer interest is growing and underlying some of the political noise, the policy trends in terms of tightening regulation and what companies have to do about sustainability, if it's plastics, if it's the social side, these just keep increasing. So, it's - there's the signs of rollback that get a lot of headlines. But I think we’re, we’re just trying to look for those companies that are really sort of have view in the longer term.

CR: Rebecca, oil has been in the headlines a lot recently and there was obviously a big spike up in oil prices earlier in the year, but that's come down a little more recently. What's your approach to the sector in the Trust? 

RM: Thanks, Cherry. So the Dunedin Income Growth Investment Trust is unique in the market in that it has a sustainable approach.

And so, we are looking to integrate ESG into our fundamental analysis of companies, but we also have a sustainability approach which outlines exclusions, both positive allocation and negative exclusions, which help us to reflect the risks and opportunities which are presented by ESG factors in the portfolio. So what this means for the oil sector, there are a number of environmental protection screens that we have in place in order to minimize the fund's exposure to the long term risks that come with fossil fuel production, given we're expecting that to be a transition towards cleaner energy and this has implications for the energy sector.

And so we're looking at companies exposures within some of the unconventional oil and gas segments, and we're looking at companies with exposure to coal as being a high-risk commodity. But when we're looking at conventional oil and gas, we're also looking at the mix within the conventional commodity exposure. So the extent to which a company in the sector is looking to develop oil assets as opposed to renewable energy generation or natural gas is a sort of transition commodity.

So that's a frame that we have in place. It means that we take the energy names on a case-by-case basis. Luckily, we've got expertise on desk – Andy with 12 years of experience in sustainability to help with this analysis aided by additional analysts on the desk and also of our central ESG team, in order to understand the extent to which different companies are exposed to those long term trends that I've mentioned.

So doing that, we’ll sort of run the analysis and we are looking to assess the materiality of environmental issues to the energy names and engagement is a really important part of that analysis too. So we're looking to understand from engagement how companies manage this. So we do have TOTAL, it’s in our top ten. It's the only oil and gas company which is in the portfolio.

And from a quality perspective, we are looking for companies at the high level which do deliver resilient earnings through the cycle. And so it's hard from a quality perspective to be too overweight oil. And I've mentioned the sustainability restrictions and sort of thresholds that we set in place as well, which does have a limiting factor. But we have to offset that with the cash generation and the income distribution which you are able to achieve from a number of the energy names too.

So there's a place for TOTAL in the portfolio, but at an aggregate level, the portfolio is underweight energy. 

AR: And I think the first point really to add to TOTAL, is that of course it's a complex sector from a sustainability perspective, but the things you would flag really or highlight, you know, this company has the largest - in recent years has made the largest - investment in low carbon energy amongst its closest peers, by far and away has the largest installed capacity for renewable power amongst all the gas majors. 

It has set out fairly ambitious targets for the amount of its CapEx which is going to put into the transition investments at to the end of the decade. And interestingly, you know, it's fairly transparent around how the company tests the resilience of its oil businesses, if we were to see a faster than expected transition and that maybe led to lower oil demand and oil prices.

Is it enough to reach all our climate goals? Probably not. And this is something we’re engaged with the company at the moment. But I think what you do see from talking to the company and all the public announcements it makes is that what it does show is the transition into that is underway and there is ambition and commitment. 

So, that positions them favourably from a perspective that as they are getting more and more ready, that if the policy as well and the regulatory environment shifts to encourage the end user to move faster away from oil, then companies like TOTAL are not only kind of ready to act and willing and to invest in it, they've also started it and that interestingly, too, to the next point on eco and cash flow, starting to show more proof points that this is actually sort of financially beneficial to the company based on the returns they make.

CR: Rebecca, I wonder if we can go back to basics a little bit. Could you perhaps give me an example of a new holding the ESG rationale for that and how you initiate an engagement with the company?RM: Yes. So we've introduced National Grid to the portfolio in the last couple of months. And so the company is a electricity transmission and distribution business, which has assets in the UK and also in the US.

So from an ESG perspective, we see the company as a solutions provider. It is enabling the energy transition that we've talked about, but also is providing energy security to the UK. 

And I think what's interesting about the ESG rationale is that it really does coincide and sort of is the same as the investment rationale, which is the demand for investment to upgrade the electricity grid infrastructure in the UK and the US is inextricably linked to the energy transition. And so the in order for the UK, for example, to meet its offshore wind renewable energy targets, there is a huge amount of investment that's required in order to connect where the energy is produced, which is which is generally in Scotland and bring it down to where it's consumed, which is down in the south of England.

And so in order to reach those ambitious targets which the government set out, we need to see over two and a half times the level of transmission in order to get that electricity to where it's needed. And so National Grid really plays into this structural theme. And it means that not only does the company forecast and guide to a huge amount of investment in the infrastructure of which 29 billion is expected to be in the renewable energy and transmission, but this then leads into the market's expectation and our expectation for asset growth for the business and also for earnings growth. So we're looking for high single digit asset growth and similarly sort of mid to high single digit earnings growth, which is pretty sort of powerful and resilient outlook from the financial perspective. 

When you couple that with the distributions - the cash distributions -  in the form of dividends to shareholders, which is expected to grow in line with inflation, so giving you that inflation protection at an attractive yield of about 6%, it should provide relatively defensive but high yielding contributor to the portfolio which fits nicely into our sustainability approach.

So, we've been assessing sort of what ESG means from a financial perspective, what that opportunity and again, to quantify it. But we're also looking at what the risks are associated with that. And so, engagement is an important part of being able to understand those issues, but also work with companies in order to communicate our expectations and share best practice.

And that is a piece of work which is ongoing. And it involves not only me and the stock analyst who covers the name at abrdn, but also the portfolio managers, and Andy has been instrumental in that engagement. 

AR: I think what the practicality issue is, is how Rebecca highlighted the fact that the electricity transmission lines that companies like National Grid and others will plan to build, will go through new areas on a larger scale that could have impacts on local populations and potentially have environmental, strong environmental impact as well, depending on the routes chosen and how those projects are implemented. And so that's the crux - our engagement with National Grid is to understand what sort of frameworks it has in place. They do have guidance and information and structures to engage with communities and ultimately, we’d say, to secure public consent. 

But as Rebecca has sort of described, the scale that we are now talking about going forward in the coming decades is so much higher that presumably there'll be so many more people affected by these things that I mean -  in a way, if the ultimate goal that we reach, reduce the risks of climate change to get towards net zero - but we can't discard the other people that will or environmental locations that could be impacted along the way. So really it's the crux of our engagement on these issues is how are the, let's say, the non-financial factors like impact on communities, how are they valued and how do we think about the environmental impacts? So ultimately, from a broader concept of cost, you know, instead of going for the most, let's say, sensible option for the country longer term, because clearly all parties want to avoid a situation where people are not compensated or they're unnecessarily affected or projects get delayed, and we sort of lose sight of the ultimate goal. 

CR: Absolutely. Andy, sticking with you, if we can, I wonder if we could explore another one of the Trust's holdings in AstraZeneca. It's currently the largest holding in the Trust. And obviously there are some clear social benefits to the company, but the pharmaceutical sector is not without its sort of risks and controversies. How do you balance the positive and negatives?

AR: I think one of the key points really to sort of start with is that for many ESG focused investors in the market, like the pharmaceutical sector, is perhaps a more challenging one than people might imagine because of concerns around, well, just the nature of the fact that there is clearly an unmet need for the drugs which the companies produce.

But then the companies are also being commercial organizations which are having to make a profit. And so how do we think about that? And that angle is, of course, a big part of our thinking in engagement with AstraZeneca. Specifically, you know, how do they think about pricing and what do they think about and what can they do about improving access to their products?

And of course, the situation is sort of evolving, not 100% perfect, 100% transparent, but I guess some of the things are encouraging of AstraZeneca is the fact that they are a strong performer on metrics such as the Global Access to Medicine index, the fact that their best in class R&D is targeted at terrible diseases like cancer, where there is clearly an enormous unmet need. So we do see a lot of positive signs there. 

I suppose, for the medium-longer term and the sort of sustainability case for AstraZeneca, for us to sort of get even more comfort around the sort of risks you mention. I'd say the company and its peers need to continue to evolve and demonstrate how they can develop new pricing or contractual agreements with countries that, you know, incentivize the company for innovation but then make sure the drugs get to the people that need it, in a fair way.

And helpfully, AstraZeneca has developed a - I think it's a so-called sort of global patient affordability programs - it's got a dashboard looking at broader metrics around affordability. And so from our side, we just really want to see going forward how that's actually going to work in practice. 

CR: Okay, great. And then just finally, a question for you both on your ESG priorities for the year ahead. Rebecca, can you kick us off on that? 

RM: Of course, so we will be continuing to do what we do in terms of identifying what are the most material ESG factors to the companies in the portfolio or being considered for the portfolio. So that focus on materiality will remain the case. But there are a number of things which we have been discussing that we think are growing in importance.

So, one that I'd highlight is the need to continue to consider social factors. A lot of the companies that we invest in and the nature of our investment approach and style is that we do have a number of human capital intensive companies and which really do depend on their talent in order to drive innovation, drive sales and deliver the growth in earnings and cash and distributions which we are looking for companies in the portfolio.

So, within the context of the UK market and a broader labour market which is relatively tight with low unemployment and high wage inflation, it's more important than ever for companies to be able to attract the right talent and retain the right talent. And it's not an easy thing for us as investors to necessarily assess and analyze from the outside of companies. But we do have frameworks in place and tools that we can use to get a better understanding of how companies are managing their human capital. 

So I could highlight an example of a company in the portfolio, Soft Cat, which is a UK IT reseller, and one of the reasons why we think the company will continue to deliver outperformance versus the market and gain market share is because of its culture and its talent and what this means for its relationship with its customers, which are mostly SMEs in the UK.

And so clearly given that is part of the company's competitive advantage and the investment case, it's high on our priority in terms of understanding and monitoring how the company is managing its workforce and through time. So we have an ongoing engagement with the company. We have an annual check in with it with the Chair, for example, and it's very often a topic of discussion with management team. So, you know, we're going to be looking at turnover, looking at development programs that the company has in place. There's been some recent sort of reporting from the company around diversity and inclusion. So we'll continue to look at what the company is doing to, for example, attract women into the workforce and promote STEM education, too.

So there are a number of areas that we'll be looking at and metrics which we'll be drawing on to assess that culture. But it remains an important and material part of the investment case. So yeah, I think sort of that's one example of, I think, where social issues remain at the fore.

CR: Thanks. And Andy, anything to add to that? 

AR: I think I would probably flag two things, two main priorities from the issuing perspective going ahead. I would say the first one obviously looks back to the first question about how are companies going to respond to any signs of, let's say, wavering political support, government support towards achieving our sustainability and net zero goals, and particularly in an environment if we have a weaker economic environment - how do companies respond to that, what are their longer-term plans and so forth. And I think the second point really is dedicating more time to understanding how companies are responding to - basically a change in climate, that's these physical risks. We've talked before about, you know, we've engaged with companies like Diageo on how it sort of manages water related risk in its supply chain. And we need to sort of step up our focus on that because, you know, in September, we've just had the hottest month on record. We're seeing these physical impacts more and more - people may attribute to different things - but the events are happening, and it leads to and is impacting, people and profits. And so we need to really see how well companies are really preparing to respond now to things that were previously perhaps thought to materialize much further down the road.

CR: Great. Okay. We'll wrap up there. So many thanks, Andrew and Rebecca, for that look at ESG today and you can find out more about the Trust at dunedinincomegrowth.co.uk. And thank you so much for joining us. 

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