Enhancements to our ESG process

– David Wanis, May 2020

We have been working on a fully integrated Environmental, Social, and Governance (ESG) approach since the inception of our firm in late 2018. Longwave Capital Partners has an investment philosophy anchored by a belief that for small caps, quality is the key driver of long-term investment outperformance. When we assess companies considering ESG characteristics, we see them as additional markers of quality.

Historically, we have considered ESG as a component in the fundamental assessment that determines the quality of a business – this is factored into the quality score that we use to drive our valuation. While cognisant of the impact ESG factors have on the quality of a business (and thereby its value), our previous approach did not have the same objective level of data capture, measurement, or comparability as the investment process that we now employ. We addressed this in Q1 2020 through the implementation of a more thorough ESG process driven by a numerical and qualitative scorecard approach.

This enhanced process achieves the following:

  • An exclusion screen that eliminates specific exposures from our portfolio.
  • A consistent and formal process for the assessment of each ESG component using a combination of qualitative analysis and observable data to support the assessment and allow comparability across stocks.
  • Direct linkage between our ESG assessments and the quality score applied to each company (formalising the link between ESG and quality). The linkage of ESG to quality then having a direct and measurable impact on our company valuations.
  • Longwave Capital Partners’ status as a signatory to the UN Principles for Responsible Investment from Jan 2020.

At Longwave we utilise a combination of systematic and fundamental analysis as the foundation of our investment process. At first glance, given numerous third-party providers have growing databases of ESG ranking scores, the use of a systematic approach to ESG appears to make sense. However, after months of investigation and research we chose to implement our enhanced ESG as a core part of our fundamental process in light of the following observations:

  • Lack of a standardised disclosure or data model and inconsistency in ESG scoring across listed companies and ESG research providers.
  • Limited history of scores and availability of data with far less complete coverage across the Australian small and microcap universe.
  • The need for context and judgement when incorporating ESG into the overall fundamental view of business quality that a score lacks.
  • The opacity of how third-party research providers undertake their process.

As an important and integrated part of our investment decision-making process, it made no sense to outsource ESG to an external party, no more than outsourcing our company valuations or views on other drivers of business quality. We believe that an improved ability to assess quality will further improve our ability to generate returns from our portfolio, as markets and societies align through time rewarding sustainable behaviour rather than seeing it as a novel or separate activity.

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