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At Fidelity, we believe that high standards of corporate responsibility generally make good business sense and have the potential to protect and enhance investment returns. The investment process undertaken by our research analysts takes ESG issues into account when, in our view, these issues have a material impact on either investment risk or return. ESG analysis is carried out at the analyst level within the investment team and, as the Portfolio Manager, I am also active in analysing the potential effects of ESG factors when making investment decisions for the Company.

By working closely with our Sustainable Investing team on the ground in Japan, we are able to identify laggard companies that are implementing real change and moving up the governance scale. This is particularly relevant for small and mid cap companies, where third party coverage is limited and simple disclosure, especially in English, is often limited. When the markets recognises these companies’ efforts, there is a good chance for them to be rerated and revalued.

Fidelity has embedded Environmental, Social and Governance (“ESG”) factors in its investment decision making process. Fidelity has been a signatory to the United Nations Principles for Responsible Investment (UNPRI) since 2012 and submits an annual report detailing how it incorporates ESG into its investment analysis.

ESG integration at Fidelity International is carried out at the fundamental research analyst level within its investment teams, primarily through the implementation of the Fidelity Proprietary Sustainability Rating. This rating was established in 2019 and is designed to generate a forward-looking and holistic assessment of a company’s ESG risks and opportunities, based on sector specific key performance indicators across 99 individual and unique sub-sectors. In addition, Fidelity’s portfolio managers are also active in analysing the effects of ESG factors when making investment decisions.

Fidelity’s approach to integrating ESG factors into its investment analysis includes the following activities:

• In-depth research
• Company engagement
• Active ownership
• Collaboration within the investment industry

Although Fidelity’s analysts have overall responsibility for analysing the environmental, social and governance performance of the companies in which it invest, it has a dedicated Sustainable Investing Team working closely with the investment teams and is responsible for consolidating Fidelity’s approach to stewardship, engagement, ESG integration and the exercise of its votes at general meetings.

The Sustainable Investing Team have a key role in assisting the investment teams with ESG integration which includes:

• Implementing Fidelity’s proxy voting guidelines.
• Engagement with investee companies on ESG issues including attending company meetings.
• Working closely with the investment team globally across all asset classes in integrating ESG into analysis and decision-making.
• Providing internal ESG reporting including analyst reports, portfolio manager reviews and industry analysis.
• Co-ordinating and responding to specific client queries on ESG topics.
• Publishing client reporting on ESG integration and proxy voting.
• Maintaining a thorough understanding of current ESG themes and trends around the world.
• Attending external seminars and conferences focusing on trending ESG issues and ESG integration.
• Providing ESG training to the investment team and across the business.

Fidelity’s investment approach involves bottom-up research. As well as studying financial results, the portfolio managers and analysts carry out additional qualitative analysis of potential investments. They examine the business, customers and suppliers and may often visit the companies in person to develop a view of every company in which Fidelity invests and ESG factors are embedded in this research process.

Examples of ESG factors that Fidelity’s investment teams may consider as part of its company and industry analysis include:

• Corporate governance (e.g. Board structure, executive remuneration)
• Shareholder rights (e.g. election of directors, capital amendments)
• Changes to regulation (e.g. greenhouse gas emissions restrictions, governance codes)
• Physical threats (e.g. extreme weather, climate change, water shortages)
• Brand and reputational issues (e.g. poor health and safety record, cyber security breaches)
• Supply chain management (e.g. increase in fatalities, lost time injury rates, labour relations)
• Work practices (e.g. observation of health, safety and human rights provisions and compliance with the provisions of the Modern Slavery Act)

Fidelity operates analyst training and development programmes which include modules on ESG themes, topics and strategies and attendance at external seminars on the trending ESG issues in the market globally as well as conferences to explore new ways of integrating ESG into the investment process across all asset classes.

Fidelity uses a number of external research sources around the world that provide ESG-themed reports and it subscribes to an external ESG research provider and rating agency to supplement its organic analysis. Fidelity receives reports that include company specific and industry specific research as well as ad hoc thematic research looking at particular topics. The ESG ratings are industry specific and are calculated relative to industry peers and Fidelity uses these ratings in conjunction with its wider analysis. Fidelity’s sources of ESG research are reviewed on a regular basis.

The ESG ratings and associated company reports are included on Fidelity’s centralised research management system. This is an integrated desktop database, so that each analyst has a first-hand view of how each company under their coverage is rated according to ESG factors. In addition, ESG ratings are included in the analyst research notes which are published internally and form part of the investment decision. The external research vendor also provides controversy alerts which include information on companies within its coverage which have been identified to have been involved in a high-risk controversy that may have a material impact on the company’s business or its reputation.

ESG and Sustainable Investing at Fidelity

Japanese companies are often perceived by overseas investors as commercially successful, but lagging international peers on environmental, social and governance factors. That perception no longer matches the reality in several areas. For example, Japan now has the largest number of TCFD (Task Force on Climate-related Financial Disclosures) supporters and CDP (Carbon Disclosure Project) A-rated companies in the world. Greater disclosure can therefore be expected by companies on plans to tackle climate change in the future. The Japanese GPIF (Government Pension Investment Fund) also reports that Japanese companies have more technological know-how which will allow them to adapt to climate change better than those in other countries, based on analysis of the patents they hold.

As disclosure improves, the efforts of Japanese companies to address ESG concerns are likely to become more widely recognised, leading to higher ESG scores and more investor capital.

Considering ESG factors is a core part of our investment process. At Fidelity, we believe that high standards of corporate responsibility make good business sense and have the potential to protect and enhance investment returns. Consequently, our investment process takes ESG issues into account when, in our view, these issues have a material impact on either investment risk or return.

Our proprietary ratings system enables us to quantify relevant elements and compare the positions of different companies. Our core belief is that if governance is weak then concerns related to a company’s environment and social impact will potentially follow. Equally, these concerns are reduced with robust governance. As a result, ESG is not an overlay, but embedded in all our fundamental analysis of any company which we consider for investment. I do not screen out companies from our investment universe purely on the grounds of poor ESG performance but rather adopt a positive engagement approach whereby we discuss these issues with the management of the companies in which we invest, or are considering investing in. We believe it is an advantage to us and our clients to build positive relationships with our investee companies as this enhances our ability to introduce constructive change where required.

For example, Sunny Optical Technology Group is a company that is in the portfolio. It’s one of China’s leading integrated optical device manufacturers. We felt the company’s ESG disclosure was limited and the governance of its sustainable strategy could be clearer. We engaged directly with the company to provide it with this feedback. After positive conversations, we welcomed its management team’s proactive approach to enhancing their ESG reporting. The company has made big improvements already by including ESG in its 2018 annual report. We encouraged increased transparency on greenhouse gas emissions targets, sustainability matters and water usage calculations. In addition, we also encouraged the company to review international reporting standards such as Global Reporting Initiative.

Another example is Li Ning, a company with a very strong local brand. We initiated a thematic engagement on human rights and responsible sourcing in the supply chain within the apparel retail sector. Insufficient management of ESG factors in the supply chain open companies up to reputational, operational and regulatory risk and the apparel industry is dominated by multi-tier supplier relationships with a lack of traceability and rapid market driven changes. The company has recently updated its human rights guidelines to include coverage of its full operations including suppliers. It runs a quality assessment scorecard for each supplier and human rights has a 10% weighting of this assessment. Its management runs on-site assessments of each of their suppliers and if they are in serious breach of any human rights issues, they will sever ties with that supplier.

Fidelity has embedded Environmental, Social and Governance factors in its investment decision making process. Fidelity has been a signatory to the United Nations Principles for responsible Investment (UNPRI) since 2012 and submits an annual report detailing how it incorporates ESG into its investment analysis. Proprietary ESG analysis and ratings are provided by the analysts in Fidelity’s investment teams and the portfolio managers are also active in analysing the potential effects of ESG factors when making investment decisions. Fidelity’s investment approach involves bottom-up research. As well as studying financial results, the portfolio managers and analysts carry out additional qualitative analysis of potential investments. They examine the business, customers and suppliers and may often visit the companies in person to develop a view of every company in which Fidelity invests and ESG factors are embedded in this research process.

Examples of ESG factors that Fidelity’s investment teams may consider as part of its company and industry analysis includes:

• Corporate governance (e.g. Board structure, executive remuneration)
• Shareholder rights (e.g. election of directors, capital amendments)
• Changes to regulation (e.g. greenhouse gas emissions restrictions, governance codes)
• Physical threats (e.g. extreme weather, climate change, water shortages)
• Brand and reputational issues (e.g. poor health & safety record, cyber security breaches)
• Supply chain management (e.g. increase in fatalities, lost time injury rates, labour relations)
• Work practices (e.g. observation of health, safety and human rights provisions and compliance  with the provisions of the Modern Slavery Act).

Fidelity operates analyst training and development programmes which include modules on ESG. This includes training throughout the year for equity and fixed income portfolio managers and analysts on various ESG themes, topics and strategies. The ESG team will attend external seminars on the trending ESG issues in the market globally as well as conferences to explore new ways of integrating ESG into the investment process across all asset classes. Fidelity uses a number of external research sources around the world that provide ESG-themed reports and it subscribes to an external ESG research provider and rating agency to supplement its organic analysis. Fidelity receives reports that include company specific and industry specific research as well as ad hoc thematic research looking at particular topics. The ESG ratings are industry specific and are calculated relative to industry peers and Fidelity uses these ratings in conjunction with its wider analysis. Fidelity’s sources of ESG research are reviewed on a regular basis.

Recent years have seen increasing concern about global warming, and the growth of serious efforts to counter its effects. Businesses for their part are under pressure to ensure that their activities are environmentally sustainable, as well as demonstrating social responsibility and good corporate governance. The standards of ESG in China, as in other emerging markets, are not as developed as those of their more mature counterparts, though are increasing each year. As a stock picker, our Portfolio Manager attempts to assess the quality of governance in the companies he researches and visits, as experience has clearly shown that better governed companies make better investments. Environmental standards are improving too, with President Xi’s increased focus on power generation on a macro scale, as well as, on a micro scale, in the discharge practices of manufacturing companies, which has had a significant effect on a number of businesses. Direct engagement with companies is an increasingly important aspect of investing responsibly and there are several examples of the Portfolio Manager having lobbied for better disclosure and governance. Our dealings with Sunny Optical Technology Group, has been a key example of this initiative in action this year. Another area that our investment team has worked hard to influence is responsible sourcing in the supply chain within the apparel retail sector.