ESG versus performance? For investors in mining it shouldn’t be a choice

Environmental, social and governance (“ESG”) driven investing now sits at the core of many investors’ strategies and has prompted renewed evaluation of companies, investment managers, and whole sectors to ensure best practice on ESG issues. Undoubtedly for the mining sector, as an extractive industry, ESG factors must be front and centre of companies’ and investors’ minds.  For Baker Steel, an active long-term investor in mining equities, the prominence of ESG research is welcome, indeed assessment of ESG issues has always been a key element of our investment due diligence and risk management processes. 

Change is underway in the mining sector as companies strive to meet ESG goals, yet some investors may still feel that a choice exists between seeking returns and a commitment to ESG factors. We are convinced this is not the case. Baker Steel has implemented a rigorous, proprietary ESG framework, through which we can engage actively with ESG issues during our stock selection process. We believe our comprehensive ESG framework and engagement with industry bodies on ESG issues, coupled with the consistent risk-adjusted outperformance by our range of funds, places Baker Steel among the leaders in mining ESG investment.

Baker Steel Capital Managers LLP – An ESG leader in mining investment

A robust ESG assessment framework

• In-house ESG screening and scoring
• Proprietary company research
• Third-party ESG data incorporated
• Engagement with industry bodies - UN PRI, LuxFLAG¹ ESG label for UCITS sub-funds

Sustainable Finance Disclosure Regulation (“SFDR”)

• Baker Steel’s UCITS sub-funds are Article 8 SFDR funds
• Baker Steel has opted to consider Principle Adverse Impacts 
• Details published regarding promotion of environmental and social characteristics (Article 10)

Change is underway in the mining sector from the dual forces of ESG investing and the green technology revolution.  ESG investing is increasing the scrutiny of companies’ practices by stakeholders, directly impacting how investors evaluate the sector and allocate capital. Any willingness among investors to put up with bad or outdated practices by miners, with regards to ESG issues, is fading fast. Progress will continue to be driven by investors, such as Baker Steel, choosing to promote sustainability.

The mining sector has made substantial progress in recent years towards achieving ESG goals, including improvements to energy efficiency, water efficiency and emissions reduction across the sector, as well as improved safety for staff. For example:

• Over the past 15 years, US mines have seen a 63% reduction in the fatal injury rate (National Mining Association).
• 75% have a dedicated Sustainability Committee (c.85% for our UCITS portfolios) *.
• 80% have Energy efficiency, Water efficiency & Emissions reduction policies (c.90% for our UCITS portfolios) *.
• 90% of companies have Ethics & Human Rights policies (c.95% for our UCITS portfolios, with the only exceptions operating in countries where legislation is effective and enforced) *. 

^{*Source: Baker Steel Capital Managers LLP, data based on research of 120 mining companies.}

This ESG progress has been supported by industry organisations, including the International Council of Mining & Metals and the World Gold Council, but of course there is much further to go, with large disparities remaining between companies. ESG-related challenges for miners can often be highly visible, creating negative perceptions about the industry, and the reputational cost of mistakes can be high. Importantly for mining companies, over 80% of the twenty largest mining investors are now signatories of the UN Principles of Responsible Investing (UN PRI), and so the pressure on miners to continue improving ESG performance is relentless.

The other major force impacting miners is the green technology revolution, which promises to transform the industry in the coming years amid a surge in demand for speciality metals and materials. Mining companies are inextricably linked to fast developing green industries, most notably EV production, battery development and renewable energy. Miners undoubtedly play a vital role within sustainable development, however there is still much progress to be made by the industry.

Has ESG changed Baker Steel’s investment process?

While the level of interest and coverage for ESG issues among investors has surged in recent years, for Baker Steel it is far from being a new concept. Given the active and bottom-up nature of our investment research process, ESG factors have long been built into our analysis, but may have fallen into different categories, such as during analysis of project risk or management competency. However, with the advent of ESG research as a distinct area of analysis it became clear to us that a formalisation of our team’s ESG research was appropriate.  It is our firm belief that the formation of our ESG framework has enhanced our ability to deliver superior risk adjusted returns relative to our benchmarks and peer group. Through increasing the scope, detail and discipline of our ESG research we believe we have further strengthened our stock selection process and risk management.

The strongest commitments to ESG in our investment approach have been the decisions to become UN PRI signatories and to classify our award-winning UCITS sub-funds, BAKERSTEEL Precious Metals Fund and BAKERSTEEL Electrum Fund, as Article 8 compliant funds under the Sustainable Finance Disclosure Regulation (“SFDR”). This means that Baker Steel’s UCITS sub-funds are committed to promote environmental and social characteristics, with details published regarding these activities (in line with SFDR Article 10). We believe this level of integration of ESG objectives is an appropriate reflection of the research and engagement on ESG issues undertaken as part of these strategies.

Our processes have also been informed by external sources and organisations, including the UN PRI, in recognition of the importance of its guidance on responsible investment activities, and the Church of England initiative on tailings safety. We have also been encouraged in recent weeks to see that both of our UCITS sub-funds have been awarded an ESG label by the Luxembourg Finance Labelling Agency (LuxFLAG) ¹. To our knowledge Baker Steel’s UCITS sub-funds are the only globally diversified mining funds to have received this label, a strong endorsement of the high level of ESG engagement by our team.

Baker Steel’s ESG framework – a vigorous assessment of miners’ ESG progress

Baker Steel’s enhanced ESG research framework integrates ESG into various stages of the investment process. At the core of this strategy is our in-house proprietary screening and scoring process, for assessing companies’ ESG performance within our investible universe.

One of the key strengths of our team is the bottom-up research undertaken as the basis for stock selection. Hence for ESG research we use our own data and inputs gathered from company research, management meetings and site visits, supplemented with data from third parties. It is important to note that in the mining sector, some companies do not yet report on ESG indicators to the high standard which the market is coming to expect. In many cases our own in-house data is more accurate than that of third-party databases. However, we recognise the need to incorporate external independent information, as a sense check for the work undertaken by our fund managers. 

Baker Steel’s framework for ESG research covers 4 areas: initial pre-screening, ESG scoring, the impact of ESG scores into investment decision making, and on-going monitoring. Initial screening, the first stage of our framework, involves the requirement for key sustainability metrics that are non-negotiable. Companies must have policies in place on ethics, anti-bribery and corruption, human rights, and anti-child labour. A further critical screen relates to tailings management, in recognition of the threat of tailings dam failure, a sizable challenge for mining companies. Our research and experience in the sector highlight that companies which have strict ESG policies typically deliver superior performance over time, due in part to lower chances of accidents, scandals, and bad practice relative to those companies without strict policies in place. Furthermore, a well-run mining company from an ESG perspective may avoid fines, production delays due to strikes or loss of investor confidence.

The second stage is the ESG scoring process, which is conducted across our investable universe with scores adjusted throughout the year in line with company updates and events. We measure and weight 20 sustainability metrics which are most relevant to our investment strategy, to evaluate a company’s ESG performance, flag issues and highlight plans for mitigation. A qualitative score is then overlayed to consider further aspects of ESG performance which fall outside of the quantitative scoring, informed by the investment team’s company research, meetings and site visits. We also utilise third party scoring as a cross check to our own scores.

Thirdly, ESG scores are incorporated into the investment decision making process. ESG scores are directly integrated into and alongside our investment valuation analysis, where inclusion in the portfolio and weighting decisions are based on ESG scores. The final stage is ongoing monitoring of companies’ ESG progress, primarily through meetings and site visits, with engagement on ESG issues and voting rights utilised as necessary to ensure companies remain aligned with our ESG principles and adhere to best practice.

An active management approach is required to ensure ESG is prioritised while seeking returns

As specialist investors in the mining sector, we see a plethora of opportunities across the sector at present. From the rapidly developing bull market in speciality metals, driven by rising demand forecasts for the “building blocks” of green technology, to the margin expansion underway in the precious metals sector, which is backed by a historically supportive macroeconomic environment of low and negative real interest rates and growing inflationary pressure, we see substantial upside potential for an active manager like us. As mining equity specialists, Baker Steel’s strategies focus on identifying value within precious, speciality and diversified miners. We seek to gain exposure for our clients to high quality producers, with effective management teams, shareholder returns policies and leading ESG practices. Readers of Baker Steel’s frequent commentaries on metals and mining will be familiar with the major themes we identify here for investors (you can read more here). 

Overall, we believe the increasing focus on ESG by investors in the mining sector underscores the critical importance of active management in this sector. A selective approach towards portfolio construction has never been more important, in order to avoid those companies with risks of bad practice or potential ESG issues.

Baker Steel firmly believes ESG performance and returns are complementary. ESG considerations are key for creating and maintaining shareholder value through enhanced risk management and instilling progressive standards of best practice. As such, we believe that good ESG practices are consistent with our objective to continue to deliver superior risk-adjusted returns to our investors.

ESG investing remains a highly dynamic area which will continue to evolve in the months and years ahead. Regulations and initiatives will catalyse further change across the mining industry, but we believe meaningful change will continue to be driven by investors engaging with companies on ESG issues, promoting sustainability, and insisting upon a high standard of practice alongside operational performance.