[MUSIC] Hi, we're here at the great Robeco building. I'm here with Masja Zandbergen, head of Sustainable investing at Robeco. Masja, thanks very much for having us here and for doing this interview. Robeco has been a pioneer in sustainable investing for over 20 years. And an example of that pioneering approach is the VDA approach. Could you tell us what it is? >> Well VDA stands for Value Driver Adjustment approach. And this means that analysts and portfolios managers when they analyze companies they also look at how companies managing long-term material ESG risk and also opportunities. And they really have to think about how these issues are affecting the ability for a company to create long-term shareholder value. This then leads to sustainability being incorporated in stock recommendations and into valuation models. And the way companies are managing these intangible assets created by external risks or opportunities. They can lead to either competitive advantages, new markets, more efficiency. But it can also of course be risk of losing businesses if they don't manage it well. And then this can be done translated into value drivers like sales growth margins, cost of capital, invested capital or competitive advantage periods. So the Value Driver Approach really makes this thought process feasible in a matrix and explicitly values ESG risks and opportunities. >> So how does it work? >> Well, we use a three step process. First, we need to determine the material ESG risk issues for each industry that we invest in. Secondly, then we need to research the companies and see how they perform on these material issues. And also how that compares to peers. And thirdly, then we need to incorporate this into the business model impact and into the value drivers that I mentioned earlier. Now to go more a little bit more into depth in the first step, key in integrating ESG issues really is to assess for each company, what is material? And then we ask ourselves a few questions. First of all, we think about how is value being created in an industry. Let's think about the internet industry as an example. Of course, the internet industry is all about gathering consumer data and using that either in marketing or selling it. When you then think about the second question that we always ask is about how our long-term is G issues? What are the long-term issues that can affect this value creation? Well, immediately comes to mind for the internet industry the basic human rights to privacy. Well, if you add those two up you understand that someting like data privacy is important for internet companies to really manage. Let's take another example, the energy sector. I mean, how is value being created there? Well, it's all about extracting, refining and selling fossil fuels, oil and gas products into various Industries. And what are the external ESG issues affecting this? Well, that's obvious, its climate change and N markets for these companies are slowly but surely changing. With the move to more sustainable fuels. Now when we go a little bit more. So that's about determining what is most material. Then we go into Step two. How do actually companies perform on these issues? Let's take the example of energy a bit further. We have a company that has a 50% market share in refining biofuels. You can see here the materiality matrix for the refining and marketing business and the material issues that we distinguish are climate and energy markets related to that. Also Innovation and adaptation, and operational health and safety, and operational excellence, and also contractor and supply chain management. Now, how does this company that we're talking about, this Refinery manage these issues and how does that then affect the business model and the value drivers? This is analyzed and you can see the example here for this company which has a 50% market share in refining biofuels and a very strong Innovative culture. And this is of course very positive. So that is step two, analyzing the business model, the markets, etc. And then step three. And this is really the tricky part is how to translate this information then into numbers. And this is really a judgment call for the analyst. And in this case again, you can see here in the example that 70% of the target price of this company is attributed to the ability of the company to generate higher top-line growth and higher margins than its peers simply because this company has this specialization into biofuels. >> So could you also tell us a bit about how this really helps you in achieving your results? >> Well, really gives us a broader picture of a company. So using information that not everyone has available, adding that to your traditional analysis. But also using this information in a different way, analyzing more long-term. And yeah, I really believe and we really believe it leads to better informed investment decisions. >> Do you have proof that it works? >> Yes. So we also analyze the performance contribution of the ESG integration approach, the VDA approach. For example, in the example that I gave you of this company, where 17 percent of the value was contributed to the ESG analysis. Now, let's say the company outperforms by a certain amount of basis points outperform the index. We then attribute 17 percent of that outperformance to our ESG analysis. Now over 2017 and 2018 combined, we found that 22% of our alpha which we say is a performance better than the index was attributed to ESG in this way. >> This is how it works in equity. But could you also explain how it works in other asset classes? >> Yeah. Well, actually we do it in all asset classes that we manage. So equity and government bonds and credits. But it also really, each investment process needs its own approach. It has to make sense and it has to contribute. So for example in quantitative equity we use a different approach than in fundamental equity. Now, let me give you another example, I we do it in credits. And we have actually the same three-step approach but the last step is different. We are not adjusting the value drivers because we don't really use the same valuation model as we do in equity, but the ESG analysis impacts the fundamental score of an issuer. Now this core is determined by traditional financial analysis, like corporate strategy, corporate structure, debt analysis, etc. But it also includes the management, again, of material ESG issues. And the resulting fundamental score combined with the credit spreads priced in the market finally determines the attractiveness of a bond. So, for example, here in the mining sector we compare two companies, look at what is material, and then we see that one of the companies actually has a much better performance on the ESG issues than the other. And that is affecting in the end the fundamental score of the company as you can see in this example on the slide. >> Well, thanks for sharing this great approach which looks very sensible. However, others are not so advanced as you are. What's your call to action for them? >> Yeah. Well, I think buying an ESD datasets and then making this available to portfolio managers is really not a very serious approach. In the end, how the information is being used in the investment process is really important. And you need to also be able to show that it really affects your decision making process. Also applying ESG integration doesn't necessarily lead to a portfolio of high-scoring ESG companies. High ESG scores are not a goal in itself. If that is your goal as an investor, you need to add other strategies like best-in-class. I think we really need to be transparent on that. But I truly believe that thinking about how material ESG issues affect company's business models, which is challenging to do. But I think that has the most profound impact. [MUSIC]
