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SKAGEN Kon-Tiki: Active ownership in emerging markets

EM companies have, in general, not only lagged Developed Markets (DM) from a reporting and management priority perspective, but EM companies have also been slower to adopt ESG targets and policies than their counterparts in DM where customers, investors and regulators have traditionally exerted more influence. However, we are now starting to see steady improvements on the back of increased awareness in EM.

For us, as long-term investors, it is important to see ESG ambitions formed on paper being followed through and ingrained in more than disclosure; they must be rooted in strategy and execution. We believe that companies that understand and pay attention to ESG tend to have a stronger culture and be more innovative. The topic creates engagement, and with more engaged employees, firms also tend to be more productive.

Excluding companies from the investment universe based solely on current (lower) levels of sustainability can limit their ability to develop. It is by investing in these companies that we as investors can take the opportunity to engage with management and help influence real positive change. Furthermore, it is often the development trajectory that provides an interesting investment case for us. Positive ESG development can in and of itself help reduce the risk premium of a company and thereby increase its value.

A good example of a company that in many ways has transformed itself on the back of a top-level decision to put ESG at the core of everything they do, is our long-term holding UPL. This is a company which had a poor ESG reputation when we initiated the position in 2014. We have engaged with them on multiple topics and issues over the years, and it is therefore even more gratifying to reflect on how far they have come in most areas. This is also a good example of the dilemmas and challenges that can arise when investors blindly trust in ESG ratings.

UPL – ESG compliant or not?

Indian-listed UPL is the world's fifth largest agriculture solutions company. They cater to the whole spectrum of a farmers' needs from crop protection to seed treatment and post-harvest solutions, with a presence in around 140 countries.

The investment case is clear and suits ESG and theme-based investors: agricultural land and water are going to be constrained resources in the future. At the same time, the world population is set to increase, consequently increasing the demand for food. It is therefore more important than ever to enhance agricultural productivity worldwide in a sustainable manner.

However, for many investors there are two major reasons why it could stop there. First, UPL is categorised as an agricultural company within the chemical industry. The chemical industry has long suffered from a poor reputation due to its potentially adverse effects on the environment, health and safety. While not all chemicals are hazardous, exposure to some chemicals can cause serious human health and environmental damage.

Second, the company was recently involved in an unfortunate incident where a fire at a warehouse in Cornubia (South Africa) rented by UPL resulted in severe environmental damage and significant impact to the surrounding area due to fumes and contaminated runoff water from fighting the fire. As a result of this, UPL was recently downgraded by an ESG rating agency.

The circumstances in this case were unprecedented; the fire was set by rioters using firebombs at many sites in the province during civil unrest. We have been in contact with various people within UPL, ranging from top level management to Head of the SA business as well as their lawyers in order to get a more accurate picture of the incident than that portrayed in local papers. We are always supported by our internal ESG experts during these types of meeting with portfolio companies, which is helpful not only for our research process, but is also appreciated by the companies as we are in many instances used as a sounding board. This is a good illustration of how we work as active investors.

In this particular case, we questioned how the ESG rating agency had done their research and reached their overly negative conclusion. Sources cited are almost entirely local press. There are straightforward factual flaws in the ESG rating report, which had not been corrected ahead of the release. In addition, despite the seriousness of the ensuing environmental damage, one accident does not make a case for systemic issues within the company. 

We have engaged with UPL on their clean-up and rehabilitation efforts and see that they are doing their best to mitigate the effects of the incident. Furthermore, there are no legal claims or proceedings against UPL at present. If the facts change, we would consider the new information carefully, but as of now we have come to a different conclusion about the incident than the rating agency rate.

Sustainability drives smarter innovation and profitable growth

This accident notwithstanding, UPL has made significant progress when it comes to ESG. The company has undergone a major transformation over recent years where they have followed a structured approach towards sustainability through many dimensions:

  1. Environmental: their first Sustainability Report (2016/17) revealed a plan to reduce their environmental footprint by 30% over three years. This covered four focus areas, and waste disposal has been reduced by 45%, carbon emissions by 26% and water consumption by 21%.  For 2025 they have set a target of further reductions of around 30%.
  2. Social: as a signatory to the World Council for Sustainable Development, they are committed to achieving the UN's 17 Global Goals for Sustainable Development. This commitment is ingrained throughout the organisation, with a strong emphasis on certain goals in particular.
  3. Governance: integration of policies, aiming for strong international standards.
  4. Economic: The company's core focus on ESG reflects their view that it will also improve financial performance as it drives innovation, helps them remain competitive and gain market share over time. ESG has guided their transformation from a products company to a solutions company with a focus on helping farmers.   

Change agents to ensure food security

With its new strategy, UPL is determined to be a change agent in the quest to ensure food security in a resource-constrained world. They see their core business as helping farmers achieve greater yields and contribute to the global agenda of enhancing food security. UPL has devised their Open AG strategy as they see close collaboration between all stakeholders in the food network as imperative.  This comes in the form of many initiatives, such as carbon sequestration, reducing stubble-burning by providing farmers with a bio-enzyme that enables quick decomposition, reducing freshwater consumption in agriculture via the use of its water conservation product Zeba, providing spraying services, etc. 

The company's focus on newer, sustainable and differentiated products is at the same time aimed at driving up margins and capturing market share. They claim to be the market leader within bio-solutions. Becoming a best-in-class sustainable producer de-risks the business from a regulatory standpoint as they can phase out more of the non-sustainable and hazardous chemicals that are increasingly being banned in various countries.  This helps their brand perception, and also improves their standing in the investment community.

Incentivising achievement of ESG targets

UPL has deployed a structural framework to incentivise the achievement of ESG targets. Key Performance Indicators (KPIs) of each employee include certain links to ESG targets, with a monthly review process of all manufacturing units in order to achieve targets.

In addition, they endeavour to make their supply chain more sustainable, with a target of deriving more than 60% of their raw materials from sustainable sources by 2025. They also put pressure on their supply chains, for example, initiatives carried out to stop the use of child labour within the industry. Their dedication encourages competitors and the whole value chain to respond in order to stay competitive and relevant.  

UPL is a good example of a company that has embraced ESG opportunities, and they are reaping the benefits through solid financial performance; UPL was the strongest contributor to SKAGEN Kon-Tiki's performance in 2021. Interestingly, UPL was ranked #1 for sustainability performance amongst its peers for the second year running by the same rating agency that downgraded it. Given UPL's significant improvements across multiple categories, the rating agency said it recognises the work they are doing to reimagine sustainability within the global food system. This includes their success in managing corporate governance, community relations, business ethics and their carbon footprint. FTSE Russell has also given them a strong score, and UPL has been included in the Dow Jones Sustainability index Yearbook under the chemical sector which is a distinction awarded only to the top 15% of companies.

Important role of active managers

ESG ratings now have a significant impact on capital flows, especially due to their role in ESG benchmark construction. Evaluations are normally used as filters on an index. There has been exponential growth in passive ESG investing, and for us the lack of transparency and consistency around ESG rating methodologies is a point of concern. However, this also emphasises the important role that we as active investors play as well as the opportunities this can create.  We do invest in companies that are exposed to ESG risks, so engagement with management is essential. It might require a long-term trust-based relationship for us to be heard, but this can also make a real difference for the direction a company takes into a more sustainable future. 



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