ESG Materiality Q4 2019

Elena Tedesco, CFA Co-Portfolio Manager – ESG strategies Global Emerging Markets

www.hermes-investment.com For professional investors only ESG Materiality, Q4 2019 Introduction

Welcome to our Global Emerging Markets’ Our for responsible long-term investing ESG Materiality commentary – a quarterly in emerging-market equities publication that demonstrates our engagement At a glance activity with portfolio companies and showcases A We aim to select companies with attractive business holdings that are creating positive impact models and, if we identify material ESG issues, we seek aligned to the UN Sustainable Development to improve them through engagement. Goals (SDGs). In addition, we explore an A In the case of companies with material ESG issues, management teams must be willing to confront environmental, social and governance (ESG) sustainability challenges and enter the transformative theme and its implications for the asset class. process of engagement. Over the past decade, we have sought to act as A We maintain a very low carbon footprint and prioritise engagements with any holdings in the extractive industries responsible investors in emerging markets by or those with higher levels of emissions. focusing on companies that can tackle A We may engage on strategic and/or ESG matters, sustainability challenges as they arise. We including issues which are relevant to achieve the SDGs, recognise that developing nations have a long and our engagements may seek positive impact across way to go in this respect, but as responsible companies’ value chains. investors, we can contribute to their evolution For more insights into the rationale of our vision for over time. responsible long-term investing, use this link.

Portfolio snapshot, Q4 2019 We engaged with Our portfolio is considerably greener than the MSCI emerging-market benchmark in terms of scope 1, scope 2 of our holdings and scope 3 greenhouse gas (GHG) emissions1. 77% making progress in 53% of these engagements. Hermes Global Emerging Markets Fund v Benchmark

GHG emissions scope 1/2/3 (million 0.6 Percentage of AUM engaged by theme tonnes of CO2 equivalent) 3.0 0.2 Carbon footprint scope 1/2/3 per million US$ AUM invested 0.7 0.1 Carbon intensity scope 1/2/3 per 0.6 million US$ sales 33% 59% 37% Fund Benchmark Environmental Social & ethical Governance

Source: Federated Hermes as at 31 December 2019. : Federated Hermes as at 31 December 2019. The benchmark is the MSCI Emerging Markets Index.

1 We adopt the methodology set by the Task Force on Climate-related Financial Disclosures (TCFD) to measure our portfolio’s emissions, carbon footprint and emission intensity. See Implementing the recommendations of the Task Force on Climate-related Financial Disclosures for further information.

ENGAGEMENT CASE STUDY

China Mengniu China Mengniu (Mengniu) is a leading Chinese dairy company.

Engagement themes A Climate change and reporting A Food safety A Supply chain

We have been engaging with Mengniu Mengniu started to collect emissions data. It committed to since 2012. At first, our engagements both improving its coverage and using better technology to standardise its measurement in 2020. In addition, it launched focused on the restructuring of its quality a number of pilot programmes, including one that improves controls and supply chain in the wake of cows’ diets, thereby reducing their methane emissions, and food-poisoning scandals prior to our another that increases milk yield by preventing breast investment. More recently, we have inflammation through improved hygiene and selecting the engaged with Mengniu on the use of most productive species of animals. We encouraged Mengniu to disclose environmental data in line with the antibiotics on milk-producing cows and Taskforce for Climate-Related Financial Disclosures (TCFD) climate change. and adopt science-based emission reduction targets, highlighting some best practice examples in the industry2. Antibiotics and food safety The food industry often uses antibiotics on animals not only for therapeutic purposes but also as a prevention of all anthropogenic treatment. However, as recognised by the United Nations, GHG emissions are the inappropriate use of antibiotics in animals is a leading 14.5% from global livestock cause of rising antimicrobial resistance, which in turn has been linked to drug-resistant infections in humans. Consumption levels of antibiotics vary considerably We also discussed the issue of water scarcity with Mengniu between countries, with China leading the way as the as it operates in areas of high water stress. The group is largest consumer of veterinary antimicrobials, both in aware of the risk to water supplies and regulatory action. relative and in absolute terms. We raised our concerns with Recently, it commissioned a third-party company to assess Mengniu and, encouragingly, the company was responsive. its water performance. In addition, it is building key Mengniu published its antibiotics policy in its Sustainability performance indicators to guide its risk assessment and Report, and it started to limit the use of antibiotics for the strategy implementation. In 2018, Mengniu established treatment of verified diseases only. Furthermore, the group water-reduction targets relative to its own historical use and began testing raw milk for traces of antibiotics. It also considered expanding sources of water and recycling to requires its suppliers to account for any antibiotics that reduce its risk exposure. We would like its pilot initiatives they have bought and used. and targets to be enforced group-wide and through its supply chain. Furthermore, we believe the company’s water Building capacity to face climate change reduction programmes should cover the water used to grow animal feed – roughage, such as forage grass, or In Q4 2019, we had a positive and constructive discussion feed concentrates in intensive concentrated animal feeding with management on climate issues. The digestive systems operation (CAFO) production systems – as generally it of cattle are responsible for significant methane emissions accounts for almost all of the water required to produce globally. According to the Food and Agriculture liquid milk.3 Organisation of the United Nations (FAO), emissions from global livestock represent 14.5% of all anthropogenic We will also follow the evolution of Mengniu’s plant-based greenhouse gas (GHG) emissions, and cattle constitute protein beverage business as the group is well positioned 65% of that. Like every sector, farming has a role to in this respect4. According to Bernstein, plant-based ‘milk’ play in the reduction of emissions as outlined in the now has a market share of 15% in the US; one day, it too Paris Agreement. could become material in Asia.

2 For instance, Arla Foods has increased milk production by 40% since 2005, while its CO2 emissions have reduced by 22% across production and packaging operations; in the farming segment, emissions per kilo of milk have reduced by 24% since 1990. Arla aims to reach net-zero by 2050. 3 According to Kigoda Consulting, various studies concur that more than 96% of water required for dairy production is related to activities on the farm, with almost all of this water used to grow feed (2017). 4 Mengniu has formed a 51%/49% joint venture with Danone’s US-based Whitewave Foods, which has launched plant-based products. Global Emerging Markets

POSITIVE IMPACT CASE STUDY

Duratex SA Theory of Change SDG alignment5: Duratex is the largest producer of industrialised wood panels, sanitaryware, metal taps and shower heads in the southern hemisphere. The group is vertically integrated. It manages forestry areas and uses the best native area conservation and management practices. It has a long history of ESG commitment, encompassing goals to sustainably manage forests, use natural resources efficiently, preserve biodiversity and reduce pesticides, irrigation water and emissions.

In 2020, Duratex will mark its 25-year Capturing carbon in LatAm forests anniversary since becoming the first The company’s forests are located in Brazil (over 95%) company in South America to receive and Colombia. The group estimates that its Brazilian Forest Stewardship Council (FSC) forests captured 4.9m tonnes of carbon in 2018, but this cannot be monetised yet due to the lack of adequate certification. This certification confirmed environmental regulation in the country. In Colombia, where that it managed a forest in a way that environmental regulations are more advanced7, its forest preserves biological diversity and benefits has captured carbon and the group obtained an ICONTEC the lives of local people and workers, Forest Compensation Certificate8. In 2018, the group sold its Colombian carbon credits with proceeds of US$4m, while ensuring it sustains economic viability. making Duratex the first large Colombian company to offset Today, having achieved FSC certification for emissions and trade carbon credits. If we consider the 95% of its forests (both owned and leased), average carbon capture per annum, the group captures the group is making good progress in more CO2e than it emits in Colombia. achieving its 2025 target of 100%6. Becoming greener Duratex also has FSC certification for the chain of custody Duratex embraces many of the SDGs and has set clear of its panel mills, which means that the raw material used targets to achieve its 2025 sustainability strategy, including to manufacture all of its products in the wood division the promise to reduce absolute Scope 1 GHG emissions at are obtained from certified forests and other controlled group level by 25%, and reduce emission intensity in its sources. Climate Advisers, a US-based low-carbon Panels and Deca and divisions. Although these economy advocate, argues that companies that integrate targets are not science-based, we are impressed because supply-chain best practices into their operations should our records show that the carbon intensity of Duratex is be considered part of the solution for tackling deforestation already well below its industry and sector peer group. in the coming decades. It assigned the highest rankings to Carbon intensity (tonnes CO e per million of sales) companies like Duratex. 2 Scope 1/2

1,000

500

0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Company Industry Sector

Source: Trucost, Federated Hermes as at December 2018.

This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. Investments in emerging markets tend to be more volatile than those in mature markets and the value of an investment can move sharply down or up. Past performance is not a reliable indicator of future results and targets are not guaranteed.

5 The 2018 Annual Report refers to other SDGs as well. We have focused on those that in our view are more intrinsic to the specificities of Duratex. 6 These figures refer to 2018 data of 214,000ha FSC certified in Brazil and 9,000ha certified in Colombia. In 2019, Duratex announced the sale of an undisclosed part of its Brazilian forest to Suzano. Duratex has a target for “forested areas” – i.e. the areas where it provides only technical assistance and seeding, while the ownership and management activities are the responsibility of a third-party producer. The relating pledge is less ambitious – 80% FSC certification by 2035 – and, while we would like it to be higher, we recognise that it is difficult to enforce standards without full ownership and management of the land concerned. Duratex currently has no certified forested area. 7 In 2016, the Colombian government introduced a symbolic US$5/t carbon tax, through which a tariff is charged to all those who consume fossil fuel and generate CO2 emissions. In 2017, the government also created a mechanism with which companies obligated to pay the carbon tax can offset their emissions. 8 The ICONTEC Forest Compensation Certificate certifies that Duratex, thanks to its forest plantations, has captured 956,000 tCO2e (tons of CO2 equivalent) from 2010 to 2017, which makes it to date the largest Forestry Compensation Program of greenhouse gases, from forest crops, in Colombia. Global Emerging Markets

IN FOCUS: Waves of protests Protests have become prominent this quarter highlighting social issues in various parts of the world.

Chile: “It’s not about 30 pesos; it’s about Unrest 30 years” caused Chile to Demonstrations in Santiago began in October over a 4% rise – 30 underperform the pesos – in metro fares, but they quickly revealed a deeper malaise MSCI EM index by over inequalities that date back to liberal policies adopted during general Augusto Pinochet’s dictatorship – and 30 years of democracy have not achieved enough to overturn them.9 21% In response to the uprising, President Sebastian Pinera introduced in Q4 populistic measures, such as lifting basic pensions and making the healthcare system more accessible. Repercussions for the asset class Egypt: No Arab spring v2.0 and our portfolio Demonstrations started last September, but security forces Emerging markets tend to lag on social issues, responded forcefully and thousands of people were arrested but investors often overlook this. Nevertheless, unrest after calling for President Abdel Fattah el-Sisi to be removed caused Chile to underperform the MSCI EM index by from power. 21% in Q4 (we have no direct exposure to Chile). In our view, investors should consider social factors as part of Sisi implemented important economic reforms (such as an their top-down analysis of emerging markets. International Monetary Fund programme that restored credibility to the market) but his rivals lament corruption, repression of the In general, when unrest triggers change, it may slow down opposition and an increase in the poverty rate. The Egyptian market-friendly reforms but speed up populistic ones (such market – and the bank we own there – dropped immediately as a higher public spend on welfare). Against this backdrop, when demonstrations started, but it has since recovered. investors will have to factor in higher fiscal budgets and inflation as well as a positive outlook for low-income consumers. India: Human rights, for some Consider Brazil, where the fear of a spill-over from social unrest in Latin America may slow down tax reforms and speed up India’s Citizenship Amendment Act (CAA) sparked protests changes in the healthcare sector in order to provide medical as the law explicitly allows citizenship status to some illegal coverage to a wider portion of the population. Our portfolio immigrants (Hindu, Sikh, Jain, Buddhist, Christian and Parsi should benefit from reforms as we invest in two healthcare refugees who left Afghanistan, Pakistan, and Bangladesh providers in Brazil. to escape religious persecution there), but excludes illegal Muslim immigrants10. Protesters argue that the CAA In India and Egypt, social unrest has not had any material discriminates against Muslims and violates the secular impact on our stocks. In Hong Kong, some stocks have partly principles rooted in the constitution: faith should not be a suffered from a slowdown in local activity. However, this was condition of citizenship.11 The market has paid little heed to partly offset by a decline in rental costs and a rise of activity these events12. in Macau (which is relevant for current holding Samsonite) or in mainland China (relevant for AIA group – note that Hong Kong: Umbrella v2.0 both Samsonite and AIA made positive contributors to our performance in Q4). Overall, the liberation movement has had Protests in Hong Kong have been taking place for months, little impact on the Hang Seng Index, partly because property adversely impacting tourism and the economy. The situation stocks have benefited from the relaxation of mortgage has received international condemnation and activists have rules and, in part, as a large portion of the index includes already obtained some concessions on their five demands13. companies whose businesses are focused more on mainland In October, a relaxation of mortgage rules provided relief to China than Hong Kong. locals struggling with unaffordable house prices. In November the pro-democratic camp scored an unprecedented victory against pro-Beijing parties, securing a majority in most of the district councils. It remains to be seen if campaigners will succeed in their call for Hong Kong Carrie Lam’s resignation and universal suffrage.

9 According to the OECD, it could take six generations for the offspring of a Chilean family in the bottom 10% of income distribution to reach the average income, compared to four to five on average across OECD countries. For more information, see: https://www.oecd.org/chile/sag2019-chile-en.pdf. 10 It also excludes Tamil refugees from Sri Lanka, Rohingyas from Myanmar and Buddhist refugees from Tibet. 11 The CAA also amends a provision which says a person must have lived in India for at least 11 years before they can apply for citizenship. The new version will introduce an exception and require only six years for refugees of the religious groups listed above if they can prove that they came from Pakistan, Afghanistan or Bangladesh. 12 While Islam is the second-largest religion in India, Muslim presence is fairly localised with almost half of the Allah believers living in three states in North India. 13 The extradition bill has been withdrawn. Federated Hermes Federated Hermes is a global leader in active, responsible investing. Guided by our conviction that responsible investing is the best way to create long-term wealth, we provide specialised capabilities across equity, fixed income and private markets, multi-asset and liquidity management strategies, and world-leading stewardship. Our goals are to help people invest and retire better, to help clients achieve better risk-adjusted returns, and to contribute to positive outcomes that benefit the wider world. All activities previously carried out by Hermes now form the international business of Federated Hermes. Our brand has evolved, but we still offer the same distinct investment propositions and pioneering responsible investment and stewardship services for which we are renowned – in addition to important new strategies from the entire group.

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