Neuberger Berman ESG Annual Report 2021
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2021 Environmental, Social and Governance Annual Report NEUBERGER BERMAN
Neuberger Berman, founded in 1939, is a private, independent, employee-owned investment manager. The firm manages a range of strategies—including equity, fixed income, quantitative and multi-asset class, private equity, real estate and hedge funds—on behalf of institutions, advisors and individual investors globally. With offices in 25 countries, Neuberger Berman’s diverse team has over 2,500 professionals. For eight consecutive years, the company has been named first or second in Pensions & Investments Best Places to Work in Money Management survey (among those with 1,000 employees or more). In 2020, the PRI named Neuberger Berman a Leader, a designation awarded to fewer than 1% of investment firms for excellence in Environmental, Social and Governance (ESG) practices. The PRI also awarded Neuberger Berman an A+ in every eligible category for our approach to ESG integration across asset classes. The firm
manages $447 billion in client assets as of March 31, 2022. For more information, please visit our website at www.nb.com.
TABLE OF CONTENTS
STAYING FOCUSED
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ENGAGEMENT AND PROXY VOTING Our Approach to Engagement
41 44 53
OUR INVESTMENT APPROACH Our Commitment to ESG Integration Proprietary ESG Ratings and Analysis INNOVATIONS AND INSIGHTS Our Net-Zero Commitment Passive ESG: The Data Conundrum
Engagement Case Studies
12 16
Proxy Voting, NB Votes & Statistics
FIRM STAKEHOLDER METRICS
62
23 30
VOICE OF THE CLIENT Hiscox Canada Post Corporation
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32 49
UBS Global Wealth Management
GEORGE H. WALKER Chairman and Chief Executive Officer
Staying Focused After three years of exceptionally strong market returns, and a pandemic that forced businesses to attend to pressing social and environmental issues, some might argue that making the case for environmental, social and governance (ESG) investing has been easy. Now, after Russia’s invasion of Ukraine, those same voices might say that heightened market volatility, inflation and the potential for an economic slowdown will concentrate minds back solely on the near-term bottom line. At Neuberger Berman, our day-to-day reality confirms the truth of the matter: ESG issues so often are the bottom line; and an event like the war in Ukraine is economically disruptive, but it is also an horrendous escalation of environmental, social and global governance risks. The new year has been met with a spate of newspaper articles and investor commentaries arguing that ESG and sustainability is at best a publicity effort and at worst a costly distraction from the real job at hand. We disagree. It’s easy to see the error in these views when, like us, you maintain a rigorous focus on material ESG issues —those that, by definition, represent real risk and opportunity for businesses, and determine environmental, social and financial outcomes. But we believe you get a true idea of the importance of ESG investing only when you look into every brick of the structure that makes positive outcomes possible. I think of this structure as having four pillars: data, integration, engagement and impact.
We believe it is much more likely to achieve real and lasting impact through engagement than through exclusion or divestment.
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As with most investment analysis, ESG investing always begins with data . What isn’t measured cannot properly be managed. But data isn’t gathered for the sake of data. A critical project for any ESG investor is combatting the ongoing lack of coverage and timeliness of ESG data, which is why we are knitting our data science insights ever more tightly into our ESG analysis, to ensure that we are identifying the lacunae that need to be filled and looking for the solutions in the right places. As we continue to integrate data science into ESG, we also continue to integrate ESG analysis across a range of our investment strategies. Years of development of our Sovereign Sustainability Assessment Framework, which we consider industry-leading, has facilitated the launch of a dedicated sustainable strategy in Emerging Markets Hard Currency Debt. The breadth of that ESG integration is regional, as well as across asset classes. This year has seen us expand our ESG capabilities into China, where we created a localized version of the NB Materiality Matrix, our measure of which ESG factors are most material for each industry. Our Hague-based Global Sustainable Equity team is now settled in, and new leadership for our more established U.S. Sustainable Equity team offers the opportunity to further integrate this global franchise. I believe that one reason why ESG integration comes naturally to Neuberger Berman is that our ESG products and initiatives tend to have their origins not in top-down directives, but in our traditional research and analysis and in the work we have done in close partnership with our clients. One great example of that in the past year was putting the finishing touches to a £1.3 billion multi-asset credit portfolio for the U.K.’s Brunel Pension Partnership, one of Europe’s leading sustainable investors. This mandate integrates a climate-transition plan to achieve net-zero emissions by 2050, with multifaceted interim targets. Discussions with Brunel on the scope, targets and risk-management parameters of that mandate drew upon our previous experience—for example, the development of our Thermal Coal Involvement Policy and our Climate Value-at-Risk analytical tools, as well as two years
of TCFD reporting and implementing our corporate climate strategy. But those discussions also gave us a wealth of new insights into what it takes to develop a serious approach to net-zero investing. Those insights now inform climate-related analysis across our product range and influence the design of new strategies; they also gave us confidence that the pledge we made when we signed up to the Net Zero Asset Managers Initiative in November 2021 is realistic and attainable. The centrality of engagement to the way we pursue ESG and sustainable investment goals will be clear to any reader of our NB Votes web page, the market-leading initiative that we launched in 2020 (see page 53 for details). It reveals the sheer speed with which we have managed to scale the volume of constructive engagement we are involved in, with some of the world’s largest and most important companies. The page offers details from 62 Annual General Meetings in 2021 alone. It also shows how engagement is not only about encouraging change among laggards, but also making great businesses realize even more of their potential. I’ve had many people ask me why Neuberger Berman opposed the election of four Berkshire Hathaway board members back in May 2021. The answer is that, while Warren Buffet is a legendary investor and it’s unsurprising that he is both CEO and Chair, that structure necessitates a strong lead independent director, which Berkshire lacks. We also voted for the firm to begin reporting its climate-related risks and opportunities— despite the obvious difficulties this presents to such a decentralized business—because we regard these factors as critically important, and an incredible business track record doesn’t exempt you from evolving standards of corporate disclosure. Around the same time, while we were delighted to see the extension of H. Lawrence Culp’s contract as CEO of General Electric as it struggled with the pandemic, we voted against his compensation package, which raised his potential payout while lowering his performance targets. Such arrangements neither align with industry standards nor reflect broader concerns about social inequality—and it’s also very difficult to see how they enhance shareholder value.
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The other point to note here is that, in all these cases, we failed to carry the vote—which didn’t surprise us. We think it’s important to make a stand for what we believe to be best practice, even against the world’s biggest and most admired companies, and even when there appears to be nothing to gain. That stance was vindicated in these instances, where we quickly saw the outcomes that we championed: appointment of a lead Independent Director at Berkshire and a revised compensation package at General Electric. You might say we lost the vote, but we think we sent a useful message. Frustratingly, we are the only major asset management firm to bring this kind of transparency to our proxy-voting activities, and we continue to invite our peers to join us. But NB Votes, and even our broader proxy voting program, represents only one part of our engagement efforts. These efforts are just as deep and advanced in our fixed income business, where we often benefit from access to senior management as major capital providers, as they are in our equity business. Why is engagement so important to us? Because we believe it is much more likely to achieve real and lasting impact than exclusion or divestment. Engagement can achieve impact in the broad sense of changing management and corporate aims and behavior. It can also support impact in the specific sense of investment strategies that raise sustainability goals to the same level of priority as financial returns—an approach that we and our clients increasingly embrace as we establish robust track records for our new U.S. Equity and Private Equity Impact strategies. We are proud of the structure we are building, but we also recognize that this is a long project, both for us and our clients, and that we are always learning and improving. I have no doubt that our efforts today would fall short of the bar we intend to set in the years ahead. As we broaden and improve the datasets that we can access, and build the technology and human resources of our platform, our challenge will be to make the very best use of those resources as we can.
That is the key objective of our new ESG Advisory Council, which aims to bring the latest knowledge from academia, the non-profit sector and institutional asset owners into the heart of Neuberger Berman. Like our work with Brunel, and with the dozens of management teams we engage with, we think our ESG Advisory Council demonstrates how important the exchange of ideas is to us. That includes practical and technical things, like how to cut a credit portfolio’s emissions without cutting its yield, or where to find the best data, or how best to build collaborative groups for sustainability advocacy. But the bigger philosophical questions are in scope, too. If a firm sells a coal-powered energy plant to a less scrupulous operator, on paper that firm looks like a more palatable investment—but the plant might have been better managed, and perhaps even closed sooner, had the same firm held onto it. The environment hasn’t benefitted, so how should we, as investors, think about that decision? If regulation of sustainable business and investment becomes too stringent or too rigid, does it risk dividing the world into binary “investable” and “non- investable” companies or sectors? Will net zero be a reality sooner if we can only invest in Tesla, rather than capitalizing and encouraging net-zero transitions at others like BMW, Ford and GM? Learning together at these different levels—the nitty-gritty and the philosophical—is critical for us. It helps us develop the solutions our clients demand. It also helps ensure that we live the values we expect to see at the companies we invest in. We continue to hit the demanding targets of the industry-leading sustainability-based credit facility that we secured back in February 2020, for example—but there is still much more for us to do. In short, when we engage with company management and partner with clients on sustainability issues, we learn as much as we guide. Some commentators might consider these efforts a distraction. We know that they make us a better firm, and better investors. And we know that our clients are urging us to be more focused on them than ever.
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Our ESG Philosophy As an active manager, our purpose is to deliver compelling investment results for our clients over the long term, supporting them to achieve their investment objectives. We have a longstanding belief that material environmental, social and governance (ESG) factors are an important driver of long-term investment returns. We take a comprehensive approach toward managing client assets, including the integration of ESG criteria into our investment processes. We also understand that for many clients, the environmental and social impact of their portfolios is considered of equal importance as the investment performance. Despite having a dedicated ESG Investing team, we take a decentralized approach to ESG integration, whereby investment professionals throughout the firm are responsible for incorporating material ESG factors in portfolios and investment research. From our first application of “avoidance screens” in the early 1940s to the launch of our U.S. Sustainable Equity team in 1989, Neuberger Berman has been at the forefront of integrating ESG factors into investment processes. Today, we continue to innovate, driven by our belief that ESG factors, like any other factor, should be incorporated in a manner consistent with the specific asset class, investment objective and style of each investment strategy. ESG factors can be employed in a variety of ways to help generate enhanced returns, mitigate risk and meet specific client objectives within a portfolio. We believe that our approach, which is focused on maximizing results for our clients, can also support better- functioning capital markets and have a positive impact for people and the planet. We are excited to expand our public commitments around managing climate-related risk across the firm by partnering with our clients, who share our ambition of achieving net-zero emissions, on seeking to develop and achieve net-zero portfolios. We will also continue to deepen the robustness of our proprietary, analyst-led ESG insights and engagement efforts to drive meaningful change over time.
In 2021, almost half of our top 100 institutional clients made some form of net-zero commitment, thereby placing ESG at the core of their long-term investment objectives. It has been a privilege to work closely with many of them on putting these commitments into practice, and to try to collectively change the climate trajectory of the planet.
JONATHAN H. BAILEY Head of ESG Investing
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Assets Under Management Around the Globe $460 billion 100% ESG Aware
First large asset manager to provide proxy vote disclosure well in advance of company meetings
First North American asset manager to secure a sustainability-linked credit facility
Awarded Top Score A+
3,162 Equity Engagements
1,463 Fixed Income Engagements
In the most recent UN-supported Principles for Responsible Investment (PRI) assessment report for our overarching approach to ESG strategy and governance, as well as ESG integration across each asset class*
1989 First dedicated sustainable investing strategy
>2,500 Credit >7,000 Equity
Proprietary NB ESG Quotient Ratings
Named to PRI 2020 Leaders’ Group, awarded to only 20 of 2,100+ PRI investment manager signatories*
Disclosed votes in advance of 62 shareholder meetings in 2021
*Please refer to page 68 for associated disclosure. All information is as of December 31, 2021 unless otherwise noted.
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ESG ADVISORY COUNCIL MEMBERS
Vijay Advani Former Executive Chairman of Nuveen, the Investment Management arm of TIAA, and current Chairman of the U.S.-India Business Council Global Board of Directors
Ben Caldecott Director, Oxford Sustainable Finance Program & Founding Director of the UK Centre for Greening Finance & Investment
Mindy Lubber President and CEO of Ceres, a sustainability focused non-profit organization based in Boston, MA
George Serafeim Charles M. Williams Professor of Business Administration and Chair of the Impact-Weighted Accounts Project at Harvard Business School
Theresa Whitmarsh Former Executive Director of the Washington State Investment Board and Chair of the Board of Directors, FCLT (Focusing Capital on the Long Term) Global
ESG Advisory Council In 2021 we established the NB ESG Advisory Council to guide our ESG investing journey. Our expert Advisory Council members provide guidance on the future of impact investing and sustainability topics, and challenge us to go further in our own efforts. The Council particularly focused in 2021 on the topic of net-zero investing.
In its inaugural year, the Advisory Council provided feedback on our decision to join the Net Zero Asset Managers Initiative. They provided valuable guidance on how to adapt net-zero alignment methodologies across asset classes, the role of climate solutions, and the impact of climate policy and regulation. Advice from our ESG Advisory Council Members on Net-Zero Alignment Under the Net Zero Asset Managers Initiative, we have one year to set an interim net-zero target, but portfolio managers and clients are asking for guidance now. What should we consider in selecting an implementation methodology? It is important to set absolute carbon reduction targets to realize emissions reductions for sectors and companies. We favor erring on the side of ambition in picking a target methodology, and thus recommend a carbon reduction and portfolio coverage approach.
Temperature alignment is another methodology often considered by asset managers, but the complexity of climate forecasting may result in misleading outcomes. A target methodology must be flexible and portable across geographies. If it includes an engagement element, the portfolio manager must be willing to divest if there is no clear improvement over a set timeframe. What is a portfolio’s “fair share” of the 50% required reduction in GHG emissions by 2030? Should it be determined by responsibility for emissions or capability to reduce emissions? Decarbonization pathways should be based on a capability approach, given available technologies, so portfolio managers must stay on top of emerging low carbon technologies within sectors. Cost-efficiency is important. For example, it is difficult for carbon-intensive sectors that are cyclical and lower margin (e.g., airlines) to decarbonize. Investors should be aware of each sector’s marginal abatement cost curve and understand the potential impact of decarbonization on corporate returns over time. Investors should
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also focus on how they, as active owners of each security and sector in a portfolio, are supporting companies in their transition to net zero. What is a climate solution? You do not necessarily need to follow a taxonomy to define a climate solution. You should ask whether a company’s products and services are enabling the substitution of lifecycle emissions, and understand that product or service’s carbon abatement potential versus the current standard. This provides an idea of its total addressable or serviceable market. In evaluating such carbon abatement potential, the council recommends applying the same margin-of-safety framework that investors use: is there confidence in both emissions reduction measurement and execution? Thresholds may differ based on sector, manufacturing process and measurement methodology, and may change as technologies mature and scale. Do the definitions of net-zero alignment, fair share and climate solutions apply consistently to private equity? The proposed definitions are generally applicable in a private equity context, but there is nuance around the pathways that companies can take to help decarbonize the economy. Here, in the context of NB’s private equity platform model, a portfolio coverage approach makes sense but may still encounter challenges given evolving portfolios and net asset values. Also, many private companies are growing and scaling, which can increase their absolute emissions even if their carbon intensity falls. A sectoral decarbonization approach is appropriate at the portfolio company level, but relevant sectoral targets are not yet widely available, and at the fund level, portfolio coverage is more feasible. Rather than excluding higher-emitting sectors, it may be better to support their transition. What were the key takeaways from the UN Climate Change Conference (COP26), both globally and for the U.S.? Globally, COP26 achieved several key outcomes: the establishment of the Glasgow Finance Alliance for Net Zero, commitments from 190 countries and companies to phase out coal, and a pledge by more than 100 countries to halve deforestation by 2030. For context, 90% of global GDP now has a net-zero target, up from 30% when the U.K. took over the COP presidency.
As we look to COP27 next year, participants are already planning how they will demonstrate progress, while the UN has commissioned an expert group to assess the integrity of net-zero commitments for companies and financial institutions. Commitments alone do not change weather patterns, of course. In the U.S. it will be crucial over the next few years that corporations and asset managers really act on their net-zero commitments, with the support of regulators. President Biden’s Climate Risk Executive Order has already directed several federal agencies to act on climate change. All financial regulators have been asked to study climate-related financial risks. The U.S. Securities and Exchange Commission has now proposed a rule on mandatory climate disclosures, but they are not yet as far-reaching as the U.K.’s requirements. The Department of Labor has announced a proposed rule allowing plan fiduciaries to consider ESG factors, while the Federal Reserve is assessing its ability to monitor climate impacts on the financial system. The U.S. is also looking at a potential climate action plan for procurement. What was missing from COP26? Despite clear progress, three important catalysts were missing from the conference: (i) a commitment to carbon pricing within developed markets; (ii) a robust framework for a carbon border adjustment tax; and (iii) meaningful assistance from developed to developing markets. We are optimistic that more progress will be made on these fronts. Will carbon markets play a more prominent role in the coming years? We have recently seen elevated interest in carbon markets. The “net” in net zero is about removing carbon from the atmosphere. In carbon markets, we must make sure the supply side has the right amount of quality offsets, while the demand side should require that actors use them responsibly. Voluntary carbon markets must grow in a way that truly impacts climate—unlike many current offset arrangements. In compliance carbon markets like the EU emissions trading scheme (ETS) carbon allowance prices are rising. However, the EU ETS was initially designed to reduce emissions, not achieve net zero; but success will require carbon allowances to operate alongside carbon removal offsets. In the U.S., carbon pricing and offsets are likely to grow in importance; however, offsets are very complicated, so almost every company and asset manager wants to better understand what is and what is not a legitimate offset.
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Getting Sustainability Covered
VOICE OF THE CLIENT A Conversation with Hiscox
Insurance companies often have complex group liabilities, with different entities underwriting protection under different capital-adequacy regimes. Can you give us a sketch of Hiscox’s structure and how it influences management of ESG issues? James Millard: We manage to Group capital and risk appetites, but look to optimize investment allocations to local ALM, regulatory and capital requirements. It’s a bit like a game of chess to ensure we deliver to both Group and local entity goals. Similarly, our approach is focused on embedding ESG within each area of our business, rather than building a large specialist sustainability team at the center. We monitor ESG risks for our investments at both Group and local entity level, providing regular updates to stakeholders across the Group. We recently selected a new ESG data provider and extended analytics to include climate stress-testing across our bond portfolios, amongst other ESG risks and opportunities we keep an eye on. Hiscox manages an investment portfolio worth close to £8 billion ($10.8 billion), backing a book of property and casualty insurance and reinsurance risks worldwide. We spoke to Chief Investment Officer and ESG Executive Sponsor James Millard about managing sustainability across its liabilities and its portfolio of largely short-dated fixed income assets.
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How does Hiscox think about the relationship between climate- related liability and asset risk? James Millard: While we carefully manage the underwriting risks associated with climate change, we also recognize new opportunities as customers’ risks evolve. One example of a clearly growing risk is flood. We’ve done a huge amount of work to understand U.S. flood risk, specifically. Our U.S. flood product, FloodPlus, provides broader, more attractive cover for homeowners and businesses than the government-backed alternative, and now serves over 75,000 customers across 49 states. We try to reduce correlations between our underwriting and investment portfolios where we have significant exposures. With respect to climate, we apply our ESG exclusions policy to sectors unlikely to be part of the transition to net zero in both our investment and our underwriting portfolios. We also think about how, for example, the unique insights we get into climate from our market-leading natural catastrophe research and modelling team can inform what we do as an investor. There is lots of collaboration on ESG and climate-related matters across the business, but how that translates into the sustainability of our asset managers and investee companies is something we’re still developing. How does Hiscox think about the net-zero transition? James Millard: As a Group, Hiscox has been operationally carbon-neutral since 2014, and we’ll continue to offset our emissions via accredited offset schemes. We’ve also recently set new greenhouse targets, including for investments, to align with a 1.5°C warming scenario, using the Science Based Targets Initiative (SBTi) methodologies. This means Hiscox could be net zero by 2050. We’ve committed to reduce our Scope 1 and 2 emissions by 50% in absolute terms and our Scope 3 emissions by 25% per employee by 2030, against a 2020 baseline adjusted to correct for the impact of COVID-19 on business travel, office use and other factors. We also aim to have more than 25% of the value of our corporate bond portfolio meet net-zero or Paris- aligned targets by 2025, and more than 50% by 2030. We prefer an SBTi-
aligned approach because, while disinvesting from companies may reduce our measured carbon footprint, engagement can help them play a role in the net- zero transition and ultimately have more of a real-world impact. Getting to net zero is a shared challenge, which is why we are also engaging with our suppliers, brokers and reinsurers on our commitments and their own plans to adopt Paris-aligned targets. Where common standards and methodologies do not yet exist—for example, in measuring and assessing supply chain impacts, and underwritten emissions—we want to foster collaboration within our industry to help shape the solution. A significant proportion of Hiscox’s assets are in bonds, of which much is short-dated. What do you say to those who argue that it’s difficult to have influence as a bondholder, and that long-term ESG risks pose little threat to short-dated investments? James Millard: The traditional view is that voting rights give shareholders the most influence on corporate behavior. In practice, however, short-term debt financing is an important part of an issuer’s capital structure, and debt issuance and refinancing typically occurs more frequently than equity issuance. That gives asset owners like us real opportunities to engage with issuers. We see the rapidly growing demand for, and issuance of, ESG-related bonds as evidence of this. We already have over $220 million in ESG-related bonds, and our short-dated portfolios enable us to quickly reinvest proceeds from distributions and maturities in issues and issuers that align with our responsible investment objectives. Some labelled bonds not only incentivize issuers to act in a more sustainable manner, they also offer lower expected volatility and better secondary market liquidity with very little detriment to returns. Our managers need strong ESG capabilities to ensure they do exactly what they say on the tin, but further development and alignment of standards, such as sustainable taxonomy regulations and non-financial disclosures, will really help us to boost exposure here.
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What are your thoughts on integrating ESG factors into the strategic asset allocation (SAA) process? James Millard: Incorporating ESG characteristics into Capital Market Assumptions appears to have relatively limited impact. If it simply punishes asset classes such as emerging markets, where companies are often behind on emissions reduction, it can lead us back to disinvestment as opposed to engaging to maximize real-world impact. An asset allocation strategy that is more forward-looking with respect to ESG, such as optimizing to Climate VaR or net-zero alignment, is conceptually more appealing, but can come with issues of methodology, consistency and coverage. Given the challenges of the approaches on offer, this is an area that needs continued investigation. Could you briefly describe what you look for on ESG from asset managers? James Millard: Over 99% of our AUM is with managers signed up to the PRI, and Hiscox itself signed up in 2021. We embed ESG consideration in our manager selection and regular monitoring processes, and we expect all our managers to adhere to our Responsible Investment Policy. We look for a strong ESG investment philosophy, relevant and robust processes, and of course appropriate resources to actually implement ESG considerations on our behalf. We want managers to incorporate their own analysis of ESG risks and
opportunities at issuer and portfolio level, and to evidence the added value of their engagement in client portfolio-level reporting in line with the latest ESG reporting standards. What are the next big ESG-related projects for you, as Hiscox’s CIO? James Millard: Important developments across the Group during 2021 included: the implementation of our ESG exclusions policy; becoming signatories of both the PRI and the Principles for Sustainable Insurance (PSI); contributing to key industry taskforces via the Sustainable Markets Initiative and ClimateWise (where I sit on the Council); setting new Group-level SBTi- aligned GHG reduction targets; and establishing a Sustainability Steering Committee, which is led by our Group CEO. Looking forward for investments, alongside preparing the new reporting required by the PRI, we’ll also be embedding our new SBTi GHG targets into our segregated mandates as we continue to work with our managers to ensure progress against those targets. We will also further investigate embedding climate risk, in particular, into our asset allocation processes. Beyond asset management, 2022 will see us looking to embed a sustainable underwriting strategy across each of our business areas.
Hiscox spoke with Neuberger Berman in London on February 22, 2022.
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2021 ESG ANNUAL REPORT Our Investment Approach
Our Commitment to ESG Integration We integrate ESG analysis across our firm, not only in traditional equity and fixed income strategies, but in private market offerings as well. Certain of our strategies that are not ESG integrated, such as our co-mingled U.S. Equity Index Put write options strategy, which writes options on the S&P 500, are difficult strategies in which to integrate ESG factors. We continue to innovate, driven by our belief that ESG factors, like any other factor, should be incorporated in a manner consistent with the specific asset class, investment objective and style of each investment strategy. ESG factors can be employed in a variety of ways to target enhanced returns, mitigate risk and meet specific client objectives within a portfolio. We believe that our approach, which is focused on maximizing results for our clients, can also support better-functioning capital markets and have a positive impact on people and the planet.
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Investment professionals throughout the firm are responsible for incorporating material ESG factors in portfolios and investment research as a part of their role. To reinforce the importance of ESG to our work, compensation for many investment professionals is tied to ESG research insights and integration. We believe the most effective way to integrate ESG factors into an investment process over the long term is for investment teams themselves to research ESG factors and consider them alongside other inputs. For this reason, ESG is included in the work of our research analysts rather than a separate ESG research team. The investment teams can then choose how best to apply all the tools of active management, whether that is to engage or ultimately to sell a security when it no longer offers attractive risk-adjusted potential returns. To augment our analysis, we regularly add new data sets and leverage the capabilities of our data science team, which play a key role in the development of our firmwide proprietary ESG ratings system, the NB ESG Quotient. We believe our proprietary data allows us to identify sometimes hidden issues whose contribution to one or more investment themes may not be fully expressed in financial disclosures, but are critical to the fundamental thesis of a company. We are continually exploring new ways to strengthen and evolve our investment processes and tools to enhance the data we use, facilitate its application across our investment platform and provide transparency to our clients through reporting.
We believe alternative and big data are likely to transform active management over the next five years, minimizing reliance on voluntary disclosure and large third-party data providers. Our ESG Integration Framework Each portfolio manager has a customized approach to ESG integration that is driven by multiple factors, including the objectives of the strategy, asset class and investment time horizon. For our ESG-integrated strategies, each portfolio management team selects an approach from our ESG Integration Framework: Avoid, Assess, Amplify or Aim for Impact. In building their portfolios, portfolio managers consider whether to simply exclude particular companies (Avoid), reach a more holistic understanding of risk and return (Assess), tilt the portfolio to best-in-class issuers (Amplify) or invest in issuers that are intentionally generating positive social/environmental impact (Aim for Impact). The approach to integration can be further customized by the type of investment vehicle employed for investing—for example, specific client vehicles can be created to implement client-specific avoidance criteria, to tilt toward specific ESG characteristics valued by the client or to seek certain types of positive impact such as pathways to net zero. We know that every client journey is different when it comes to ESG, and changes in regulation or legislation over time are going to require a product that can be dynamic and adaptable.
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Integration Approach
Fund/Investment Strategy Category
Avoid Excluding particular companies or whole sectors from the investable universe
Assess Considering the material effect on risk and return of ESG factors on investments alongside traditional factors in the investment process “ESG INTEGRATED” (used in description of strategy and fund offering documents, but not in the fund names) Portfolio manager systematically and explicitly include material ESG considerations as a factor in its investment analysis and investment decisions for all securities.
Amplify Focusing on ‘better’ companies based on ESG factors that are expected to have a material effect on the investments’ risk and return “SUSTAINABLE” (in name of strategy and offering documents) Portfolio manager selects and includes securities on the grounds that they fulfill certain sustainability criteria, such as being best-in-class issuers. There are clear investment rationales for focusing on sustainability leaders, such as the potential to signal business quality or to align with secular sustainability trends. Engagement outcomes are set and tracked with influence on sell decisions.
Aim for Impact Seeking to intentionally generate positive social and environmental impact alongside a financial return
“IMPACT” (in name of strategy and offering documents)
Portfolio manager seeks to achieve positive social and environmental outcomes for people and the planet alongside a market rate financial return. The core business, products or services of each holding contributes to solutions of pressing environmental and social issues. Further, all holdings meet the firm’s ESG threshold for a “sustainable” fund.
The Rise of Regulation Rapidly evolving global sustainability-driven regulations are being felt across the asset management industry. European regulations such as the Sustainable Finance Disclosure Regulation (“ SFDR ”) 1 and European Taxonomy Regulation have set the global benchmark by introducing EU sustainability disclosure obligations and creating an EU common classification system.
The SFDR Regulatory Technical Standards (the “ SFDR Level 2 ”), which will set out the content, methodology and detailed disclosure requirements is expected to be implemented on 1 January 2023, following a further postponement of the implementation date by the EU Commission. Until SFDR Level 2 comes into effect, compliance with SFDR Level 1 is on a principles or high-level basis only.
1 “SFDR” means Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector. European Taxonomy Regulation means Regulation EU/2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment and amending SFDR, as may be supplemented, consolidated, substituted in any form or otherwise modified from time to time;
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Meanwhile, other jurisdictions that are not as advanced on their sustainability journey may have taken a different or even conflicting approach to that adopted by the EU which could prove challenging for all stakeholders to manage. It is not just asset managers who are coming to terms with the new levels of reporting and disclosure, but, equally, we acknowledge the challenges our clients are facing to meet their regulatory commitments. At Neuberger Berman we offer a range of Article 8 and Article 9 funds as designated under the SFDR and are here to support clients through the regulation challenges they face. Oversight of ESG Integration Investment professionals throughout the firm are responsible for incorporating material ESG factors in portfolios and investment research. A high percentage of our professionals have ESG responsibility as a part of their role. As much as ESG is a common thread across all that we do at Neuberger Berman, our ESG Committee has top-down responsibility for overseeing ESG integration and activity across the firm. The ESG Committee is chaired by the Head of ESG Investing and composed of senior investment professionals, including the Chief Investment Officer for Equities and representatives from Equity, Fixed Income and Private Equity teams. The ESG Committee also includes our Chief Risk Officer and senior professionals from our client coverage organization, as well as our legal and compliance teams. The ESG Committee delegates responsibility for the detailed review of new and existing strategies making an ESG-related claim to the ESG Product Committee to ensure integrity and consistency in their integration of ESG. The ESG Product Committee is responsible for determining whether portfolio managers systematically and explicitly include material ESG considerations as a factor in their investment analysis and investment decisions for all securities. The ESG Product Committee is also responsible for determining the SFDR classification of in-scope funds and segregated
mandates. In addition to ongoing monitoring by risk and internal audit teams, the ESG Oversight Committee provides an annual review of all sustainable and impact-labeled products. Neuberger Berman also has a dedicated ESG Investing team, which is responsible for setting the firm’s global ESG Strategy in collaboration with the ESG Committee and after consultation with portfolio managers, CIOs and our CEO. The ESG Investing team drives the implementation of the global ESG strategy by deepening the integration of ESG themes into new and existing investment strategies. The ESG Investing team also coordinates the firm’s approach to proxy voting and engagement, works with research teams on innovating our proprietary ESG assessment of companies and issuers, and provides thought leadership that highlights our ESG research in order to encourage dialogue and share best practices. The ESG Investing team’s work is supported by ESG working groups at the asset-class level that are responsible for providing context-specific expertise and assisting with education and implementation among the investment teams. For additional detail on asset-class specific ESG philosophies, please reference our ESG Policy. Monitoring Progress We monitor the progress we are making and are continually enhancing the integration of ESG into our investment processes. Relevant indicators of progress include the proportion of assets under management that are formally ESG-integrated, our score in the PRI assessment report each year, the effect of ESG analysis on portfolio performance, the impact of our engagement and proxy voting activities, and whether we are meeting the needs of our clients for ESG-integrated solutions. Given the dynamic and evolving nature of ESG factors that are material to investment performance, we are committed to continued innovation and improvement.
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Proprietary ESG Ratings and Analysis At Neuberger Berman, we have long believed that material ESG characteristics are an important driver of long-term returns. Our proprietary analyst-informed rating system, NB ESG Quotient, captures ESG considerations with potentially material impacts on financial performance at both the company and portfolio levels, and informs investment strategies across asset classes. Developed through a collaboration of the ESG Investing team and NB’s Global Equity and Fixed Income Research teams, this custom rating measures performance on ESG issues that we have identified as material across corporate and sovereign issuers. As shown in the NB Materiality Matrix, we have identified material ESG factors in each of 73 industries (e.g., privacy in the technology sector or raw material use in packaging). We then employ three broad tools to measure performance in each category: available third-party ESG data, non-traditional ESG data and, most significantly, input from our research analysts on hard-to-measure factors such as net-zero transition opportunities, equity, inclusion and diversity (“EID”), and expected governance impacts. The result is an industry- relative rating, or NB ESG Quotient, on separate Environmental and Social (ES) and Governance (G) characteristics for over 7,000 equities and 2,500 credit issuers. Over the past year, we have focused on two key aspects of our ESG analysis process: leveraging our dynamic model to consistently refine inputs and enhancing our use of non-traditional ESG data in partnership with our Data Science team.
We use Big Data to elevate our understanding of human capital trends by integrating alternative data from job postings, publicly available databases and employment review websites into the NB ESG Quotient.
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Dynamic Inputs & Data Science Insights As material ESG factors evolve, the NB ESG Quotient evolves with them. We review the factors with sector analysts at least annually to determine if new material factors have emerged and whether there is a more accurate way to capture them. Qualitative analyst inputs are generated by our central research analysts in partnership with the ESG Investing team for areas where there is limited data availability. Currently, our model includes over 40 custom analyst inputs. Furthermore, through our ongoing partnership with NB’s Data Science team, we also continuously integrate alternative data sources that go beyond third-party ratings. NB ESG Quotient already integrates alternative data from job postings, publicly available databases (OSHA, etc.), and employment review websites.
This year, we particularly focused on using Big Data to elevate our understanding of human capital trends. We onboarded a new dataset that allows us to conduct deep dives on companies where disclosure on EID is lacking. This collaboration between the Neuberger Berman ESG and Data Science teams led to the construction of 15 unique EID indicators. Through a historical backtesting exercise, we identified certain of these 15 indicators had a material impact on shareholder returns for the U.S. banking sector. We discovered that gender pay gap and minority pay gap in particular have historically been correlated with stock performance for this industry. These indicators were subsequently integrated into the NB Quotient for the U.S. banks. The ESG big data landscape is constantly evolving. We will continuously evaluate new and innovative data providers to enhance our proprietary ratings where corporate disclosure may be lacking.
HISTORICAL SHAREHOLDER RETURNS FOR U.S. BANKS DIFFERENTIATED BY GENDER PAY GAP
HISTORICAL SHAREHOLDER RETURNS FOR U.S. BANKS DIFFERENTIATED BY MINORITY PAY GAP
400%
400%
300%
300%
200%
200%
100%
100%
0%
0%
‘09
‘11
‘13
‘15
‘17
‘19
‘21
‘09
‘11
‘13
‘15
‘17
‘19
‘21
Minority Pay Gap - Low Performers Minority Pay Gap - High Performers
Gender Pay Gap - Low Performers Gender Pay Gap - High Performers
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DEVELOP SYSTEMATIC AND ASSET CLASS-SPECIFIC ESG RATINGS BY COMPANY NB ESG Quotient Company Rating Example: Financials – U.S. Commercial Banks
Quantitative evaluation of the bank’s credit exposure to the oil and gas sector and its emission reduction targets. Analyst evaluation of bank’s net-zero methodology to assess resilience to climate change
ENVIRONMENTAL & SOCIAL
Bank #1
Bank #2
Bank #3
Bank #4
Overall E + S Rating
A
B
C
D
Access to Finance Climate Risk Data Privacy & Security
Leverages third-party data provider’s measurement of data privacy and security protection practices
Consumer Financial Protection Human Capital Development Responsible Investment Business Ethics
Combines proprietary data science analysis of equity, inclusion, and diversity information with third-party evaluation of human capital and training practices Analyzes green financing opportunities and the bank’s policies and procedures related to integrating ESG across its lending platform Analytical studies conducted on the relationship of material ESG factors to investment performance Qualitative analysis, including reviewing specific compensation metrics and looking in detail at board capabilities
GOVERNANCE Overall G Rating
1
2
3
4
Risk Management Expertise Director Equity Policy Annual Incentive Measures Board Gender Diversity
Rating
Stronger
Average
Weaker
Central Research Analyst’s view of the environmental, social and governance characteristics of a company on material factors relative to the peer group. For environmental and social, A – D quartiles where A is best, D is worst. For governance, 1 – 4 quartiles where 1 is best, 4 is worst.
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OUR PERSPECTIVE
Global Sustainable Equity
Sustainability is deeply entwined with a company’s financial performance Sustainable investing is a multidisciplinary investment philosophy that seeks positive returns by considering the financially material consequences of companies’ impact on society and the environment. The Global Sustainable Equity team believes there are potential financial benefits from investing in high-quality, resilient, properly governed companies, including those that address unmet and growing environmental and social needs. It also engages companies to help their transition to resilient and more responsible business models.
Strategy Overview The Neuberger Berman Global Sustainable Equity strategy is a risk- controlled sustainable investment opportunity that uses a robust multidisciplined, bottom-up ESG analysis approach to invest in high-quality companies on a global scale. • Focus on high-quality companies with durable growth and resilience through downturns • A concentrated portfolio of 40 – 60 holdings, typically at the lower end of that range • Fundamental analysis of sustainability attributes specific to companies and their value chains, not an exclusion-based or top-down screen or an approach reliant on third-party assessments
• An integrated screening policy, which excludes companies that conduct highly controversial behavior and those with very poor ESG assessments scores • Engagement is at the core of the process A consistent and repeatable process from research to investment The team’s focus is on materiality, momentum and engagement. They incorporate proprietary, bottom-up environmental, social and governance (ESG) analysis, focusing on material issues that affect a company’s sustainability and financial performance; and company engagement helps to identify ESG momentum and non-quantitative idiosyncratic risks. ESG is deeply embedded at different levels in the investment process:
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