Saker Nusseibeh likes to do things differently. The Hermes CEO has the rare distinction of being labelled a “hippie” by the Financial Times while seeing inflows into his active asset management business rocket in the last few years.
The industry mega-trend of towards passive management has left the £28.5bn ($36.6bn) AuM business unscathed, prospering even, and largely immune from fee compression.
He puts this down to the counter-trend of investing based on environmental, social and governance (ESG) factors. “You could say we’re a disruptive company,” says the CEO since 2012.
“We have a very different way of looking at the world, we integrate ESG and we’re very long term. We’re as close as you can get in terms of active share to a hedge fund, without shorting.”
Indeed, its median active share was 87% last year. Its 2016 annual report, published in April 2017, also showed that it AuM increased by £5.5bn from £23bn in 2015, a gain of 24%. It continues the trend of the last five years, which has seen its assets swell by 300%. Its performance also is excellent; 74% of its funds outperformed their benchmarks over a three-year period.
Its ESG philosophy is something that resonates particularly with the emerging generation of millennial investors. But it has been a mantra that Hermes has followed since its inception, as the captive asset manager of what is now the BT Pension Scheme, and one that Nusseibeh wholeheartedly maintains. It has been an overnight success, as they say, more than thirty years in the making.
Hermes is made up of autonomous teams with their own independent processes, so it cannot be said to follow a particular style. “We spend more time than any other house working out whether a specific strategy theoretically works, how it would work in practice and then make sure that we have the right people working it. What unites all the teams is the idea that we integrate ESG into everything we do.”
Bits of the ESG debate are nonsensical, as everybody is surely looking for certain things. Who would not value a sustainable business model or want to be exposed to environmental risks?
Nusseibeh agrees and says this is really about governance: “We can prove to you that governance does impact the performance of companies in terms of their profitability and share price.” Even so, his pronouncements go well beyond avoiding financial risks, with comments sounding very much like altruism creeping in. “People invest because we want to retire in a better situation, and who wants to retire in a sludge-filled Gotham City?”
Nusseibeh says the investment process is behind its outperformance. “We’re talking about being better than other active managers – so it could be that we’re smarter, more handsome and eat better superfoods, but I don’t think so. It could be that we just do things slightly differently and we have an informational advantage. I think that’s the truth. So being good is actually good business.”
The information advantage Nusseibeh refers to stems from Hermes EOS, its business that carries out engagement and stewardship for itself and third-party clients and represents £261bn, almost ten times is own AuM. It engages with boards on behalf of investors, often when the owner cannot disinvest from an indexed-tracking fund.
“You can never sell out of a stock in an index fund so the logical thing to do – as
It is now the largest provider of engagement services in the world, which “is pathetic, because we represent less than £300bn,” he says. “It tells you that most people that put their money in index funds are simply betting on the market rather than truly investing.”
Many investment managers claim to follow ESG principles, but there is no official way to recognise ones that take it seriously. At the end of 2016 there were 16,000 signatories to the UN-backed Principles of Responsible Investment, representing AuM of $62trn, a tenfold increase in the decade since it was launched.
With ESG accounting for 20% of investment in the US, according to a recent State Street report, there is a danger that too many firms jumping on the bandwagon will devalue its meaning. The report notes that 47% of ESG investing is done through exclusionary screening or values-based exclusions and only 21% engaging in active ownership, as Hermes practices.
Sustainalytics has been providing services for 25 years and offers an expanding suite of tools. Likewise, in April MSCI launched MSCI ESG Metrics that allows managers to gauge their exposure to risk factors such as carbon regulation or corruption.
While Hermes managers also use such products, Nusseibeh says the metrics quickly date: “Our engagers have up to the minute information, having had conversations with the chairman, the board, whoever it may be, so it gives us a competitive advantage.”
Over the last 10 to 15 years fund managers have increasingly narrowed the bits of the company they are interested in to purely financial metrics, says Nusseibeh. “But no company survives because of financial metrics. It’s nonsense! If you choose to go to a Marks & Spencer or John Lewis, it’s partly emotional.”
Nusseibeh says engagement should be focused on governance concerns, rather than just the financials. “We ask the CEO or CFO how the business is doing like everyone else, but we also ask about governance. If the governance is weak, the chances are you are at risk.”
He likens the process to business rather than financial analysis. “What’s the supply chain like? If it’s no good, the chances are there will be a strike. What is your pricing policy?’
“When I started in fund management many years ago it was in fundamental analysis. I went to look at stores and factories as well as the buyers and competitors. There was a lot of legwork and it was not glamorous. Now analysts phone the CFO to ask what’s happening – that is not research.”
He says whether a firm has a good or bad season it’s just not important; it’s the long-term fundamentals. “Why was it that Sports Direct – which we don’t own, thank God – tanked?”
The sportswear company became the centre of the ‘zero-hours contracts’ scandal, trashing its reputation. “What questions did managers ask Sports Direct – did they just ask ‘tell me about your quarterly sales of shoes’? That’s not what hurt the share price.”
Nusseibeh stresses that ESG considerations are fundamental to long-term profitability – and need not have anything to do with altruism. It begs the question of why some asset managers don’t follow the same path and leave returns on the table?
“There was a massive misconception in the market that on the one hand there is fundamental research and on the other hand there is this hippie 1960s thing called ESG, which was all about hugging trees. People, in their minds, separate the world into discrete bits that are not related to each other.”
He uses the example of gender equality and anti-discrimination in the workplace – of which, of course, he is a “big proponent” – to illustrate how inefficiencies perpetuate. “If I am a buyer of talent, explain to me why it’s not in my own self-interest to make sure that the supply is not halved. So why do people say this about doing good?”
In the recent past, when Barack Obama was president, it seemed there was an inevitability to things such as environmental standards only tightening; it was a one-way street that asset managers could incorporate into their strategies, perhaps helping to explain why ESG factors could boost performance. However, in the Trump era, it seems far from inevitable this will continue.
“The election of President Trump… his policies are clearly a reversal of that, very clearly,” he concedes, although points out that there is still increasing awareness of environmental concerns and the debate is not finished.
He also sees the election, as well as Brexit and the record support for Front National leader Marie Le Pen in the French presidential election, in ESG terms.
“People have realised that there’s a disconnection between their place in society
Another trend that will not go away is investors’ preference for low-cost passive products. Hermes is positioned at the completely opposite end of the spectrum with very high active share and a research-heavy investment process.
“It means that the space for informational advantage exponentially increases,” he says. “I can reliably predict that returns from our skill, alpha, will increase as more people go into index.”
He says this is not what he wants to see happen, quite the reverse: “I would love to be arbitraged out of the business. Why? Because I have children and I would like them to live in a better world, and that means I’d like my performance to be eaten away slightly with everybody else becoming more concerned.”
He cannot be accused of not practicing what he preaches. In April, for example, Hermes published a white paper relating to ESG and bonds, the lessons from which could be adopted by other asset managers to arbitrage away a profitable niche.
“My shareholders are 320,000 pensioners
“The question is, whose interest are we serving? It’s not as nuts as it seems, it’s in the interest of the investors to ensure that there is a sustainable political economy, not just economy, and be in a system that works.”
Hermes was created to invest on behalf of BT’s pension scheme, which is still its owner, but it has progressively taken on third-party money. In 2009 just 8% came from clients but now more than half, £14.6bn at the end of 2016, is external. It is fair to say that these clients invested with their eyes firmly open.
“Most people thought we were mildly eccentric and soft-centred. But over the last seven years people have come to us because we were the first to say ‘the system is broken and here is a possible way of trying to fix it’.”
It is all very well taking this position but asset managers need to recoup their research costs if they are to come up with the next big idea – just as a pharmaceutical company needs to cover the cost of developing new drugs.
But Nusseibeh makes a convincing counter-argument: “It’s precisely because we’re giving away the family silver that people trust us, that we’re doing this for the right reasons and care about all of our investors, not just our bottom line. And, it pushes us to be at the frontier and find new stuff. That’s good.”
In any case, even if the ideas are beginning to gain ground, firms still need to catch up and do the ongoing work, and, he says, it will take a long time to change the minds of “a generation brought up on “
Whether politicians care to admit it or not, the tightened regulation in the post-crisis era is not informed by faith in Friedman’s free markets. But has the combined effect of regulation made the industry sustainable?
“You just can’t regulate for attitude,” he says, so there will always be dangers. Regulatory capital requirements have led to a boom in direct lending by asset managers, as banks have withdrawn. Nusseibeh says Hermes entered the business when a “rare talent” became available but notes that the nascent industry has the potential to cause problems.
“If more and more people come into this because they want to make money but don’t know how to do it you could have a problem, of course you could.” There’s not yet enough in this market to “attract the sharks”, he says. “But, every time, what breaks things is not the product per se, what actually breaks things is the greed of those who want to make the most amount of money.”
“It’s not the product, it’s the people,” he says, noting that hedge funds can sustainably produce 6% but “people levered it and clients lost a lot of money”.
“The crucial point is you can’t legislate for people. The investment community has a huge amount of power but it has no responsibility. We are the only asset management firm in the world that has a pledge.
“I note with sadness that the Investment Association still can’t bring itself to say its members will put the interests of their clients before their own. It’s extraordinary! Imagine, would you see your doctor if you suspected that he might prescribe you a medicine to increase his income?”
Nusseibeh says the industry should be bound by professional standards. “First and foremost, you should look after the interests of the investors more than your own. The second thing you expect of a profession is an approbation body,” such as The Law Society or General Medical Council. “I am calling for the professionalisation of fund management.”
Active asset managers almost universally feel under pressure from fee compression. Does Nusseibeh? “No.” He says, as Hermes came from being an in-house asset manager, fees, and manager remuneration, were always lower.
He adds that the industry still gets paid handsomely: “The industry is used to managing its business on margins of 50%. Every other industry has margins of 4%, 10% or 20%.” The Hermes annual report for 2016 shows its margin was 15%.
“Where my competitors are being squeezed, as far as I’m concerned our margins are expanding.” Profit margins should come from selling something rare, he says, where supply restricted.
“As a point of almost belief, I think that fund management is a business based on rare talent. It’s an oddity to in the fund management industry to say ‘we have something unique’ and then mass-produce it. I can’t run off 55,000 copies of a Rembrandt and say it’s the same thing.”
So, given the business practices, the lack of professional standards, regulatory threats and fee compression, would asset manager stock pass the Hermes ESG filter?
“Good question! I’d look at whether the business is sustainable. I think is the sweet spot is up to £50bn, the high-skill specialist players. As the big guys suck up every last billion, it becomes easier to make alpha.
“Would I invest in those behemoths? Maybe, because the economics make sense. Would I invest in the amorphous bit in the middle? I have nothing but the deepest love and respect for my colleagues in the industry, but I’m not so sure.”
- Assets under management and advice: £28.5bn
- Assets under stewardship (Hermes EOS): £261bn
- Percentage of revenues from third parties: 59%
- Companies engaged: 562
- Employees: 351
- Underlying revenue: £111.8m
- Underlying profit: £15.5m