Sustainability / ESG Disclosure

Introduction

While the UK is no longer part of the European Union (EU), Argonaut Capital Partners LLP (‘Argonaut’) would like to show its commitment to its EU clients by making certain disclosures in relation to the Sustainable Finance Disclosure Regulation (SFDR). SFDR is part of the EU Sustainable Finance agenda and was introduced by the European Commission as a core part of its 2018 Sustainable Finance Action Plan.

The stated aim of SFDR is to ‘reduce information asymmetries in principal‐agent relationships with regard to the integration of sustainability risks, the consideration of adverse sustainability impacts, the promotion of environmental or social characteristics, and sustainable investment, by requiring financial market participants and financial advisers to make pre‐contractual and ongoing disclosures to end investors when they act as agents of those end investors (principals)’¹. 

Sustainability risk is defined as ‘an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment’².

Sustainability risk is typically known as Environmental, Social and Governance (ESG) risk and any single examination of ESG risk is complex given the necessary data is often difficult to obtain, inaccurate or out of date. Furthermore, there is no common requirement for entities to publish ESG data using the same template, standard or data points. Although this is likely to change in time it is an important point and serves to highlight just how nascent this part of the investment industry is.

More philosophically, ESG investing ultimately involves excluding certain stocks from an investment universe based on a subjective moral non-economic objection. If one is minded to do so, it is possible to find a moral objection to the behaviour of almost every corporation. It is also, in practice, almost impossible to have an investor client base whose own views will agree with every non-pecuniary grievance held by their fund manager.

Therefore, rather than impose a subjective view on our unitholders, Argonaut’s current approach is to have no formal policy on ESG matters.

However, in the spirit of transparency and with regard to Argonaut’s European clients in particular, we outline some further thinking on sustainability risk and our approach to ESG below.

Sustainability risk

The integration of sustainability risk into the investment decision-making process is a key objective of SFDR.

The EU defines sustainability risk as ‘an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment’.

Argonaut do not run ESG mandates or investment strategies that are governed by ESG considerations yet this does not mean environmental, social and governance matters are not considered within Argonaut’s investment process.

The occurrence of environmental and social events which negatively affect shareholder value may be fairly infrequent, yet their impact can be large thus the consideration of environmental and social factors – at both industry and enterprise level – is a relevant part of any fundamental equity analysis.

Governance meanwhile has always been a key element of Argonaut’s investment process with honest, competent corporate management teams with a clear sense of duty towards the creation of shareholder value a basic prerequisite for Argonaut long positions. 

Overall, there remains no common standard for the practical analysis or evaluation of environmental, social or governance risks and while Argonaut does not consider itself to run ESG-integrated investment strategies, the risks identified in the EU’s definition of ‘sustainability risk’ are risks that are already identified and considered within Argonaut’s existing investment process.

Indeed, by some measures it could be argued that Argonaut’s investment process takes a significantly more robust approach to identifying such risks. 

For example, the wider investment industry’s interpretation and analysis of governance risk enabled the Wirecard fraud to go undetected for almost a decade whereas Argonaut’s investment process identified this early on. Steinhoff, NMC Healthcare and Adler are similar such examples.

Such instances highlight the complexity of ESG integration as well as the nascency of the regulation generally.

Practical considerations for long-running niche investment strategies in a new and rapidly evolving regulatory framework 

While sceptical on the method of application, Argonaut is supportive of many of the core principles that underlie efforts to mitigate the risk of environmental, social and governance events negatively impacting the value of investments.

The practical implementation of such regulation is fraught with complexity and conflict risk, particularly for non-mainstream or actively differentiated investment strategies.

For example, the legally-enshrined objective of the VT Argonaut Absolute Return Fund is to provide positive returns over a 3-year period regardless of market conditions³.

The fund is not (and never has been since it’s 2009 inception) marketed or promoted as an ESG or sustainable product and investors are well-aware of this when they decide to purchase units in the fund.

The core motivation for investors purchasing units in the fund is an expectation of an unconstrained investment approach and the hope of non-correlated positive absolute return over a rolling 36-month period. 

COBS 2.1.1 states that a qualifying firm must act honestly, fairly and professionally in accordance with the best interests of clients⁴.

In the context of the VT Argonaut Absolute Return Fund’s prospectus, stated objective and how it has been marketed to clients since its 2009 inception, Argonaut considers ‘best interests’ to mean best economic interests.

Argonaut thus considers the maximizing of returns within the funds specified risk framework and regulatory regime in which it operates to be the prime consideration in discharging its fiduciary duty.

Argonaut is also of the view that a reduction in the fund’s investable universe and/or a compromising of investment returns due to an increased emphasis on non-pecuniary factors would conflict with its ability to act in clients best economic interests.

Transparency on adverse sustainability impacts

As a non-EU firm Argonaut has determined that it cannot currently commit to reporting as per the indicators in Table 1 of Annex 1 to the SFDR Level 2 Regulations, nor has it performed an assessment of the likely impact of sustainability risks on the returns of its investment products or those of its clients.

Argonaut anticipates that sustainability considerations will continue to evolve and does not rule out making such reporting in the future.

Remuneration policies in relation to sustainability risk

At the heart of Argonaut’s Remuneration Policy is the need to ensure that the structure of an employee’s remuneration is consistent with, and promotes, sound and effective behaviour and that it does not encourage excessive risk-taking or behaviour inconsistent with the values and objectives of the business.

Performance assessment will not relate solely to financial criteria but will also include compliance with regulatory obligations, internal policies and general contribution to the business. For example, attendance of compliance training and the correct and timely submission of Personal Account (PA) dealing requests is monitored and reviewed for all employees. Considerations such as these will factor in an employee’s annual appraisal and ultimately their remuneration.

The firm does not award guaranteed bonuses. The management group set aside a proportion of the firm’s profits to form a bonus pool out of which variable remuneration awards will be made. The size of the bonus pool will be at the discretion of Argonaut’s directors, and duly recorded, giving due consideration to both the need to incentivise personnel and to the current and future stability and profitability of the firm.

Argonaut seeks an appropriate and balanced ratio between fixed and variable components of staff remuneration. At its core, the firm believes in merit-based renumeration where strong performance is rewarded. However, it also seeks to guard against excessive risk-taking and thus overall, staff are paid sufficiently high levels of fixed remuneration relative to variable remuneration to enable the operation of a fully flexible policy on variable components, including the possibility of paying no variable remuneration at all in any single year.            

Where remuneration is performance-related, then in addition to the performance of the individual Argonaut will also take into account the overall results of the firm.

Review

This disclosure will be reviewed annually.