Sustainable and responsible investing - ESG
Alinea Capital Management AS (“The Company” or “Alinea”) manages Alinea Capital (the “Fund” or “Alinea Capital”), a Swedish “special-fund”, investing in stocks within the Technology, Media and Entertainment, and Consumer Services sectors. Alinea’s goal is to offer clients a high level of expertise within asset management, combined with risk management, and insight/business understanding in the underlying sectors in which the fund invests. Alinea aims to become a solid, pro-active, and innovative investment manager.
The purpose of this Responsible Investment Policy (“RI Policy”) is to explain how we handle Environmental, Social and Governance (“ESG”) issues, and how ESG issues influence and inform our investment decision making process. It is also meant to demonstrate Alinea’s responsible investment approach to our clients, owners, employees, service providers, regulators, and other stakeholders.
Sustainable and responsible investing - ESG
We have chosen to adapt the framework of the The UN-sponsored initiative PRI (Principles for Responsible Investment), which has become widely adopted as an industry wide standard — by asset managers and institutional clients alike. The PRI defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership. We plan on becoming PRI signatory in the future. The trend is clear – various players on all sides – consumers, capital markets, businesses, governments, and regulators – are all favoring ESG issues to become embedded in business model going forward. However, for Fund Managers – different strategies, stages of maturity, and fund sizes demand different approaches to Responsible Investment.
Our approach to Sustainable and Responsible Investing is based on our belief in a positive relationship between ESG and long-term value creation. By integrating ESG factors into the investment process and portfolio construction, we believe this will lead us to more easily discover companies that will outperform their overall underlying industry sector. Hence, increasing our chances of generating alpha and outperformance in our own portfolio. Innovation in our targeted sectors, Gaming, and iGaming, are driven by the younger generations. This generation of consumers rightfully value companies (brands) that take ESG seriously. Hence, investing in brands that take proactive steps to stay relevant, we view as the smarter way of investing. For us, adopting ESG factors into the investment process is a “win-win”, providing clear conscience and a way to get ahead.
Our Co-portfolio manager, William Hatle, has the overall responsibility for the integration of ESG factors into our investment process. He is also responsible for the implementation of, and compliance with, this RI Policy. Since Alinea currently only manages Alinea Capital, there is a clear alignment between the Fund Manager, the Fund, and Investors in the Fund. If Alinea were to take on further mandates, we will make sure to sort out/avoid any conflicts of interests.
1. Incorporating ESG-factors into our investment practice
PRI – Principles for Responsible Investment
The PRI is an investor initiative in partnership with UNEP Finance Initiative and UN Global Compact. PRI has developed six Principles for Responsible Investment. The six Principles for Responsible Investment are a set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice. In implementing them, signatories contribute to developing a more sustainable global financial system.
Alinea intend to become a PRI signatory, and therefore, where consistent with our fiduciary responsibilities, will comply with the six principles:
- We will incorporate ESG issues into investment analysis and decision-making processes.
- We will be active owners and incorporate ESG issues into our ownership policies and practices.
- We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- We will promote acceptance and implementation of the Principles within the investment industry.
- We will work together to enhance our effectiveness in implementing the Principles.
- We will each report on our activities and progress towards implementing the Principles.
2. (P1) We will incorporate ESG issues into investment analysis and decision-making processes
As mentioned above, Alinea believes in a positive correlation between ESG and long-term value creation. Hence, identifying and investing in companies/stocks/brands that take ESG issues seriously, we believe will lead to superior investment performance.
Companies that balance traditional ways of operating with a clear focus on ESG, may be able to combine short-term results with creating long-term competitive advantage. This way, ESG becomes material to the financial performance of the company. As Investment Managers and Fiduciaries, we are obliged to look at anything that may materially affect the financial returns of our funds.
In Alinea, we believe in thorough research and genuine active management. Our investment research, security valuations and investment processes include identifying material financial factors and incorporating them into the traditional portfolio construction. Hence, we will develop and include ESG-related tools, metrics, and analyses. We look at both quantitative and qualitative factors.
Alinea Capital is long-biased, as it focuses on sectors with strong underlying structural growth. Successful companies are often recognised by having strong management teams and high standards of governance. Benefits to such companies include among others:
- Faster revenue growth,
- Lower cost of capital,
- Higher company valuation (multiples), and
- Ability to make value creating acquisitions.
Our investment universe (the Technology, Media and Entertainment, and Consumer Services sectors) contains a lot of “asset light” companies that have a substantial part of their value tied up in so-called ‘intangible assets’ like brand recognition and goodwill. For these companies, handling ESG issues well is not only a formula for success, but also a risk mitigant. Ignoring reputational risk, may quickly get them into trouble, erasing a lot of “goodwill” among their end costumers/consumers.
Alinea attributes In the Nordics we spend a lot of time in the outdoors and are used to going the extra mile… Alinea attributes that make our ESG exercise meaningful and worthwhile include:
- Focused approach
- In-depth sector knowledge,
- Structured and data-driven,
- Carefully constructed and concentrated portfolio,
- Long-term holdings, and
- Long-term investor base.
How do we minimize risk? • By conducting thorough research before entering a position, • By actively speaking to company management, other investors, analysts, and brokers; and • By having strict requirements for entering a position.
3. (P2) We will be active owners and incorporate ESG issues into our ownership policies and practices
The traditional way of combining active ownership and ESG has been “negative screening” – that is to exclude sectors/stocks that does not match our “ethical standards” or have sub-standard governance. Alinea’s mandate is to invest in the Technology, Media and Entertainment, and Consumer Services sectors. Hence, “a sin stocks list” is not that relevant to our strategy or mandate. However, we do not invest in companies associated with tobacco, weapons, fossil fuels, abuse of human rights and poor labor standards.
Alinea is focused on the Gaming- and iGaming-sectors. These sectors contain “asset light” digitalized companies that have “low carbon footprint”. This is consistent with the Alinea teams’ view on ESG issues and makes us aligned with the transition to a low-carbon future. In addition, many of the digitalized companies in our sectors have become wary of how they spend their resources – and are focusing on using Clean Energy to become “Carbon Neutral”. They are also highly aware of who their end consumers are, and these consumers’ view of environmental and social challenges such as climate change, water scarcity and loss of biodiversity = important! In conclusion, all the above considered, when fulfilling our mandate – “G” for Governance is probably the most relevant ESG-factor for Alinea to incorporate.
- Thorough research and genuine active management,
- Strong network with sector expertise,
- Selective distribution of our cases,
- Able to go both long and short, and
- Able to participate in Special situations (restructuring, pre-IPOs, etc).
Short selling – our approach
Our mandate provides us with the opportunity to consider material ESG factors separately for our long and short positions. Short selling can be used to express investment views on companies that fail to manage ESG factors adequately.
We short stocks with
- Structural headwind due to changing market conditions, regulations, disruptive competition or changing customer behavior, and/or
- Deteriorating businesses with operational underperformance (for instance caused by lack of “goodwill”/damage to reputation).
4. (P3) We will seek appropriate disclosure on ESG issues by the entities in which we invest
At Alinea, we will monitor more than 200 companies on a regular basis. To narrow down to our investment shortlist and potential investments we will use screening tools where ESG issues are also included. Our target is to meet 100 companies a year and have more than 300 calls with analysts.
During this process, we will certainly engage with the companies on ESG issues. Good governance, integrity and accountability among management teams are important to us. We look for:
- Able and honest management,
- Strong business moats and revenue models,
- Structural tailwind and competitive advantages,
- Often created by good governance and pro-active management!
To enter our portfolio as a long holding, the companies certainly need to have a clear ESG policy. We favor ESG leaders, but also seek to enhance our portfolio-companies growth prospects by steering them in the right direction. Management teams that have been slow to react to both ESG challenges and opportunities may be “nudged” in the right direction. To a certain extent, we will try to contribute to solutions. Investing in a company that is on a path from being an ESG laggard to becoming an ESG leader, may also yield strong financial returns. (However, we are also aware that we will be a “small” investor to many of our portfolio companies in the start.)
Companies that are unable or unwilling to change behavior might be good short candidates. Technology disruption is a constant factor in these sectors:
- The Gaming and iGaming sectors evolve quickly with new trends, regulation and customer behavior which also create short selling opportunities!
Gaming – reputational risk
Even large global gaming companies face reputational risk. If the end customer feels “tricked” or “used”, the indignation might spread like fire through dry grass.
An example of this, is Electronic Arts Inc. (EA). From generating revenue by selling software on discs a decade ago, a significant proportion of global video game revenues are today generated through in-game purchases after the game have been released. The amount of revenue generated from a game is driven by the number of players, average amount of time spent playing, and the attractiveness of making a purchase. In 2018, in-game purchases accounted for 38% of revenue for Electronic Arts, according to Bernstein research.
There are several methods for generating this revenue, one of them is through “loot boxes”. Loot boxes allow purchases where the content and value are randomly generated. They may be of great value, although probabilities can be very low. According to Sudhir Roc-Sennett of Vontobel Asset Management, loot boxes became a visible issue following Electronic Arts release of “Star Wars: Battlefront II” in late 2017. Gamers were unhappy with the low probabilities of being up on a loot box purchase, and there was an impression that the company was over-charging gamers. At the same time, Electronic Arts was named one of “The World’s Most Admired Companies” by Fortune magazine in 2018!
Hence, decisions by management can lower or raise a company’s exposure to Reputational (ESG) risks. Several companies have later dropped loot boxes and moved revenues towards direct sales or battle passes. Notably, the big game title “Fortnite,” from unlisted U.S. gaming company Epic Games (40% held by Tencent), does not use loot boxes. This response, in the ways in which gaming companies are changing their earning structure, serve to underline how just how significantly regulatory changes can impact businesses.
iGaming – regulatory issues
At Alinea, we believe that the iGaming companies with a proactive approach to regulatory issues, compliance, and concessions – will prevail in the industry. We favor companies with a strong focus on ethics and compliance. Re-regulation is an ongoing trend in the sector. An increasing number of countries have started to issue national gaming licenses which gaming companies are required to hold to operate or to market their services in those countries. Within the EU, an EU compliant license system is slowly evolving.
The implementation of responsible gaming principles is a critical aspect of the iGaming companies’ business model — not only in reducing risk, but also in driving a more sustainable revenue stream. We favor companies that apply high ethical standards, for instance by using new technology to block and avoid unwanted clients. Being responsible iGaming investors – we will seek to get appropriate disclosures from the companies of the responsible gaming policies they have implemented. And we will engage management if the measures taken are deemed insufficient.
iGaming – S&P ratings and cost of capital
The rating agency S&P clearly favors compliant companies when giving credit ratings:
“Governance factors play an important role in regulators' licensing decisions for gaming companies. This is because it is a heavily regulated industry that requires companies, management, board members, and significant equity owners to be found suitable to secure and maintain gaming licenses. Failure to adhere to licensing suitability standards, anti-money laundering regulations, laws, and other regulations can lead to fines or, in the most severe instances, license/concession revocation. Severe regulatory infractions can have a material impact on a gaming company’s competitive position and therefore on our ratings on it.” - S&P
5. (P6) We will each report on our activities and progress towards implementing the Principles
Alinea plan to report on our ongoing ESG activities. We will report on what is most material and relevant to our particular strategy.
For further information regarding Alinea’s sustainable investment practices, please see the Alinea Capital’s Information Memorandum (“Informationsbrochyr”).