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HERMES IMPACT OPPORTUNITIES2018 Annual Impact Report

Hermes Investment Management

Hannon Armstrong Sustainable Infrastructure provides financing for behind-the-meter projects that increase energy efficiency. In 2018, the company avoided 469,000 metric tons of CO2.

ENERGY TRANSITION

The human genome project estimates that the cost of sequencing the first human genome was between $500m and $1bn.

Xylem delivers wastewater treatment solutions – and it is a pioneer in creating innovative water technology solutions, including Flygt Concertor, the world’s first wastewater pumping system with integrated intelligence.

WATER

Illumina, a diagnostics company that dominates the next-generation sequencing market, has been instrumental in driving down the cost of sequencing – it is credited for breaking the $1,000 genome-sequencing barrier. It has also openly declared its intent to drive this cost down further to $100.

HEALTH ANDWELL-BEING

To limit global warming to 1.5°c by 2050, annual investment in low- carbon energy technologies and energy efficiency will need to be six times higher than it was in 2015.

80% of wastewater flows back into ecosystems without being treated or reused.

A WORLD IN TRANSITION1

Impact opportunities

Sustainability challenges

1 Source: Hermes, UNESCO, National Human Genome Research institute, Hannon Armstrong Sustainable Infrastructure, Xylem and GEN in July 2019.

IMPACT OPPORTUNITIES: ANNUAL IMPACT REPORT 2018

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Hannon Armstrong Sustainable Infrastructure provides financing for behind-the-meter projects that increase energy efficiency. In 2018, the company avoided 469,000 metric tons of CO2.

ENERGY TRANSITION

The human genome project estimates that the cost of sequencing the first human genome was between $500m and $1bn.

Xylem delivers wastewater treatment solutions – and it is a pioneer in creating innovative water technology solutions, including Flygt Concertor, the world’s first wastewater pumping system with integrated intelligence.

WATER

Illumina, a diagnostics company that dominates the next-generation sequencing market, has been instrumental in driving down the cost of sequencing – it is credited for breaking the $1,000 genome-sequencing barrier. It has also openly declared its intent to drive this cost down further to $100.

HEALTH ANDWELL-BEING

To limit global warming to 1.5°c by 2050, annual investment in low- carbon energy technologies and energy efficiency will need to be six times higher than it was in 2015.

80% of wastewater flows back into ecosystems without being treated or reused.

Impact opportunities

Sustainability challenges

HERMES INVESTMENT MANAGEMENT

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The Hermes Impact Opportunities Fund is a high-conviction global equity strategy with a bold objective. It aims to generate long-term outperformance by investing in companies succeeding in their core purpose: to generate value by creating positive and sustainable change that addresses the underserved needs of society and the environment. In this way, it focuses on tomorrow’s leading companies, today.

CONTENTS

Letter to investors 5

Fund philosophy 6

From philosophy to practice: how we identify impactful companies 10

Portfolio characteristics 12

Impact measurement: philosophy 14

Impact measurement: case study 15

Impact measurement: a snapshot of our portfolio companies 18

Operational footprint 28

Engagement 31

This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results and targets are not guaranteed.


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LETTER TO INVESTORSDear Investors,

For many, 2018 will be remembered as the year in which volatility returned, trade tensions escalated and stock markets across the world fell. For impact investors, however, 2018 will bring back fonder memories.

According to estimates from the Global Impact Investing Network (GIIN)2, assets under management in impact investing strategies doubled in 2018 to $228bn. By April 2019, this estimate hit $502bn3.Impact investing really has come of age.

Like us, many investors realise that the United Nations (UN) Sustainable Development Goals (SDGs) can act as a lens for examining emerging growth opportunities. They present a framework for identifying product and service areas that are exposed to sources of enduring demand – and these markets will grow substantially over the next decade and beyond. In addition, governments worldwide are getting serious about the SDGs, and consumers are increasingly demanding more sustainable products.

Yet, impact investors face challenges, particularly on the question of impact measurement. We are often asked how we effectively measure and track the impacts created by portfolio companies. So, in this report we have included some of the key performance indicators that we use to measure impact as well as a case study and a summary of our philosophy. In addition, investors’ disclosure needs are evolving – and companies are taking note. They are increasingly focused on publicly disclosing the impacts generated by their products and services as well as their operational footprint.

The first full calendar year for the Fund provided a healthy excess return over the reference index, though this performance was not delivered without challenges. To begin, we were reminded that education providers in developing nations are still affected by macroeconomic weakness, especially among lower-income demographics where enrolments slowed. Our holdings – Curro in South Africa and Kroton in Brazil – will have their most pronounced impact on this demographic, as students’ futures are disproportionately improved by the potential opportunities that a quality education can help deliver. Meanwhile, our investments in Future Mobility – companies that contribute to increasing the penetration of electric vehicles (EVs) – were also in the spotlight last year as the entire automotive value-chain came under pressure. Vehicles sales fell worldwide, hurting major car producers’ profits.

This contributed to delays in the rollout of new energy vehicle (NEV) platforms and created broad headwinds for businesses supplying the building blocks to enable this transition.

These examples remind us that impactful businesses are not immune to short-term macroeconomic challenges. That said, last year’s tumult did not detract from the long-term market-growth opportunities that await these companies. Disruption, displacement and substitution of older, unsustainable ways of doing things remain ongoing, despite the vagaries of global trade disputes.

Our research-intensive learning environment is central to our approach. Through it, we established the Hermes SDG Taxonomy to demonstrate clear connections between the underlying targets of the SDGs and investment opportunities.

We are constantly reviewing and identifying new information to refine our expectations of how the nascent markets in which our portfolio companies operate will evolve and expand in the coming years. This allows us to use periods of short-term share price weakness to make timely additions to a number of our positions.

This year, the investment community is navigating further challenges and will continue to do so in H2 amid a re-escalation of trade wars, disentangled economic unions and ongoing political polarisation. We will continue to analyse how this dynamic backdrop might affect our portfolio companies in the short-term. That said, these impactful companies should continue to provide attractive long-term potential as well as new investment opportunities at attractive valuations.

Finally, we would like to thank our clients for their support and conviction in our investment philosophy and process. We will continue to seek innovative, mission-driven companies that are committed to delivering positive change.

Yours sincerely,The Hermes Impact Opportunities team

2 Note: GIIN estimates are based on surveys completed by members. Source: “2018 GIIN Annual Impact Investor Survey,” published by GIIN in 2018. 3 “Impact investment universe grows to $502bn,” published by the Financial Times in April 2019.

Hermes Impact Opportunities: industry initiatives and recognition


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4 “World Investment Report,” published by the United Nations Conference on Trade and Development (UNCTAD) as at 2014.

Figure 1: How we compare to our peers 1a. The Bridges Spectrum of Capital

Source: The Bridges Spectrum of Capital as at November 2015.

Hermes Impact Opportunities’ positioning

OUR MISSION STATEMENT We aim to outperform the broad global equity market by:

FUND PHILOSOPHY With the ongoing surge of interest in impact investing, it remains important to ask whether public market strategies can fulfil the requirements of being impact investments, and truly move beyond a mere asset-gathering and relabelling exercise to become a real catalyst for societal change.This was the question we asked ourselves when we designed the Hermes Impact Opportunities Fund three-years ago. Impact investing has been one of the most innovative areas in finance over the last decade, and preserving the integrity of early impact investing pioneers was a central priority in building our approach.

We also needed to understand how our thinking around impact could contribute to the development of a global equity portfolio seeking to deliver attractive long-term risk-adjusted returns to our clients.

For the Hermes Impact Opportunities Fund, therefore, our definition of impact investing became: investing in companies that are growing because their products and services are delivering innovative solutions to society's underserved needs.

The concept of “additionality”, developed by the original impact investors, is one of the most important differentiating features of impact investing and one that brings an important focus on tackling unmet societal needs as a source of untapped future growth. Given the surge of interest in the UN SDGs, this is how best to view them: a useful common framework for understanding areas of structural future growth that the underserved needs represent, rather than a simple mapping exercise of existing themes and activities.

After all, the United Nations Conference on Trade and Development estimates that $5-7tn of investment is required annually to meet the SDG objectives by 2030.4 That represents a significant growth opportunity for companies with a strategy aligned to the delivery of the goals. It also represents the nascent growth opportunity from which the Hermes Impact Opportunities Fund is seeking to benefit.

As part of our philosophy, we deliberately set the bar high for impact validation. That’s because all companies have a complex mixture of positive and negative impacts. An imperative for public impact investing, therefore, is not just to find companies whose whole purpose is impactful – they are not that plentiful – but to help encourage a broad reduction in negative impacts and reinforce the positives. While this does not necessarily create new impacts, it does mean that the net system change is positive and potentially meaningful. This is the power of public markets: the size and breadth of their coverage provides a powerful opportunity to leverage change on a significant scale that can endure over time.

Financial-only Responsible Sustainable Impact Impact-only

Delivering competitive financial returns

Mitigating Environmental, Social and Governance (ESG) risks

Pursuing Environmental, Social and Governance opportunities

Focusing on measurable high-impact solutions

Focus: Limited or no regard for environmental social or governance (ESG) practices

Mitigate risky ESG practices in order to protect value

Adopt progressive ESG practices that may enhance value

Address societal challenges that generate competitive financial returns for investors

Address societal challenges where returns are as yet unproven

Address societal challenges that require a below-market financial return for investors

Address societal challenges that cannot generate a financial return for investors

1. Investing in companies whose outputs have a positive impact on society and the planet.

The provision of solutions to the most pressing problems of our time is the core growth driver of our portfolio companies. In other words, our portfolio companies’ impact theses are synonymous with their investment theses.

At an investor level, we engage with our portfolio companies in a way that we can deliver additionality. To illustrate our standing in the investment universe compared to other investment products, we have used the Bridges Spectrum of Capital and the Impact Matrix (see Figure 1a and 1b).


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Hermes Impact Opportunities’ positioning

Source: The Impact Management Project.

1b. The Impact Management Project

Act to avoid harm

Benefit stakeholders

Contribute to solutions

Signal that impact mattersEngage activelyGrow new/undersupplied capital marketsProvide flexible capital

E.g. Ethical bond fund E.g. Positively-screened / best-in-class ESG fund

E.g. Sovereign-backed bonds (secondary market) funding vaccine delivery to underserved people or renewable energy projects


E.g. Shareholder activist fund E.g. Positively-screened / best-in-class ESG fund using deep shareholder engagement to improve performance

E.g. Public or private equity fund selecting and engaging with businesses that have a significant effect on education and health for underserved people


E.g. Anchor investment in a negatively-screened real estate fund in a frontier market

E.g. Positively-screened infrastructure fund in a frontier market

E.g. Bond fund anchoring primary issuances by businesses that have a significant effect on environmental sustainability, access to clean water and sanitation


Investment archetype not widely observed


E.g. Private equity fund making anchor investments in businesses that have a significant effect on income and employment for underserved people




E.g. Below-market charity bonds, or an unsecured debt fund focused on businesses that have a significant effect on employment for underserved people




E.g. Patient VC fund providing anchor investment and active engagement to businesses that have a significant effect on energy access for underserved people


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2. Identifying emerging growth opportunities that meet a structural, underserved need.

To us, emerging growth opportunities are companies with business models that thrive by being exposed to strong, structural growth drivers, while underserved needs provide these structural growth opportunities. We identify these opportunities by using our proprietary SDG Taxonomy.

Figure 2: The Hermes SDG Taxonomy allows us to consolidate structural growth opportunities into our investment themes An example of how the taxonomy works

Source: Hermes Investment Management as at July 2019. For illustrative purposes only.

SDG – one of the UN’s 17 sustainable development goals – in this case, “14: Conserve and sustainably use the oceans, seas and marine resources for sustainable development”.

Product or service solution – goods and services that could help achieve this particular SDG target.

Impact risks – here we outline the unintended or unexpected actual or potential negative consequences of investment in the target area.

SDG target – an example of the 169 specific SDG targets as outlined by the UN.

Theory of change – this section describes in further detail the relevant issues, as well as the potential for related investments to contribute positively.

Impact theme – one of Hermes Impact Opportunities’ nine sustainable investment themes. In this case, the investment area of Waste Collection has been identified as coming under the larger impact theme of the Circular Economy.


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Hermes Impact Opportunities

Figure 3: Best practice public impact portfolio construction

Source: Hermes Investment Management as at July 2019. Note: this is based on the framework for long-term responsible and sustainable investing produced by the Investment Leaders Group at the Cambridge Institute for Sustainability Leadership.

Strength of long term responsible and sustainable

investing *

High Horizon

5-10+ years Unconstrained High High Low 20-50 stocks Strong

1-3 years MarketCapitalisation

Low Low High 70-80+ stocks Weak

Benchmark Trackingerror

Activeshare

Turnover EngagementPortfoliosize

Low

3. Taking advantage of market inefficiencies when pricing long-term change.

The short-term nature of financial markets gives rise to inefficiencies when pricing long-term opportunities. Our long-term investment horizon allows us to exploit these inefficiencies. The companies in our

concentrated portfolio are high-conviction calls, which allows us to reap the financial benefits of low turnover and harness the power of compounding returns. The Cambridge Institute for Sustainability Leadership has developed a framework for long-term responsible and sustainable investing – and we believe it best represents the construction of a public impact portfolio (see Figure 3).


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In practice, our impact investing process comprises four steps:

� The Hermes SDG Taxonomy is our starting point: it ensures that our ideas have full traceability back to the underlying SDGs. Through a detailed review of the 169 underlying SDG targets, we developed the Hermes SDG Taxonomy. It examines the ‘Theory of Change’ of each target and identifies investable solutions through public equities (see Figure 2).

� The addressable targets identified in our SDG taxonomy feed into our nine impact themes: Circular Economy; Health & Well-Being; Water; Food Security; Energy Transition; Future Mobility; Education; Financial Inclusion; and Impact Enablers.

1. Idea Generation

Idea Generation Validation PortfolioConstruction

Measurement Engagement, 360 Review

WATER

HEALTH & WELLBEING

EDUCATION

FINANCIALINCLUSION

FUTURE MOBILITY

IMPACT ENABLERS

CIRCULAR ECONOMY

FOODSECURITY

Herm

es SDG

Taxonomy

Watchlist


portfolio

5+ year holding period

Nature

Intentionality

Additionality

Balance

Improvement

Thematic research

Company meetings

Hermesinvestment

teams

Financial value creationappraisal

Impact assessment

Long-term sustainability

validation

Measurement

Engagement

360 review

Output

Outcome

Impact

Input

Milestone 1

Milestone 2

Milestone 3

Milestone 4

ENERGY TRANSITION

Figure 4: Identifying impactful businesses – our process

Source: Hermes Investment Management as at June 2019.

For this reason, a high level of integrity must be ingrained into the impact investment process. In addition, impact investors’ intentionality – the intention of an investor to exert a positive social or environmental impact – must be strong. After all, investors need to employ a robust, repeatable process to consistently generate market-beating performances over time.

To succeed in public equity markets, an impact investing process should follow an integrated, holistic approach – from assessment to valuation. It should be undertaken by analysts with

FUND PHILOSOPHY TO PRACTICE: HOW WE IDENTIFY IMPACTFUL COMPANIES

To succeed in public equity markets, an impact investing process should follow an integrated, holistic approach

As our philosophy highlights, impactful companies are not plentiful in public markets. Indeed, in public markets, companies are large and have extensive supply chains. Consequently, they generally have a more complex set of impacts than private companies. In addition, they are directly more exposed to short-term pressures from financial markets.

a multi-dimensional skillset that continually collaborate and engage in debate and discussion with other team members. This efficient process enables true integration and provides a more holistic view of a company.


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4. Measurement, Engagement and 360 review

2. Validation

� As we already mentioned, the Cambridge Institute for Sustainability Leadership has developed a framework for long-term responsible and sustainable investing. We have adopted this framework as we believe it best represents the construction of a public impact portfolio (see Figure 3).

� At inception, we constructed a broadly equally-weighted portfolio, which demonstrates strong conviction in each of our holdings and mitigates excessive idiosyncratic risk by avoiding portfolio concentration in a single or handful of positions. We only adjust the size of our holdings for companies that are listed in volatile domicile currencies or have a market capitalisation of less than $1bn to manage currency and liquidity risk, respectively.

� For each portfolio holding, we track key performance indicators that we use to measure impact. We engage directly with our portfolio companies to ensure that we hold management to account and outline the improvements that we expect. On an annual basis, each portfolio holding is reviewed by a different team member to the original sponsor. This ensures that we continually challenge our decision making.

Idea Generation Validation PortfolioConstruction

Measurement Engagement, 360 Review

WATER

HEALTH & WELLBEING

EDUCATION

FINANCIALINCLUSION

FUTURE MOBILITY

IMPACT ENABLERS

CIRCULAR ECONOMY

FOODSECURITY

Herm

es SDG

Taxonomy

Watchlist


portfolio

5+ year holding period

Nature

Intentionality

Additionality

Balance

Improvement

Thematic research

Company meetings

Hermesinvestment

teams

Financial value creationappraisal

Impact assessment

Long-term sustainability

validation

Measurement

Engagement

360 review

Output

Outcome

Impact

Input

Milestone 1

Milestone 2

Milestone 3

Milestone 4

ENERGY TRANSITION

� Impact assessment: contributing to a broad SDG or investment theme is insufficient for determining whether a company contributes substantively to the SDGs. As such, impact must be assessed on an idiosyncratic basis. We have developed an impact assessment framework that centres on five key dimensions: nature, intentionality, additionality, balance and improvement.

� Financial value creation: our approach to financial analysis and valuation is focussed on our understanding of an emerging product or service market’s growth potential; the underlying companies’ ability to capture this market; and understanding the extent to which this has been anticipated by the investment community.

� Long-term sustainability validation: we analyse whether a company is managed for the long-term, through a combination of traditional ESG research and other indicators, such as the composition of value added, accounting quality and investments in real growth.

3. Portfolio Construction� We undertake thematic research to understand the opportunities throughout the value chain and the product areas that are best placed to add value as they deliver an impactful product or service to the market. The larger the addressable market, the bigger the potential to deliver impact. Our value chain analysis also helps identify companies that are best positioned to create value from both an impact and financial perspective.


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Source: Hermes Investment Management as at 31 December 2018. Inception date: December 2017. Note: 12.3% of our exposure is not directly related to any of our nine impact themes.

Nevertheless, we believe it is important to demonstrate our portfolio characteristics.

PORTFOLIO CHARACTERISTICS

The Hermes Impact Opportunities Fund focuses on companies exposed to the drivers of future growth. We aim to invest in future leaders rather than today’s index heavyweights. In this way, we are unconstrained by sector or geography.

Thematic exposure � In 2017, we assigned our thematic exposure based on the largest contributor towards company revenue and expressed the breakdown according to the proportion of the fund that was exposed to this primary theme. While this provides an indicative view of thematic exposure, we recognise that often companies have multiple thematic exposures (for example, portfolio holding Umicore has significant exposure to both the Circular Economy and Future Mobility themes) or some revenues that may not be directly exposed to any impact theme.

� This year, we have bolstered our approach: we now break down each company’s revenues and end-market exposure to obtain a more granular and accurate assessment of our current thematic exposure. However, we do acknowledge that the relationship between impact and revenue is not straightforward.

� Companies are dynamic entities: they move into new business areas, divest businesses or strategically focus growth in specific areas. For this reason, our new approach provides full accountability of each portfolio company’s entire revenue at any given point in time, based on the latest reported information.

5.2% Improving access to quality water supply and preservation of the resource

2.1%Ensuring a sustainable food supply and productive farmlands for future generations

23.6%Improving lifeexpectancyand quality

2.6%Providing financial servicesto underserved populations

7.1%Improving vehicle efficiency to increase low-carbon transportation

Enhancing resourceefficiency and waste reduction

At inception: 9.3% 5.7%

Transforming the energy system to power a low-carbon economy

10.9%At inception: 11.9%

Providing crucial solutions and services to impactful companies directly involved in the various themes

27.2%At inception: 18.6%

At inception: 30.5%

At inception: 0%

At inception: 8.4%

At inception: 3.3%

At inception: 5.0%At inception: 8.0%

WATER

PORTFOLIO

HEALTH & WELLBEING

EDUCATION

FINANCIALINCLUSION

FUTURE MOBILITY

IMPACT ENABLERS

ENERGY TRANSITION

CIRCULAR ECONOMY

FOODSECURITY

3.4%Providing opportunities forall – irrespective of wealth, geographical location or ability

Figure 5: Thematic exposure as at 31 December 2018


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Source: Hermes Investment as at 31 December 2018.

Figure 6: Geographic exposure by company revenue

Geographic exposure It is important to look beyond a company’s location to understand where its impact occurs (see Figure 6). By examining a company’s geographic exposure by revenue, we can better depict a company’s impact.

Our main exposure is to developed markets, particularly North America and Europe. This in part reflects our healthcare exposure, which has a high representation of revenues in North America owing to the size of the market. In addition, the path to decarbonisation in Europe and the US is creating significant business opportunities in these geographies.

That said, we also have significant revenue exposure to emerging markets, where at least 18% of revenues are generated. Some of our portfolio companies, such as Kroton in Brazil, Curro in South Africa and Bank Rakyat in Indonesia, operate in emerging-market countries, while others, such as Valeo, have significant activities in emerging-market countries.

Africa

0.50%

Unassigned (24.25%)

Australasia

Europe

North America

Asia Pacific ex Japan

Central & South America

Japan

24.09%

2.16%

15.88%32.10%

0.28%

0.74%

Remember that the value of investments, and income from them, may go down as well as up and you may not get back the original amount invested. It should be noted that any investments overseas may be affected by currency exchange rates. The performance of Hermes Impact Opportunities Fund may have some dependence on the economic environment of emerging markets which may negatively affect the value. Past performance is not a reliable indicator of future results and targets are not guaranteed.


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Source: Hermes Investment Management as at 31 December 2018.

IMPACT MEASUREMENT PHILOSOPHY Our impact measurement philosophy is built on five key pillars:

For insights into the rationale of our impact measurement philosophy, please read our explanatory commentary: Understanding and measuring impact.

Engagement, not estimation

We choose regular, constructive engagement over estimating impact.

We believe that it is more productive to encourage companies to understand, measure and, ultimately, be accountable for their impact.

Over time, regular engagement will hopefully lead to companies reporting more robust metrics that we can integrate into our measurement framework.

Impact measurement

philosophy ESG ≠ Impact

Research intensive

We apply a ‘Pathway of Change’ model to each portfolio company; the more we are able to track progress over time, the richer our understanding of the company’s impact.

We use independent research – provided by intergovernmental organisations, non-governmental organisations (NGOs) and academics – to understand the link between company-produced outcomes and the broader impact.

In the future, we expect that improved disclosures and innovative technologies will help us bridge the gulf between impact and outcomes.

Qualitative and quantitative

ESG data is not designed for impact measurement. It focuses on how sustainably a company is run, rather than the impact that its products and services deliver.

Impact measurement should validate or nullify the Theory of Change, which underpins the investment case.

We examine a company’s negative impacts too, including its operational footprint.

We use quantitative metrics alongside qualitative inputs to form an opinion about the company’s impact performance.

The availability and quality of impact data is problematic for publicly-listed companies. Unlike financial statements, few impact data points are audited or adhere to a common reporting standard.

We have been reaching out to our portfolio companies to understand the methodologies behind published impact data. We only include metrics in our framework which will be reported on an ongoing basis.

Collaboration

Impact measurement practice is in its infancy and characterised by opaque, disparate approaches across the industry.

We acknowledge the need for a shared, ‘pre-competitive’ performance standard for impact measurement.

We therefore see it as our responsibility to contribute to measurement and reporting initiatives.


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5 See: "Understanding and measuring impact," published by Hermes in July 2019.

IMPACT MEASUREMENT CASE STUDY

LONZA GROUP AG

Lonza’s Theory of Change (summary)

Here we use current holding Lonza Group as a case study to demonstrate the different elements of our impact measurement approach5.

As a contract manufacturing and development company, Lonza helps companies to develop more sophisticated, complex medicines at a lower cost. Lonza’s solutions are not only confined to the commercial manufacturing stage, but also cover preclinical and clinical outsourcing services, thereby spanning the entire healthcare value chain. Drug companies generally outsource biologics manufacturing as it is more capital intensive, complicated and technical compared to chemical drug manufacturing.

Biologics currently grow twice as fast as conventional pharma (and are expected to continue this trajectory), due to their exceptional efficacy and safety and, importantly, their ability to address previously untreatable conditions. Lonza therefore enables businesses to develop and manufacture some of the most disruptive new treatments in medicine, ranging from cell therapy to antibody drug conjugates, speeding up medical progress.

1. The Theory of Change

This is our starting point for impact measurement, setting out the roadmap to impact. We have both a condensed Theory of Change, which functions as a summary (see below in bold), and an extended version, which links our impact hypothesis to independent and/or academic evidence.

Source: Hermes Investment Management as at June 2019. Note: The information contained in this case study is for illustrative purposes only and does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.

OutputsInputs

§ Construction of manufacturing sites (either by greenfield or brownfield expansions), approximated by Capital Expenditures (USD)

Development, production and eventual commercialisation of biological medicines:§ Commercial, large molecule medicines supplied by the company (#)§ Clinical, large molecule programmes supported by the company (#)

Outcomes

§ Enables manufacturing/development of disruptive drugs/programmes which otherwise would not be manufactured due to lack of capacity/expertise of SMEs§ Improved time-to-market of drugs, allowing treatment to become available sooner

Impact

§ More biologic medicines – such as gene therapy – will come to market (especially by SMEs), allowing for treatment of the underlying cause of the disease, rather than providing symptomatic relief and thereby substantially improving duration and quality of life for patients

Figure 7. Lonza’s Pathway of Change

It establishes the link between the Theory of Change and the impact metrics used. The impact metrics, which we track include:

� Inputs – the resources invested in the activity.

� Outputs – the tangible products or people serviced as a result of the activity.

� Outcomes – the specific outcomes resulting from the outputs.

� Impact – the broader, long-term systemic change that occurs as a result of the specific outcomes.

2. Pathway of Change


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3b. Company metrics

Impact metrics are divided into theme- and company-specific metrics – and they need to be tracked consistently over time.

We use standardised IRIS metrics developed by GIIN. This set of indicators provide consistency across our nine themes; they measure the impact of every company in each primary investment theme, thereby enabling aggregation at thematic level.

3. Impact metrics 3a. Theme metrics

These are tailored to each company’s business model. As such, they vary on a company-by-company basis, allowing us to capture the portfolio companies’ idiosyncratic impacts.

Name Theory of Change

Source Description 2016 2017 2018

Total Revenue (USD)*

Year-on-year % change

N/A Bloomberg The value of all revenue received by the organisation during the reporting period.

4,195,700,000 4,620,500,000 5,666,300,000

6% 10% 23%

*(IRIS, 2016. Total Revenue (FP6510). v4.0).

Lonza’s theme-specific metrics

Name Theory of Change

Source Description 2016 2017 2018

Capital Expenditures (USD)


Input Bloomberg The amount the company spent on purchases of tangible fixed assets.

360,500,000 433,800,000 539,800,000

35% 20% 24%

Commercial, large molecule medicines supplied by the company (#)


Output Company Annual Report

The number of commercial medicines supplied by Lonza in a given year, focused on mammalian and microbially expressed medicines, antibody drug conjugates, cell and viral therapy. Figures include Capsugel.

20 22 25

10% 14%

Clinical, large molecule medicines supported by the company (#)


Output Company Annual Report

The number of clinical medicines supported by Lonza in a given year, focused on mammalian and microbially expressed medicines, antibody drug conjugates, cell and viral therapy. Figures include Capsugel.

191 290 305

52% 5%

Lonza’s company metrics


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These are used to define the impact metrics and highlight the main caveats pertaining to the impact metrics, measurement methodology and other updates.

4. Notes

Lonza’s notes

5. Engagements

Commercial, large molecules medicines supplied by the company (#) and clinical, large molecule programmes supported the company (#): this is defined as the number of large molecule commercial medicines supplied by Lonza. In its Capital Markets Day presentation (September 2018), the company includes “mammalian and microbially expressed medicines, antibody drug conjugates, cell and viral therapy” in this definition. Moreover, the metric includes the number of Capsugel programmes and medicines, a company which Lonza only acquired in July 2017. In an email exchange about impact measurement on 15 January 2019, the company confirmed that it will publish its product pipeline annually.

Clinical, large molecule programmes supported the company (#): please note that this is an approximate number.

Capital expenditure ($): we use capital expenditure as a proxy for the new construction or expansion of existing manufacturing sites (increasing its capacity to develop and manufacture products for its clients). We use this number with some caveats, as disciplined capital expenditure is key for Lonza given that it has been criticised in the past for its overly ambitious greenfield investments in new manufacturing sites, which eventually resulted in a weak bargaining position. As a result, Lonza became more disciplined in its capacity expansion, although the prior approach resulted in the closure of 10 sites and accounted for the slump in capital expenditure in 2014. From here, capital expenditure should increase in the mid-term to keep up with Lonza’s growth plans. The number of facilities built could be used as an alternative to this figure, but it would not take into account brownfield expansion, which is an explicit strategic objective of Lonza. Lonza currently has 29 manufacturing facilities on three continents (September 2018). Please note that the quoted figure is in USD (in order to aggregate this across the portfolio), while Lonza reports in CHF.

Regular, constructive engagement with all of our portfolio companies is crucial, particularly around the issue of publishing relevant impact data. We believe that most existing ESG data is ill-suited for impact measurement purposes. That’s why we

actively encourage companies to publish data that is suitable for assessing its real-world impacts. Importantly, our engagements provide a continuous, positive feedback loop to companies. In turn, this encourages them to increase their net positive impacts.


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Key considerations:

� The figures used in our impact metrics have been provided in most cases by the company itself in publicly-available documents and, in a small number of cases, by regulatory agencies.

� As a general principle, we refrain from using our own estimates of a company’s impact for measurement purposes and only use primary data (see our explanatory commentary: Understanding and measuring impact).

� We report the impact of the entire company and do not attribute a percentage of that impact to the size of our holding.

� The figures used are aligned with the financial year of the respective company and may therefore fall outside the 2018 calendar year; where figures were not available for 2018, we used 2017 numbers.

� These examples are for illustrative purposes only and do not constitute a solicitation or offer to buy or sell any related securities or financial instruments.

We launched the Hermes Impact Opportunities Fund in December 2017. Here we provide context for each of our impact themes and provide one company-level impact measurement example per theme.We have not exited any of our holdings since inception. However, there have been a few additions to our portfolio: we took a position in Brambles in Q1 2018 and Autolus in Q2 2018 and we also added Tomra to our Circular Economy theme in Q1 2019. As this new position falls outside of the 2018 calendar year, we have excluded Tomra from the impact measurement analysis.

IMPACT MEASUREMENT: A SNAPSHOT OF OUR PORTFOLIO COMPANIES


19

Overall, data availability is good; all of our Energy Transition companies report on one of the theme metrics. Currently, there is no consistent methodology or standard approach for calculating avoided GHG emissions; as such, grouping these numbers into a single metric is problematic.

Ørsted is the world leader in offshore wind, having installed more than a quarter of the total offshore wind capacity globally. Its mission is to lower offshore wind’s Levelised Cost of Electricity (LCoE). According to the International Renewable Energy Agency, the construction and installation of offshore wind farms – Ørsted’s core competency – accounts for more than 60% of the total LCoE reduction potential for offshore wind from 2016-2025. A decreasing LCoE of renewable energy improves offshore wind’s economics vis-a-vis fossil fuels, which in turn speeds up adoption and allows for a quicker transition to a low-carbon economy.

Climate change is one of the biggest existential threats to humanity and the planet.

A landmark report published by Intergovernmental Panel on Climate Change (IPCC) in 2018 found that limiting global warming to 1.5°C would require “rapid and far-reaching” transitions in land, energy, industry, buildings, transport and cities: in particular, global net human-caused greenhouse gas (GHG) emissions would need to fall by about 45% from 2010 levels by 20306.In 2018, the physical effects of climate change were record-breaking: GHG concentrations for carbon dioxide reached their highest levels ever, as demand for energy continued to outstrip growth in renewable energy capacity; it was the warmest year on record for ocean heat content – notably, about 93% of the heat that is trapped

in the atmosphere by GHG ends up in our oceans7. The international community is beginning to realise that the real impacts of climate change are happening faster and more dramatically than many could have anticipated.

Against this backdrop, vast investment in renewable energy is needed. In our portfolio, offshore wind is the renewable energy technology which features prominently in our Energy Transition theme. Offshore wind is particularly attractive due to its continuous cost reduction thanks to improving technologies and facilitating grid decarbonisation at scale. We are also invested in one of the key financiers of the energy system of the future, which contributes to wind, solar and energy efficiency projects.

Theme-level measurement

Theory of Change Company-level metrics

Output

Output

Output

Output (proxy)

Load factor, offshore wind: 42%

Green energy share: 75%

Energy Generated for Sale: Renewable8: 13 TwH

Greenhouse Gas Reductions due to Products Sold9: 18.47m metric tonnes

An example of company-level measurement in our portfolio

Contribution to SDG targets 7.2, 7.4, 13.1

Energy Transition

Ørsted A/S

6 "Summary for Policymakers of IPCC Special Report on Global Warming of 1.5°C approved by governments,” published by the IPCC in October 2018. 7 “State of the climate: How the world warmed in 2018,” published by the Carbon Brief in January 2019. 8 IRIS, 2016. Energy Generated for Sale: Renewable (PI5842). v4.0. 9 IRIS, 2016. Greenhouse Gas Reductions due to Products Sold (PI5376). v4.0.


20

The two companies in our Financial Inclusion theme provide the ‘Value of Loans Disbursed’ metric. We use the value of micro loans disbursed for Bank Rakyat Indonesia. We converted the local currencies into US dollars, using the average exchange rate for 2018 for aggregability purposes.

Southern and south-eastern European countries have been struggling to generate the kind of inclusive economic growth that would generate enough opportunities, especially for younger people, which has translated into inadequate livelihoods, as well as high unemployment and emigration rates. According to Eurostat, small-to-medium sized enterprises (SMEs) account for two-thirds of total employment in the European Union. Access to finance has been hard to come by for these employment drivers. This is where the development-oriented commercial bank ProCredit steps in, with about 90% of its loan focused on SMEs. In addition, ProCredit particularly aims to grow its green loan portfolio (through energy efficiency and renewable energy in particular), thereby providing financing for businesses that aim to reduce anthropogenic environmental impacts and boost resilience to climate change.

Financial inclusion underpins the majority of the SDGs; it enables economic prosperity and upward mobility. Indeed, it is a challenge that particularly pertains to developing economies – where the majority of the world’s unbanked adults can be found.

Progress has been encouraging, with account ownership rising 18% worldwide since 201110. However, according to the latest Findex Report, 31% of the global population remain unbanked,

while progress for women has stalled altogether: globally, 65% of women have an account compared to 72% of men, and that gap that has been broadly unchanged since 201111. However, finding the right tools for fostering financial inclusion is not straightforward and, to a large extent, it is dependent on the local context. Our two portfolio companies in the Financial Inclusion theme have a background in microfinance, but they operate in strikingly different contexts.



Value of green loan portfolio: €676m

CO2 saved by green loans: 56,536 metric tonnes

Installed capacity of financed renewable energy projects: 50.30 KWh


Contribution to SDG targets 1.4, 8.3, 9.3, 10.2, 13.1

Financial Inclusion

ProCredit Holding AG & Co KGaA

Outcome

Output

Output

Output

10, 11 “2017 Findex Report” published by Findex in 2017. 12 IRIS, 2016. Value of Loans Disbursed (PI5476). v4.0.

Value of Loans Disbursed12: $24.55bn


21

Data availability is average. Only one of our portfolio companies uses a metric to report how much waste it reduces; it comprises waste reductions from both products and services. We have therefore chosen to combine these two IRIS indicators.

Brambles manages the largest pool of reusable and standardised crates, pallets and containers, which provide a circular alternative to their disposable counterparts. Brambles ‘share-and-reuse’ pooling model therefore offers a circular solution for supply-chain participants in the fast-moving consumer goods, retail and manufacturing industries by ensuring an efficient flow of goods. By reducing transport distances and the number of platforms required to service supply chains, Brambles delivers savings which all participants share, as well as reducing the carbon, water, wood and waste footprint of its customers. End-to-end supply chain management allows companies to operate more sustainably in a resource-constrained world: in 2018, the Earth Overshoot Day18 occurred on August 1, the earliest date yet.

The world’s resources are being depleted at a much faster rate than they are being replenished.

If the global population grows to 9.6bn people by 2050 (which is 0.2bn short of the latest UN estimate), the equivalent of almost three planets will be needed to sustain our current consumption patterns13. This rapid and large-scale depletion, pollution and extinction has led some scientists to claim that we have entered a new geological age: the first created by man, the Anthropocene14.

In 2018, the world woke up to the problem with plastic (see our Q1 2019 Impact Report for a deep-dive on the topic of plastics). The widely acclaimed BBC documentary Blue Planet II starkly

exhibited the impact of plastic pollution on marine life: for example, it broadcast unsettling images of albatrosses feeding their chicks pieces of plastic. A recent study found that 88% of viewers have changed their behaviour as a result of watching the documentary15.

At the heart of this dilemma is the linear ‘take-make-waste’ model of our economy. We believe that our Circular Economy portfolio companies provide circular solutions that prevent the world from drowning in waste and over-exploiting scarce raw materials.



CO2-e saved: 2.6 megatonnes

Number of trees saved: 1.7m


Circular Economy

Brambles Ltd

Waste reductions from services sold16 and waste reductions from products sold17: 1.4 megatonnes diverted from landfill

Outcome

Outcome

Contribution to SDG targets 2.1, 2.4, 8.4, 11.2, 11.6, 12.2, 12.3, 12.5, 14.1, 15.2

13 "Goal 12: Ensure sustainable consumption and product patterns," published by the UN. 14 "What is the Anthropocene and are we in it?" published by the Smithsonian Magazine in January 2013. 15 "Waitrose & Partners Food and Drink Report 2018-19," published by Waitrose in November 2018. 16 IRIS, 2016. Waste Reductions from Services Sold (PI5678). v4.0. 17 IRIS, 2016. Waste Reductions from Products Sold (PI5926). v4.0. 18 Note: Earth Overshoot Day marks the date when humanity’s demand for ecological resources and services in a given year exceeds what earth can regenerate in that year.

Output


22

Data availability and comparability is high. We must be prudent and take these metrics with a pinch of salt; acquisitions inflate both output metrics without the additionality that would otherwise occur through organic growth.

Educational quality is subject to regulatory oversight. As such, we are able to measure outcome metrics; these are provided by government agencies.

Curro broadens access to education by offering good quality education to South Africa’s middle class. The quality of education in South Africa is poor (in the OECD’s 2015 league table, it ranks second-to-last). However, the majority of private education is unaffordable for most South Africans, with the average private school fees taking up almost all of the average household income. Curro’s pricing sits just between very expensive private schools and free state schools: it offers good quality education at up to a third of the price of its private competitors. By growing its business, Curro helps to improve the access to quality education, which is the bedrock of social mobility and economic prosperity.

“One child, one teacher, one book, and one pen, can change the world.”

So said education campaigner and Nobel Prize laureate Malala Yousafzai. Education – which sits at the heart of societal equity and sustainable development – is the underlying, elementary driver for the achievement of the 17 SDGs. Going beyond lifting educational standards and granting greater access, quality education has numerous concomitant positive impacts. For example, Project Drawdown (the most comprehensive plan proposed to reverse global warming19) ranks educating girls as the sixth in a list of solutions (by effectiveness) to combat climate change, after more traditional solutions, such as onshore wind20.

In 2018, the UN General Assembly adopted a resolution that proclaimed an International Day of Education; it recognises the ubiquitous contribution that education makes to the rest of the SDGs.21

The provision of education by for-profit institutions can be perceived as a virtue or a vice. We concur that education should be a right, not a privilege, but we also believe that there are instances in which private players can bridge the chasm created by governments that fail to provide the quality education that their citizens deserve. Our portfolio companies, which operate in South Africa and Brazil, are instrumental in increasing access to quality education.



Percentage of learners who achieve >60% (NSC): 31.70%

Percentage of learners who achieve >60% (IEB): 73.20%


Contribution to SDG targets 4.1, 4.2, 4.5, 4.6

Education

Curro Holdings Ltd.

School Enrolment – Total22: 906,433

Teachers Employed23: 13,467

Outcome

Outcome

19 "Drawdown: The Most Comprehensive Plan Ever Proposed to Reverse Global Warming," by Paul Hawken published in 2018. 20 Project Drawdown as at 2017. 21 "UN General Assembly proclaims 24 January International Day of Education," published by UNESCO in December 2018. 22 IRIS, 2016. School Enrolment: Total (PI2389). v4.0. 23 IRIS, 2016. Teachers Employed (OI5896). v4.0.

Output

Input


23

We currently only have one company in our Water theme. Xylem does not currently disclose the desired metric for this theme.

Xylem, one of the biggest water technology companies in the world, provides a full suite of solutions across the water cycle – from smart water infrastructure analytics to water treatment. Water infrastructure is aging in developed markets, while it is inefficient or underdeveloped in a lot of emerging markets. This leads to loss of an already scarce resource, which could be avoided with the use of Xylem technology and analytics. Moreover, Xylem’s water treatment solutions address the world’s gargantuan wastewater problem: UNESCO estimates that 80% of wastewater flows back into the ecosystem without being treated or reused. Xylem therefore contributes a full suite of solutions to the water crisis.

Water – the source of all life and bedrock of modern civilisation – is now becoming scarce.

That’s because climate change is exacerbating the water cycle, pollution is increasing, and water quality is deteriorating. At the same time, dramatic population growth propels demand for water-intensive agriculture. Both forces act in concert to exacerbate the demand and supply imbalance of water: demand is expected to outpace supply by 40% by 203024. There is no immediate solution to our water crisis: we face severe structural challenges across the board. Indeed, by 2025, half of the world’s population will be living in water-stressed areas25.

In 2018, Cape Town suffered severe water shortages and faced the real threat of becoming the first major city to potentially run out of water. Through the efforts of its citizens, Cape Town managed to delay such an outcome, for now.

Our holding provides solutions across the water cycle, ranging from smart metering and wastewater treatment to infrastructure analytics.



Average percentage of energy efficiency improvement of products: 2%

Vitality Index (Percentage of sales from products launched in the last five years): 25%


Contribution to SDG targets 6.1, 6.2

Water

Xylem Inc

Water Savings from Products Sold26: N/A

Outcome

Output

24 “Charting our water,” published by McKinsey in 2009. 25 "Drinking water: key facts," published by the World Health Organisation in June 2019. 26 IRIS, 2016. Water Savings from Products Sold (PD5786). v4.0.

N/A


24

It is difficult to provide a meaningful, aggregable metric for the Health and well-being theme. Most companies do not administer treatments or supply drugs to patients. Even when companies publish estimates of the number of patients they reach, they do so on a cumulative rather than an annual basis. In addition, the majority of companies have diverse product portfolios, which contain a multitude of treatments, making it difficult to isolate the impact of a single treatment area.

For companies that estimate their patient reach, theme-level metrics appear to be of limited use. That’s because patient outcomes vary significantly on a treatment-by-treatment and

CSL is the largest global provider of plasma therapies used to treat plasma-deficiency diseases, which due to limited supply, remain vastly undertreated. Plasma therapies are being used to treat a host of diseases, ranging from serious immunodeficiency diseases to coagulation disorders. Human immunoglobulins, one of CSL’s growth drivers, feature on the WHO’s list of essential medicines, which lists the most efficacious, safe and cost–effective medicines for priority conditions. CSL has an ambitious plan to dramatically increase its plasma collection capacity, which should in turn allow it to produce more plasma-derived therapies. The remainder of its global business sells vaccines, with influenza topping the list of burden of disease and disability-adjusted life years (DALYs study – 30% of total burden).32

Population health is one of humanity’s success stories: life expectancy has more than doubled in the past two centuries27 and child mortality has declined in every region of the world.28

Despite this progress, the looming threats to population health should not be underestimated: the world is grappling with antimicrobial resistance – a backlash resulting from our careless overuse of antibiotics in animals and humans – and non-communicable diseases, such as obesity and diabetes, which kill 41m people each year (equivalent to 71% of all deaths globally).29

In 2018, the World Health Organisation (WHO) celebrated its 70th anniversary and the World Health Day focused its efforts on universal health coverage. The WHO Director-General pointed to “remarkable progress” in healthcare last year, while at the same time, highlighting “huge challenges” in under-five mortality, such as non-communicable diseases and air pollution.30

We are optimistic that disruptive innovation – including genetic sequencing, molecular diagnostics and biologic drugs – will change medicine for the better.



Number of plasma collection centres: >200

R&D expenditure: $702.4m

Number of pre-clinical and clinical studies commenced: 17


Contribution to SDG targets 3.3, 3.4, 3.5, 3.8

Health and well-being

CSL Ltd

Client Individuals – Total31: 29.2m

product-by-product basis. It is worth noting, however, that there appears to be an inverse relationship between product innovation, which is exceptionally high for the companies in this theme, and aggregability of impact metrics.

Input

Input

Output

27 "Good news at last: the world isn’t as horrific as you think,” published by The Guardian in April 2018. 28 "Global health: boom or gloom,” published by The Telegraph in August 2018. 29 "Noncommunicable diseases: key facts," published by the World Health Organisation in June 2018. 30 "World Health Statistics 2018: Monitoring health for the SDGs," published by the World Health Organisation in 2018. 31 IRIS, 2016. Client Individuals: Total (PI4060). v4.0. 32 "Influenza ranked highest in burden of disease measured in DALYs,” published by the European Centre for Disease Prevention and Control in April 2018.

Output


25

Data availability is poor. Our portfolio companies provide component parts or testing systems to carmakers. As such, they are one step removed from vehicle production.

Metrics such as CO2 avoided are very difficult to estimate and report for these companies as they are heavily dependent on several variables, which are largely out of their control. The difficulty in estimating this number was raised by our portfolio companies, citing concerns about their ability to provide meaningful numbers.

Valeo manufactures automotive components that enable the electrification of powertrains from mild hybrids to full EVs. CO2 emissions from battery electric vehicles (BEV) were about 40% lower than ICE vehicles in 2018.38 That said, it is dependent on the energy mix of the grid and the reduction can be as high as 80%-90% in a country like France, thereby mitigating climate change. More generally, beyond pure BEV, electrification improves fuel efficiency for ICE vehicles, which is particularly important for the gradual transition before BEVs dominate vehicle fleets.

After decades of undisputed monopoly, the days of the internal combustion engine (ICE) are now numbered.

Today, two-thirds of the world’s oil is consumed by cars and trucks, with transport accounting for 23% of all carbon dioxide emissions.33 To tackle global warming, the transportation sector needs to be disrupted. Such disruption is possible through autonomous, connected, electrified and shared (ACES) vehicles – and powertrain electrification is one of the more immediate steps on the horizon. To enable this disruptive transformation and achieve full autonomy, companies need to solve the stifling bottlenecks of high battery costs and range anxiety as well as technological hurdles.

In 2018, the automotive industry grappled with tariff rhetoric, cyclical contractions in the macro environment (which lead to a decline in car

sales) and the tightening of NOx and CO2 emission limits (which sent jitters across the industry). Despite these broader headwinds, EV sales hit a record high last year, with close to two million sold. This is an increase of 84% year-on-year in 4Q 2018.34 This number is expected to hit 2.7m in 2019. 35

Despite this fierce growth trajectory, the electrification revolution is still in its infancy, with EVs comprising 5% of total passenger vehicle sales today.36 The revenue exposures of our Future Mobility companies are therefore in their infancy too. But through their investments, we believe that they are already positioning themselves as the solution-providers to the low-carbon economy of tomorrow.



R&D expenditure: $315.4m

Proportion of innovative products in order intake: 53%

Share of products contributing to carbon emissions reduction (percentage of sales): 50%


Contribution to SDG targets 3.3, 3.6, 7.3, 8.2, 11.2, 11.6, 13.1

Future Mobility

Valeo SA

Total Revenue37: $10.31bn

Input

Output

Output

33 Project Drawdown as at 2017. 34, 35, 36 “Global Electrified Transport Market Outlook,” published by BNEF in March 2019. 37 IRIS, 2016. Total Revenue (FP6510). v4.0. 38 "Electric cars are cleaner even when powered by coal,” published in January 2019.

Output (proxy)


26

Our Impact Enablers companies our highly idiosyncratic in their impact. As such, we believe that aggregating any metric for these companies would be meaningless. For this reason, we have used Total Revenue as a proxy for company output (we have converted revenues to US dollars for comparability).

As a contract manufacturing and development company, Lonza helps companies to develop more sophisticated, complex medicines at a lower cost. Lonza’s solutions are not only confined to the commercial manufacturing stage, but also cover preclinical and clinical outsourcing services, thereby spanning the entire healthcare value chain. Drug companies generally outsource biologics manufacturing as it is more capital intensive, complicated and technical compared to chemical drug manufacturing. Biologics currently grow twice as fast as conventional pharma (and are expected to continue this trajectory), due to their exceptional efficacy and safety and, importantly, their ability to address previously untreatable conditions40. Lonza therefore enables businesses to develop and manufacture some of the most disruptive new treatments in medicine, ranging from cell therapy to antibody drug conjugates, speeding up medical progress.

Companies in our Impact Enablers theme provide a product or service that allows their customers to have a positive impact.

Even though these companies are one step removed from the impact itself, it does not dilute the power of the impact that they can deliver.

Our Impact Enablers theme is made up of a diverse range of companies, ranging from an antibody manufacturer to a charity-aligned investment trust.



Capital expenditures of tangible fixed assets: $539.80m

Commercial, large molecule medicines supplied by the company: >25

Clinical, large molecule programmes supported the company: >305


Contribution to SDG targets 3.2, 3.4, 3.4, 3.8, 7.3, 8.2, 9.4, 9.5, 12.2, 12.5

Impact Enablers

Lonza Group AG

Total Revenue39: $23.44bn

Input

Output

Output

39 IRIS, 2016. Total Revenue (FP6510). v4.0. 40 “Rapid growth in biopharma: Challenges and opportunities,” published by McKinsey in 2014.

Output


27

We did not find meaningful metrics beyond what is currently measured at a company-specific level. This may change when more companies are added to the theme.

Ecolab provides its customers with safe food (37% of revenues), while minimising their environmental impact. Water consumption currently accounts for 20% of the worldwide total, with overall freshwater withdrawals having tripled over the last 50 years. Ecolab is working at nearly three million customer locations across a plethora of industries, helping companies minimise their water, waste and carbon footprints. In 2018, Ecolab helped customers safely produce 25% of the world’s processed food and 44% of the global milk supply, while at the same time helping them conserve drinking water for more than 650m people. The company has a 2030 goal of saving 300bn gallons of water for its customers annually as well as preventing more than one million foodborne illnesses each year.48

How can we double our agricultural output while minimising the negative environmental footprint of agriculture?41 This is one of the important questions that we will have to wrestle with in the next century.

By 2050, the world population is expected to reach 9.8bn.42 To feed the growing population, crop production will need to double.43 We need to rethink our approach to nutrition; we are currently dealing with a double burden of malnutrition – where people are either not eating enough, or they are eating the wrong foods.

Our already overexploited planet will not be able to satisfy the resource-hungry nature of agricultural practice today. Agriculture irrigation, which consumes 70% of the world’s water use,44 has been a major contributor to deforestation and surface-water pollution, while its monoculture and use of synthetic pesticides has reduced biodiversity. It is also a major contributor to climate change, with emissions of livestock accounting for 14.5% of all anthropogenic GHG emissions.45

Last year, there was an unprecedented level of investment made in plant-based and cell-based meat companies signalling a significant shift in consumer preferences.46

Indeed, the polarised debate on how to ‘fix’ agriculture complicates finding solutions. That’s because the proponents of industrial agriculture are in one corner and the proponents of organic, smaller-scale agriculture are in the other. The merits of both approaches depend on the crop type, impact category and local agricultural context. These factors have ultimately also made it difficult for us to find clear-cut solution-providers of sufficient scale.



Energy savings from products and services sold: 3.28m

Water Savings from Products Sold49: 188bn gallons of water


Contribution to SDG targets 3.9, 6.3

Food security

Ecolab Inc

Client Individuals – Total47: 29.2m

41, 43 "Where will we find enough food for nine billion?” published by National Geographic Magazine. 42 "World population projected to reach 9.8bn in 2050, and 11.2bn in 2100,” published by the UN in June 2017. 44 "Managing water sustainably is key to the future of food and agriculture,” published by the OECD in 2019. 45 "By the numbers: GHG emissions by livestock," published by the Food and Agriculture Organisation of the United Nations. 46 "New GFI reports show accelerating investment for plant-based and cell-based industries,” published by GFI in May 2019. 47 IRIS, 2016. Client Individuals: Total (PI4060). v4.0. 48 "New report highlights crucial role of water development,” published by UNESCO in March 2009. 49 IRIS, 2016. Water Savings from Products Sold (PD5786). v4.0.

Outcome

Outcome

Outcome


28

We are cognisant that every company has both positive and negative impacts when it comes to its operations. We have used a framework based on fundamental indicators and ESG metrics (as opposed to policy metrics or ESG ratings) to present the operational footprint of our portfolio as at 31 December 2018.

50, 52 TRIR and LTIR were standardised per 200,000 hours worked or per 100 full time equivalent employees, assuming that employees work 40 hours per week and 50 weeks per year. 51 Note: Data availability: the percentage of portfolio companies that currently report the relevant data. 53 Note: this figure does not account for new employees that were acquired during mergers etc, as this does not contribute to job creation. Number of employees represents 2018-2017/2017.

OPERATIONAL FOOTPRINT

■ Average percentage of women as a percentage of the employee base; management; and the board: see Figure 8.

Data availability (employees):

Data availability (management):

Data availability (board):

People


26% women 39% women 29% women

74% men 61% men 71% men

Employeebase Management Board

Figure 8. Workplace gender equality

59%

66%

100%

This is an imperfect, high-level view. These indicators are only a selection of some of the factors that we consider important to track at portfolio-level. They should always be considered within their company-specific context.

Safety

1.36Total number of recordable incidents50

31%Data availability51:

0.43Lost time incident rate52

28%Data availability:

16,064Net job creation 53

new jobs97%Data availability:

Employment

Diversity


29

Prosperity

$5,464.87M

Taxes paid by portfolio companies

Data availability across data points and time periods:

■ Allocation of value among stakeholders (stakeholders: employees, executives, tax authorities, shareholders): see Figure 9.


■ Distribution of investments: see Figure 10.


■ Inequality (ratio of CEO/ average employee expense v peers): see Figure 11.


72%

69%

90%

66%

Source: Bloomberg; Hermes Investment Management as at 31 December 2018.



Figure 10. Distribution of investments

Figure 11. Ratio of CEO to average employee expense

Figure 9. Distribution of value created among stakeholders ($m)

0%10%20%30%40%50%60%70%80%90%

100%

2014 2015 2016 2017 2018Net capex R&D Wages Dividends Share buybacks Acquisitions

0

5,000

10,000

15,000

20,000

25,000

2014 2015 2016 2017 2018

Employees Shareholders Tax authorities Executives

0.0

20.0

40.0

60.0

80.0

100.0

120.0

2014 2015 2016 2017 2018Ratio of CEO to average employee expense


30

Innovation

GHG emissions

Waste



Figure 12. GHG emissions (scope 1, 2, 3)

Figure 13. Waste (total and recycled), in metric tonnes

Scope 1: company direct operations

Scope 2: emissions from purchased electricity

Scope 3: emissions from the supply chain

Planet

Xylem Inc/NY: 0.86K

Horiba Ltd: 0.91K

Siemens Gamesa Renewable Energy SA: 1.04K

Hella GmbH & Co KGaA: 3.21K

Duerr AG: 3.85K

Umicore SA: 4.19K

Scope 2: 2.02K

Scope 3: 20.73KTotal Emissions: 24.54K

Scope 1: 1.79K

Novo Nordisk A/S: 0.003KANSYS Inc: 0.03K

Hannon Armstrong: 0.03KCurro Holdings Ltd: 0.04K

Orsted A/S: 0.04KBank Rakyat Indonesia Persero Tbk PT: 0.05K

CSL Ltd: 0.06KIllumina Inc: 0.07K

Brambles Ltd: 0.10KQIAGEN NV: 0.22KSartorius AG: 0.25K

LivaNova PLC: 0.27K

Agilent Technologies Inc: 0.29K

Lonza Group AG: 0.41K

Kroton Educacional SA: 0.43K

Ecolab Inc: 0.84K

Valeo SA: 6.85K

Carl Zeiss Meditec AG: 0.48K

200Empire State

Buildings

That's equivalent to:

That's equivalent to:

5,122Eiffel Towers

68.74mTotalwaste

51.73mRecycled

waste

168,124,997M3

Water (total water use)

Data availability:

Data availability (total):

Data availability (recycled):

55%

52%

45%

$9,579.92M

R&D expenditure


31

54 "New research shows the importance of board-level contact for impactful engagement,” published by Hermes EOS in September 2017.

ENGAGEMENT

Since its inception, Hermes has been at the forefront of responsible investing and active ownership. Our stewardship and engagement arm, Hermes EOS, established a pioneering model for working constructively with corporate boards and management teams in the long-term interests of investors, coining the term for this practice – engagement – along the way. We contributed to the development of the Principles for Responsible Investment in 2005 and are a founding signatory. Today, Hermes EOS has one of the largest stewardship resources of any fund manager in the world, with a team of 33 professionals that engage in every region, across social, environmental, governance and strategic issues. The primary focus of Hermes EOS is personal, board-level interaction, which has shown to be most effective in generating positive change at the corporate level54.

The Hermes Impact Opportunities team is aligned with the company-wide ethos: we consider stewardship as one of the cornerstones of responsible investment. As a result, active engagement and voting form a core part of our investment process. On top of that, and as outlined earlier, we consider engagement to be the most effective way to deliver investor-level additionality in public markets.

Hermes: a long history of active ownership

We therefore aim to engage with all of our portfolio companies. This engagement is conducted and led by one or more of the Hermes Impact Opportunities team. Where Hermes EOS is already engaging with companies held in our clients’ portfolio, we collaborate on these engagements.

Measuring progress in engagementOur engagement progress follows the ‘Milestone System’ adopted by Hermes EOS (see Figure 14) and is tracked on our proprietary engagement platform. Milestones are set at company-level and are tailored to reflect the nature of the objective, company and the market in which it operates.

By its very nature, engagement only yields meaningful results in the long-term: an engagement objective can take up to three years to complete as it depends on a number of factors, such as the nature of the issue and how receptive the company is to engagement. Indeed, this long-term focus is aligned with our investment process.

We also log engagement issues at company-level. Engagement issues are defined as environmental, social, governance or strategic risks which are notable but not yet material enough to warrant establishing an engagement objective. Engagement issues aid the monitoring of engagement activity in relation to the identified issue. Our interactions with portfolio companies may or may not be linked to an issue or engagement objective.

Raise concern at appropriate level

1 Concern acknowledged by company

2 Company commits to credible change

3Change implemented

4

Milestone Progress

Figure 14. Our engagement milestones

Source: Hermes EOS. For illustrative purposes only.


32

55 Note: these statistics represent the 2018 calendar year. Engagements are conducted by both Hermes EOS and Hermes Impact Opportunities.

Figure 17. Issues and objectives engaged by geography


■ We made milestone progress on 50% of our engagement objectives (five out of 10 overall)

Figure 15. Issues and objectives engaged by E, S, G & S


Figure 16. Issues and objectives engaged by investment theme


2018 engagement and voting statistics55

3%2%

12%

12% 26%

45%

Australia & New ZealandDeveloped AsiaEmerging & Developing MarketsEuropeNorth AmericaUnited Kingdom

EnvironmentalSocial and EthicalGovernanceStrategy, Risk and Communication

28.3%

13.0%

23.9%

34.8%

Future MobilityImpact EnablersHealth & WellbeingFinancial InclusionCircular EconomyEducationWaterFood SecurityEnergy Transition

16%1%2%

5%13%

5%17%

14%

8%

VOTINGTotal meetings voted: 29

Figure 18. Voting in 2018


Figure 19. Voting breakdown: issues that we voted against/ abstained in 2018


Total meetings voted in favourMeetings where voted against (or voted against and abstained)Meetings where abstainedMeetings where voted with management by exception

48%

7%0%

45%

Board structureRemunerationShareholder resolutionCapital structure and dividendsAmend articlesAudit and accountsGovernance

12%

8%

4%

0%

4%

4% 4%

52%

12%

ENGAGEMENT ■ 80 interactions with companies overall – this equates to

2.8 interactions per portfolio company

■ 58 of these interactions were explicitly linked to issues and objectives


33

Reflections on the statistics■ The majority of our engagements focus on our portfolio holdings.

However, as part of our due diligence process to understand a company’s impact before we invest, we also interact with companies that we do not hold in our portfolio as well as other stakeholders such as industry initiatives, NGOs and standard setters. These engagements are not included in the above statistics. For example, we engaged extensively with a company which produces advanced biofuels – supposedly a more sustainable alternative to fuels that are currently used for vehicles and aviation. After several discussions with the company and other stakeholders and NGOs of the palm oil industry, we decided that the company’s commitments were not ambitious enough for it to qualify as a net positive impact company.

■ The vast majority of our engagements are based on the sustainability of a company’s operations – that is, its operational footprint rather than what it sells. Here, we would engage on matters such as employee turnover, remuneration and CO2 emissions depending on materiality.

■ Our share of ‘Strategy, Risk and Communications’ engagements is large due to our engagement on impact measurement metrics, which fall under communications. As part of our impact measurement exercise, we sought to understand the measurement methodologies that our portfolio companies use to calculate their metrics, as well as the limitations of these methodologies and the robustness of the data. We will seek to build on this initial engagement further in 2019.

Engagement highlights Our engagements, which we have conducted alongside Hermes EOS, were undertaken in many different forms: we attended annual general meetings, met board chairs and CEOs, and featured in the sustainability reports of some of our portfolio companies. As the Fund is just over one-year old, we have few meaningful engagement outcomes to report from 2018. However, we have collated a number of 2018 highlights. They include:

■ Bank Rakyat Indonesia: our engagement objective, which focuses on ensuring that its anti-money laundering, fraud and incentive system risks are managed robustly, progressed by two milestones. Additionally, the company’s chief financial officer (CFO) provided an update on the company’s Sustainable Finance Plan and we were pleased to learn that it covers lending and palm oil. We urged the CFO to adopt the Taskforce on Climate-related Financial Disclosures (TCFD) framework. We also assessed ESG training materials and performance indicators: devised for its relationship managers, the quality of the performance indicators are critical to a robust lending assessment for palm oil-related loans.

■ ProCredit: we attended the AGM of ProCredit, a leader in SME lending in emerging Europe that is underpinned by strong ethical and environmental standards. This provided us with an opportunity to meet senior management, including the heads of each regional bank, and the chair of the Supervisory Board to discuss the company’s long-term strategy and corporate governance.

■ Siemens Gamesa Renewable Energy: as proprietary director and executive chair of Siemens España, the chair of the board is not independent. Although the company has separated the chair and CEO roles, we would like to see a lead independent director in place to function as a conduit for shareholders as they are not directly represented on the board. In 2018, we set up an engagement objective to this effect; we have raised this matter repeatedly with Siemens Gamesa’s corporate secretary and general counsel.

■ Future-Fit Foundation: we introduced a few of our portfolio companies to the Future-Fit Benchmark – a free tool which identifies the environmental and social performance thresholds that all companies must ultimately strive to reach – to encourage them to holistically measure and report on their operational footprint. Like us, two of our portfolio companies, Ørsted and Novo Nordisk, are members of the Future-Fit Development Council. We have also helped the Future-Fit Foundation trial and develop its ‘Health Check’ tool – a resource that investors can use to get an initial sense of a company’s ‘future-fitness’. We are continuing this collaboration in 2019.

■ An OECD stakeholder workshop on the cobalt supply chain: at a stakeholder workshop organised by the OECD, we discussed how to implement the OECD and Chinese guidelines on the cobalt supply chain. After discussions with NGOs (PACT), mining companies with local operations (Umicore and Glencore), smelters and refiners (Huayou Cobalt) and downstream companies (Samsung Electronics), we concluded that progress towards eliminating child labour from the cobalt supply chain has been mixed. We urged companies to work together and, with the support of the OECD, address these systematic issues and political complexities between the central and regional Congolese governments. It also provided us with the opportunity to confirm that Umicore was considered among the most proactive in managing these supply chain issues.


For professional investors only. This document does not constitute a solicitation or offer to any person to buy or sell any related securities, financial instruments or products; nor does it constitute an offer to purchase securities to any person in the United States or to any US Person as such term is defined under the US Securities Exchange Act of 1933. It pays no regard to an individual’s investment objectives or financial needs of any recipient. No action should be taken or omitted to be taken based on this document. Tax treatment depends on personal circumstances and may change. This document is not advice on legal, taxation or investment matters so investors must rely on their own examination of such matters or seek advice. Before making any investment (new or continuous), please consult a professional and/or investment adviser as to its suitability. All figures, unless otherwise indicated, are sourced from Hermes.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Any investments overseas may be affected by currency exchange rates. Past performance is not a reliable indicator of future results and targets are not guaranteed.

Hermes Investment Funds plc (“HIF”) is an open-ended investment company with variable capital and with segregated liability between its sub-funds (each, a “Fund”). HIF is incorporated in Ireland and authorised by the Central Bank of Ireland (“CBI”). HIF appoints Hermes Fund Managers Ireland Limited (“HFM Ireland”) as its management company. HFM Ireland is authorised and regulated by the CBI. Further information on investment products and any associated risks can be found in the relevant Fund’s Key Investor Information Document (“KIID”), the prospectus and any supplements, the articles of association and the annual and semi-annual reports. In the case of any inconsistency between the descriptions or terms in this document and the prospectus, the prospectus shall prevail. These documents are available free of charge (i) at the office of the Administrator, Northern Trust International Fund Administration Services (Ireland) Limited, Georges Court, 54- 62 Townsend Street, Dublin 2, Ireland. Tel (+ 353) 1 434 5002 / Fax (+ 353) 1 531 8595; (ii) at https://www.hermes-investment.com/ie/; (iii) at the office of its representative in Switzerland (ACOLIN Fund Services AG, Leutschenbachstrasse 50, CH-8050 Zurich www.acolin.ch). The paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1/am Bellevue, P.O. Box, CH-8024 Zurich. Issued and approved by Hermes Fund Managers Ireland Limited (“HFM Ireland”) which is authorised and regulated by the Central Bank of Ireland. Registered address: The Wilde, 53 Merrion Square, Dublin 2, Ireland. Telephone calls will be recorded for training and monitoring purposes. HFM Ireland appoints Hermes Investment Management Limited (“HIML”) to undertake distribution activities in respect of the Fund in certain jurisdictions. HIML is authorised and regulated by the Financial Conduct Authority. Registered address: Sixth Floor, 150 Cheapside, London EC2V 6ET. Telephone calls will be recorded for training and monitoring purposes. Potential investors in the United Kingdom are advised that compensation may not be available under the United Kingdom Financial Services Compensation Scheme.

In Singapore: This document and the information contained herein shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a Hermes Investment Funds Public Limited Company prospectus, as supplemented with the global supplement, the relevant fund supplement, and the relevant Singapore supplement (the “prospectus”), describing the offering and the related subscription agreement. In the case of any inconsistency between the descriptions or terms in this document and the prospectus, the prospectus shall control. Securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. For the avoidance of doubt, this document has not been prepared for delivery to and review by persons to whom any offer of units in a scheme is to be made so as to assist them in making an investment decision. This document and the information contained herein shall not constitute part of any information memorandum. Without prejudice to anything contained herein, neither this document nor any copy of it may be taken or transmitted into any country where the distribution or dissemination is prohibited. This document is being furnished on a confidential basis and solely for information and may not be reproduced, disclosed, or distributed to any other person. This document has not been reviewed by the Monetary Authority of Singapore. In Spain: The information contained herein refers to a sub-fund (the “Sub-Fund”) of Hermes Investment Funds plc (the “Company”), a collective investment scheme duly registered with the Spanish Securities Market Commission (“CNMV”) under number 1394, the website www.cnmv.es may be consulted for an updated list of authorised distributors of the Company in Spain (the “Spanish Distributors”). This document only contains brief information on the Sub-Fund and does not disclose all of the risks and other significant aspects relevant to a potential investment in the Sub-Fund. Any investment decision must be based solely on the basis of careful consideration and understanding of all information contained in the Company’s latest prospectus, key investor information document (“KIID”) and the latest half-yearly and audited yearly reports. The Spanish Distributors must provide to each investor, prior to that investor subscribing for shares of a Sub-Fund, a copy the KIID translated into Spanish, and the latest published financial report. All mandatory official documentation shall be available through the Spanish Distributors, in hard copy or by electronic means, and also available upon request These documents are also available free of charge at the office of the Administrator, Northern Trust International Fund Administration Services (Ireland) Limited, Georges Court, 54- 62 Townsend Street, Dublin 2, Ireland, tel (+ 353) 1 434 5002 / Fax (+ 353) 1 531 8595, or at https://www.hermes-investment.com/ie. It is advisable to obtain further information and request professional advice before making an investment decision. BD004059 0006635 07/19

For more information, visit www.hermes-investment.com or connect with us on social media:

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HERMES INVESTMENT MANAGEMENTWe are an asset manager with a difference. We believe that, while our primary purpose is to help savers and beneficiaries by providing world class active investment management and stewardship services, our role goes further. We believe we have a duty to deliver holistic returns – outcomes for our clients that go far beyond the financial – and consider the impact our decisions have on society, the environment and the wider world.

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