ESG investing in the focus of institutional investors
An interview with Dr Hanno Kühn, Chief Investment Officer (CIO) and head of apoBank’s institutional investment business, and Hubertus Leonhardt, Managing Director and partner of SHS Gesellschaft für Beteiligungsmanagement mbH.
Düsseldorf and Tübingen , 22.7.2021
As the largest cooperative primary bank in Germany, apoBank is the number one financial services provider in the health care sector. Its business activities include advising institutional investors such as professional pension funds, pension funds, foundations and other collective capital investment institutions on all investment issues.
As CIO, Dr Hanno Kühn heads the Institute’s institutional investment business.
Tübingen-based SHS Gesellschaft für Beteiligungsmanagement mbH has been investing in medical technology, healthcare and life science companies since 1993, with a focus on expansion financing, shareholder changes and succession situations. Investors in SHS funds include institutional investors, pension funds and family offices.
Hubertus Leonhardt is Managing Director and Partner of SHS.
How has your business and day-to-day work changed since the outbreak of the Corona pandemic?
Dr Hanno Kühn, apoBank: As is the case with many other financial service providers, the majority of colleagues at apoBank have been working from their home offices since the outbreak of the Corona pandemic. This is working out well. As far as the institutional investment business is concerned, customers’ need for advice has increased significantly. We have been observing a corresponding trend among our institutional clients for several years now. So far, this was mainly due to the increased regulatory requirements and the persistently low interest rates. The classic direct pension investment alone is no longer sufficient to fulfil the promised target returns. It is much more important to take risks in a conscious and controlled manner. Covid-19 has now added to the general uncertainty in the market. As a result, the demand for independent risk assessments and sound reporting for documentation to internal and external supervisors is increasing. Since both are quite costly, many institutional investors seek our support here.
Hubertus Leonhardt, SHS: The last quarters during the pandemic were extraordinarily eventful for our portfolio companies and in the transaction business. For SHS, it was the most successful period since the company was founded, especially in terms of transactions. We currently hold more than two dozen investments in healthcare companies from Germany and Europe. Of course, some of these have also suffered from the pandemic, but all in all, our portfolio companies have grown, some even significantly. This is reflected in the performance of our private equity funds. Of course, this pleases our investors, who specifically focus on the investment theme of healthcare. Corona has brought the healthcare sector more into the spotlight. Politicians and society have recognised the outstanding importance of this sector. This has given us a tailwind.
Dr Kühn, apoBank sees an increased need for consulting services in the area of institutional investors in the future. What services do you offer your customers?
Dr Hanno Kühn, apoBank: With our consulting service apoConsult, we enable our institutional clients to optimise their strategic asset allocation (SAA) in a targeted manner. The basis for this is an asset analysis, which offers a comprehensive inventory of the entire capital investment and provides information about upcoming cash flows. At the same time, we determine the client-specific risk-return parameters and derive optimisation potential for the SAA. The subsequent implementation is carried out by a transparent and independent asset manager selection process, which delivers an optimal result for the investment strategy. We use our own proven risk management system for performance and risk reporting. This includes individual, detailed reporting and controlling, which provides the results of the strategy and the individual target investments on a regular basis and reviews them with regard to the agreed targets. The reporting can also serve as a basis for discussions with internal and external committees.
Sustainability, as was heard at an apoBank conference, is also playing an increasingly important role among institutional investors. What do your customers understand by this, and do investors actively approach you with the demand for ESG investing?
Dr Hanno Kühn, apoBank: We are observing that the regulatory requirements for our customers in terms of sustainability are constantly increasing. Currently, market standards for investment and reporting are being developed, which all institutions active in funded pension provision will have to observe and fulfil in the future. This is another reason why the demand for ESG-compliant investments is growing rapidly. ESG is not a new topic for professional investors, as the meticulous analysis of the “social” and “governance” components in particular is a fundamental building block for avoiding default risks. Even during the height of the Covid 19 crisis, sustainable investments proved their worth. The corresponding MSCI indices show that ESG investments performed significantly better than those that did not take sustainability aspects into account.
Mr Leonhardt, SHS has been investing in medtech/healthcare companies for 27 years. ESG investing is nothing new for SHS. What criteria do you use to select your investments?
Hubertus Leonhardt, SHS: We would expect the better performance of ESG investments mentioned by Dr Kühn in both private and public equity, not least because companies without a convincing ESG positioning have to deal with higher capital costs. At SHS, we have been guided by ethical standards in our investments for almost 30 years. This fundamentally excludes ESG-critical industries such as fossil and nuclear energy, tobacco, alcohol and weapons. Within the healthcare sector, we also exclude pre-implantation diagnostics or work with embryonic stem cells. The healthcare sector continues to offer very good growth opportunities and investment opportunities for us as a specialised private equity firm. We have an experienced Head of ESG at partner level in Dr André Zimmermann, who ensures that ESG criteria are met. Operationally, we use the analysis tool of the European Private Equity Association, which we have adapted to the healthcare sector.
SHS is currently planning its sixth fund, SHS VI. Who invests in SHS funds, and are there any requirements on the part of fund clients with regard to sustainability and ESG?
Hubertus Leonhardt, SHS: Our fund investors include many institutional investors, including pension funds, provident funds, churches, health insurance companies and industrial companies. In addition, there are family offices, HNIs and, of course, the SHS managers themselves. Especially among institutional investors, who are committed to their clients or pension beneficiaries, the topic of sustainability and ESG has gained a lot of importance, and the portfolio managers rightly expect that the ESG requirements are also comprehensibly observed by the portfolio companies and that this is documented. But of course institutional investors to whom ESG is important also have a clear return orientation. This comes with the condition: We would also like to have an impact in the social sphere. This can of course be achieved well with an investment in the healthcare sector.
Dr Kühn, what advice do you have for institutional investors who want to invest sustainably but also value a good long-term return? How do you dispel concerns that sustainability and returns do not go together?
Dr Hanno Kühn, apoBank: As already explained, for us ESG-compliant investments are closely related to the avoidance of default risks. Especially in a low-interest phase, price losses or even total defaults hurt twice as much and should be avoided at all costs. We provide support in this regard with our independent creditworthiness analysis APO Score. In addition to a large number of qualitative and quantitative factors, the scoring procedure also takes sustainability criteria into account. Among other things, we examine the efforts of issuers to improve their ESG position. If these goals are achieved, this can have a positive effect on the price value of a bond issue, for example. The sustainability effort then pays off for the investor. At the same time, we aim for the best possible balance between return and risk in the institutional investment portfolios we manage. Against this backdrop, sustainable investing contributes greatly to the stability of portfolios – an important aspect for any commitment-oriented investor when it comes to fulfilling the return promises made to their clients.
What role does the medtech and healthcare sector play in your investment considerations, Dr Kühn?
Dr Hanno Kühn, apoBank: The health care market has been attracting increased attention from institutional investors for some time now, as it is showing significant growth rates worldwide. As a bank specialising in the health care sector, we also take this into account on the investment side – through various investment alternatives for private and institutional investors. For institutional investors, investments in the healthcare market become particularly interesting when combined with private equity, an asset class that has significantly outperformed in the last decade.
Mr Leonhardt, what influence does SHS exert as a private equity investor to embed the topic of sustainability and ESG in its portfolio companies?
Hubertus Leonhardt, SHS: We have always seen ourselves as an active private equity investor, and our investors know that. This means that we are always represented on the advisory board or supervisory board of our portfolio companies and promote sustainable action. In addition, the ESG progress of our investments is regularly documented in a monitoring system, so that improvements can be shown over longer periods of time. However, since we already apply ESG criteria in the selection process for our investments, we are actually always dealing with contacts in the portfolio companies who have the topic of ESG on their radar screen.
In view of the Corona pandemic, which has not yet been defeated, the topic of healthcare has become much more important, also for Germany as a business location. How do you see the healthcare sector developing in the next few years?
Dr Hanno Kühn, apoBank: The health care market is an absolute growth market. On the one hand, this is due to demographic change, which ensures long-term growth in demand: in industrialised countries due to increasing life expectancy, in emerging countries due to rising prosperity. On the other hand, it is due to technological progress and the increasing digitalisation of the industry that goes hand in hand with it. Where health and IT meet, new business models emerge that improve the efficiency and effectiveness of health systems in innovative ways. The fact that the health market has proven to be relatively immune to economic fluctuations makes it even more attractive. The latter is particularly evident at the moment: Covid-19 has made the healthcare industry even more strategically important, which should further fuel takeover activity in the sector.
Hubertus Leonhardt, SHS: I see it exactly the same way: the health market is a growth market with a future. You can see that in the transaction market, which is really booming. International groups are often on the lookout for innovative medtech SMEs or promising growth companies. With these acquisitions, the big players want to complement or round off their product range. German and European medtech companies are among the most innovative in the world. In terms of patent applications, the industry has been top for years. Digitisation will give the healthcare industry, which is strongly characterised by small and medium-sized enterprises, an enormous boost because politicians have also recognised in the last 12 months that the poor level of digitisation in our healthcare system is no longer acceptable. Then there is artificial intelligence, which some experts say will revolutionise healthcare. Healthcare companies that accept this challenge have very good prospects – whether medium-sized or growth companies. We will actively accompany this development and provide targeted support with our SHS funds. The constant interest in our portfolio companies makes us confident.
What advice do you have for institutional investors in these times?
Dr Hanno Kühn, apoBank: The first order of business is to remain calm. Those who have set up their portfolios in a balanced and broadly diversified manner and hedged them accordingly will be able to let the current volatility in the market pass them by largely unperturbed. It is important to regularly review the strategic asset allocation and to continuously monitor the risk.
Hubertus Leonhardt, SHS: Diversification across all asset classes is indeed an important topic. In the search for absolute returns, an allocation to private equity can be a sensible strategy for asset investment. We see that many investors are expanding this area. Particularly for institutional investors in the area of pension and benefit management, I would recommend that they look more closely at the dynamic and resilient healthcare sector. In a way, healthcare is also a hedge against actuarial longevity risks. It certainly makes sense to then consider this in both the liquid allocation and the private equity allocation. For both areas, I would look specifically for sector specialists in the universe of portfolio managers.
Thank you very much for the interview.