Federated Hermes is known for its specialism in sustainability strategies, but its latest release was particularly eye-catching: a biodiversity fund launched in partnership with London’s Natural History Museum. While interest may have been especially piqued for Brits fond of fossils, the fund itself had an interesting evolution.

Managed by Ingrid Kukuljan, head of impact and sustainable investing, the Article 9 fund has six themes: land pollution, marine pollution and exploitation, unsustainable living, climate change, unsustainable farming and deforestation. Each link to UN Sustainable Development Goals (SDGs).

As part of our mission to uncover the product development process, Citywire Amplify spoke to Hermes’ head of product Stuart Ballard to ask how the idea was developed, how it’s been brought to market and how it expects to deliver tangible results – both financial and biological.

Citywire: Where did the fund’s development begin?

Stuart Ballard: One of our clients came looking for some of our best ideas of what we hadn’t done.

We pulled together a variety of things that we hadn’t commercialised or brought to market, and this was one of them. The impact team had already been thinking about the sub-investable themes of their strategy, and there had been a lot of engagement from our stewardship services, EOS, on the theme of biodiversity with companies.

We pitched it to the client back in January 2021, at a high level. They wanted more information. We took it away and over the following month or two started to look at what a paper portfolio could look like, the parameters of a product, objectives and what types of company would or would not fall within the scope of something biodiversity related.

We got down to the last few ideas this client had. They were talking to other managers. Ultimately, they went with someone else, with a different idea, not biodiversity-related.

We’d done so much great work on it already, we decided to test this a little bit more broadly. We set meetings with other clients, hosted some breakfasts and teased the idea. We got feedback on features and on interest in the strategy. It started to gain quite a lot of momentum, to the extent that by June we had something really interesting and credible.

In Morningstar’s Ecology sector there were lots of different environmentally centric funds, but not very much strictly biodiversity-related, and nothing quite like this.

We started the process of developing it in earnest, without a pre-identified seed client, in June. Then by August/September, we started putting regulatory documents in, operational set-ups, to get the fund authorised in Q3, Q4, and ready for launch at the start of this year. At which point, we did identify seed clients and went live with third-party capital on day one.

CW: Is it normal to seed so late?

SB: It depends on the type of strategy. Something like this, which is so different, so esoteric, you’re not looking at a commonly made investment allocation by investors.

Who are the competitors? What do they do? How do we do it? You’ve got to consult with your clients more, to test the concept, because the market intelligence isn’t there in a structured format. Through the process of creating a product, in consultation with clients, you identify seeding clients: people that come along with you on the journey have had a say in the creation of the strategy.

CW: Who was involved?

SB: In the product team, we’re very familiar with the Ucits rules, and the regulatory and operational complexities. So product and investment worked very closely. Once we felt like we had something viable, we helped coordinate a session to train all of the sales teams on this idea. The investment team was pitching to all of the sales teams, to gain their feedback, and to understand it. Which then facilitated the sales teams going out to some clients.

The process of pulling something together that could be put in front of the client heavily involves our marketing function, which needs to make sure that they’re putting something together compelling. And our compliance teams, of course.

Then we moved into the product-build phase. We get everyone from the business involved. All of our operations and middle office, our trading desk, marketing, legal, tax, the whole breadth of the business – the press team, of course.

In product, we coordinate that activity, to make sure that everyone’s getting involved at the right time, contributing to the right part of the process, so that we can move from an idea through to a live product.

CW: What about the museum relationship?

SB: The first conversations took place at our COP26 #FurtherFaster event in Glasgow, in October last year.

Our impact team learnt about a set of biodiversity impact data, which the Natural History Museum’s experts had been developing. It has created something called a Biodiversity Intactness Index, which looks at estimates around biodiversity loss, biodiversity data, ecosystems, species and populations. While our impact team had already been using its own data sources, it saw an obvious overlap. Our team has been working with the museum, looking at these data sources and how they can be refined into investment pieces.

But we wanted to contribute back in some way. The museum wasn’t looking for us to pay for that data. It’s all open-source. But we wanted to give 5% of our net revenue from the product to worthy charitable causes and the museum seemed like a natural fit.

CW: Why Article 9 and how does it help?

SB: I’d go as far as to say there wasn’t any choice other than Article 9. It was a question of how we technically meet the criteria.

Biodiversity loss and restoration is one of the EU’s six taxonomy objectives. Those objectives are very heavily linked to the Sustainable Finance Disclosure Regulation (SFDR). We had to ensure sufficient overlap with the EU’s technical criteria for contributing to biodiversity, and do no significant harm to biodiversity through the types of companies we invest in.

We’ve had an SFDR and taxonomy-related project ongoing for some time. We used the insight from that project to inform product design. We structured the legal documents in such a way that we made sure we were answering the questions of the regulation, despite the regulation not being fully enforced when we were coming up with the design.

In the design phase, it was quite an easy fit. Where it becomes more challenging is in the reporting phase. Biodiversity related data for companies is not easily available. Where we can get information on carbon footprint relatively easily, getting information on a company’s operations, and how it can negatively or positively impact biodiversity, is something that you can’t just source off of an open database.

We are investing with a degree of confidence, but we don’t have access to all of the data points. No one does at this stage.

CW: What does Sonya Likhtman from EOS do?

SB: We have EOS, which is our engagement services platform. With a few products that we’ve launched, notably the SDG Engagement Equity and the SDG Engagement High Yield strategies, we had taken a dedicated resource out of EOS to help support the investment team. We work closely with them on tailoring the engagement to the strategy, for the names within that portfolio.

Sonya’s role is to ensure there’s engagement with the companies in the portfolio on topics like climate change, deforestation, sustainable food and plastics. She’s there to make sure they are not just contributing strongly to biodiversity, protection and restoration, but make sure that they are not negatively contributing through their operation and through the supply chain.

The engagement resource is focused on getting that information from the company, understanding their operating model, understanding their processes and helping them to improve.

CW: Why does the fund sit in the Morningstar Ecology sector?

SB: The challenge with these types of funds is it’s very hard to benchmark them. You have a global portfolio, so you may use the MSCI World for performance comparison, but the style of investment you have, as a high-conviction, concentrated portfolio of impactful names, is not going to perform in the same way as a benchmark. You might compare it to a peer group. But the peer group is diverse in what it’s seeking to achieve and the types of companies that those funds are investing in.

We looked at the other funds in that Morningstar Ecology grouping, and there wasn’t a single fund that we had more than a 20% crossover in portfolio holdings with. Our fund is materially different. If you compare them from a peer-group perspective, they’re going to perform wildly differently. Investors need to understand the process, they need to understand what they’re buying, the themes they’re buying into, and what that’s likely to result in as a performance outcome in different scenarios. Comparing it with a third-party property isn’t going to give you anything.

That group of funds within Morningstar, over the past five years, has grown from about $11bn (£8.8bn) to $82bn (about two-thirds European cross-border funds). A lot of that growth happened in the past two years.

CW: Who are the target clients?

SB: We’ve had expressions of interest across wholesale and institutional, across pension clients. The interest has been across Europe, UK and Apac. It’s interesting: a strategy of this type is not region-specific. It’s not tailored towards a certain client type. It’s a very thematic, very esoteric product.

CW: Does technology help with a fund like this?

SB: The impending SFDR and taxonomy-related regulation is making it mandatory for people to report on certain metrics. As a result, the data providers will be asking companies to provide it. There are huge tech- and data-related elements in regards to ingesting all of this information, quality-checking it, and making sure it’s appropriate.

Then doing something interesting with it, not just for regulatory reporting, but making client reporting quite interesting. Our clients will expect to see the impact of their capital. We’re at the very, very early stage of this product, and it’s going to be a huge challenge. The amount of data we have available to us is only going to increase.