Sometimes words speak louder than actions. This is particularly true for those looking to improve corporate cultures. Investors sitting down to talk with the leaders of their portfolio companies to facilitate change instead of simply throwing their hand in the air to vote against them at AGMs is becoming a crucial part of environmental, social and governance (ESG) investing.
More commonly known as engagement, holding such discussions with companies behind the scenes is designed to create change in areas that include recruitment, harmful gas emissions or transparency among others.
“Through engagement we aim for change,” says Carola van Lamoen, who leads Robeco’s active ownership team.
Engagement is a big part of helping investors to build a more sustainable world. Indeed, active ownership is one of the United Nation’s six Principles for Responsible Investment (PRI).
Engagement typically takes two forms: gathering information to understand a company’s ESG profile and to change behaviors.
Helena Viñes Fiestas, head of sustainability research at BNP Paribas Asset Management, says that engagement is part of the fiduciary duty. “How are you going to understand what a company is doing unless you are engaging with them?” she adds.
This is a big issue for BNP Paribas AM. Since 2016 it has changed its voting policy to include ESG factors twice. So if, for example, a company will not provide information on carbon emissions or their 2-degree strategy, the asset manager will vote against the board’s nominations.
Engagement is about changing behaviors, not business models. It will not, therefore, help those who invest in a tobacco company but don’t approve of smoking or those with a low carbon policy backing an energy company that generates most of its power from coal.
MAKING AN IMPACT
There are various categories of engagement. First there are conversations targeting governance, which tends to be a priority for investors. “When there is good governance there tends to be good management of ESG issues,” Viñes Fiestas says.
Then there are investors or portfolio managers speaking to companies about ESG issues. There are also industry-wide projects, such as encouraging sectors to improve access to medicine or nutrition. Finally, there is emergency engagement which takes place in the aftermath of a scandal.
Measuring the impact of these dialogues could be difficult. This is especially true when it comes to long-term issues, such as climate change. It is difficult to know if a decision made by a company was the result of something you said or a result of pressure from the other parties in society that are working to tackle the issue.
Asset manager Robeco has enjoyed a dialogue with Royal Dutch Shell for years and in 2018 there was a breakthrough. In collaboration with the Church of England and others, the asset manager persuaded the oil giant to set climate targets, the success of which are linked to the amount it pays its executives. This is believed to be the first oil and gas company to commit to such a policy.
Ian Burger, head of governance at Newton Investment Management, says: “If engagement didn’t work, we wouldn’t do it.”
He points to getting a US consumer goods company to produce a corporate social responsibility report following several meetings with management as one of the firm’s successes.
So the strategy is effective, but success is not guaranteed. If an engagement team fails to persuade a management team to provide it with information or make changes after several requests, the option open to long-term investors is to divest.
“It would be incorrect for me to say that we are always completely successful,” Burger says. “There are occasions when engagement has not had the desired effect, which has ultimately led us to divest or not invest in the first instance.”
Success in engagement is not just about Royal Dutch Shell or BP announcing that they are investing more in cleaner energy sources. It can be the little things that can make a difference to have companies are run too.
A WIDER STRATEGY
“Engagement is different from voting. Engagement is starting a conversation proactively,” van Lamoen says, pointing out that voting at AGMs is a more reactive form of active ownership.
Most engagement between companies and investors happens all year round outside of AGMs, but public meetings with shareholders do have a role to play.
“Sometimes a shareholder proposal is a last resort, a sign maybe that engagement failed,” says Alan Brett, head of corporate governance ratings research at MSCI. “It is an extra lever to make sure that you are listened to when companies are not listening.”
From the people I have spoken to for this article, engagement appears to be a strategy that is more popular in Europe than the US, where filing resolutions at shareholder meetings tends to be the preferred route creating change across the Atlantic.
“In Europe, it is more under the radar, it is more subtle, but it definitely works,” says David Czupryna, Candriam Investors’ head of ESG client portfolio management. Engagement is not a policy that should be used in isolation. It is not a substitute for integrating ESG into your investment decisions. “When you integrate ESG you are doing a risk management exercise,” Viñes Fiestas says. “Engagement is about the companies that you want to continue investing in.”
So it is clear that engagement is part of an overall strategy that starts with an ESG policy. “To get the most benefit from engagement we believe the most effective approach is to integrate it within the investment process,” Burger says.
Mette Charles, a senior investment research consultant at Aon, adds that you need a responsible investment policy first to be able to spin-out the engagement policy. “Engagement is going to be more effective if you know what your stance is, so you know what you need to insist on.” Her colleague, investment consultant Tim Manuel adds: “What are you engaging on if you don’t have an ESG policy?”
Collaboration is an option to get companies to listen, especially larger companies in the FTSE 100 where it is difficult to build a sizeable stake.
Climate Action 100+ is an engagement group backed by investors globally to ensure the world’s largest greenhouse gas emitters take action on climate change. Other groups include ShareAction, a charity that promotes responsible investment. “We work with other shareholders to increase our influence,” Czupryna says. “Collaboration is essential in getting companies to listen.”
Indeed, Candriam joined 10 new collaborative initiatives in 2018, which included Climate Transition for Oil and Gas, Plastic Solutions Investor Alliance and the UK Living Wage Engagement Campaign.
One of BNP Paribas AM’s collaboration successes involved a rouge pharmaceutical company. Three years ago, the bank discovered that products made by four of its portfolio companies were being used to execute prisoners in the US. After holding discussions, one company was not as open to change as the others were. In response, BNP Paribas AM formed a pressure group with other shareholders and the Dutch government (because of where the company was based). The strategy worked and the pharmaceutical agreed to introduce distribution control systems.
“A collaborative approach is needed as a number of different people have to be involved to achieve results,” Brett says.
Collaborative action does not necessarily mean that you are positioned against management, Burger says. “We have worked hard with management for them to recommend shareholders to support the shareholder resolution that we are co-filing [at BP’s AGM this year], so they will recommend voting in favour of it.
“I don’t remember seeing a shareholder resolution on a US company AGM agenda where management has recommended that shareholders you support it,” he adds. Increased collaboration is not the result of just the will to work together. The regulator has made it easier for investors to work together by clarifying the takeover rules a few years ago to allow collaborative engagement where investors would not be acting in concert.
“That was a key decision that enabled a lot of this action to start happening,” Brett says. “Before then investors would have been concerned about being caught out by the rules.
“Certain topics are now seen as fair game on what they can work on collaboratively, as long as they are not becoming insiders and are trying to influence strategy, they have more leeway now following the ruling,” he adds.
PLAYING THE LONG GAME
Of course, institutional investors do not have the time or resources to engage with every company in its portfolio or to vote on every issue at AGMs. That could mean that they have to consider thousands of issues across various companies every year.
Then there is the time issue. Robeco’s van Lamoen advises investors to be patient as engagement dialogue can take years to make an impact. “Change does not happen overnight,” she adds. “If you have an engagement conversation today the company does not typically change tomorrow.” Burger agrees that the time it takes before action stems from engagement is a “how long is a piece of string-type question”.
“Generally, a couple of years are required for change to come through fully, so you need to be patient and persistent,” he adds. “That is one of the areas where we have struggled in terms of reporting and evidencing the success of our engagement,” he adds, pointing out that the firm reports each quarter on where it has engaged with companies, and what on, in terms of ESG.” Charles says that there is a lot of pressure on investment managers to report on their engagement policy, but there is still a long way to go. “This is still early days. Engagement reporting is still poor. Transparency is still poor.
“Waking the corporate world up to the need and demand for transparency of what they are doing is still early days,” she adds. Manuel adds that the reporting on what managers are doing in terms of voting is better than it was, but this is just one part of engagement. “Where it is not as good is on the broader engagement that they are having with organisations outside of the voting cycle.”
Charles adds that reporting on engagement and voting tends to be generic. “You don’t get down to the nitty gritty.”
Part of the problem is that managers can participate in thousands of votes each year, which focus on administration issues, governance and some that involve ESG. “How can reporting in granular way on that much activity is quite a challenge,” Manuel says.
To be a “good sparring partner” for a company you need to do your homework, be constructive and don’t aim to make headlines, says van Lamoen. “We are active not activists.”