Embedding ESG in your investment portfolio
How to be an active steward
The pressure on pension schemes and asset managers to act as active stewards is mounting. Consumer concerns about climate change and egregious remuneration practices are forcing the industry to review how to be an effective and responsible investor. Meanwhile the UK Government has promised to consult on changes to the ways pensions schemes should carry out engagement as part of their stewardship obligations1.
The first step for an institutional investor is to determine its stewardship beliefs. That should include a plan for how it should approach environmental issues as well as which social policies and governance practices it wants to support.
In our opinion, there are two aspects to acting as a responsible investor – firstly a scheme needs to determine how it will use its voting rights, such as:
Secondly, it needs to determine how it wants to engage with companies to influence corporate behaviour. Both should be covered in a responsible investing pledge.
Once a philosophy has been determined, the next step is to establish how to turn these ideas into investment practices. For example, institutional investors have a number of ways they can manage their voting rights. They can decide to do it themselves, ask their asset managers – and set ‘red lines’ for the standards that they expect from them – or request a third party does it for them.
Examples of ‘red lines’ include:
Though in theory it’s possible for a pension scheme to do this itself, this can be challenging in practice. Both investors and managers can benefit from the services of proxy voting services because such providers collate the myriad of notices about annual general meetings and the voting options.
Once these votes have been collated, they need to be centralised, ‘quality controlled’ and prioritised. This data helps the stakeholders decide how to vote because it provides a summary of the issues as well as the options available.
The ability of an asset manager to use the data from the proxy voting services effectively will vary. For example, an active manager with a constrained portfolio should be a highly effective steward. They will have carried out the necessary research on each stock selected for their portfolio so should understand the issues affecting each company.
The job for a provider of passive vehicles is, however, more complex. These companies have not handpicked the stocks to be included in their products – they are instead selected to provide the best replication of the index.
In addition, these managers are often providing trackers of global securities, which will cover thousands of the different stocks. There are, for example, 1,636 stocks covering 23 developed markets in the MSCI World index. And that’s just one benchmark: passive providers may offer multiple global indices across numerous asset classes.
As a recent investor stewardship report produced by Willis Towers Watson said, the stewardship job at an index provider is vast: “It requires corporate engagement on dozens of complex issues covering close to 10,000 companies, voting on tens of thousands of resolutions, regionally fragmented public policy engagement, research, disclosure and external communication.”*
Index providers should, in theory, have the scale to build the teams required to take on this sizeable challenge. In the past, however, they have not done this:
*Source: Willis Towers Watson 2019 ‘Investor stewardship: One hand on the wheel?’
In theory, index providers could address this challenge by building their own internal expertise but it might make better sense to outsource this to a specialist organisation.
Such an organisation can do much more than proxy voting services – it can invest in the teams needed to research the tens of thousands of available securities in order to make exercising voting rights effective.
By working with a number of different large institutional investors it would have the necessary influence to help make meaningful change at corporations. For example, by commanding a sizeable minority of the shares, it can ensure companies address global warming.
Institutional investors are going to face growing pressure to act as effective stewards by engaging with companies to affect meaningful change. If an index provider cannot provide the level of stewardship service required by its increasingly demanding institutional investors, it should instead look to contract out these services. In our view, pension schemes will choose to work with managers which have taken the right steps to address these challenges and can demonstrate this in their portfolio.
1 June 2018: Government Response to Advisory Group
Photo credit: Felicity Kerridge
A version of this article was previously published in Funds Europe
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