Maybe you have heard about “active ownership”? It means that shareholders are taking a more active role in ensuring that companies they are investing in are operating responsibly and more sustainable. Although active ownership is a positive step, it is only part of the solution. Active ownership is an important way to make companies responsible for sustainability issues, however, it does little to improve the sustainability of companies whose core product provision is harmful. In this article, we take a deeper look at active ownership – pros and cons – and we discuss what the best strategy is for investing sustainably.
The field of Environmental Social Governance (ESG) investing – in many cases referred to as sustainability investing – has exploded over the last 15 years. In the past, ESG lay at the margins of the investment landscape, playing little role in the investment decisions of institutional investors. Today, the landscape has changed, with talk of ESG moving firmly into the mainstream of the institutional investment industry. More than a quarter of the $88 trillion assets under management globally are now invested according to ESG principles, a McKinsey & Co. study found. At face value, this looks encouraging, with many of the world’s largest institutional investors committed to investing responsibly.
The question that needs to be asked, however, is what investing ‘responsibly’ actually means in practice, and whether these commitments are being backed up with action. One way in which institutional investors claim to promote ESG in their investments is through “active ownership” strategies, in which they engage proactively with companies on ESG issues. This can take a number of forms, including shareholder resolutions and proxy voting, informal dialogues and active monitoring, all with the end goal of improving the ESG policies of a company.
A force for good
Active ownership strategies have undoubtedly created positive change in the past. In 2016, Trillium Asset Management filed a resolution to protect LGBT workers from discrimination in the employment policies of transportation company J.B Hunt. Despite the company’s board strongly recommending that shareholders vote against the proposal, the vote passed with 54% in favour of the resolution. Even the biggest companies in the world have been influenced by active ownership. For years the organisation who manage the pensions of California Public Employees, Calpers, engaged with Apple to ask it to improve board accountability by relinquishing the plurality voting model that allows multiple candidates to the board to be elected with a single vote. A Calpers proposal at the 2011 Annual General Meeting won the support of 73% of Apple shareholders and a similar proposal in 2012 over 80%, leading Apple to eventually agree to change.
This move towards active ownership can be seen across the investment space. Blackrock, the world’s largest investment management company, with $6.3 trillion in assets under management, sent waves through the investment world with a letter to the CEOs of every company in Blackrock’s portfolio, encouraging them to consider the societal implications of their business decisions and to focus on their long-term plans.
Does it always have an effect?
This move is a positive one and can tangibly impact the ESG policies of companies. Nonetheless, this is far from the full story. For companies in ‘neutral’ industries, whose core product provision is not creating significant harm or damage, active ownership can be an effective means for positive impact. However, for companies whose primary product provisions destroy the most value, in industries such as fossil fuels, tobacco and weapons, these shareholder resolutions are a mere drop in the ocean in terms of improving their ESG performance. In 2015, BP, Shell and Statoil all received shareholder resolutions proposing that they improve their climate reporting standards. These resolutions passed – an example of successful active ownership. However, improving climate reporting standards is one thing, but the damage done by fossil fuel companies in their day-to-day operations far outweighs the positive impact created by the passing of the climate reporting resolution. And unfortunately, this imbalance seems to have had few consequences, as shareholders have held on to their investments and continued to legitimise companies’ irresponsible and unsustainable behaviour.
A recent report from shareholder advocacy group As You Sow, on investor engagement with fossil fuel companies, found that 160 climate change shareholder resolutions were filed at 24 US oil and gas companies between 2012 and 2018. However, none of these companies have adopted plans or targets to cut greenhouse gas emissions from burning fossil fuels and most are investing to maintain or expand production. Active ownership, in these cases, often does little to improve the sustainability of the most harmful companies, who are unlikely to change behaviour surrounding their core product provision.
Let’s refer quickly back to the example of Blackrock. The letter to the CEOs of their portfolio companies professed their commitment to only having socially responsible companies in their portfolio, and was accompanied by a wave of positive PR. However, the leading asset managers can and should do more to set the tone on sustainable investing. As the world’s largest investment management company, Blackrock has repeatedly topped PAX’s ‘Don’t Bank on the Bomb’ report, which highlights who invests most heavily into nuclear weapons. This means there is still work to be done. Blackrock, with their letter to CEOs, took a huge step in raising the profile of sustainable investing and engagement. Now, to convert on this promise, they have the responsibility, as well as the capacity, to be a leader in divesting from harmful industries, such as weapons, tobacco and fossil fuels.
How do we solve this?
Primarily, the answer is through negative screening and divestment. This refers to avoiding entirely investing in companies or countries which do not meet ESG standards, or avoiding investing in “sin stocks”, referring to the weapons, tobacco and fossil fuels industries among others. By divesting from or screening these investments, investors can set the foundations for a truly responsible portfolio – as well as send a clear signal to the companies left out. Blackrock themselves have shown that negative screening is possible, with the creation of two “gun free” investment funds.
Passive investors, including many pension providers, have argued that because they are invested in indices, within which a single company out of many may be harmful, they cannot divest because it would mean divesting from the entire index. This argument is holding less and less, with the emergence of many indices ranking companies on different aspects of their ESG performance, such as the Dow Jones Sustainability index and the FTSE4Good index. Indices like these allow passive investors to divest or negatively screen harmful companies, opening them up to invest in companies who have a positive impact on society.
Investors cannot claim to invest sustainably until they divest, and continue to exclude through negative screening, companies who are actively damaging the environment and society as a whole. There are an increasing number of options to avoid these companies in investments with the emergence of sustainable indices and companies offering divestment and screening services.
As we have seen repeatedly, active ownership is an important and powerful way to change companies for the better on ESG issues. Nonetheless, whilst an investor is still invested in value destroying companies, active ownership is at best, insufficient, and at worst amounts to “green-washing”, covering up their bad investments. Only after harmful companies have been excluded from an investor’s portfolio, can the impact of active ownership and other positive value creating methods start to truly make an investor “sustainable”.