Investor engagement can help companies minimise their exposure to financially material risks, including environmental, social and governance (ESG) factors, and maximise their long-term potential. However, to be effective – particularly in this period of rapid technological advancement and societal change – investors need to focus their engagement on the issues where they can have the greatest impact.
Forward-looking value creation
As responsible managers of investment assets on behalf of our clients, engagement with investee companies plays a crucial role in the management of all our investment portfolios. Without effective stewardship of the assets that we oversee, ESG risks can proliferate and bad practices can be left to fester, potentially destroying value and undermining returns.
To help mitigate these risks, our engagement programme has both a company-specific and thematic focus. At the company-specific level, we engage with companies proactively when financially material issues are identified by our research analysts, portfolio managers and stewardship experts. We also engage reactively when there has been a breach of international norms or a particular controversy has come to light that could have a material impact on returns.
At the thematic level, we engage more broadly on the wide-reaching ESG issues that we’ve identified as carrying the most serious long-term risks to the companies in which we invest. The aim is to set out our expectations to company management teams on our ESG priorities, while the companies themselves have the opportunity to report on the progress they are making on these vital environmental and societal issues. With the right information, investors can push companies to set targets, or put in place realistic timeframes for crucial ESG improvements to be made.
At all stages, our objective is to use the access we have to company management teams and boards, based on the mutual trust that we have built up over time, to encourage long-term positive change and manage material ESG risks with the goal of driving value for investors.
Maximising impact and influence
At the company-specific level, we often find that engagement can have a big impact on small things and a small impact on large things. For example, when engaging with smaller and medium-sized companies, or emerging market companies, we may be one of the few large investors to be having in-depth discussions on ESG topics. We look to use our expertise, and our access to senior management and the board, to help address ESG risks directly. Through our engagement, we’ve assisted a mid-sized hotel group with its cyber security risk management and advised a smaller oil group on its carbon pricing strategy, among other recent successes.
When it comes to the specific issues and broader themes impacting the largest, multi-national companies, it’s often the cumulative impact of regular feedback and engagement from many like-minded asset managers, asset owners and wider stakeholders that achieves the biggest outcomes. While we focus on one-to-one engagement with companies, we also partner with other stakeholders as members of sustainable investing and corporate social responsibility initiatives when we feel we can play an active role to influence change.
On the issue of gender diversity, for example, we’re active members of the 30% Club, which works to encourage greater female representation on company boards. And on the issue of global warming, we work closely with Climate Action 100+, among other shareholder and investor organisations, to urge the world's largest corporate greenhouse gas emitters to take action on climate change risks.
The power to persuade
Perhaps the most important thing, whether conducting company-specific or thematic-level engagement, is to engage regularly and for the long term. Engagement isn’t a quick win, or a box-ticking exercise, and real change doesn’t happen overnight. We look to maintain close contact with the companies in which we invest, with our analysts and stewardship experts often building relationships with company managements over many years, even decades. As long-term investors, we have the opportunity to build trust and gain influence gradually, over time.
Our recent engagement efforts with Rio Tinto regarding its mining operations in Western Australia are illustrative. Following the explosions in 2020 that destroyed the Jukkan Gorge in Pilbara, a site of significant archaeological and cultural importance, we engaged intensively with Rio’s management team on its response to the controversy. Incidents such as these can have a material financial impact thanks to potential fines and operational disruption, while a company’s social licence to operate can be threatened if it loses local community support, with potentially serious consequences for future profits.
Given the risks involved, we wanted to ensure that appropriate remedial action was being taken urgently and comprehensively. Our repeated engagement focused on Rio’s efforts to resolve the governance, business culture and controls failings that we’d identified. We called for clear accountability and transparency of the findings of independent investigations. Or engagement contributed to a series of ongoing management, board-level and corporate reforms, including the publication of a social and communities report detailing the progress that Rio has made to prevent similar issues from happening in the future.
Tackling the biggest ESG risks
Engagement isn’t just about reacting to ESG incidents and controversies. We also use our authority as large shareholders and investors to proactively encourage companies to take action on the major ESG themes that could have a material financial impact on their future operations.
Climate change is a case in point. With COP 27 highlighting the urgent need for climate action, it’s clear that reaching net zero is central to the transition of the global economy away from its dependence on fossil fuels. As such, net zero is also a key business challenge for many of the companies in which we invest. Companies that fail to set out clear plans to manage the energy transition could end up facing significant financial penalties or losing market share – even in sectors where decarbonisation is particularly challenging, such as steel, cement and transportation.
To reflect this reality, our climate engagement has moved well beyond simply asking companies about their current emissions and carbon reporting, with the emphasis now on their future plans and the action they are taking to mitigate climate risk. We want to know how companies are planning to remain competitive and profitable while sticking to a transition pathway that keeps the temperature rise as close to 1.5oC as possible.
As well as climate change, we engage with companies on five other long-term ESG themes: human capital management (including gender diversity and the rights of indigenous groups); stakeholder engagement (such as cyber security and supply chain management); governance (capital allocation, board composition etc); long-term strategy alignment (which is closely linked to executive compensation); and more recently we’ve decided to add natural capital and ecosystems, reflecting the importance of the economic relationship between companies and the natural world.
These themes are the biggest, most panoramic ESG issues that we believe have the potential to affect the widest range of companies, based on our own research and on feedback from our clients. Importantly, these themes are not fixed and will evolve over time. We will also engage tactically on shorter-term ESG themes as they arise, such as health and employee issues raised by the Covid pandemic.
At the interface of ESG risk and return
ESG risks can significantly impact a company’s ability to grow profits, create value and generate returns for shareholders. By harnessing the information gathering skills of our investment analysts and portfolio managers, and the specialist expertise provided by our team of dedicated stewardship professionals, we have the means to work with the companies in which we invest to understand and better manage the material ESG risks that they face.
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