Corporate engagement has a crucial role to play in the management of environmental, social and governance (ESG) risks within investment portfolios. Without effective stewardship of the assets that fund managers own, bad ESG practices can be left to fester, potentially undermining long-term returns.
The power to persuade
The objective of investment stewardship is to use the access fund managers have to the companies in which they invest – and the mutual trust that they have built up over time – to manage material ESG risks and create value for clients. This means maintaining close contact with companies on the most pressing ESG themes of the day, and staying engaged for the long term. The aim of effective stewardship is always to build trust and influence long-term positive change.
Climate change is a case in point. As the Intergovernmental Panel on Climate Change (IPCC) makes clear in its latest Assessment Report, limiting global warming to 1.5°C is important in order to achieve a fair, equitable and sustainable world1. As a result, companies that fail to take action on 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. Climate engagement therefore needs to focus on the action that companies are taking not only to reduce their exposure to climate risks, but also to mitigate the risks that the energy transition may pose to their operations. Investors need to know how companies are planning to remain competitive, and profitable, while sticking to a credible transition pathway that keeps the global temperature rise as close to 1.5°C as possible.
While climate change is of crucial importance, effective stewardship requires engagement on a range of other ESG issues that have the potential to impact a wide range of companies. At J.P. Morgan Asset Management, as well as climate change, our key stewardship priorities include human capital management (such as gender diversity and the rights of indigenous groups); stakeholder management (such as cyber security and supply chain management); governance (for example, the allocation of capital and board composition); long-term strategy alignment; and natural capital and ecosystems, which focuses on the relationship between companies and the natural world.
We believe that regular engagement that is targeted at these big ESG themes can have a positive long-term influence on companies. However, investors should also look to ensure that they are ready to engage tactically on important shorter-term ESG sub-themes as they arise, such as the health-related issues and employee wellbeing concerns raised by the Covid pandemic.
Maximising impact and influence
The impact of engagement can vary depending on the specific case. Engagement can have a large impact on a smaller company, for example, where a fund manager may be one of the only major shareholders and can therefore more easily use its own expertise to help address ESG risks directly – such as assisting companies with cyber security risk management or advising companies on carbon pricing strategy.
When it comes to the specific issues and broader themes impacting larger companies, ongoing one-to-one engagement can be amplified by engagement from other investors on the same issue. The cumulative impact of regular feedback from many like-minded asset owners can be a powerful persuader.
Investors can also work closely with other stakeholders as members of sustainable investing and corporate social responsibility initiatives to encourage companies to take action on ESG issues. On the issue of gender diversity, for example, the 30% Club provides a forum for investors to encourage greater female representation on company boards. And on the issue of global warming, Climate Action 100+ is one of many shareholder and investor organisations that are working to urge the world's largest corporate greenhouse gas emitters to take necessary action on climate change.
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 investment analysts and portfolio managers, and the specialist expertise of dedicated stewardship professionals, active investment stewardship provides a means by which fund managers can help companies understand and better manage the material ESG risks that they face.
1 IPCC, “Summary for Policymakers”, [H.-O. Pörtner, D.C. Roberts, E.S. Poloczanska, K. Mintenbeck, M. Tignor, A. Alegría, M. Craig, S. Langsdorf, S. Löschke, V. Möller, A. Okem (eds.)]. In “Climate Change 2022: Impacts, Adaptation, and Vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change”, [H.-O. Pörtner, D.C. Roberts, M. Tignor, E.S. Poloczanska, K. Mintenbeck, A. Alegría, M. Craig, S. Langsdorf, S. Löschke, V. Möller, A. Okem, B. Rama (eds.)]. Cambridge University Press, Cambridge, UK and New York, NY, USA, p. 3-33 (2022). doi:10.1017/9781009325844.001.