The rules of engagement

17th March 2020


Quintin Rayer offers tips for ethical investors that want to strengthen their engagement with companies

Ethical and sustainable investors focus on issues such as environmental, social and governance (ESG) factors, UN Sustainable Development Goals and traditional areas such as alcohol, tobacco, gambling, pornography, armaments, nuclear power, animal testing and intensive farming.

Many investors are also acutely aware of the increasing likelihood of extreme weather events and other challenges associated with global warming. Despite Paris Agreement targets to hold global average temperature increases to less than 2°C above pre-industrial levels, current warming appears to be on track for at least 3°C by 2100.

Many fund managers engage with companies to end harmful practices. Yet engagement is opaque, and fund selectors struggle to assess managers' commitment and the progress made.

Engaging for a 'green rinse'?

Concerns that sector exclusions can lead to under-performance (Posner and Langbein, 1980) may motivate less categorical policies such as engagement, underweighting firms with harmful activities or overweighting those that support solutions. It is not obvious that ethical investments should underperform. Ethical strategies may offer reduced risk and competitive advantage (Rayer, Feb 2018), with several studies supporting this conclusion (Rayer, 2017; April 2018; March 2018).

Many ethical investors state they use engagement to influence companies. While position size and holding period help, it is tough to appraise the quality and commitment to engagement work. Discussions with NGOs and others suggest this vital area is significantly under-assessed. A stronger focus on engagement is essential, especially for it to be a key tool for addressing issues such as climate change.

Difficulties appraising engagement quality can lead to fears of greenwashing – engagement could be a 'cosy chat' with management, with no real prospect of company action. Fund managers may fear to confront boards in case they damage relationships, reducing access to corporate information.

Strengthening engagement

Many mutual funds outsource voting to proxy firms, passively following their guidance more than 95% of the time (Doyle, 2018; Brannon, 2019; Thomas and Mooney, 2019). This appears weak, particularly if managers are not even formulating their own views. Funds should be defining in-house voting policies. Stronger approaches might involve proposals linking director remuneration to issues of concern [19] [20] or resolutions that formally instruct directors to address them (Covington and Thamotheram, 2015; Cowling and Gourley, 2019).

Engagement should involve more than voting; a two-way dialogue is required. Ethical investors should articulate legitimising standards, their expectations, and follow-up with boards. They may need to identify issues and develop the expertise to actively educate boards on emerging problems (Gifford, 2010; Gond et al., 2018).

Fund managers need non-confrontational ways to raise contentious issues with boards without damaging relationships. Identifying and sharing best practice may be one approach (Gifford, 2010; Gond et al., 2018). Sector benchmarking might be another, with robust assessments shared anonymously or published as circumstance permits (Gifford, 2010).

Engagement escalator

When overtures do not produce results, managers should follow an escalation pathway, with progressively more assertive engagement practices (Wagemans and Kraamwinkel, 2014). Follow up initial meetings with collaborations with other investors, public statement of concerns, voting against boards or, ultimately, divestment.

Some fund managers may see voting against boards as evidence of engagement failure. However, boards should not expect to be able to take institutional shareholder support for granted. Like divestment (Wagemans and Kraamwinkel, 2014), engagement is likely to be more effective when backed by a credible threat of being prepared to oppose board resolutions. Discussions with boards pre and post voting could help place voting decisions within a more constructive context.

For impactful engagement, fund managers will need to allocate significant resources to research issues thoroughly. They will be able to present problems to boards, together with possible solutions. If boards find engagement discussions with investors become a valuable source of information on business challenges, perhaps tricky conversations can be used to strengthen, rather than damage, relationships.

Tangible results

Fund managers carrying out engagement need to ensure it has an impact. Tangible results are necessary, particularly as engagement quality is hard to assess.

A global climate crisis is emerging, with fossil divestment or engagement proposed to help promote the transition to a low-carbon economy. If engagement quality is opaque and results appear inadequate, investors will drop engagement as a tool in this crucial area. Fund managers need to ensure that engagements produce meaningful outcomes.

However, engagement and divestment need not be competing opposites. Divestment or engagement need not be justified as if everyone followed the same approach by adopting a Kantian imperative. Individual investors are not the entire market, and a credible divestment threat is an important part of engagement. Those investors who divest and clearly say why give strength to those continuing to engage.


Dr Quintin Rayer is a Chartered Wealth Manager, Fellow of the Institute of Physics, and head of research and ethical investing at P1 Investment Management.

Image credit: iStock

References:

Posner R and Langbein J. Social investing and the law of trusts. Michigan Law Review. 1980; 79, 72-112.

Rayer QG. The price of conscience: arguments for ethical out-performance. DISCUS. 22 February 2018 [online]. Available: discus.org.uk/price-conscience-arguments-ethical-performance

Rayer QG. Why ethical investing matters. Personal Finance Professional. 2017; Winter, 44-46.

Rayer QG. Why clean money matters. The Actuary 2018; April, 18-19.

Rayer QG. The price of conscience: analyses supporting ethical out-performance. DISCUS. 22 March 2018 [online]. Available: discus.org.uk/price-conscience-analyses-supporting-ethical-performance

Doyle TM. The Realities of Robo-Voting. Harvard Law School Forum on Corporate Governance. 29 November 2018 [online]. Available: corpgov.law.harvard.edu/2018/11/29/the-realities-of-robo-voting

Brannon I. Diminishing the Power of Proxy Advisory Firms. Forbes. 11 July 2019 [online]. Available: www.forbes.com/sites/ikebrannon/2019/07/11/diminishing-the-power-of-proxy-advisory-firms/#27439f1b452c

Thomas D and Mooney A. Battle brews over influence of shareholder advisers. Financial Times. 26 August 2019 [online]. Available: www.ft.com/content/0927edb4-c342-11e9-a8e9-296ca66511c9

Covington H and Thamotheram R. The Case for Forceful Stewardship (Part 2): Managing Climate Risk. SSRN. 19 January 2015 [online]. Available: ssrn.com/abstract=2551485

Cowling C and Gourley L. Turning the tide to greater corporate accountability. London: Ernst & Young LLP, 2019.

Gifford E. Effective Shareholder Engagement: The Factors that Contribute to Shareholder Salience. Journal of Business Ethics. 2010: 92; 79-97.

Gond JP, O'Sullivan N, Slager R, Homanen M, Viehs M and Mosony S. How ESG engagement creates value for investors and companies. UN Principles for Responsible Investment, 2018.

Wagemans F and Kraamwinkel D. Engagement: box-ticking or catalyzing sustainability? Utrecht: VBDO, 2014.

Subscribe

Subscribe to IEMA's newsletters to receive timely articles, expert opinions, event announcements, and much more, directly in your inbox.


Transform articles

A social conscience

With a Taskforce on Inequality and Social-related Financial Disclosures in the pipeline, Beth Knight talks to Chris Seekings about increased recognition of social sustainability

6th June 2024

Read more

Disinformation about the impossibility of averting the climate crisis is part of an alarming turn in denialist tactics, writes David Burrows

6th June 2024

Read more

While biodiversity net gain is now making inroads, marine net gain is still in its infancy. Ed Walker explores the balance between enabling development and safeguarding our marine environment

6th June 2024

Read more

David Symons, FIEMA, director of sustainability at WSP, and IEMA’s Lesley Wilson, tell Chris Seekings why a growing number of organisations are turning to nature-based solutions to meet their climate goals

6th June 2024

Read more

Sarah Spencer on the clear case for stronger partnerships between farmers and renewable energy developers

6th June 2024

Read more

Groundbreaking legislation on air and noise pollution and measures to tackle growing concerns over disposable vapes provide the focus for Neil Howe’s environmental legislation update

6th June 2024

Read more

A system-level review is needed to deliver a large-scale programme of retrofit for existing buildings. Failure to do so will risk missing net-zero targets, argues Amanda Williams

31st May 2024

Read more

Media enquires

Looking for an expert to speak at an event or comment on an item in the news?

Find an expert

IEMA Cookie Notice

Clicking the ‘Accept all’ button means you are accepting analytics and third-party cookies. Our website uses necessary cookies which are required in order to make our website work. In addition to these, we use analytics and third-party cookies to optimise site functionality and give you the best possible experience. To control which cookies are set, click ‘Settings’. To learn more about cookies, how we use them on our website and how to change your cookie settings please view our cookie policy.

Manage cookie settings

Our use of cookies

You can learn more detailed information in our cookie policy.

Some cookies are essential, but non-essential cookies help us to improve the experience on our site by providing insights into how the site is being used. To maintain privacy management, this relies on cookie identifiers. Resetting or deleting your browser cookies will reset these preferences.

Essential cookies

These are cookies that are required for the operation of our website. They include, for example, cookies that enable you to log into secure areas of our website.

Analytics cookies

These cookies allow us to recognise and count the number of visitors to our website and to see how visitors move around our website when they are using it. This helps us to improve the way our website works.

Advertising cookies

These cookies allow us to tailor advertising to you based on your interests. If you do not accept these cookies, you will still see adverts, but these will be more generic.

Save and close