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The PRI defines Stewardship as – ‘a practice which aims to promote the long-term success of companies in such a way that protects and enhances the value that accrues to the ultimate beneficiary of an investment.’
Engagement is an aspect of good stewardship. It is ‘the individual interventions in specific assets to preserve and/or enhance value. In modern investment terms, this is the dialogue with the management and boards of investee companies and other assets.’
The Investor Forum, a UK group set up to facilitate collective dialogue between investors and investees, describes engagement as ‘active dialogue with a specific and targeted objective … the underlying aim … should always be to preserve and enhance the value of assets.’
- To be impactful, engagement requires clear objectives, professional resources and persistence
- Engagement requires a long-term mindset – change is an iterative process that cannot be rushed
- There are 5 barriers to engagement:
- Investors perceive two main solutions to these barriers:
- Reinforcing the close integration of stewardship with fund management activity
- Making full use of all available resources
- Ideally, engagement should be part of the role of every fund manager and analyst – which would significantly reduce resourcing constraints
- Whilst there are significant practical barriers to collective engagement if done well it helps investee companies to understand more clearly the reasons for investors’ concerns
- Dialogue – active discussion between companies and investors takes two forms:
- Monitoring – dialogue that informs an investment decision
- Engagement – two way dialogue that has a specific and targeted objective to achieve change
- Understanding of and respect for the industry/ company specifics of an investee company, as well as consistency, transparency and clear objectives are key to achieving positive results from engagement
The components of stewardship (from The Investor Forum)
Preserving and enhancing the value of assets with which one has been entrusted
Investment approach and decisions
Allocation of capital in accordance with investment purpose, mandate and client interests, at portfolio and individual asset level
Active discussions between companies and investors. Two principle forms:
Dialogue for investment purposes: to understand the company, its stakeholders and performance
Informs incremental buy/ sell/ hold decision
Purposeful dialogues with a specific and targeted objective to achieve change
Individual or collective basis
– Detailed and specific questioning
– Investors seeking insight
– Two-way dialogue
– Investors expressing opinions
|Characteristics of high-quality delivery:|
– Framed by close understanding of the nature and drivers of a business and its long-term opportunity to prosper
– Appropriately resourced so dialogues can be delivered professionally in the context of full understanding of each individual company
– Dialogue must be consistent, direct and honest
– Dialogue is respectful and seeks to build mutual trust
– Set in mutual context of fund managers investment style and approach
– Recognises that change within companies is a process and sometimes takes time to be reflected in external indicators of performance
– Resources are used efficiently so that neither parties time is wasted
– Fuller insight leads to better informed decisions
– Includes feedback so that mutual understanding can be reinforced over time
– Set in context of long-term ownership and focus on long-term value preservation and creation, so that engagement is aligned with investment thesis
Recognizes that change is a process – while haste may at time he needed, change cannot be inappropriately rushed
– Overall resources used efficiently so engagement coverage is as broad as possible whilst also proving effective
– Clear and specific objective leads to effective change
Involved reflection so lessons are learned and taken fully into account in the future
|Resulting in:||Resulting in:|
– Changed investor decision-making
– Efficient capital allocation by investors
– Appropriate risk-adjusted returns for clients
– Preserved/ enhanced value
– Delivery of client objectives and investment purpose
– Changes company behaviours
– Efficient capital allocation by companies
– Appropriate risk management by companies
– Preserved/ enhanced value
– Delivery of corporate purpose and culture, through effective oversight
Engagement takes place throughout the investment value chain. Some asset owners may undertake engagement directly or leave this responsibility to their asset managers. They in turn may have varied models including either, or both, direct engagement between portfolio managers and their investee companies, or specialist stewardship teams. Engagement can also be fully outsourced to specialist stewardship service providers.
The CFA institution identifies a distinction in engagement style between stewardship teams with a history of governance led engagement versus those with a more environmental or social engagement history.
Teams with a heritage of engaging on Environmental and Social issues tend to be organised by sectors. Their style reflects this with a focus on specific issues being pursued across sectors and markets as a whole seeking to drive improved best practice.
Teams who look predominantly at Governance issues tend to be split by geographies as national laws and codes vary by region and country. These teams tend to focus more on individual companies to drive change.
Escalation of engagement
The former UK stewardship code set out a list of escalation methods that still functions as a useful reference:
- Holding additional meetings with management specifically to discuss concerns
- Expressing concerns through the company’s advisers
- Meeting with the chair or other board members
- Intervening jointly with other institutions on particular issues
- Making a public statement in advance of general meetings
- Submitting resolutions and speaking at general meetings
- Requesting a general meeting, in some cases proposing to change board membership
- Writing a formal letter setting out concerns, usually following one of the above meetings, and typically to the chair; such letters are usually private, but may occasionally be leaked publicly if frustrations worsen
- Seeking dialogue with other stakeholders, including regulators, banks, creditors, customers, suppliers, the workforce and NGOs. Stakeholder dialogue is most typically a tool in European markets, but is increasingly being used elsewhere as well
- Taking concerns public in the media or in some other form, not only as the code said in relation to AGMs or EGMs
- Seeking governance improvements and/or damages through legal remedies or arbitration
- Formally adding the company to an exclusion list, or otherwise exiting or threatening to exit from the investment
Collective engagement and proxy services
Many institutional investors reply, at least in part on proxy voting, through advisory firms who offer analysis and voting recommendations across public companies.
Other stewardship service providers offer differing levels of stewardship service depending on client requirements – at its most extreme effectively taking on the role of the investor to engage on their behalf. By aggregating the interests of multiple clients, these providers can build scale and exercise greater influence.
Collective engagement vehicles can also function as a platform for asset managers to interact and engage in both formal and informal dialogue.
Collective engagement is often the most resource efficient methods of engagement as it allows investors to leverage off each other’s resources and expertise to achieve a common goal.
Challenges to engagement
The PRI’s 2018 report on how engagement adds value for investors and companies identified potential challenges and barriers to engagement1:
|Corporate perspective||Investor perspective|
|Relational factors||– Language barriers and communication issues|
– Lack of continuity in interactions
|– Language barriers and cultural differences can hamper dialogue|
|Corporate factors||– Company bureaucracy preventing changes in internal practices and/ or external reporting on (new) practices.|
– Lack of resources, insufficient knowledge to meet investor demands.
– Lack of actual ESG policies, practices and/ or results that can be reported externally
|– Refusal by top executives to be engaged on ESG issues|
– Functional. Sustainability manager struggles to advance ESG related issues
– Too small a shareholding to attract sufficient attention
– Corporate inability to meet objectives and targets
|Investor factors||– Lack of investor preparation, overly generic questions/ responses|
– Lack of knowledge about the company
– Lack of sufficient investor tracking process to determine whether engagement requests have been met
– Changing engagement objectives and targets
|– Lack of buy-in from clients and/ or senior management|
– Small, under-resourced ESG teams
– Lack of clear engagement policies, objective & monitoring systems
– Under-developed relationships with key corporations
– Difficulty demonstrating materiality of engagement
– Insufficient mechanisms to guarantee asset managers conduct successful engagements
Challenges to collective engagement:
In addition to the potential barriers identified by the PRI, groups involved in collective engagement also face some further challenges:
- Coordinating a potentially disparate group of different investors, and trying to maintain a consistent view.
- Concerns about anti-competitive behaviour rules ( e.g. concert parties – where a number of separate investors work together to use their holdings as a single bloc).
When done well, stewardship and engagement can enhance shareholder value and support investors in their fiduciary duty by encouraging the flow of information between investors and investees.
Module 3 will include an overview of Stewardship codes and standards.
1PRI. 2021. Enablers and barriers to successful ESG engagement. [online] Available at: <https://www.unpri.org/academic-research/enablers-and-barriers-to-successful-esg-engagement/3063.article> [Accessed 17 September 2021].