JON DUNCAN: Stewardship rivals ESG integration in responsible investment
Sustainability issues can and do influence long-term return outcomes
The term “shared value” is a technical term first coined by Harvard academics Michael Porter and Mark Kramer in 2011. The concept refers to “a management strategy in which companies find business opportunities in social and environmental problems”.
The central premise behind creating shared value is that the competitiveness of a company and the health of the communities and the environment around it are mutually dependent, with the concept, along with those of responsible investment and green growth, gaining traction in the period after the 2008 global financial crisis.
Fast-forward to where we stand at the starting line of 2021 and the world is again staring down the barrel of a financial crisis — a crisis that has its origins in the biophysical realm. The scale of Covid-related fiscal stimulus far outweighs that of the 2008 global financial crisis, and the relative proportions provide an interesting proxy for how economically vulnerable the world is to biophysical system shocks.
It is thus perhaps no surprise that policymakers, regulators and capital allocators are beginning to recognise the importance of directing the stimulus in ways that build long-term system resilience.
As a business our approach to responsible investment is founded on the understanding that sustainability issues can and do influence long-term return outcomes. Issues such as resource depletion, climate change, poor governance and social inequality pose both investment and long-term systemic risks to society and the biophysical environment.
Across the asset management industry much of the initial focus and innovation in the field of responsible investing was directed towards solving for environmental, social & governance (ESG) integration in research, valuation and portfolio construction activities. However, stewardship — comprising proxy voting and company or regulatory engagement — has become an equally important aspect of responsible investment practice.
Applied correctly, stewardship has the potential to lower risk and be additive to returns, as evidenced by research undertaken by Elroy Dimson, emeritus professor of finance at the London School of Business.
Dimson’s analysis concludes:
- A two-tier engagement strategy, combining lead investors with supporting investors, increases the success rate of an engagement substantially (by 26%-39%, depending on the specification).
- An investor is more likely to lead the collaborative dialogue when the investor’s stake and exposure to the target firm are higher, and when the target is domestic.
- Success rates are elevated when lead investors are domestic, and the investor coalition is capable and influential.
Delivered in this fashion stewardship has the potential to play a role in delivering shared value outcomes across the markets. We expect this trend to continue into 2021 and additionally envisage that the trend towards passive investing will amplify its importance.
As 2021 starts to gather momentum we believe the green economy transition, which was well under way before Covid-19, will only be hastened and the trend towards responsible investing will continue. Alongside this we expect the demand for active stewardship will increase as asset owners with long-term investment horizons will want to speak with one voice across their holdings.
We expect this will result in greater collaboration and clearer industry positioning on ESG issues. We believe the following is likely to be important stewardship topics in the next 12 months:
- Governance of strategy and the extent to which long-term ESG issues are considered by both company boards and management. We expect the use of transition scenarios and technology road maps will be key in this process.
- Executive remuneration and alignment with strategy — we expect to see the regulatory environment becoming more supportive on matters of remuneration and “say on pay”. We also expect to see greater focus on ESG issues and the long-term duration of share award vesting horizons.
- Clarifying shareholder rights regarding tabling shareholder resolutions as it pertains to ESG issues.
- Cross-asset class collaboration on common ESG issues to drive change.
The year ahead will magnify the demand for effective outcomes-based stewardship, not only because it is essential in the fragile economic environment, but also because long-term asset owners will want to ensure their assets are used to effectively drive shared value outcomes.
• Duncan is head of responsible investment at Old Mutual Investment Group.
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