What’s your view on engagement as part of a broader sustainable investing strategy?
We’ve long believed that company exclusions may align a portfolio with its investors’ values, but they don’t necessarily result in companies improving their practices. We think it’s better to invest in and engage with these firms instead, and to build on their resources and capabilities to achieve meaningful real-world change. We view engagement as a way for investors to drive incremental positive impact with their strategy, where the environmental and social outcomes are measurable and verifiable.
What’s the main aim of an engagement strategy: to produce good investment returns or improve companies’ behavior?
At UBS, we believe the two goals should go hand-in-hand. If you engage with companies on meaningful issues, there should be financial and investment performance benefits as a result. The key word here is ‘meaningful’ or, as we often call it, ‘material’. These are issues that can affect companies’ business models and potentially the wider industry. So we expect to see both environmental and social outcomes and good financial performance.
Can private investors effect change in the same way as institutions?
Private investors often believe it’s more difficult for them to make a meaningful contribution than for an institution because they have less clout – they have less individual capital than, say, a pension fund and fewer or no dedicated resources to have direct one-to-one conversations with companies. Selecting an engagement-focused strategy within a portfolio enables private investors to direct their capital toward positive change, even though it’s via a fund manager rather than directly. When their capital is aggregated, private investors can have as much as or even greater leverage than institutions to effect positive change.
In the upcoming webinar Antonia will discuss why she believes engagement is such a powerful tool. Join the webinar on May 10.
What’s the prime merit of a dedicated engagement strategy?
First, from the private investor’s perspective, they provide the opportunity to contribute to environmental and social change by allocating capital to effect positive change via the fund manager’s engagement efforts.
Second, they can provide diversification benefits. An increasing proportion of private investors want to allocate all of their capital in a sustainable way. That might sound straightforward, but it requires them to think about sustainability in a portfolio context, considering issues like diversification, factor exposures and risk-return requirements. Engagement strategies tend to focus on companies you wouldn’t necessarily think of as sustainable, such as industrials or materials firms. These companies need to be transformed because they’re important to our economies, are often resource-intensive and need change for us to make progress – they can’t just be left behind. These companies probably offer the most potential for change, which is what many investors focused on sustainability are looking for. As such, by investing in companies that wouldn’t necessarily be included in more standard best-in-class ESG approaches, an engagement strategy can provide differentiated exposure to benefit sustainable portfolios.
Similarly, on the credit side, engagement strategies generally invest in high yield bonds, whereas other sustainable credit investments typically allocate to the quality, investment grade segment.
Are there big differences in how different fund managers go about engagement?
Yes and no, in our experience from looking at the broader market. There’s a common denominator in that the managers pre-define environmental or social outcomes that they want to achieve through engagement. They usually have a long-term holding strategy – achieving meaningful outcomes often requires numerous conversations with company management, so they’ll hold positions for a number of years. And they usually break down outcomes into milestones and can adapt their strategy if these milestones aren’t met.
But there are some differences. Some engagement fund managers prefer to engage with small- and mid-size companies, especially if they are engaging on their own. Often they perceive a greater opportunity in this segment and feel they have more influence with smaller companies, which may not yet have incorporated sustainability extensively into their business models and operations.
Other managers see greater opportunity in engaging with large- or even mega-cap companies due to the potential scale of impact. In such cases, they generally form a coalition with other asset managers looking to effect the same positive change. We see engagement occurring in a broader set of companies across size, sector and region.
What constitutes a powerful engagement?
We think engagements are most powerful when they consider two sets of factors. The first is how material the issues in question are to the company’s business model – for instance, if you’re engaging with a bank, it’s probably not that relevant to talk about reducing water consumption in its buildings, even though this is certainly an ESG issue. Engagement managers need to be able to identify critical issues for companies, industries and regions.
The second is the role of the company at large. Some of the most powerful engagements we’ve seen have been on issues like health and safety with firms that are big employers in certain regions. The engagements can not only improve conditions at the company, but can have a spillover effect into best practices in an entire region. Another good example is engagement with fossil fuel companies on diversifying and developing renewable energy capacity. Such outcomes beyond the company itself are difficult to quantify from an impact investment perspective, but they show the true power of engagement.
What skills do those undertaking engagements require?
It’s vital to be able to pinpoint the critical ESG issues a company faces. Sometimes such issues are easy to identify and measure, but they don’t always have the broader spillover effects we’d like to see. Engagement specialists need to understand a company, what it stands for and the industry it operates in – similar to what is required from conventional investment specialists – but also have a strong understanding of the relevant sustainability issues. Longstanding management relationships clearly help, as does knowledge of best practice and developments in the world of engagement.
On the soft side, they would need to be good mediators and collaborators. Engagement should be a win-win for investors and companies. Some private investors might choose to steer away from activist approaches that use the stick rather than the carrot, instead preferring more constructive engagement, but still expect their engagement managers to recognize when engagement is not working and it is time to switch gears.
Do engagements focus too much on environmental issues rather than social factors?
In our view, social engagement is no less important than engagements about climate-related issues. The challenge is that climate outcomes tend to be perceived as easier to measure – it’s more straightforward to assess how much you’ve reduced your carbon emissions or where you source energy from than social factors, which are often more qualitative in nature.
There’s been a lot of progress on social issues – companies in many different industries are seeing the need to become social role models and set the standards for others. And we’re definitely seeing more engagements on social issues than a few years ago. There’s also been a spike in proxy voting on social issues in the past year.
Is there any proof that engagement strategies work?
There are some academic studies out there to suggest they do, but one of the challenges with analysis is that even though engagement strategies have been around for a while, engagement focused on sustainability outcomes has only become more formalized in recent times and it takes several years for meaningful outcomes and actual impact to be achieved. So, it’s work in progress. From our observation of the market, we see increasing success with intermediate milestones, which makes us optimistic, but we’re still to find out the final results. On our end, we aim to support academic research in the field as well, by partnering with doctoral students on analysis of what drives sustainability-focused engagement success on a case-by-case basis.
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