Environmental, social, governance (ESG) investing is not just about positive and negative screens and though a low regulatory bar for transparency has been set, financial advisers need to be asking fund and portfolio managers the hard questions about engagement.
According to the Responsible Investments Association Australasia (RIAA), corporate engagement and shareholder action is the second most popular responsible investment strategy in the country.
However, in Australia, stewardship codes for asset managers and owners to sign up to for a set of practices is only voluntary, meaning transparency on ESG engagement and shareholder action is low.
Corporate engagement and shareholder action give power to shareholders to influence corporate behaviour through proxy voting in alignment with the shareholders own ESG charters.
While this seems straightforward, many funds vote inconsistently and against their own ethical charters.
VOTING VS PRIVATE MEETINGS
In 2019, 10 of the country’s largest superannuation funds supported only 38% of climate resolutions for international and Australian companies, according to Market Forces data. Some funds cited the reason for voting against their own ESG charters was due to the fact that they preferred to talk behind closed doors on issues.
RIAA chief executive, Simon O’Connor, told Money Management that proxy voting was the most visible way investors could showcase their ESG intentions and articulate how important certain issues were to them.
“There’s still far too many managers and super funds who are not adequately disclosing or transparently reporting their engagement and voting activities. It is really important for these investments to be held accountable to Australian investors,” O’Connor said.
“It’s increasingly important that assets managers can talk publicly about what engagement priorities they have, activities, and outcomes they have. That doesn’t necessarily mean they need to name and publicly write notes on every meeting and companies they speak to because a lot of that is private.”
However, O’Connor noted that just because a fund had a strong policy towards an issue, such as climate change, it did not necessarily mean they would support every climate resolution.
He cited reasons such as the fact that a resolution might be poorly targeted, and that some resolutions that were planned for an annual general meeting (AGM) would often drive conversations with large institutional investors before the meeting.
“Often this has resulted in these companies making concessions and commitments in advance of the AGM that meet a request of the resolution. Then you’ll find a lot of those investors will not vote in favour of the resolution because they’ve already achieved what they hoped to achieve through that engagement,” he said.
“The way we are measuring how many investors vote in support of each resolution is a bit of a blunt analysis. The onus is on the investors on why they are voting in a particular way and explaining their practices clearly.”
Fidelity International global head of stewardship and sustainable investing, Jenn-Hui Tan, said votes were more understandable when placed in context.
Tan said if a fund was having a productive discussion on an issue and were happy the firm they were invested in would meet their target within a certain timeframe, they would not necessarily vote against management.
“You want to be able to reflect the discussion you’re having and the progress you see. You only want to vote against when you don’t think they’re not progressing well but you also want to provide greater transparency around the nature of those discussions,” he said.
Tan said there were ‘voting red lines’ in the industry where some investors would always vote a certain way on an issue irrespective of how good or bad management was.
“To us that is not an informed way of voting. We want our votes to reflect the discussions we have with management. When we vote we think about the context of everything we are trying to achieve so we don’t have a lot of red lines,” he said.
“Red lines are helpful and useful to give a consistent message but they’re not helpful when trying to tailor your approach to companies that are doing better and companies that are doing worse.”
Australian Ethical head of ethics research, Stuart Palmer, said private conversations were often helpful with complex issues as conversations could be more open and productive.
Palmer said that when speaking behind closed doors companies were less worried that everything that was said would be publicly held against them.
“But if it never gets elevated beyond the private then companies which choose not to respond and engage meaningfully will see the consequences,” he said.
“Part of it is well intentioned to not to be outspoken in public or assertive in engagement, but there’s a growing realisation that if you’re never assertive in public then that’s not a good long-term strategy.”
In 2019, Fidelity voted at over 4,300 shareholder meetings globally, had 16,000 engagement meetings with companies, and were actively engaging with over 680 firms.
The largest themes the firm voted on were for remuneration, governance structure, and shareholder proposals. Over 23.6% of votes were against management and 71.3% with management.
However, not all funds have the capacity to vote on every agenda and outsourcing proxy voting has been way for funds to get around this by using firms such as Intermediary Outsource Solutions (ISS).
O’Connor said many fund managers were asked to consider thousands of resolutions and votes every year and that getting advice from service providers made sense.
But the difference was that a proactive asset manager would take that advice and be conscious on how they would vote on key ESG resolutions.
“We shouldn’t shy away from scrutiny from NGOs and other stakeholders because fund managers need to be aware that today there is an expectation for them to clearly articulate why they are voting or engaging in a particular way or why they are not voting or engaging in a particular way,” he said.
Palmer said his firm used ISS and CGI Glass Lewis for sustainability research and voting advice.
“They serve an important role and we use them for international stocks. A good development is that these organisations have introduced different types of recommendations for voting. They have their standard recommendations, sustainability guidelines and recommendations, and some have a suite of recommendations they give for a given resolution in a given AGM. The fund manager then can decide which one to take,” he said.
Palmer noted that it would be concerning if there was not any independent judgement or oversight by a fund manager on the votes being cast.
“It’s hard to see how they fulfil their role as a responsible investor if they’re not interested in engagement and influence on the voting side,” he said.
Robeco senior engagement specialist, Peter van der Werf, said that outsourcing voting did take away a lot of flexibility to make the fund’s own decision.
“When you run your own proxy voting with your own analysts you have the ability to assess every single AGM and look for the merit in every proposal. Then you have a truly decisive way to responding to what the companies are putting out there and therefore you’re a truly active owner on every stock you own,” he said.
“The same goes with engagement – the more outsourcing you do the thinner the layers become and the more muted the signal you’re sending as an active owner is.”
While there were good reasons to outsource, he stressed there was a difference between completely outsourcing and never looking back at a decision made or never being actively involved in direction and strategy.
One red flag Palmer said advisers needed to look out for when assessing fund engagement was whether the fund had ever divested from a company due to a lack of action.
“Divestment definitely needs to be in the toolkit if you’re not achieving the change you think is important. Withdrawing capital from a company is a consequence that companies pay attention to,” he said.
He said there were arguments that believed there was no leverage if investors always divested as soon as there was something they did not like. However, the other end of the spectrum was that if investors never divested they lost their capacity to influence.
“How meaningful is it if company managers and directors know that you’re never going to sell their stock?” he said.
Another red flag advisers should look out for were if funds did not have any exclusions, whether it was a responsible, sustainable, or mainstream fund.
“If a manager says they would continue to be invested in a company that unaddressed their disregard for human rights in a systemic underpayment of workers then I don’t think that’s consistent with a responsible or sustainable model of investment management,” Palmer said.
“It goes beyond specific mandates and there’s a growing recognition that capital is not just this passive thing that doesn’t have an influence. It helps shape the future, helps markets and economies with systemic challenges like climate change. So, to ignore that, I think those days are numbered.”
A final aspect advisers needed to look for was a fund’s engagement transparency as it was important to disclose reporting to clients on how they were fulfilling engagement responsibilities.
AMP Australia head of research and solutions, Leanne Milton, said advisers and clients needed to review a firm’s sustainability or engagement reports to ensure that the manager’s engagement program and voting activities are in alignment with the client’s responsible investment beliefs and policies.
“The report should also outline how the manager has taken account of ESG issues in their practices and processes, the investment decisions that have been made as a result of ESG integration, and the progress and outcomes from the engagement activities,” Milton said.
“Advisers and clients should also review fund manager commitments or adherence to relevant external standards and accountability processes, such as reporting against the United Nations Principles for Responsible Investment (UN PRI) commitments or certification of products by the RIAA.”
Tan said there was no substitute for due diligence and interrogating fund managers when evaluating their engagement processes.
More scrutiny that was brought to the bear, he said, the better the practices in the industry would become.
“Advisers should be interrogating fund managers and asking the difficult questions around their engagement and voting practices and getting satisfactory answers that give their ultimate end clients the information they need to make their investment decisions properly,” he said.
Tan noted that funds should not be treating ESG in a silo as it had to be integrated across the whole investment management process.