‘Divestment is a thorny topic, you can’t just divest from things’

In ESG Clarity Intelligence‘s September e-zine: ESG evolution explained: Unpacking the biggest developments in ESG and sustainable investing, Lindsey Stewart, director of investment stewardship research within Morningstar’s global manager research team, talks about engagement and the investment industry.

Watch the full video interview above and read the transcript below.

Lindsey Stewart: Engagement with companies isn’t solely about ESG. Obviously, asset managers, investors engage with companies on their financial performance all the time and have done for many years. But ESG has certainly come to the fore in recent years.

So both portfolio managers and ESG professionals, stewardship professionals, will engage with companies on a one-to-one basis, just explaining and finding out exactly what companies are prioritising with regard to climate, biodiversity, other social issues like DEI, as part of the whole look at the investment process and how companies are integrating those factors into how they invest.

Natalie Kenway: And could you give us a round up perhaps of the key engagement themes from the past year or so?

LS: So climate has long been the key engagement theme within the sustainability space that investors and companies engage on. That certainly hasn’t changed in the last year, but the range and the depth of topics in which investors and companies are having conversations on climate has certainly widened.

We’re starting to look at more technical issues, like what is known as Scope 3 reporting, that’s reporting on emissions outside of a company’s direct value chain. Also asset retirement obligations, those kinds of things. Climate certainly isn’t going away.

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However, there’s also a wider range of topics that’s expanding now. Biodiversity is certainly becoming a key topic in which asset managers and companies are engaging. As well as social issues, particularly within the workplace, and workers rights are certainly coming to the fore in the United States and the UK recently.

And there’s a continued focus on diversity, equity and inclusion, ensuring that companies have access to the fullest range of talent that is possible for them to execute on their strategy. So there’s certainly a variety of topics emerging there.

NK: And with that wider variety of topics, would you say asset managers are stepping up their game in terms of engagement?

LS: Some are stepping up, some are not. I think it is fair to say, given what we’ve seen from data in the recent year or so, that European managers are becoming, they’re expressing a bit higher ambition than US managers. I think there’s a regulatory tailwind behind that. There’s European regulation as well as in the UK that is kind of pushing them to take a much closer look at sustainability topics.

I think in the US maybe that’s heading in the other direction where you’ve seen a very visible ESG backlash and asset managers a bit more reticent to dig deep beyond the kind of reporting aspects of sustainability. They just want an outline of what are the risks and opportunities that companies are facing rather than asking for specific action.

So there’s a range of responses that are being employed by asset managers at the moment.

NK: One of the big debates in ESG is the divestment from higher polluting companies versus engaging with them to ensure they decarbonise. And I think as this is about education. I think that’s maybe something the end investor doesn’t understand as being a higher polluting company within an ESG portfolio. Do you have any insights on that, what are asset managers saying?

LS: I think that has been, and will continue to be, a fascinating question. I think first, for the end investor, it’s important to realise that just because there’s an ESG or sustainability label on a fund that is an indication of what is being considered by the investment manager, not necessarily what is actually being done.

And that divestment is a thorny topic because you can’t just divest from things if you are an investor. You have to have something else that you want to invest in. So ethical preferences such as exclusions for tobacco or gambling, those have been catered to by the investment industry for years. But then if you are now asking investors to exclude, what is in the UK well over 10% of the market in terms of oil and gas companies, that is actually a tricky problem for a portfolio manager to solve.

And so investors do need to be clear about what they want. And to have their priorities respected if they want a fund that divests from oil and gas, then that’s well within their right. But it’s also important to understand what the trade offs are in terms of the risk in the portfolio with the potential outcomes and what that may mean for their investment goals when they’re going into that.

So it’s important to be clear-eyed about these choices.

NK: And what should fund selectors be asking asset managers in their conversations? What are the sort of key things they should be looking out for in terms of ensuring that asset managers are engaging as they promised.

LS: To take that one step backwards, it is more important than ever that fund selectors are absolutely crystal clear about what their end investors want with regard to sustainability, whether their end investors have sustainability objectives or not and what those objectives are, and explaining to them exactly what those choices mean and what trade offs there are.

Once they’ve understood that, then it’s important for them to ensure that asset managers are making choices that are in line with what those independent investors want. So it’s becoming much more important to analyse engagement priorities and themes, to analyse proxy voting records, to check that asset managers are actually acting in line with the preferences of those investors.

NK: And to finish, what do you think is coming up for engagement and stewardship? The key things to look out for and do. What would you like to see?

LS: I think there’s going to be a continuation of the themes that we’ve seen over the last few years. In the UK, we’ve had a new iteration of the stewardship period for a couple of cycles, so that’s very conscientious about connecting outcomes with activities.

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But there really has been a focus on what those activities are recently. A lot of managers are reporting higher and higher numbers of engagements, but it still isn’t 100% clear what an asset manager means when they say engagement. Have they just wrote a letter that wasn’t responded to, or has there been a continuous process with a defined objective over months, or even years, seeking a particular sustainability outcome?

There is not a lot of distinction between reporting on exactly what that means. So asset managers are under a bit more pressure to explain exactly what they mean by engagement and have that communicated to investors so that they really understand what they are investing in.

NK: Thank you so much for coming in, great chatting with you, as always.

LS: My pleasure Natalie.