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Active ownership and policy: how it works and what we ask of policymakers

Can active ownership help deliver policy targets? Marina Severinovsky thinks well-designed regulation which promotes healthy marketplaces and long-term sustainability is needed.

14/09/2023
active engagement

Authors

Marina Severinovsky
Head of Sustainability, North America
Kimberley Lewis
Head of Active Ownership

We believe that social and environmental forces are reshaping societies, economies, industries and financial markets.

Approached thoughtfully and with focus, encouraging companies to adapt to these changes, and holding them accountable for doing so, can strengthen the long-term competitiveness and value of their businesses, thus helping their shareholders and serving our clients.

At the same time, this can help accelerate change towards a more sustainable global economy. The insight gained through engagement can also directly influence the investment case.

In this article we explore active ownership and its relationship with policy in more detail.

Why is active engagement important?

The twin challenges of climate change and biodiversity loss epitomise why such engagement is so important. It is more important than ever to find ways of tackling these threats while also maximising the potential investment performance for our clients.

Schroders research into investors’ preferences consistently finds that active ownership is important to them.

For example, according to our Institutional Investor Study 2022, 95% of institutional investors surveyed consider engagement to be part of their sustainable investment strategy. Key asks from professional investors were: (i) evidence of how engagement impacts financial performance, and (ii) the impact on real world outcomes.

Additionally, 89% of advisers think that events over the past two years have reinforced the importance of stewardship and of using an asset manager which actively engages with company management.

Our Global Investor Survey 2022 found 63% feel it is important for investors to engage companies on nature and biodiversity (deforestation, pollution etc), and 59% feel the same about engaging on climate (net zero and other decarbonisation goals).

Good, long-term relationships with companies make it more likely that we can influence their practices. That is the reason why constructive “fact-finding” engagements may increase the chances for successful “change-facilitation” engagements. Affecting change is usually a long process and engagement is ongoing.

How does active ownership work in practice?

We focus on sustainability issues that have the potential to be material to the long-term value of our investee holdings. These issues reflect expectations and trends across a range of stakeholders including employees, customers, and communities, as well as the environment, suppliers and regulators. 

We generally engage with one of two objectives in mind:

1. Outcomes-driven: to seek improvement in performance and processes in order to enhance and protect the value of our investments;

2. Insights-driven: to enhance our analysis of a company’s risks and opportunities or to monitor developments in ESG practices, business strategy and financial performance within a company.

We also believe that voting is an essential part of our fiduciary duty. We use our voice as shareholders, in a carefully considered way, to take positions backed by a strong investment rationale. The details of our engagement and voting approach may be found in our Engagement Blueprint.

Does active ownership work? How can we gauge its effectiveness?

Although the practice of stewardship is inherently long-term, it is critical that active investors regularly monitor their progress with companies and evaluate whether and how they are generating real-world outcomes which enhance their return on investment.

At Schroders we have decades of history of engaging companies, which provides us with the data needed to assess the impact of engagement. Two pieces of our own research have recently explored this topic.

The first is an analysis of Schroders’ engagements and associated returns. The second is analysis of engagement on climate and progress on reducing emissions and setting targets aligned to net zero pathways. Although these studies do not determine causation, they contribute to the body of work which allows us to begin to unpack the value of engagement.

What is the value of engagement? A study focused on returns

We analysed the difference in peer-adjusted returns for companies with various levels of exposure to engagement. This peer group assessment compared the financial returns of over 1,000 engaged companies in 47 countries with the returns of unengaged peer-group companies. 

The study examined engagement on key elements of corporate governance, such as board independence and leadership change, capital allocation, executive remuneration and the issuance of pre-emptive rights.

Drawing on engagement data from the period 2010-2019, the study quantified the association between Schroders’ engagement on these issues and the companies’ financial performance via their returns to shareholders.

The analysis found that, for nearly two years from the start of a committed and sustained engagement, investors see better returns than investors in peers.

At its peak, this engagement approach sees returns that are 6% higher than peers towards the end of year one. The analysis also examined engagement quality, and companies who were engaged more frequently in the two years first saw higher returns.

These engagements often encouraged change at the board and management levels, and the intensity and depth of the engagement over the two-year period saw the most substantive increase in returns. This suggests that engagement, when done constructively and with purpose, may be associated with better returns.

Although this study does not measure causality, we believe it is an important contribution to the evidence base which demonstrates the value of engagement as a driver for positive change at the companies we hold.

What is the perspective of the companies we invest in? A survey of investees

We also understand that the investment community is one of many voices which can hold companies to account. To complement this analysis, we surveyed more than 350 companies to understand the investee companies’ perspectives on engagement.

One of the key takeaways from the study was that while companies consider customers the most influential stakeholder, the investment community was almost on par with government policy as also very influential in driving change.

Furthermore, companies with below average performance were more likely to be influenced by government policy.

This underscores the point that engagement should not occur in a vacuum, but rather that engagement strategies should be informed by and cognisant of regulatory policy and trends.

What is the value of engagement on climate change?

Schroders understands climate change to be a material investment risk, and to this end has made a number of commitments related to decarbonisation. These include establishing greenhouse gas reduction goals which are validated by the Science-based Targets initiative, joining the Net Zero Asset Manager initiative, and disclosing in line with the CDP and Taskforce on Climate-related Financial Disclosures. Engaging on climate with the companies we invest in is one of the most important tools we have to achieve the goal of reaching net zero across our value chain by 2050.

In 2022, we engaged over 700 companies, representing approximately half of the group’s financed emissions from portfolios in scope of our targets. We have set expectations that companies decarbonise their business models by around mid-century and set long-, medium-, and short-term emissions reduction targets, among other climate-related goals.

Although the climate engagement program continues to evolve, there are initial indications that engagement on climate is an effective mechanism to encourage companies to understand their climate-related risks and act to mitigate them.

Examples of this include:

  • The companies we engaged on climate since 2021 have been almost twice as likely to set a new below 2°C target than those we did not. We have seen the temperature-alignment of those portfolios falling from 2.8°C to 2.6°C during the year.
  • Our own analysis[1] has shown that companies able to reduce their emissions quicker than peers have typically outperformed in recent years. As policy measures intensify to encourage decarbonisation and penalise emissions, we expect that performance tailwind to continue.

We recognise that corporate action on climate is driven by a multitude of factors, ranging from policy, consumer preferences and physical and transition risks, and we strive to ensure our engagement strategies on climate are additive.

We record and monitor our ESG engagements, and define expected timeframes for milestones and goals. We track progress against these, and revise them as necessary, and assess the efficacy of our climate engagements as we work towards our net zero goals.

How should regulation support the role of active ownership?

Our philosophy on engagement is centred on understanding the risks and opportunities companies face, and using our influence to ask companies to recognize and manage these risks and capture the opportunities available to them. We believe companies which demonstrate good foresight and take the steps to invest in their long-term sustainability make good investments.

However, while stewardship plays an active role in steering companies towards more sustainable business practices over the long term, this can be a slow process, especially with investee companies who cannot justify a change to their business practices in the absence of a legal impetus.

Change can occur more purposefully and swiftly via the accelerator that regulation can provide. Globally, investors[2] view regulators as key to mitigating climate change.

We believe well-designed regulation which promotes healthy marketplaces and long-term sustainability is an important lever to promote effective engagement. Change to regulation is one of the most material and consistent risks companies can face both in the near and long-term. Our engagement strategy often uses a “carrot and stick” approach, where the carrot represents the opportunities a company has if it acts on a specific issue affecting its long-term sustainability, and the stick is the penalty it may face if it does not act.

Often the “stick” imposed by regulation is the stronger motivator. Large corporations are often hesitant to be an early mover; however, regulation provides the certainty they need to understand the costs of not acting and can help level the playing field by making companies play by the same rules.

Where active investors have identified a regulatory risk facing a company, it’s important that this risk has a genuine chance of materialising. Without the regulatory “stick”, the credibility of engagement can be eroded even if the requested change would still benefit the company’s long-term sustainability.

We therefore would ask that policymakers:

  1. Recognise the efforts that the investment industry is making around active ownership, and support it via sustainable finance legislation and regulation. This policymaking should not simply apply a “tick the box” and “number of engagements” approach to engagement and transition (and hence the overall practice of stewardship), but rather seek to support more robust, committed and evidence-based long term active ownership efforts. 
  2. Deliver on commitments made, especially around climate mitigation, by prioritising legislation which creates the “environmental framework” that companies will operate in going forward, and for which our stewardship efforts are designed to help them prepare.

Climate change in focus

While sustainable investment spans a wide spectrum of social and environmental trends and their investment consequences, climate change stands out for its dominance of policy agendas and social concerns. Our Climate Transition Action Plan sets out how we will manage our business towards net zero omissions with clear objectives around the investments we make on behalf of our clients. These objectives guide our engagement efforts with investee companies. In 2021, we independently engaged with the FTSE 350 to request that they produce and publish detailed, costed, climate transition plans. These asks mirrored the mandatory reporting that will come into force but we are extending the scope to the full FTSE 350 and accelerating the timeframe. Similarly, we track proposed and forthcoming regulations in other regions, like the US and Asia, in order to align our engagement efforts with these priorities.

Finally, we could caution that in the absence of adequate legislative and regulatory efforts, investors alone cannot chart the path for companies, and indeed can face severe criticism, as is currently happening in parts of the US, for appearing to “pressure” companies to take actions beyond existing laws and regulations.

If the promises that governments make around climate or social regulation are not delivered, the investment sector may be left exposed as a result of having promulgated stewardship efforts which were in service of this expected legislative and regulatory change, and which may then be accused as having been financially suboptimal for end-investors’ portfolios.

This is why it is so critical for regulation to support the efforts made by active owners and to set the path that stewardship efforts may then follow.

[1] Based on Schroders analysis of listed companies in the MSCI ACWI IMI index. We examined changes in companies’ emissions over the last five years, relative to sector peers, and compared the total shareholder returns delivered by companies in each quintile of emissions reductions.

[2] Schroders Global Investor Study 2021: 74% of investors consider national government/regulators to be most responsible for climate change mitigation.

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Authors

Marina Severinovsky
Head of Sustainability, North America
Kimberley Lewis
Head of Active Ownership

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