Hermes: Five misconceptions of company engagement

Apr 01, 2019
The role of an investor in addressing and improving a company’s environmental and social impact through engagement is being increasingly recognized

This investor engagement role remains a young phenomenon for most and therefore many myths exist around approaches to engagement and a company’s willingness to change. Here, Will Pomroy, lead engager of the Hermes SDG Engagement Equity Fund, puts to bed five misconceptions.

Myth one: ‘Dirty’ companies will never become fully clean

Some believe engagement with so-called ‘dirty’ companies is destined to fail given the nature of the business. But our investment approach targets companies with scope for improvement and the ability to have a tangibly positive impact on the communities in which they are situated. We, unapologetically, have exposure to ‘dirty’ sectors such as chemicals, mining and oil & gas E&P, and the companies we identify don’t typically score exceptionally high on the league tables of ESG ratings by research firms. Engaging with these companies, however, is precisely what is needed from investors and – so far – we have seen encouraging results.

One example is Alliant Energy, a US-based utility company, which generates about 27 percent of the portfolio’s carbon emissions. Since 2005, the company has retired about 30 percent of its fossil-fueled generation capacity. In August 2018 the company published new targets for 2030, in which it committed to renewables being greater than 30 percent of its energy mix and cutting CO2 emissions from fossil-fuel power generation by 40 percent. Going further, by 2050 the company aims to eliminate all existing coal from the energy mix and reduce CO2 emissions from fossil-fueled generation by 80 percent.

We have had discussions with management before and after these new targets and have welcomed the direction of travel. More encouragingly, the company considers the new commitments to be very conservative, agreeing that it may be able to move more quickly than expected – something we will be continuing to encourage it to do.

There are some industries or companies where engagement will likely prove futile and others where engagement is very unlikely to counteract the harmful effects of the underlying products. Generally, though, we consider each company on a case-by-case basis, weighing up both good and bad factors and, importantly, the firm’s capacity to improve. 

For example, we don’t consider all oil & gas E&P companies to be off-limits; instead we understand that low-cost fossil [fuel] production remains necessary in the near to medium term and many of these companies have the ability, as with mining companies, to radically transform for the better the often isolated and undeveloped regions in which they operate.

Myth two: Only large companies can effect change

Given their often global reach, large corporates are more easily able to influence and effect change. If we are to meet the UN Sustainable Development Goals (SDGs) by 2030, however, then it is not only large caps that have a role to play, but also companies of all sizes as well as investors, governments and citizens.

Investors often assume smaller companies are perhaps less advanced in their thinking on sustainability matters and also less engaged with shareholders, NGOs and the broader stakeholder community. We have, however, been able to use our long-standing expertise in both small and mid-cap investing and company engagement to help shape the future of these companies. In reality – and in contrast to larger companies – at their best, smaller companies are able to grasp and respond to an issue more quickly. As such, we expect many of these companies to rapidly leapfrog larger peers or value chain partners.

During our first year, our SDG engagement efforts found a generally receptive response among the companies we approached. Many management teams and board members shared our view that ‘doing well by doing good’ is often a route to sustainable long-term success. But most companies face immediate complex business challenges that can hinder their attempts to make good on those intentions. Smaller firms, in particular, struggle to convert willingness to change into action, due to a lack of resources and the shorter-term performance demands foisted on them by the market. 

Over 2019 we will be looking to leverage many of these initial positive conversations into ambitious, outcome-oriented objectives, shifting the dial from managing ESG risks to generating tangibly positive impact.

Myth three: You have to sacrifice financial returns to reap social benefits

Impact investing is not a zero-sum game. In fact, we believe companies that recognize their responsibility toward society will be rewarded with greater brand loyalty, more motivated employees and more innovative product developments – and ultimately deliver investment outperformance.

Our investment strategy has the dual purpose of delivering attractive returns and measurable real-world impact. We seek this by targeting traditional financial performance goals as well as aiming for positive social and environmental change by engaging with companies to help deliver the UN SDGs – and in so doing helping to ensure the sustainability of those returns in future.

Engaging with companies on the SDGs provides investors with valuable insights into investment risks and longer-term commercial opportunities, as well as answering questions central to a company’s intrinsic sustainability. We must dispel the myth that investing sustainably means sacrificing returns and instead see how – when combined – they can offer attractive investment opportunities.

Myth four: Only developed market companies are receptive to change

With several existing stewardship and governance codes in place in developed countries and the constant emergence of legislation being published to raise standards, it is easy to see why some investors believe only the developed world would be receptive to change.

Since we have commenced engagement, we have noticed just how willing management teams in emerging markets are to listen to what we have to say. While governance can be more variable in these markets, consideration of sustainability is often front of mind. Indeed, many of the social and environmental challenges highlighted by the SDGs are real-life issues for these companies and their employees.

More broadly, sustainability has rapidly moved from something that all management teams ought to consider to something they need to consider. It has moved from a regulatory matter with the legal department to a boardroom agenda item.

In the context of the SDGs, there is an additional point to consider: companies based in developed markets will commonly have an interest in emerging markets, too – whether through a subsidiary, outsourced manufacturing, their supply chain or possibly as a market for their goods or services. We, and they, are therefore able to indirectly instigate positive change in emerging markets through our engagement with a developed market management team.

Myth five: The best way to initiate change is through an activist approach

We can only credibly deliver change – and thus impact – with listed companies via engagement, but any successful engagement strategy requires buy-in from company management and boards. Our approach is to treat companies as partners rather than combatants. Without buy-in, any success may be short-lived and thus unsustainable.

Our understanding of effective shareholder engagement has been developed over many years. In our view, dialogue with board members and senior executives is more effective than wielding the big stick of voting power (although that can help): what matters most is the strength of our argument, not the size of our proxy vote. Through engagement, we can give management teams the confidence to be bold and imaginative in developing more mutually beneficial relationships with stakeholders.

Clearly, purposeful engagement is resource-intensive and demands pragmatism and patience from all parties. Results cannot be achieved overnight – but those worth pursuing are also worth waiting for.

Will Pomroy is lead engager of the Hermes SDG Engagement Equity Fund at Hermes Investment Management

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