Director of Responsible Investing at Federated Hermes, leading ESG integration and engagement across $600 billion in global assets.
If there is any doubt that public controversy can damage a good name, one need only look at the case of Captain Charles Boycott. A manager of an estate in late 19th-century Ireland, Captain Boycott faced a well-organized community response after evicting farmers struggling to pay rent following a poor harvest. Other tenants stopped harvesting. Stores ceased supplying him, and even his own servants refused to work. His surname was adopted and remains the term of choice to express dissent.
In today’s consumer-oriented culture, voting with your dollar can be a potent tool. Well-organized campaigns can pressure a company more swiftly than governments and regulators. But some of the most effective boycotts aren’t those that renounce a product or shun a brand but rather those that first engage with the company and its leadership. Protest and disassociation may cause an initial, albeit often temporary, impact on a company’s sales and reputation. But when advocacy leads to consistent monitoring and engagement, real change can happen.
The popularity of divestment raises a similar dynamic for asset owners and investment managers. Often driven by their constituents, endowments, pensions and other institutions are increasingly demanding that their capital be better aligned with environmental and social good. Or, rather, that it doesn’t cause harm. In recent years, stakeholders have been asking portfolio managers to avoid the usual suspects of fossil fuels, chemicals, mining and a variety of other “dirty” industries.
But is abstaining from a sector of the economy the best path for investors intent on promoting change and generating long-term sustainable wealth? While excluding certain companies, industries or countries can send a message, you effectively give up your seat at the table. Publicly disclosing a divesture may make headlines, but it may not be as effective as advocating for change from the inside. Think of it this way: It is far easier for a company to brush off an outsider than an active owner.
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Establish Your Voice
Many prominent asset owners are opting for engagement as the preferred mechanism for sound stewardship. This practice is proactive and best achieved by global engagement specialists with the skills and credibility to directly engage the board of directors and C-suite about material environmental, social and governance (ESG) risks and opportunities. Engagement strategies must be specific to each company, informed by a deep understanding of the sector, ESG issues and markets in which that entity operates. It’s not seasonal letter writing or exclusive to shareholders. Tangible outcomes are achieved through long-term, objectives-driven and continuous interactions directly with senior executives of any corporate issuer irrespective of the investment vehicle.
The impact is clear. Without years of dialogue on the structural headwinds confronting the energy sector, would many global oil producers even consider adopting a more carbon-neutral strategy? Good things can happen when you keep your seat and effectively use your voice for positive change.
The hallmark of ESG integration is that investing with purpose doesn’t mean losing value. Specifically, high-touch engagement performed by stewardship experts can enhance a fund manager’s ability to generate long-term risk-adjusted returns. Moreover, continuous board-level interactions with a corporation can bring critical insights for investment decisions. In this respect, it isn’t any different from traditional due diligence leading to the discovery of mispriced investment opportunities. Identifying a company perceived by the market as an “ESG laggard” but poised to fix its sustainability issues can be highly lucrative.
One thing is true: Companies that Wall Street already deems to be an ESG darling are consensus picks. Some you still want to own, but others already may be overvalued. Rather than timing the market, discovering “ESG improvers” and advocating for positive change through robust stewardship can be a better approach. Divest, and you have no idea if the business is improving or devolving.
Prudent Risk Management
Lastly, an exclusionary approach simply means fewer choices — especially if one is avoiding entire sectors — and that usually means more relative risk. Fiduciary concerns are real, and rare is the investor and beneficiary OK with losing money. Institutions, in particular, are bound by long duration obligations and liabilities. Strategic allocation across different assets and sectors is key to managing volatility, so why not leverage active engagement as a path to optimal, risk-adjusted returns?
Investing for environmental and social good is complicated. Passions compete, even within each stakeholder. Divestment may be the right call once all other options have been exhausted. But advocacy, like change, often is more effective when coming from within.