Engagement is how fund managers are keeping companies on track

As more fund managers are coming under pressure to deliver ESG-focused investments, their engagement with their investments and how their ESG credentials play out have become crucial.

Hugh Cuthbert, European and global equity fund manager at SVM, says the bottom line when it comes to engagement is that company management will respond to the incentives that are created for them.

He says that apart from voting against management at the annual general meetings of companies he is invested in, the best way to achieve long-term change is by encouraging a structure where, if ESG targets are not met by the company, then the bonuses of the top management are withheld.

He notes this will incentivise company management to behave in a way that delivers on the responsible investment outcomes they speak about when they talk to fund managers.

Cuthbert adds that engagement is important as a way to enhance the returns for investors, as “[if one] just buys a fund of perfectly ESG companies, one would be buying an expensive fund.” 

Types of engagement 

John Fleetwood, director of responsible and sustainable investing at consultancy Square Mile, says: “"Engagement comes in two forms. The first is direct engagement with investee companies; meeting with company management to question them and influence them on responsible investment issues.

"This sometimes involves sharing best practice, or might mean questioning them on their climate policies and practice, or on ensuring that human rights are respected in their supply chains. 

"The second type of engagement is collaborative in nature and can take the form of advocacy or collective lobbying to bring about change.” 

Sebastian Thevoux-Chabuel, ESG analyst and portfolio manager at Comgest, tends to buy established companies with proven track records in financial and ESG terms, but says regular interaction with companies is always worth doing as “there is no such thing as the perfect company”.  

Sarah Norris, investment director at Aberdeen Standard Investments (rebranding as Abrdn in the summer), says engagement is part of any normal investment process, not just ESG, and is about assessing the investment risk of a company.

She says the ESG element of engagement is about “getting comfortable with the balance of risks” associated with a company’s policies in relation to treatment of employees and the impact on the climate and wider society.

She describes engagement as “an ongoing process” rather than just something that happens when the AGM takes place. 

Shaunak Mazumder, global equity investor at Legal & General Investment Management, says that as a fund manager his priority is to buy companies that he thinks are well run and are ESG-compliant, but adds this approach does not render engagement unnecessary. 

He says: “The first stage is to eliminate companies such as tobacco, that have business models that cannot be ESG even if you engage with them.

"Engagement is for the next tier of companies, where it is a question of business practice. That is about what the company does and how it does it. There would be two or three engagements from us a year, and what we want to see is improvement each time, and we quantify this with our own ESG scores.

"We have found that about 30 per cent have seen no change, and 70 per cent have improved. Our investment team engages with the company management but also with the board. This doesn’t mean each engagement leads to us getting what we want, but its improvement over time.” 

Sandra Crowl, stewardship director at Carmignac, says practices that would mean a company scores badly in terms of ESG is also likely to be a sign that the company is run less than well, and that has implications for the financial returns a company can achieve. 

It is for this reason she says investment houses “have a duty” to engage with investee companies. She identifies high levels of staff turnover and lack of action on carbon emissions as two particular red flags. 

She says: “It’s a pretty structured approach; if we score a company low on ESG, we want to know why. We do our own scoring but use external ratings agencies as a guide as well. Governance has been 90 per cent of the decision for most companies, but the E and the S considerations are becoming rapidly more important.”    

Yuko Takano, portfolio manager at Newton Investment Management, says she and her team generally disagree with company management about 30 per cent of the time, and vote accordingly. 

She says dedicated engagement professionals and the investment managers, such as herself, tend to also want to be involved. She says the engagement is more effective when the actual fund manager – the person with “skin in the game” – is properly part of the investment process, and not just a bolt-on. 

James Budden, director of marketing and distribution at Baillie Gifford, says that active fund management companies are likely to be more able to engage with investee companies because they have the ability to sell the shares of companies they believe are not making progress, while index funds must own them.

But he adds that “it is also a question of time. At Baillie Gifford we are invested in 300 or so companies across the funds, but a big index provider will be invested in close to 3,000, and that makes meaningful engagement much harder and creates something closer to box ticking”. 

Angus Parker, who runs the HSBC Global Equity Climate Change fund, says: “Engagement with portfolio holdings is an essential ingredient in exercising fiduciary duty. As well as interactions initiated by individual portfolio managers or analysts in support of a particular investment, engagements can also form part of firm-wide programmes to promote responsible investment outcomes. 

"Participation in collective initiatives with other investors, such as the Climate Action 100+, is another powerful way to engage with corporates where speaking for a wide group of investors carries more weight. For the HSBC Global Equity Climate Change Fund we deliberately seek companies whose revenues are aligned with the energy transition and decarbonisation themes and who are intentionally trying to make a positive change."

He adds: "Engagement with these companies is patient and private and about understanding and encouraging appropriate commitments, setting standards to drive outcomes and establishing expectations. Inevitably issues will emerge that might contradict the sustainable development goals and this will require more detailed engagement to ensure that any effective resolution is achieved in a timely manner.”

Paul Niven, head of multi-asset portfolio management at BMO Global Asset Management, says: "First off, diversification is key and by spreading our exposures across a range of asset classes, geographies and individual companies we limit the impact of disappointments in any one area. It also means we’re casting our net wider over a host of potential sources of return.

"Diversification is a fundamental investment principle for very good reason. Asset allocation plays a key role and for more cautiously minded investors we place greater emphasis on fixed income over equities, for example.

"Alongside this more strategic perspective, we believe that it’s important to think tactically, and adjustments taken on a more near-term view will be important in helping protect capital and take advantage of volatility. Our stock-pickers must also think about capital protection and the quality of businesses and valuation play a key role in that.

"Right now for example, many commentators are concerned about valuations in equities. We think with fiscal and monetary policy, markets look reasonably supported, but there are certainly some areas of excess, in US tech for example. Avoiding such pockets and emphasising sectors and companies where valuations are less stretched is a sensible way of adding an element of downside protection."

David Thorpe is special projects editor at FTAdviser