How ‘Stewardship’ Aims to Make Passive Funds Greener

(Bloomberg) -- What happens when the century’s two biggest investment trends collide? That is, what happens when pressure to make climate change a focus of investment decisions runs into the multi-trillion dollar flow of money into passively managed funds, many of which are locked into holding shares of big carbon emitters? One response has been a new emphasis on the concept of stewardship. The companies that run the largest passive funds (and some active-management peers) call stewardship an organized effort to use their influence to change companies’ environmental ways. Some activists call it a smokescreen for the billions these funds keep sending to fossil-fuel producers even as they talk up a low-carbon future.

1. Why does passive investing have this conflict?

Passive investing generally means buying or selling shares in a category of stocks rather than individual company stocks; the most popular examples are funds that buy every stock in the Standard & Poor’s 500 Index. That lets an investor benefit from overall market growth and save substantially on fees. But it also means giving up the ability to divest – sell – shares of Exxon Mobil Corp., Chevron Corp., ConocoPhillips, and other oil and gas giants included in the index.

2. How is stewardship a solution?

Where money managers once were solely concerned with financial performance, a growing number of investors want to take what are known as ESG issues – environmental, social and governance – into account, since these are now considered factors in creating or eroding value. Stewardship teams are the tools that large asset managers use to represent those ESG interests. They do so by casting proxy votes for their investors on shareholder resolutions, and also by exerting pressure through what the industry calls an engagement – what is supposed to be a constructive two-way dialogue, generally private, between an investor and a portfolio company on a matter material to its future outlook.

3. What does that look like?

BlackRock, the world’s largest money manager, has the largest investment stewardship team in the industry with more than 45 people (out of a workforce just shy of 15,000) and had 2,050 engagements in 42 markets between July 1, 2018 and June 30, 2019, the last period for which it has published data. As Larry Fink, the company’s chief executive officer said, BlackRock is a “permanent shareholder” in all of the companies its passive funds are invested in. UBS Asset Management says its stewardship activities usually fall into one of four categories: thematic engagements, which involve dialogue with companies on key ESG issues such as climate change or food security; reactive engagements, when a company breaches international standards on human or labor rights; engagements related to proxy voting; and proactive engagements by the firm’s investment analysts and portfolio managers. Aberdeen Standard Investments said in the third quarter it engaged with Johnson & Johnson on opioid addition issues, with Brazil’s Vale SA on environmental standards related to a dam collapse that killed 270 people, and with miner BHP Group on its membership of industry associations that promote policies inconsistent with the goals of the Paris climate accord.

4. Do other investors practice stewardship?

Yes. While fellow index-tracking managers Vanguard Group and State Street Global Advisors also have stewardship teams (the former said it engaged 868 companies in the 12 months ended June 30, while the latter says it had more than 1,400 engagements in the first half of last year), plenty of active managers also engage. Axa Investment Managers, which describes itself as an active asset manager, said it engaged with 217 issuers last year, with climate change issues accounting for 40% of those discussions, while fellow active manager Federated Hermes created a specialist stewardship service for institutional investors more than 15 years ago.

5. What kinds of things can stewardship achieve?

Federated Hermes said Tencent appointed its first female director last year after it had engaged with the company on gender equality. But some of the biggest changes have been won by groups of funds working together, as with Climate Action 100+, an activist group of major investment firms with a combined $40 trillion in assets under management. In 2019, shareholder support for a resolution the group proposed led BP Plc to agree to report in detail on how its investments are compatible with the Paris climate pact. It has also extracted pledges from Royal Dutch Shell Plc and commodities giant Glencore Plc.

6. What does stewardship mean for returns?

Several academic studies have concluded that stewardship can improve investor returns, with one suggesting engagement can generate higher annualized returns of as much as 7.1% per annum while also reducing risks.

7. What are its shortcomings?

Federated Hermes said last year many asset managers’ engagements are reactive, sometimes coming only in response to a crisis, or focused only on what will come up at an annual general meeting; funds also tend to focus too much on executive pay at the expense of strategy, risk management and ESG issues. Engagement can also be superficial: Hermes said it often involves just asking add-on questions following financial updates and is “information seeking rather than change seeking.” And non-profit Majority Action analyzed the 2019 proxy voting records of BlackRock and Vanguard and found the two firms voted against at least 16 climate-related shareholder proposals where their backing could have given the measures majority support. Late last year, the United Nations-backed Principles for Responsible Investment warned that the quality of stewardship across the industry was too low.

8. Is this all voluntary?

Not entirely. While client pressure is the biggest force globally, policy makers in a number of countries from the U.K. to Japan have introduced guidelines for how investment firms should be responsible investors and how they should interact with companies they own shares of. The U.K., which was the first country to introduce a stewardship code in 2010, launched a revised code this year after a previous version was criticized for being ineffective. The 2020 code has been broadened to include investments in assets other than publicly traded stocks and requires asset managers and asset owners to report on stewardship activities and their outcomes, with the first Stewardship Reports to be submitted by March 31, 2021.

The Reference Shelf

• Reports on stewardship from BlackRock and Federated Hermes.
• Studies by Principles for Responsible Investment on the state of stewardship and on the performance of funds that pursue ESG engagement.
• A report from Willis Towers Watson on engagement by passive managers.
• A briefing paper on the U.K.’s stewardship code.

To contact the reporter on this story: Alastair Marsh in London at amarsh25@bloomberg.net

To contact the editors responsible for this story: Tim Quinson at tquinson@bloomberg.net, John O'Neil

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