ESG Engagement – What Does it Mean?

Our March RIA Channel ESG Practice Playbook catalyzed several audience questions related to ESG engagement and divestment. Below are a couple of (slightly edited) questions we received:

• How can investors influence companies to be even better in ESG performance?
• How can advisors get more information on the proactive efforts of ESG funds that try to drive positive change?

Great questions!

One major way of influencing company behavior is via engagement, which encompasses everything from direct dialogue with a company to the filing of shareholder proposals to voting proxies. In our SMART Investing Solutions, we favor asset managers that incorporate strong engagement practices into their overall approach.

For example, Green Century Funds, a manager in our mutual fund models, puts engagement central to its strategy. It states that the companies themselves “may also gain from strong relationships with their stakeholders.”¹ The firm has deep experience in efforts to reduce deforestation, especially with respect to palm oil, which has led to tangible shifts in corporate behavior.

In session one of our ESG Practice Playbook (video playback still available!), Martin Jarzebowski, CFA of Federated Hermes, a manager in our Climate UMA, said his definition of engagement is “a collaborative dialogue with the board of directors and with the senior leadership…to really better understand their ESG risks and opportunities, but also very importantly to be able to have a seat at the table to advocate for positive change.” Engagement enables an investment team to see the progress on the ground and potential “ESG momentum.”

Engagement is a powerful tool, but there may be good reasons to consider divestment, especially when the issues go way beyond a single holding, or if an entire sector is in question for ethical reasons. In the 1980s, divestment was a contributor to the end of apartheid and, more recently, divestment movements are influencing change with respect to the use of the fossil fuels and the private prison sector. The choice to divest, engage, or both may depend on various considerations including firm values, investment thesis, and theory of change, along with the circumstances of a specific situation.

Circling back to engagement, when dialogue fails, an issuer may be subject to a shareholder resolution and votes that go against the preferences of company management. According to US SIF, The Forum for Sustainable and Responsible Investment, “such resolutions are a meaningful way for shareholders to encourage corporate responsibility and discourage company practices that are unsustainable or unethical. A shareholder resolution need not win a majority of the shares voted to succeed in persuading management to adopt some or all of the requested changes.”² Sometimes, simply filing a resolution brings a company back to the table for discussion and the filer may withdraw the resolution in response.

We are now in the 2021 proxy season, which according to Barron’s, “looks unusually active.”³ The resolutions currently on the table show that several large companies are getting requests to conduct racial-equity audits, with others facing political spending and “Say on Climate” proposals. State Street Global Advisors will vote against “nominating and governance committee chairs at S&P 500 companies that don’t disclose the racial and ethnic makeup of their boards this year.”⁴ And, unsurprisingly, given the increasing focus on climate change, there are a number of resolutions in play asking for climate disclosures and ambitious emissions reductions.

For those of you looking to follow how the season unfolds and more generally understand how managers engage and vote, there are several places to check:

• Managers with strong ESG integration and engagement practices often publish information on their websites regarding proxy voting policies, votes, engagement outcomes, and resolutions filed. For example, Federated Hermes, Calvert Investments, and AllianceBernstein.
• The Principles for Responsible Investment (PRI) has a shareholder resolution database where you can see which companies have received filings from which managers.
• Proxy voting service providers such as Glass Lewis collate the trends of the past season and the previews for the current season.

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