What’s the value of Company Engagement for Ethical Investment?

Engagement Themes…

A key part of this long-term approach is company engagement, the process of ongoing dialogue between the fund manager and the companies they invest in. Company engagement work ranges from simple letter writing to detailed discussion and debate with a company’s senior management.  Engagement can be about topics specific to a given company, such as if Health and Safety was flagged as a concern.  More generally, fund managers will select a number of themes as the focus of their ongoing engagement work.

For example, Rathbones’ engagement priorities for 2024 include Modern Slavery, net zero, biodiversity and corporate Human Rights.  Similarly, Liontrust has focussed its engagement work on the climate crises, preserving and restoring nature, worker wellbeing, and increasing corporate diversity.

EdenTree’s engagement priorities for 2024 are summarised in the graphic above.  As an example, they have been engaging on the theme of a “Just Transition” in renewable energy.  While the climate crisis requires a rapid expansion in the world’s renewable energy infrastructure, it is also critical that this transition does not harm people and communities.  EdenTree has been working with the investment trusts held in its green infrastructure fund, exploring concerns such as the rights of indigenous peoples, and forced labour in solar panel supply chains.  Eleven of the twelve companies they engaged with have now committed to publishing a standalone human rights policy.

…not just “Nice to Haves”

The key thing about such engagement topics is that these are not just ethical “nice to haves”.  There is a strong body of evidence which shows well-managed businesses which behave with clear ethical values and policies will deliver better returns for their investors.  Issues such as human rights, water resources, and biodiversity are materially significant – they create very real operational and reputational risks for companies, and for their long-term profitability.

Fund manager engagement is therefore very much a process of stewardship – preserving and enhancing the value of the assets they hold, on behalf of their clients.  Liontrust’s engagement with Daikin provides a good example.  Until recently, Liontrust held Daikin Industries in some of its Sustainable Future (SF) funds.  Daikin are global leaders in energy-efficient air conditioners and heat pumps.  Their products cut carbon emissions by around two-thirds versus traditional technologies, so fit well within sustainable investment themes.

However, in 2023 Liontrust engaged with Daikin on two particular issues of concern – the production of white phosphorus for the Japanese military and the production of PFAs (‘forever chemicals’).  The engagement identified that, in both cases, the relevant regulations were being complied with (and the ethical screen was not being breached).  That said, the fund managers remained concerned.  For example, despite the company’s confirmation that the white phosphorus was being used for training purposes, it was not able to guarantee that it would never be used in military combat.  Liontrust believed that there was too much increased risk in its Daikin investments and therefore divested (sold) these holdings from its Sustainable Future funds.

Voting for Change

The Daikin example demonstrates that, ultimately, if a company is not open to change, a fund manager can – and will – sell their holdings.  That said, company engagement is usually considered as a more gradual process, looking to encourage, motivate and support companies to improve their practices.  One mechanism by which fund managers reinforce their engagement work is by voting at company Annual General Meetings (AGM).  As Rathbones explain:

“..the power of our engagement as investors rests on the board’s knowledge that there are consequences if we think the board isn’t listening to our concerns.  We will, if necessary, vote against it on issues at the AGM.”

As an example, Advanced Drainage Systems (ADS) is a market-leader in the production of thermoplastic pipes.  It facilitates the water industry’s move away from traditional concrete and steel (both more expensive and environmentally impactful) and is also one of the largest recyclers of plastic in North America.  However, in 2023, EdenTree felt that ADS’s Board was insufficiently diverse and that the company was providing insufficient information on its workforce demographics.  EdenTree therefore voted against the re-election of the Chair of ADS’s Nominations Committee.

Recent research by the Financial Times highlights that not all fund managers adopt a consistently ethical approach to voting.  Vanguard is the world’s second largest fund manager, holding over $9.3tn in assets.  The FT reported that, in 2021, Vanguard voted in support of 46% of shareholder proposals on environmental or social issues.  This number fell to 2% in 2023 and – in the 2024 season – Vanguard supported none of the 400 such measures it considered.  Similarly Blackrock, the world’s largest fund manager ($10.6tn), voted in favour of just 4% of such measures worldwide this year.  The FT reported that both companies have reduced or ended their involvement in groups advocating to fight climate change, while at the same time facing heavy criticism from some US politicians over accusations of using their shareholdings to support “woke capitalism”.

Engaging Collaboratively

The enormous size of Vanguard and Blackrock make their weak and wavering support particularly frustrating.  That said, on the issue of size, ethical fund managers are now increasingly working collaboratively, pooling their resources and their influence. Individual fund managers will lead the engagement with particular companies, on behalf of the collaborative group.  Examples of such initiatives include:

• CA100+ – aimed at pressurising large corporate greenhouse gas emitters to take more significant action on climate change
• Find It, Fix It, Prevent it – a global group of investors working to tackle Modern Slavery
• Investor Action on Microbial Resistance – leveraging investor influence to combat drug-resistant ‘super-bugs’
• The Valuing Water Finance Initiative – a global investor collaboration engaging companies with a large water footprint
• Investors for Sustainable Solar – engaging with solar photovoltaic energy and inverter companies on issues such as toxic substances and child labour in supply chains.

Each of these initiatives includes ethical fund managers that we deal with here at Investing Ethically.

Issues such as ‘natural capital’ and water management are now recognised as materially significant to the long-term viability of many companies.

Wider Engagement

Amongst the fund managers we deal with here at Investing Ethically, some – such as EdenTree – only provide ethically-screened funds.  Others offer a range of both ethically and non-ethically screened products.  However, even with their ‘non-ethical’ funds, these fund managers still recognise the vital importance of ESG (Environmental, Social and Governance) issues for long-term investment success.  They are therefore engaging on issues such as climate or biodiversity, not just with the companies in their ethical funds, but with their wider portfolios.  In other words, they are engaging with companies outside the normal scope of ethical investment, for which environmental and social issues may well have been less of a priority.

Examples include Jupiter Asset Management’s engagement with mining firms – with De Grey Mining on the rights of indigenous peoples in Western Australia; and with South32 on decarbonisation and on health and safety.  Similarly, Janus Henderson is engaging with oil and gas companies on improving reporting and target-setting of methane emissions.  Methane is an extremely powerful greenhouse gas, often released as a pollutant biproduct during oil and gas extraction.

Conflicting Issues to Consider

We have written previously about the UK’s new Sustainable Disclosure Requirements (SDR), including the labelling of ethical funds.  Company engagement will be an important mechanism for funds using the  ‘Sustainability Improver’ label: investing in companies that have the potential, over time, to improve their environmental or social sustainability.  At one level, it is good thing to be reducing the methane emissions associated with oil extraction… but it does highlight our concerns about this ‘Improver’ label.  It’s far better, and much more moral, to be investing in the future of greener, more sustainable products and services, than in trying to improve “laggard” industries.

However, such thinking also highlights that taking an ethical approach to investing can be complex, with sometimes conflicting issues to consider.  So, for example, part of Rathbones’ engagement work is as a member of Global Investor Commission on Mining 2030.  This collaborative group aims to make mining more environmentally and socially responsible.

At first thought it might seem odd that an ethical fund manager would have any engagement with a heavy industry such as mining.  However, the shift towards a Net Zero society will rely extensively on technologies such as car batteries and solar panels.  Tackling climate change depends – to some extent – on our ability to extract raw materials, such as silica, lithium and cobalt.  Understanding the many environmental and social issues within such extractive industries, and the upstream manufacturing processes, requires long-term industry engagement.  Rathbones’ work is focussing on the mining industry’s response to social risks.  The aim is to develop a standard for socially responsible mining, which investors can then press companies to meet.

What’s the value of Company Engagement for Ethical Investment?

So, in conclusion, company engagement is an essential activity for ethical investment, helping fund managers to understand key issues and to influence companies’ activities.  Our experience, over nearly twenty-five years, is that – while screening remains important – engagement is becoming more and more significant.  This may be because, although ethical issues are becoming increasingly mainstream for investors, they are also becoming increasingly complex, inter-related, and urgent.

We’ll finish with a quote from Stewart Investors, one of the fund managers we deal with, which neatly summarises what we’ve been discussing: 

“We believe that no company is perfect and as long-term shareholders, engagement, voting and research are key responsibilities for us. We see engagement as a way to mitigate business risks, protect against potential challenges and improve investment outcomes.”

We hope you’ve found this article interesting! If you’d like to know about how your investments could help tackle ethical issues, and how our Chartered Financial Planners can help you, please get in touch.