In recent years, there has been much debate about whether institutional investors that have ESG targets should pursue a strategy of divestment or stewardship and engagement when selecting or monitoring funds that do not align with the overall ESG ambitions. In this blog post, we will examine both strategies and explore which one might be the right path for your organization.
Divestment involves removing investments from certain industries or companies that do not align with an investor's values or principles. For example, an institutional investor may choose to divest from fossil fuel companies due to environmental concerns. The main advantage of divestment is that it sends a clear message to the market that the investor is serious about its values and principles. However, divestment can also be seen as a missed opportunity to engage with companies and drive change from within. Additionally, divestment can have negative consequences for the investor's returns, as it may limit the range of investment opportunities available.
When an institutional investor decides to divest from a particular equity, it typically involves selling its shares of that equity in the market. This can lead to a decrease in demand for the equity, which in turn can lead to a decrease in the equity's price. However, the effect of a single institutional investor divesting from a particular equity can be limited, especially if the equity is widely held by other investors. In fact, the impact on the equity's price may be insignificant if other investors do not follow suit and continue to hold or even increase their positions.
Additionally, the sale of the divested equity may be quickly picked up by other investors who see an opportunity to buy the equity at a discounted price, thereby offsetting any negative impact of the divestment.
It is worth noting that the impact of divestment may vary depending on the size and influence of the institutional investor. For example, if a large pension fund or sovereign wealth fund divests from a particular equity, it may have a greater impact on the equity's price and market demand than a smaller investor.
Overall, while divestment by an institutional investor can lead to a decrease in demand and price of the divested equity, the effect may be limited and offset by other investors.
There have been several instances in which large institutional investors have divested from equities they considered not ESG (environmental, social, and governance) aligned. Here are some notable examples:
Fossil fuels: Several large institutional investors, including the Norwegian Sovereign Wealth Fund, the University of California, and the Rockefeller Brothers Fund, have divested from fossil fuel companies due to concerns about their impact on climate change.
Tobacco: Many institutional investors, including the California Public Employees' Retirement System (CalPERS) and the New York State Common Retirement Fund, have divested from tobacco companies due to concerns about the health risks associated with smoking.
Firearms: In the wake of mass shootings, some institutional investors, including BlackRock and the California State Teachers' Retirement System (CalSTRS), have divested from firearms manufacturers.
Private prisons: Several large institutional investors, including JPMorgan Chase and Wells Fargo, have divested from private prison companies due to concerns about their treatment of prisoners and the ethics of for-profit prisons.
Human rights: The Sudan divestment campaign was launched in 2007, in which institutional investors including the New York State Common Retirement Fund, TIAA-CREF, and the California State Teachers' Retirement System (CalSTRS) divested from companies doing business in Sudan in response to the humanitarian crisis in Darfur. In the case of the Sudan divestment campaign, the goal was to pressure companies to stop doing business in Sudan to put an end to the humanitarian crisis in Darfur. The campaign aimed to cut off the financial resources that were enabling the government to continue its campaign of violence against civilians.
As a result many companies withdrew from Sudan, and the campaign was credited with putting pressure on the Sudanese government to end the violence in Darfur.
In some cases, divestments may have unintended consequences, such as the loss of jobs in certain industries or a negative impact on the local economy. However, in many cases, divestments can also serve as a powerful tool to signal to companies and governments that institutional investors are serious about their commitment to ESG principles and may lead to positive changes in the practices of those companies.
Although there are subtle differences between stewardship and engagement, both involve actively working with companies in an investor's portfolio to promote positive change.
Engagement is the process of actively communicating with companies to encourage them to improve their ESG performance. Stewardship, on the other hand, is the active management of investments in a way that aligns with ESG principles.
Engagement typically takes place before an investment is made or during the holding period of an investment. Stewardship, on the other hand, takes place throughout the entire lifecycle of an investment.
Engagement often involves direct communication with companies through channels such as meetings, letters, and shareholder proposals. Stewardship involves a range of activities, such as proxy voting, engagement, and monitoring, to manage investments in a way that aligns with ESG principles.
The main advantage of both an engagement and stewardship approach is that they allow the investor to use its influence to create positive change in the companies it invests in. However, both stewardship and engagement require significant resources and expertise, as well as a long-term view of investment returns. Additionally, there is no guarantee that engagement will result in the desired outcomes.
For investors undertaking either engagement or stewardship, visibility and transparency is going to be essential. There are limited solutions on the market that can allow transparency of underlying assets, particularly in private markets and where complex and sensitive ESG data is unavailable. Dasseti Collect for ESG data collection, aggregation and analysis can improve the flow of data between LPs, GPs and portfolio companies in private markets, making transparency achievable.
There have been some notable examples of where engagement has been successful:
Climate change: The Institutional Investors Group on Climate Change (IIGCC) is a group of European institutional investors that engage with companies on climate change-related issues. The IIGCC has led engagement efforts with some of the world's largest emitters, encouraging them to set targets to reduce their greenhouse gas emissions.
Board diversity: Several institutional investors, including State Street Global Advisors, BlackRock, and Vanguard, have engaged with companies to encourage them to increase board diversity. In some cases, these investors have voted against board members who are not diverse or have been slow to make progress on this issue.
Human rights: The Investor Alliance for Human Rights is a coalition of institutional investors that engage with companies to promote respect for human rights. The coalition has engaged with companies in industries such as apparel, mining, and technology to improve their practices in areas such as labor rights, supply chain management, and data privacy.
Sustainable agriculture: The Principles for Responsible Investment (PRI) is a global organization of institutional investors that engages with companies on ESG issues. The PRI has engaged with companies in the food and agriculture sector to promote sustainable practices in areas such as water use, soil health, and biodiversity.
Waste reduction: The Ceres Investor Network engages with companies on a range of sustainability issues, including waste reduction. The network has engaged with companies in industries such as retail, food and beverage, and packaging to encourage them to reduce waste and promote a circular economy.
These are just a few examples of institutional investors engaging with either investment managers or equities to drive positive change from an ESG perspective. Engagement is often an effective way for investors to promote ESG principles while also maintaining their financial objectives.
Some high profile investors running successful stewardship programmes include:
BlackRock: BlackRock, the world's largest asset manager, has developed a comprehensive stewardship programme that includes active engagement with companies on ESG issues, voting their shares at shareholder meetings, and publishing regular reports on their stewardship activities. In 2020, BlackRock voted against 53 companies for failing to make sufficient progress on climate change, diversity, and other ESG issues.
CalPERS: The California Public Employees' Retirement System (CalPERS) has a long-standing stewardship programme that includes active engagement with companies, proxy voting, and annual sustainability reporting. CalPERS has used its shareholder power to push for changes at companies in a range of areas, including board diversity, executive compensation, and climate risk.
Legal & General: Legal & General, a UK-based insurance and asset management company, has developed a stewardship programme that includes active engagement with companies on ESG issues, proxy voting, and the publication of an annual sustainability report. In 2020, Legal & General used its shareholder power to push for greater board diversity at companies in its investment portfolio.
USS: The Universities Superannuation Scheme (USS), a UK-based pension fund for higher education employees, has developed a stewardship programme that includes active engagement with companies, proxy voting, and the publication of an annual responsible investment report. USS has used its shareholder power to push for changes at companies in a range of areas, including climate risk, executive pay, and gender diversity.
Norges Bank Investment Management: Norges Bank Investment Management, the asset management division of Norway's central bank, has a comprehensive stewardship programme that includes active engagement with companies, proxy voting, and the publication of an annual responsible investment report. In 2020, the fund voted against the reelection of 94 board chairs who did not have a woman on their board.
These are just a few examples of successful stewardship programmes run by institutional investors. By actively engaging with companies on ESG issues and using their shareholder power to push for positive change, these investors are working to align their investments with their values and promote sustainable and responsible business practices.
The right path will depend on an organization's values, principles, and investment objectives. However, it is important to note that divestment and stewardship and engagement are not mutually exclusive. In fact, many investors are pursuing a hybrid approach that combines all strategies. This may involve divesting from certain companies or industries while engaging with others to drive positive change.
Ultimately, the key to success for institutional investors is to take a holistic view of their investment portfolio and consider all factors, including financial returns, ESG considerations, and impact on society. It is the responsibility of Chief Investment Officers to make informed decisions that balance the interests of the investment firm and its stakeholders. By taking a thoughtful and strategic approach to fund selection, it is possible to ensure that the investment firm's investments align with its values and principles, while also generating positive financial returns.
There are several ways that institutional investors can drive change from an ESG perspective beyond divestment and stewardship, including:
Impact investing: Impact investing is an investment strategy that aims to generate positive social and environmental impact alongside financial returns. Institutional investors can direct capital towards impact investments that align with their values and promote positive change in areas such as renewable energy, affordable housing, and community development.
Collaborative engagement: Collaborative engagement involves institutional investors working together to engage with companies on ESG issues. By pooling their resources and engaging with companies as a group, investors can amplify their impact and push for change more effectively.
ESG integration: ESG integration involves the incorporation of ESG factors into the investment decision-making process. Institutional investors can use ESG integration to identify companies that are well-managed, financially sound, and aligned with their values.
Active ownership: Active ownership involves the use of shareholder power to push for change at companies. Institutional investors can use their voting rights to support ESG-related shareholder proposals and hold companies accountable for their ESG performance. More typical in the private equity space, active ownership can include voting on shareholder proposals, engaging with companies on ESG issues, and taking legal action to hold companies accountable for their ESG performance. The goal of active ownership is to directly influence the actions of companies and promote positive change.
Public policy advocacy: Institutional investors can use their influence to advocate for public policies that support sustainable and responsible business practices. This can include lobbying for stronger ESG regulations, engaging with policymakers on ESG issues, and supporting advocacy organizations that promote sustainable business practices.
It really goes without saying that accurate data is essential for setting ESG-related investment goals and ambitions. ESG data provides investors with important information on how companies are managing environmental, social, and governance issues, and helps them to identify risks and opportunities related to these factors.
Without accurate and reliable data, it is difficult for investors to make informed investment decisions based on ESG considerations. For example, inaccurate or incomplete data may lead investors to overlook important ESG risks or opportunities, or to overestimate the ESG performance of a particular company or asset.
In recent years, there has been a growing focus on improving the quality and availability of ESG data, as investors have become increasingly interested in incorporating ESG considerations into their investment strategies. This has led to the development of a range of ESG data providers and rating agencies, as well as industry-led initiatives to promote ESG reporting and standardization.
However, there are still challenges in obtaining accurate and reliable ESG data, including issues related to data quality, consistency, and comparability. This highlights the importance of working with reputable ESG data providers, and of conducting rigorous due diligence to ensure that the data used in setting ESG-related investment goals and ambitions is accurate and reliable.
As with other data collection, investors need to take a "Trust but verify" approach when it comes to collecting ESG data. While ESG data can provide valuable insights into a company's environmental, social, and governance performance, it is important to ensure that the data is accurate and reliable before making investment decisions based on it.
ESG data is often self-reported by portfolio companies, which can lead to inconsistencies and inaccuracies in the data. Additionally, ESG data may be incomplete or limited in scope, which can make it difficult to fully evaluate a company's ESG performance. It can be hard to understand levels of exposure when data points are inconsistent across sectors, company sizes or types. Comparing apples with pears is always a problem.
Investors in the private equity sector can use Dasseti Collect for ESG to conduct one to one independent research to validate or bolster market data. Talk to the Dasseti team today about our award-winning ESG Data Collection Solution.