Responsible Investing: To Divest or Engage

Responsible investing has evolved from the early days of ethical investing when it removed so-called sin stocks and, for many firms, engagement is now the preferred method of working with companies on climate and social change.

“It allows you to be part of the conversation,” says Jenifer Rush, Head of Responsible Investing and Manager Research at Sun Life Global Investments in a Benefits and Pensions Monitor interview on ‘Responsible Investing: To Divest or Engage.’ Adelina Romanelli, Director of Responsible Investing at Sun Life Global Investments, added “it’s part of making meaningful lasting change that is not achievable without that engagement or stewardship. By broadening that picture to think about systems, you then begin to consider policy and stewardship on the regulatory and policy side. In short, we recognize that change in the real economy is ultimately dependent on engagement.”

Romanelli used climate change as an example as it is a “defining issue of our time and time is of the essence. It’s a monumental challenge and it’s something that is occurring now.”

However, industrialization, rising consumerism and global population growth have all been dependent on traditional fossil fuels. So transforming systems and moving towards a low carbon economy essentially requires a transformation in the way energy is produced.

How do you identify companies that you want to engage with?

Rush: As a manager of managers, our approach to ESG integration is with our sub-advisors, not the underlying companies in a portfolio. We engage with our sub-advisors on issues we have identified and we don’t defer to a sub-advisor’s prepared dialogue in order to engage. We will address what we’ve seen in their portfolios, observed from their remarks, and assessed from their activities.

Right now, the first area of concern is climate. Nothing else matters as much and we need to talk about how to act collectively now.

Romanelli: We engage with every sub-advisor on our platform, beginning with a more formal due diligence method. We also engage on subjects we feel require heightened attention. For instance, last year, we sent a comprehensive climate questionnaire to all of our sub-advisors. We also have ad hoc queries that we add during monthly or quarterly reviews. With these reviews, we’re not systemically addressing corporate or specific issues, but engaging with the purpose of striving to understand where they are on their ESG journey. This journey begins with foundational aspects, given that a solid foundation is key to a shift in mindset and the act of transforming their culture.

In transforming a culture, you need to think further than the ESG information and frameworks they have at their disposal (or of tools that enable them to gather insights), but of how the firm is allowing them to understand that this added ‒ and often complementary - information can provide the foresight to be able to navigate this constantly evolving landscape. Quite frankly, the ESG ecosystem is really dynamic as well as very complex and nuanced, and consequently, much more than data alone.

We utilize multiple external data sources to inform us on these issues. We learn from the news media, social media, reports from non-profit organizations (NGOs), and think tanks.

All of these produce findings and we attempt to keep track of the issues and concerns that arise.

How should asset managers be evaluating engagement outcomes?

Rush: As a manager of managers, we are in a unique position. We work with a spectrum of managers (sub-advisors) and so, in terms of the true impact, we’re looking for concrete change and actual results. We’re able to look at each individual sub-advisor, but we’re also able to compare them against their peers, so we can see who’s adopting leading practices. We look at things as simple ‒ but important - as voting records. We track voting records and engage on them as needed.

Ultimately, it’s really about progress. We’re looking for specific forms of engagement. What are they actually doing? What issues did they focus on and how did they identify the company at hand? Are they tracking out- comes and collaborating when beneficial?

Romanelli: If we think about leading practices, we can segregate them into firm competencies, prioritization areas, and transparency.

Competencies are ultimately about what they are doing to upskill and to collaborate because, as we all know, you cannot achieve anything without collective efforts. Those that have been doing this for some time, and are heavily engaged in key areas, are looking at diverse requisite skills sets. Now they’re looking to fill the gaps and these sub-advisors recognize that this is mission critical. So that’s definitely a leading practice.

Prioritization is a bit more subjective. It boils down to how deliberate their overall strategy is with respect to identifying key focus areas. Again, those committed are more apt to drive change. They’re really able to provide clarity on why certain companies, for instance, were targeted as part of their engagement activities. This is really very important. If they can tell you the reasons for engaging with specific companies, it tells us they have a strategy that trickles down from their overarching investment and sustainability/ESG philosophy.

Finally, not only is there increasing demand from stakeholders for more transparency, but also from regulatory bodies, NGOs, and think tanks. They’re all scrutinizing companies around actions, especially if they are big, influential players.

One of the aspects in transparency is what we refer to as reporting on milestones. It consists of reporting on your achievements via these engagement activities, so tracking those outputs or outcomes is important. Of course, consistently voting according to principles and pre-declaring intentions when possible would be considered a leading practice.

How will engagement evolve going forward?

Rush: What is changing now is that responsible ownership is really the focus ‒ being a strong responsible owner of your assets. It starts with the recognition that the actions of one company or one government affects others. People are starting to understand that and firms are investing using the Principles for Responsible Investing (PRI). We are looking for what is called ‘active ownership 2.0’ which is a framework for more deliberate stewardship – the stewardship we need now. Active ownership 2.0 talks about the systemic risks, climate change, and the inequitable structures threatening the long-term performance of the economy and asset owner portfolios. As a company or an asset owner, it should be important because businesses may be threatened, but also the beneficiaries of businesses may be threatened.

If you think about, for example, chemical companies, a hazardous discharge is not an isolated event. That’s an event that may impact land and water, which may impact crops. This could impact the price of those crops utilized by a beverage or food company. That impact goes right through the economy.

Romanelli: In terms of the pace, if you think about where we were decades ago, I’m not saying we weren’t aware, but the awareness wasn’t as broad as it is today in terms of pressures mounting on human capital and, of course, physical or natural capitals. Pressures are mounting globally. And climate change, of course, is at the nexus of this. Stakeholders, including corporations, recognize that this ESG lens or sustainability lens is no longer a nice-to-have, it’s becoming a strategic imperative.

If we start thinking of ESG as a strategic imperative, we want companies to have the skills on the board level and on management levels, but they also have to be aligned. So we would look at the KPIs (key performance indicators) with respect to ESG. And there’s more and more attention paid to that as a lot of times these KPIs are somewhat easily achievable. There’s growing recognition that people are really homing in on the details to say, wait a minute, is this KPI incremental, or does it truly require bolder action?

So that’s why things have changed and are changing, because of ESG’s business relevance and, by extension, investment relevance.

What happens if engagement efforts fail to drive action?

Rush: Ultimately, we would divest from the sub-advisor. But it’s really important that this decision would be the result of our collaborative engagement with that sub-advisor within our escalation process. We know their commitment and we know the level of commitment as we’re always evaluating this. We haven’t hired them without knowing where they’re at.

But we expect our sub-advisors (and ourselves) to constantly and consistently evolve in terms of depth and breadth of ESG investing. We increasingly expect our sub-advisors to be transparent with respect to their escalation strategies.

But as a last resort, absolutely, we would recommend divestment from a sub-advisor.

Romanelli: With climate change, one of our key areas is to keep holding our sub-advisors to a higher standard. However, we have to hold ourselves to a higher standard as well because that’s the only way to drive real change. If we don’t do it collectively, we are never going to drive any meaningful or lasting change.

To this end, we are developing our own sub-advisor escalation strategy, focusing on one or two key areas which are a natural extension of our net zero asset manager journey. We will be looking for more transparency, more proof statements, and more clarity around their escalation strategy.

Divestment is clearly a last resort, but is it enough?

Romanelli: Divestment from one segment alone doesn’t necessarily result in real change.

For example, the fossil fuel industry is an important driver in rising emissions. However, an important part of this industry lies in the hands of national producers, it’s not all private. So if you’re divesting from the public fossil fuel sector, it doesn’t necessarily change the fossil fuel landscape.

As well, divesting from corporates or the more intensive emitters may result in unintentional consequences. George Serafeim, the Charles M. Williams Professor of Business Administration and the Co-principal Investigator of the Climate and Sustainability Impact AI Lab at Harvard Business School, has found when you divest from these companies, you potentially make their share price more appealing to the less-than-ESG oriented investors or investors with different circumstances.

That’s why the real change lies with advocating for changing government regulations and policies that address these challenges and incentivize changes (for example, green technologies and fair social systems) at the scale and pace that is needed. If we can incentivize change, we can then catalyze businesses to transform.

Jenifer Rush is the Head of Rsponsible Investing and Manager Research at Sun Life Global Investments, while Adelina Romanelli is the Director of Responsible Investing.