Investor stewardship is beginning to come of age. Look no further than recent global media to see that the environmental, social and governance (ESG) interests of investors are starting to be accounted for in ways they never have before.

When it comes to climate change in particular, investors are demanding tangible action from companies and their voices are being heard. The 2021 annual proxy season was unprecedented, with a record number of climate and environment related shareholder proposals put forward. Climate Action 100+, the largest ever investor-led climate engagement with more than 570 investors responsible for over $54 trillion in assets under management, has led much of the charge.

In May, we saw a dramatic shake up at ExxonMobil where a majority of shareholders voted to replace members of the board with a selection of candidates experienced in clean energy and energy transitions. This was following concerns that the company was moving too slowly to align its strategy with global climate action.

Meanwhile at Chevron Corporation’s annual general meeting (AGM), 61 per cent of shareholders voted in favour of proposals for Scope 3 emissions reductions targets. In addition, a first-time proposal for climate-related financial risk reporting nearly passed, with 48 percent of the vote.

In Australia, the case of Rio Tinto has also been notable. Institutional investors echoed global outrage at the weak response from Rio Tinto following their destruction of sacred Aboriginal caves, destroying 46,000-year-old shelters, and lobbied to remove senior executives. At the company’s AGM in May, more than 60 per cent of investors voted against the pay-outs to former executives, notably including the former CEO.

It’s clear there is a shift underway, with investors stepping up their active ownership practices.

As shareholders of companies around the world, investors have a fiduciary duty to use their influence to maximise overall long-term value. This includes the value of ESG assets, upon which returns, and their clients’ and beneficiaries’ interests ultimately depend.

At PRI we’ve been working with global investors on Active Ownership 2.0 since 2019, an aspirational standard to help usher in a more ambitious era of stewardship, whereby investors seek outcomes, prioritise systemic sustainability issues and collaborate to overcome issues of collective action. With major deadlines for action on the Sustainable Development Goals and the Paris Agreement looming, we only see this trend continuing to accelerate.

Capital is truly global, and therefore investors are and will continue to respond to international corporations with both individual and collaborative stewardship practices. Yet, not every government has grasped the inevitability and importance of this global trend. My home country of Australia is the prime example, where the Treasury recently issued proposals that would create ineffective and burdensome disclosure obligations on proxy advisors, including in the advice they provide to Australian superannuation funds.

Proxy advisors play a valuable role in the market – enabling more informed voting in a cost-effective way. Many institutional investors use proxy advisory firms’ recommendations to supplement their research and understanding of multiple, detailed and sometimes dense proxies for their portfolio. They generally provide high quality, independent analysis, linked to voting recommendations based on institutional investors’ priorities.

Without confidence in the impartiality of proxy firms’ recommendations, investors — particularly smaller and mid-size investors — would lack the capacity to synthesise the relevant information they need to determine how they will vote their proxies and would have difficulty fulfilling their fiduciary duties as a result.

Of course, more transparency and accountability for proxy advisers and how investors vote is welcome. There has been a tendency among some proxy advisers to overlook how environmental and social factors affect long-term shareholder value, and a failure to scrutinise boards for these failures. However, measures such as those proposed in Australia focus more on reducing their ability to challenge management and hold boards accountable – the precise opposite of what is needed.

Yet, the Australian government isn’t the first to venture down this road, with similar Trump-era reforms having previously been enacted in the US.  Although they are already moving to rectify this retrograde policy which is impeding investors. The Securities and Exchange Commission (SEC) chair and staff from the division of corporate finance are currently considering whether or not to recommend the Commission revisit the interpretation, guidance and rules and in the meantime have decided not to enforce them until their review is complete. By failing to learn lessons from their predecessors, the Australian Treasury’s reforms could place complex and ineffective disclosure obligations on superannuation funds that would not result in any material benefit and may add additional costs and confusion to the detriment of members.

At PRI we’ve submitted a response to the Treasury’s consultation, with key recommendations on how to move forward. Our more than 4,000 signatories, who represent, A$133 trillion in AUM,  190+ of whom are based in Australia, have committed in line with our second principle, to be active owners and to incorporate ESG issues into their ownership policies and practices. It’s our belief that investors should be using all the stewardship tools available to them to their fullest potential—including voting—to advance the systemic issues that are most critical to investors and their beneficiaries.

With a distinct lack of empirical evidence as to their rationale, it’s clear the Treasury’s reforms would constitute a backward step for responsible investors.

The proliferation of grand gestures of sustainability, such as net zero commitments, means manager due diligence is even more important and more intensive, according to global head of research at Willis Towers Watson, Luba Nikulina.

“Sustainability and climate is massive in everyone’s agenda right now,” she says. “But there is an issue of greenwashing. If you think about the net zero commitments, they are statements of intent of something that is changing very quickly and also depends on our ability as a society to innovate and come up with transition plans for carbon intensive businesses and new technologies. Could these statements be characterised as greenwashing? We need to unpack the statements and see what their beliefs are and how that translates into actions.”

The sheer extent of the commitments by players means discerning greenwashing is becoming more complicated, she says.

“Credibility is hugely important. It means an intensity of due diligence, you have to put more resources into unpacking those statements of intent,” she says.

The manager research team at Willis Towers Watson did 30 per cent more manager meetings in 2020 than it usually does in a year which was a silver lining of the lack of travel and a reflection of the ongoing use of technology by managers and consultants in the research process.

Nikulina says not only did her team do around 3000 meetings last year, but the quality of interaction did not drop due to a lack of in-person due diligence.

“The quality of insight didn’t drop, but it morphed into something different,” she says. “Seeing investors in their homes, and how they interact, provides a very different perspective in due diligence meetings.”

While many aspects of manager due diligence were not impacted by remote working, and perhaps even improved, operational due diligence was made more difficult. A practice of touching and looking closely at technology and systems plays a core part of assessing operational due diligence and there was a short period of time where this was not possible at all. But with offices and people on the ground all over the world the consultant was able to deploy local people to do operational assessments, when otherwise that might not have fit their job specifications.

“In the case of new growth opportunities, like the increase in demand for China-focused assets, we had to rely on colleagues on site to do due diligence.”

Willis Towers Watson has a team of 110 people doing research, 90 of which are doing pure manager research, a further 10 are doing macro-economic research and there are also 10  people employed by the Thinking Ahead Group.

The consultant has researchers in seven locations around the world, and in some instances it had to rely on client consultants to do the physical check of assets and be the eyes on the ground.

“Last year emphasised the need for agility for everyone and for us as well. To always be prepared for change is a very important takeaway,” he said.

“Diversity and inclusion is a litmus test of a manager’s culture.”

Willis Towers Watson recently published a report reflecting on 20 years of manager research and one change that Nikulina believes is evident is that the industry, more than two decades ago, is built on purpose.

“Last year the purpose of the industry came more vividly to the forefront for many more stakeholders. From a research perspective we think about how do you distil this purpose,” she says.

Even a decade ago the job of a manager researcher was knowing the universe of 100,000+ managers, and ranking them.

“This has changed quite significantly and 2020 emphasised this. You will achieve better outcomes if you built long term relationships and through the period of change you evolve together,” she says. “Then it is easier to get to this purpose.”

Purpose, or why people come to work, is different for different managers.

“It’s interesting to see how different managers relate to the purpose of the industry. 10 years ago it was fine to have a financial purpose as the guiding light. For many firms that is becoming much broader.”

The move to more engagement with managers, rather than pure ranking, is a lesson for asset owners in their selection and relationship with external managers.

“Asset owners can save a bit of governance in not trying to rank the entire universe, and develop more fruitful relationships and increase their chances of success if they select the partners they can work with in developing mandates and ensuring their firms evolve in line with their needs,” she says.

In its manager research process Willis Towers Watson emphasises qualitative or soft factors considerably, including culture.

“Everything quant becomes technologic, it’s about how we process data effectively and get more data, but as researchers we spend less time on it, it’s an input,” she says. “Now people are spending time on how to evaluate the qualitative factors, how to judge culture, get through marketing screens, and what their beliefs are and how they lead their firms.”

In 2020 culture was put to the test, says Nikulina, as people moved to working online. “Managers with a strong culture thrived and we could see that from different angles in doing our remote assessments. But those with fragile cultures found it more difficult.”

She says diversity and inclusion is almost a litmus test of the manager’s culture, emphasising the evolution of DEI rather than the evaluation at a point in time.

“It doesn’t lead you to good decision making when your team is homogenous,” she says. As the industry and various teams embrace DEI and move to be more inclusive culture plays an important role.

“There will be fractures along the way as teams become more diverse, a lot may go through a rollercoaster so culture will be important,” she says.

“DEI has to come to the forefront and 2020 re-emphasised this fact that where a manager is dependent on one personality there are so many more risks. If you have a sustainable business around a team, and a diverse and inclusive team, it is so much more sustainable and more likely to succeed. This has jumped up in our priorities quite a bit.”

Nikulina urges managers to keep clients’ needs at the core of their evolution.

“There are so many players and it’s a competitive industry so you would have expected a lot of innovation. But my assessment is we are not doing as great a job as society should expect form our industry,” she says. “We have very standard products, rather than something that is suited to what asset owners actually need and linking it to the long-term needs of society. We are not innovative enough, we need to think more holistically and innovate more.”

For more commentary on this topic you might like the coverage of the session that Luba Nikulina spoke on at the Fiduciary Investors Symposium in May about the increased use of technology in manager due diligence. Click here for more.

China is a simultaneous threat and an opportunity for investors. This discussion looks at how to navigate a worsening geopolitical situation and what it means for economic growth. Is the current course a steady state, or are big shocks, for the better or for the worse, possible and even likely? Geopolitical expert, Professor Stephen Kotkin, examines what lies ahead for investors.

About Stephen Kotkin
Stephen Kotkin is the John P Birkelund Professor in History and International Affairs at Princeton University. He is the co-director of the program in history and the practice of diplomacy and the director of the Princeton Institute for International and Regional Studies. He established the Princeton department’s Global History initiative and workshop, and teaches the graduate seminar on global history since the 1950s. Professor Kotkin received his PhD from the University of California, Berkeley in 1988, and has been a professor at Princeton since 1989. He is also a senior fellow at the Hoover Institution at Stanford University. At Princeton Professor Kotkin teaches courses in geopolitics, modern authoritarianism, global history, and Soviet Eurasia, and has won all of the university’s teaching awards. He has served as the vice dean of Princeton’s Woodrow Wilson School of Public and International Affairs, and chaired the editorial committee of Princeton University Press. Outside Princeton, he writes essays and reviews for Foreign Affairs, the Wall Street Journal, and the Times Literary Supplement, among other publications, and was the regular book reviewer for the New York Times Sunday Business section for many years.  He serves as an invited consultant to defence ministries and intelligence agencies in multiple countries.  His latest book is Stalin: Waiting for Hitler, 1929-1941 (Penguin, 2017).  His previous book was a finalist for the Pulitzer Prize.
About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.
What is the Fiduciary Investors series?
The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.
The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

About Joseph Stiglitz

Joseph E. Stiglitz is an American economist and a professor at Columbia University. He is also the co-chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and the chief economist of the Roosevelt Institute. A recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979), he is a former senior vice president and chief economist of the World Bank and a former member and chairman of the (US president’s) Council of Economic Advisers. In 2000, Stiglitz founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. He has been a member of the Columbia faculty since 2001 and received that university’s highest academic rank (university professor) in 2003. In 2011 Stiglitz was named by Time magazine as one of the 100 most influential people in the world. Known for his pioneering work on asymmetric information, Stiglitz’s work focuses on income distribution, risk, corporate governance, public policy, macroeconomics and globalization. He is the author of numerous books, and several bestsellers. His most recent titles are People, Power, and Profits, Rewriting the Rules of the European Economy, Globalization and Its Discontents Revisited, The Euro and Rewriting the Rules of the American Economy.

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

What is the Fiduciary Investors series?
The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.

The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

When behavioral economists get a secret handshake, it will be a shrug, a self-deprecating nod to how financial institutions initially greet their ideas.

Ricardo Research’s brilliant analysis of how short-term behavior predictably ensues from the usual mandate contracts between asset owners and asset managers – together with the commentary in Top1000funds.com – is what brings this to mind.

“The first step towards a more effective monitoring approach is to recognise that short-term performance data are at best a weak indicator of success for strategies with long-term objectives”, write Paul Woolley, Phillip Edwards, and Dmitri Vayanos. “Investment cycles can be long-lasting, so even over periods of 5-10 years investors should be wary of drawing overly strong conclusions from performance data alone.”

FCLTGlobal’s experience bears this out exactly.

Last year we released the second edition of our toolkit for investors to build long-term mandate contracts. A key part of this update was adding case studies of how asset owners and asset managers have used these provisions in the real world. The most widely used provision, by far, is a seemingly-minor behavioral nudge: reordering performance tables so that longer-term data comes before short-term returns.

The list of institutional investors that have made this change and talked publicly about it is long, including Ontario Teachers’ Pension Plan, CalSTRS, MFS, Federated Hermes, Kempen, and Brazil-based NEO Investimentos. The evidence of this nudge’s effectiveness is the enthusiasm investors have for talking about it with others.

It must be noted that this is not a change of the performance data that gets presented. All of the return figures remain. These long-term investors merely have reordered the data. The impact comes from knowing that people give the most attention to the information that they see first, often to the point of not giving any attention to the last information in a sequence, so these investors are being intentional in how they use this focus.

It’s really no more complicated than saying what you mean to say (and not saying what you don’t).

This longer-term mandate practice is most widely-adopted, but it is far from singular. Woolley, Edwards, and Vayanos also emphasize the importance of fee arrangements, and very appropriately so. It is stunningly common how often asset owners get what they pay for – but pay for something other than what they want.

Fee arrangements can nudge longer-term focus in a number of ways. Just for example, OTPP also has used a longevity discount with asset managers, accepting higher up-front costs in exchange for steeper reductions over time, and agreed that it would pay a penalty in the event if no-cause termination. Both provisions give OTPP’s asset managers confidence that it really is committed for the long term, and that they must be too.

Risk parameters also need to be on the list because they frame the investable universe for asset owners and managers. Woolley, Edwards, and Vayanos emphasize how multiple times horizons matter. Investors with sincere and strongly-held beliefs about the long term often are surprised by short-term disruptions in the interim period and panic – even though such disruptions are generally foreseeable. Long-term investors agree in their mandate contracts to project risk across multiple time horizons so that they have sound estimates not just about where they are going but also what it will be like to get there.

“Short-termism” is a euphemism for a suite of behaviors in which one individual’s or institution’s time horizon does not match another.

Woolley, Edwards, and Vayanos are entirely correct that the origin of these behavioral mismatches often is the mandate agreement that asset owners and asset managers use to set the incentives and parameters for their relationships. The investors referenced above are leading in this regard.

Practical – indeed, practiced – alternatives are available for other long-term investors that are ready to follow suit.

 

Matthew Leatherman is a research director at FCLTGlobal, a non-profit organization whose mission is to rebalance capital markets to support a long-term, sustainable economy.

Mercer will incorporate DEI considerations into its manager research the same way it pioneered the incorporation of ESG factors in its manager ratings process back in 2012. The integration of DEI is a parting gift from long-term global head of investment research, Deb Clarke, who retired yesterday. Amanda White spoke to her about her legacy and the investment industry’s unfinished business.

For nearly 10 years to get a high ESG rating from Mercer, fund managers have had to demonstrate ESG considerations across the generation of ideas, construction of portfolios, implementation of active ownership and a firm-wide commitment to ESG.

Now Deb Clarke, one of the most senior women in the global investment industry and a trailblazer in manager research, says the consultant will give more emphasis to DEI issues in its manager assessments.

“We want to integrate the DEI data. If we are going to give our highest conviction then DEI will need to be evident at the asset manager,” she says.

Clarke, who says quotas just encourage portfolio managers to consider diversity as an HR problem, says Mercer is tackling the issue by focusing on data transparency.

“We will be more intentional. Diverse teams make better decisions and so deliver better returns for clients;  if you don’t have a diverse team, we will be less likely to have high conviction in the strategy. And it must be genuinely diverse and not just ‘bringing along a female to the finals’,” she says, quoting a fund manager who sought her counsel on diversity. (Her response was “don’t bother coming to the finals”.)

The focus of the data will not be on a certain point in time, but what the manager is doing about the pipeline of talent to increase diversity of thought.

For many years Clarke has been advocating ESG and DEI issues and after her retirement will continue to campaign for change.

“While I have been in the industry there has been a shift away from a star fund manager towards the team. Recent events have also shown that people are more comfortable if there is a team effort and oversight. People want to feel their money is secure, and they are dealing with people with integrity.”

Similarly, she’s observed the evolution of ESG from nascent beginnings to universal claims.

“When Jane [Ambachtsheer] and I first started looking at ESG, many PMs didn’t even know what ESG stood for. We’d ask them if they incorporated ESG into their process and they’d say, ‘absolutely not’. They didn’t want to be associated with it,” she says. “In the last three years PMs are now saying ‘of course we do’. It’s totally reversed.”

Clarke’s hope is that in five years’ time there is no conversation around ESG because it is just embedded into everything investors do.

But between then and now there is a lot of work to do, like other consultants Clarke believes many investors have made a commitment to net zero without any real idea on how to get there.

“If you just sell the companies that you think will do badly it’s like throwing your rubbish over your neighbour’s wall,” she says. “The only way to solve this is through industry cooperation.”

Clarke retired this week after 16 years as global head of investment research leading more than 125 manager research specialists covering hedge funds, fixed income and equities.

“One of the things that strikes me about what has changed in that time is that information is now so freely available. When I started there was still a prize around people getting really good information, now there is a deluge of information. The important thing is not the information but the way you use it,” she says. “The skill set of managers has changed in that time and will continue to change. There is a synthesis of information and having someone who can step back and join the dots is a skill.”

“Many investors have made a commitment to net zero without any real idea on how to get there.”

And while there has been some evolution, her reflection on the industry is one that is very slow to innovate, with a difficulty in identifying any real innovation.

“The industry hasn’t been very good at innovation really. It’s created some new asset classes like LDI and secured finance to meet client needs, and there has been a move from indexing to ‘solutions’ but I’m not sure it’s really innovation. Even something like AI is not really innovative,” she says.

Clarke believes the industry is at risk of disruption and calls for the industry to be inventive.

Fees are an area that are ripe for disruption, and under Clarke’s guidance Mercer has presented some radical ideas for a fee structure revolution including fixed amounts, loyalty fees, share of alpha and cost of capital.

“We were trying to solve for a different fee structure; managers are using the clients’ capital so they should give some of the return upfront. There were some challenges with this around how managers would need more cash on their balance sheet, but the principle is right. You don’t know in advance which managers will do well or badly and there is no alignment of interest. It’s skewed to when the manager does well, and it feels like someone could disrupt that.”

Clarke points to the last 15 months as a case study for the need to create alignment of interest between the industry and the people whose money they are managing.

“The industry has done really well over the past year, while in many other industries people have been furloughed or have lost jobs. We don’t want to see headlines of our industry getting the biggest bonuses ever. Does that feel right? At times I worry the industry can appear tone deaf.”

Clarke does however think there is a sea change in the industry, moving back to focusing on the end client.

“It’s not about the portfolio managers but about creating genuine value for the police, teachers and fireman whose money they are managing. For too long the industry was focused on the PM.”

“Don’t take too many meetings with managers, don’t waste time on things that don’t fit your values and beliefs.”

Clarke leaves Mercer’s global investment research role to Jo Holden, and while genuine retirement beckons, she has taken a non-executive director role with Blackrock EMEA.

“We have a great team and a good inclusive culture where people can progress. We have taken our research to the next level and had good results with that. So that is a good legacy to leave.”

After a lifetime researching managers, Clarke has some parting advice to asset owners regarding their asset manager partners, centred around values and beliefs.

“Really understand what it is you want from your asset manager and hold them to account on that. Do you want them to act like an owner on your behalf? What are they doing that aligns with your values and is not just them managing your money in a silo? Don’t take too many meetings with managers, don’t waste time on things that don’t fit your values and beliefs. Partner with the people that culturally fit with you,” she says. “Use tech to your advantage as best you can, and definitely take the long-term perspective, there could be something creative in the fees that way.”