Historically, corporate engagement was a concept typically associated with two camps: activist investors who sought to generate short-term profits through corporate actions and proponents of exclusions (nuclear energy, tobacco, etc.) and more sustainable corporate business practices. Over time, however, important trends converged. First, some traditional active managers came to understand that ongoing engagement could enhance long-term return opportunities; second, the development of more rigorous research tied to environmental, social and governance (ESG) factors created whole new areas for constructive dialogue. Today, we believe that engagement should be a constant element in seeking positive corporate behavior—whether to limit risks and enhance opportunity or to achieve long-term goals tied to sustainability.
Pragmatism, Outcome-Driven Action
In our view, material ESG issues can affect long-term return generation, and so we believe it’s important to focus engagement on matters that could have the largest impact on the preservation or enhancement of client capital.
Rather than take a combative approach, we believe that it is usually effective to engage companies in a constructive and pragmatic manner, communicating views and concerns directly to management and the board. Where a portfolio manager or analyst has a long-term relationship with a company, it may be far more open to their ideas than it would with a more “transactional” investor who comes in with specific, immediate grievances and seeks near-term resolution. Moreover, the familiarity that comes with ongoing research and contact with the company, its customers, competition and industry experts may allow the manager to introduce pragmatic solutions that could achieve real results.
For example, if a company proposes a new director, portfolio managers and analysts may be able to assess the candidate’s experience and effectiveness at other companies to determine if they would be an appropriate addition to the board, and sometimes suggest individuals that they believe would be well suited to the role. They may also have opinions as to compensation approaches—what may or may not work in the industry or be suitable for the particular goals of the company. If they have an established relationship with the company and build on long-term investment, their voice is likely to be heard.
Although the bulk of issues can be resolved quietly over time, some situations may require more assertive action. That may start with formal written communication identifying areas of concern and recommended courses of action, or extend to the nomination of director candidates, or the filing of shareholder proposals and proxy contests—the ability to use all these touch points can make a real difference.
Bringing quantitative rigor to this process can help significantly in deepening interactions and enhance the level of insights drawn from them, often creating a virtuous circle of engagement. A cornerstone of our approach is the NB ESG Quotient, a proprietary rating system that identifies ESG considerations with potentially material impacts on results at both company and portfolio levels. It draws on generally available data, but also harnesses the insights of our Data Science team and, importantly, the expertise of our fundamentals-driven sector analysts.
For example, in 2020, we engaged with an energy infrastructure operator that had recently divested high-emission assets, but the action was not yet reflected in third-party data. The company was able to provide us with estimates of what portion of historical emissions the assets represented so that we could adjust the inputs in our system, resulting in a higher, more forward-looking ESG rating.
We spoke with another company over the years on workforce topics such as employee pay rates, employee retention, workforce diversity and culture, as well as ways it could improve its disclosure to better reflect those efforts. The company’s focus on employees enabled it to respond more effectively to the onset of the COVID-19 pandemic, acting more decisively than peers in prioritizing employee well-being, offering bonuses and keeping its stores as safe as possible—all of which helped to uphold its reputation as a premier retail workplace and improve the rating we gave the company compared to peers.
Other quantitative tools, specific to particular concerns, may also prove valuable. As discussed in the last Investment Quarterly, we introduced our Climate Value-at-Risk (CVaR) scenario analysis to help identify vulnerability tied to the physical impact of climate change from extreme weather, wildfires and other events, and longer-term trends such as higher sea levels, as well as transitional risk tied to changes in government policy, spending and consumer preferences. CVaR has already contributed to numerous discussions with companies about our expectations for progress on climate-related matters. It also reinforced our decision to strengthen our thermal coal policy (limiting the acceptable proportion of coal in a company’s power generation and new facility construction), which in turn led to new engagements as we explained our policy to companies and explored with them avenues for reducing exposures.
Regardless of the specific diagnostic elements, engagements by our analysts and portfolio managers often involve ongoing collaboration with companies. For example, over several years, we encouraged a diversified utility to accelerate its shift away from coal, eventually resulting in a more aggressive, public timeline for its adoption of alternative energy sources and greater reporting transparency. During the pandemic, we interacted repeatedly with an expanding “warehouse” retailer on crisis-related concerns and longer-term issues, including diversity, governance and capital allocation. Its actions to improve pay for frontline workers, adjust absentee policy, and enhance safety and social distancing protocols, as well as its commitment to further financial disclosure and adjustments to board voting, have served to enhance its potential resilience not only in crisis, but into the future.
Amplification of Impact
Although the progression of engagement usually starts with private dialogue, it can, as mentioned, move to more escalated methods and proxy contests. The decision to take further steps may depend on the degree of exposure a portfolio manager has to a particular issuer, willingness to accept input, and the choice of actions by corporate management that could lead to improvement. In one case, for example, our portfolio managers and analysts engaged privately with a company for several years, and then took a more public stance when another investor advocated changes that we believed could prove detrimental to the long-term health of the company. Our intervention produced a compromise solution that included changes to the board and executive compensation, and put in place various new metrics to better assess capital allocation.
In our view, proxy voting can work well with other avenues of engagement in seeking to achieve favorable results. Even when not associated with a particular initiative, however, thoughtful proxy voting can help to push companies along and signal investor views on a variety of topics. Indeed, proxy voting is a natural way for active managers to add value, given their ability to draw on expertise and deep knowledge to move beyond more superficial observations of proxy advisory firms and the passive investment firms that typically follow them.
Although public discourse and thoughtful proxy voting can help move a particular company in the right direction, we believe that signaling our views more broadly can help accelerate the adoption of sustainable practices across industries. Last year was the first in which our firm announced our voting intentions in advance of select annual general meetings, in a program called NB Votes.
To allow for engagement on each vote decision, we chose to focus on 25 – 30 companies where our clients have significant ownership. We sought to include a broad range of proposals with a balance of votes in support of and against the recommendations of management. This enabled us to share our analysis and expectations on a variety of matters. For example, we voted for a shareholder proposal to require more meaningful diversity reporting at a major hotelier, but we voted against increased greenhouse-gas-reduction reporting from an energy company that we believed had already been very detailed in its disclosures and in its commitment to a reduced carbon footprint.
The approach is designed to enhance the level of transparency around our proxy voting decisions, improve corporate practices among companies, and encourage other asset managers to also begin preannouncing proxy votes and openly encourage better corporate practices.
Governance and Engagement Principles
In engaging with companies, we look for strong leadership in the following nine areas:
For illustrative purposes only.
Beyond individual dialogue and proxy voting, we believe that broad collaborative efforts can make a significant difference in helping to promote the adoption of ESG-informed activity and analysis across industries. We have engaged with many organizations, including the U.N.-sponsored Principles for Responsible Investing, which encourages ESG disclosure and practices, the Investor Stewardship Group, which works to develop common standards of investment stewardship and corporate governance in the U.S., and the Financial Reporting Council’s U.K. Stewardship Code, which sets forth industry-leading expectations on stewardship practices and disclosures.
Often collaborations can be fruitful in driving change around key issues. For example, serving as a member of the sustainability-focused Ceres network of investors and companies, we have worked with various companies to make progress on their climate oversight and reduce emissions. As part of Christchurch Call to Action, we engaged with social media companies to strengthen their controls on extremist content and enforce codes of conduct for their platforms. We also partnered with the Marine Conservation Society to engage manufacturers on the problem of microplastic pollution from synthetic fibers—the first North American asset manager to do so.
In our view, if we are going to require change of others, we need to make good ourselves. These involvements, and our general information-sharing on sustainability, also reinforce for companies our seriousness about ESG investing.
Making Engagement Work
Events over the past year have reinforced what we consider the potential benefits of engagement. In the midst of crisis, many companies were looking for guidance as to how to maintain operations safely, rework supply chains and address the trauma experienced by many employees. In this environment, we were pleased not only by their interest in compassionate solutions, but found opportunities to provide supportive input and reinforce already strong relationships. Ironically for a period when many ESG initiatives could have become an afterthought, the crisis environment underlined the importance of sustainable business models and of addressing an array of environment risks and social issues, while drawing on effective boards and governance practices to move effectively and forcefully when needed. As a result, we believe companies are likely to focus on ESG factors more than ever, while investors who integrate ESG considerations into portfolio decisions are likely to see increased opportunities going forward.