Investors are increasingly calling for asset managers to divest from certain companies in their portfolios for environmental, social and governance reasons. But is this the only right approach? Sean Hagerty asks in an essay on finews.first.
This article is published on finews.first, a forum for authors specialized in economic and financial topics.
The industry's core mission should be to advocate for all investors, treat them fairly and give them the best chance of investment success. That is why we believe investors should keep their investment costs low and choose funds with broad diversification.
Broad diversification, in turn, means being invested in companies from all market sectors. Yet investors are increasingly calling for asset managers to divest from certain companies in their portfolios for environmental, social and governance (ESG) reasons. But is this the only right approach?
An analysis of ESG equity funds between 2004 and 2018 found that ESG funds have neither systematically higher nor systematically lower raw returns or risk than the broader market. Nevertheless, for some investors, owning certain companies is not consistent with their values. This is particularly true in the context of climate change.
«Of critical importance in this context is the Investment Stewardship Programme»
For this reason, the industry should of course offer fund products that exclude certain companies. But we also believe that ESG investing should allow investors to invest in and engage with portfolio companies in a broad-based index fund. By keeping fund providers remain invested in companies and encouraging them to take positive action against material ESG risks, they can create long-term sustainable value for investors without having to divest from these companies.
Of critical importance in this context is the Investment Stewardship Programme. By engaging with portfolio companies and encouraging their boards to monitor and mitigate all material risks to long-term shareholder value, the stewardship team ensures that investors are protected. These now include ESG risks in particular.
We believe that engagement with boards and management teams can help establish good governance practices, drive meaningful change and support long-term value creation. An important aspect of our engagement in this regard is to vote on issues and executive appointments at AGMs.
«This is may even thwart the equitable and orderly transition to a low-carbon economy»
Particularly with regard to climate change, we believe that it is better to own, engage and encourage boards to manage climate risks by transitioning to a low-carbon economy than to exclude and divest. Investors who divest from carbon-producing assets risk selling them on to those who do not want to engage and encourage change. This is not conducive to, and may even thwart, the equitable and orderly transition to a low-carbon economy that investors hope to achieve.
Addressing the risks that climate change poses to shareholders is a top priority for our stewardship team. Therefore, index fund providers should talk to companies about their plans to reduce greenhouse gas emissions and improve their climate-related reporting as they prepare for a lower-carbon future.
«Boards should be held accountable for the clarity of their disclosure plans and progress in implementing them»
Crucially, in our view, boards should be held accountable for the clarity of their disclosure plans and progress in implementing them. To encourage the development of standardized climate-related disclosures, asset managers can, for example, support the Taskforce on Climate Related Financial Disclosures (TCFD).
In addition, the trustees of the International Financial Reporting Standards (IFRS) announced in early November that they will establish an International Sustainability Standards Board to develop harmonized global sustainability disclosures in the interest of all investors.
«This approach best serves the interests of investors»
Companies should also be encouraged to develop appropriate action plans to protect shareholder value in the face of anticipated material risks. These risks may include significant stranded assets or physical climate risks, reputational damage, damaging customer relationships, an adverse competitive position, or the impact of future regulations.
We believe this approach best serves the interests of investors and offers much greater promise than simply divesting from companies that have a poor ESG profile and shifting responsibility to others.
Sean Hagerty is managing director for Vanguard Europe, responsible for leading the operations and distribution efforts of the European business. He joined the firm almost 25 years ago.
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