Thursday, May 19 2022

Investors are increasingly asking 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 finenews.first.

This article is published on finenews.first, a forum of authors specializing in economic and financial topics.

The industry’s primary mission should be to advocate for all investors, treat them fairly, and give them the best chance of investment success. That’s why we believe investors should keep their investment costs low and choose funds that offer broad diversification.

Wide diversification, in turn, means being invested in companies from all market sectors. Yet investors are increasingly asking 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 neither consistently have gross returns or risks that are consistently higher nor consistently lower than the broader market. However, for some investors, owning certain companies is not in line with their values. This is especially true in the context of climate change.

“In this context, the investment management program is of crucial importance”

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 and engage with portfolio companies in a broad-based index fund. By keeping fund providers 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 those companies.

In this context, the Investment Management Program is of crucial importance. By engaging with portfolio companies and encouraging their boards to monitor and mitigate any 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 commitment to this is voting on issues and executive appointments at AGMs.

“It could even thwart the fair and orderly transition to a low-carbon economy”

Particularly in relation to climate change, we believe 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 themselves of carbon-producing assets risk selling them to those unwilling to engage and encourage change. This does not promote, and may even thwart, the fair 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 reporting as they prepare for a low-carbon future.

“Boards should be held accountable for the clarity of their disclosure plans and progress in implementing them”

Fundamentally, in our view, boards should be held accountable for the clarity of their disclosure plans and the progress made in implementing them. To encourage the development of standardized climate disclosures, asset managers can, for example, support the Taskforce on Climate Related Financial Disclosures (TCFD).

Additionally, the Trustees of International Financial Reporting Standards (IFRS) announced in early November that they will establish an International Sustainability Standards Board to develop harmonized global sustainability reporting for the benefit 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 significant anticipated risks. These risks may include significant stranded assets or physical weather risks, damage to reputation, damaging customer relationships, adverse competitive position or the impact of future regulations.

We believe this approach is in the best interests of investors and holds far more promise than simply divesting companies that have poor ESG profiles and shifting responsibility to others.

Sean Hagerty is Managing Director of Vanguard Europe, responsible for leading the operations and distribution efforts of the European company. He joined the firm nearly 25 years ago.

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