Rules of engagement
Written by Matt Ritchie
Public pressure and the aftermath of the global financial crisis have pushed pension funds to take a closer interest in the activities of the companies in which they invest. Matt Ritchie looks at the rise of engaged investing, and how funds are using this approach to their advantage
The investment decisions of pension funds move markets. But increasingly, funds are using their influence to change the behaviour of the companies they invest in. Whether it be through encouraging companies to improve their environmental performance, improve their standing as corporate citizens, or concentrate on ensuring their businesses remain strong into the future, funds are finding and using their voice.
The search for answers in the wake of the financial collapse that rocked global markets from 2008 identified many culprits. But the financial services industry and what was popularly identified as a culture of short-term profit taking over long-term value creation attracted particular scorn.
Relaxed, light-handed regulatory regimes were derided for allowing the culture to flourish, but lately the behaviour and incentives of shareholders themselves has been identified as an important check to undesirable business practices. This extends beyond corporate governance, and shareholders are increasingly being expected to take a greater interest in the overall impact of their investments.
This is especially true of pension funds, which as large investors with the ability to exert significant influence can be expected to use that power for purposes higher than simply growing their asset base.
“One of the biggest trends we’re seeing is there’s been much more media and NGO attention on pension fund investment in unsavoury companies,” says F&C director governance and sustainable investment Alexis Cheang.
“Particularly on the continent we’ve seen a number of media programmes similar to the Zembla programme in the Netherlands or Panorama in the UK that will highlight a very concerning issue, and then go on to say: ‘The following European pension funds are invested in these companies’.”
Governance for Owners chief executive Stephen Cohen agrees an increase in public scrutiny is influ-encing the engagement behaviour of pension funds.
“Pension funds have become more aware through the media, and because in turn some scheme members have been contacting the trustees on these issues and asking what their policies are,” he says.
However, media attention and the ensuing client pressure are not the only factors driving what Cohen says is an increasing level of activism among pension funds.
According to Cheang, it is now accepted as good practice globally for pension funds to have an ESG strategy, and some level of engagement with the companies a fund invests in has become a de facto standard. Large funds can take on the engagement role themselves, but commonly funds will require their asset manager to do this for them.
Taking a closer interest in extra-financial factors is not about altruism either. “A good management team that’s running the business in the interests of all stakeholders should be a more resilient and successful business over the long term,” Cheang says.
“Overall strong management is a key ingredient for successful companies, and that includes strong management over corporate governance and sustainability issues as well.”
Cohen says closer links between environmental, social, and governance teams and investment teams have also contributed to a greater interest in shareholder engagement on the part of pension funds.
This link between investment decisions and ESG analysis and engagement is key, says Ownership Capital partner and chief investment officer Alex van der Velden.
“If the investment team isn’t interested in extra-financial issues, if they’re not changing the way they invest as a result of those factors then you often have situations where the investment team wants to do one thing and the engagement team wants to do another.
“What you really want is for the investment teams to be taking these issues on board and to be doing the engagement themselves so they can get the feedback loop of understanding the relevance of these factors,” van der Velden says.
Engagement needs to be done right to meet the goal of contributing to more sustainable, valuable businesses. There has been a recent trend of investors staging public campaigns to pressure companies to take steps that the investors feel will move the share price.
Changes of this nature are often not motivated by the long-term best interests of the company, van der Velden says, and this form of activism is a different concept altogether from taking an ownership approach to engaging with businesses.
“The negative consequences of activism have become clearer over the last few years,” van der Velden says. “There has been a shift against that sort of negative sabre rattling, especially in Europe. Even in situations where it has delivered a good return for that specific investor it has had wider societal consequences when it has failed.”
But what if investors approach target companies only to find the door is closed when they try to engage?
Fortunately it seems increasing levels of engagement have meant pension funds are receiving a warmer welcome around the management table.
“Companies are increasingly receptive. 2012 in the UK saw a large percentage of votes against resolutions,” Cohen says. “AGM voting outcomes can in effect then force them proactively to engage in discussions with investors on specific topics.”
Cheang agrees that the barriers between investors and those that run listed companies have broken down. She says 10 years ago companies simply did not understand why a shareholder would approach them with concerns around their ESG practices.
Some companies will always be ‘unengageable’, but in 2013 businesses are much more willing to open a dialogue with their investors.
The way an investor chooses to engage can have just as big of an influence over whether a company is willing to listen as the number of shares they hold. A company is unwilling to listen if shareholders ask the wrong questions, Cheang says, regardless of the size of their holding.
“On the flip-side if you ask sensible questions of the company around governance or sustainability issues and you frame it in a way that indicates ‘this is good for the company, this is good for us as investors’ then the company will frequently listen even if you’re a relatively small investor.”
And companies need to feel there is value in engagement for them too.
Ownership Capital’s van der Velden cites an example of a company chief executive who listened to and acted on a European pension fund’s concerns only to find their holding in his business decreased, illustrating how companies can become disillusioned with taking the time to engage. In van der Velden’s real-life example, the fund in question was an index investor.
“The credibility of investors who do not put money behind their engagement becomes diluted, because you’re not giving the companies a reason to act. If they don’t see that their actions translate into their share price improving over time, then they will focus on the things that do make their share price move. And those tend to be short-term strategic moves and acquisitions and the like. That relegates long term thinking to second place.”
Written by Matt Ritchie, a freelance journalist