This article is from the latest Good Investment Review, which you can download free here.
Grassroots campaigns are woven into the history of environmental and social reform. In the US, they have played a crucial role in the introduction of transformative welfare and healthcare provision, clean water legislation and wildlife protection laws.
They have enjoyed a similar degree of success in Europe. How curious, then, that within the world of responsible investment, the equivalent strategy – harnessing shareholder power to bring about improvements in company behaviour and business strategy – has been a low priority for most investors. One explanation for the lack of enthusiasm is that the alternatives to corporate engagement appear to have a more immediate impact.
Avoiding ‘bad’ companies altogether or investing exclusively in firms that operate in sustainable industries both give the impression of being more effective and easier to deploy. But on closer inspection, a more complicated picture emerges.
Allocating capital to listed businesses specialised in, say, green technology or social care, makes sense only up to a certain point. Once a stock price fully embeds a company’s environmental or social premium, it becomes expensive. That reduces the scope for additional investment returns. Many of the listed firms with strong social or environmental credentials are already trading at high price-earnings multiples, in our view. Which means investing in such shares might not always make financial sense. Divestment – or excluding sin stocks – has rather more serious drawbacks.
Divestment might not be enough
A report by Pictet, Retraites Populaires and the Enterprise for Society Center (E4S) showed that the effects of divestment often run counter to investors’ aims. The study, which focused mainly on corporate carbon emissions, found that divestment failed to incentivise highly polluting firms to adopt sustainable business practices.
The limitations of divestment and targeted capital allocation are not the only arguments in favour of corporate engagement.
The same report also concluded that excluding ‘dirty’ companies from portfolios had little or no effect on such firms’ capital costs or access to finance, contradicting what advocates of divestment policies claim.
This was particularly true for firms operating in the energy sector.
Engagement is essential because, deployed judiciously, it can improve the sustainability of businesses that score poorly on ESG metrics but are nevertheless crucial to the transition, such as mining, utility and energy companies.
It is for these reasons that investment managers of Pictet Asset Management’s Positive Change strategy put engagement at the heart of their portfolio construction process. The team invests in companies that are central to the building of a sustainable economy but whose potential contributions to that effort are not fully appreciated by the market at large.
Alignment with the Sustainable Development Goals
We deploy engagement with two broad goals in mind.
The first is to steer businesses towards improving the alignment of their products and services with a sustainable economy. Here, we focus on companies that are either already making a contribution to the green transition or whose products and services have a clear social benefit. The engagement can involve urging companies to expand upon their positively- aligned activities. But it can also see us calling on the same companies to curtail activities that are negatively aligned with sustainable development goals. The second objective is to encourage companies to improve their ESG credentials and mitigate ESG risk,
This could involve embracing business practices that, for example, reduce pollution, improve working conditions or optimise corporate governance.
The engagement process has several distinguishing features that make it an especially effective tool.
First, it draws on – and is informed by – high quality data. We assess a company’s sustainability by analysing how closely its products and operations align with the United Nations Sustainable Development Goals (SDG). SDG alignment can have a strong bearing on the performance of a company’s share price.
According to our analysis, firms that succeed in aligning their operational set-up and products and services with the UN SDGs deliver superior investment returns over the long run. And we believe engagement can hasten a company’s progress along that path.
Another distinctive aspect of our approach is that it is targeted. We don’t enter into intensive discussions with every company that forms part of our investment universe. Rather, we only invest in and engage with businesses that demonstrate both the capacity and desire to change.
Positive Change strategy
By following this process, we can devise bespoke engagement programmes, each containing what we believe are challenging – but feasible – objectives and mutually-agreed timetables for delivery.
Since the launch of the Positive Change strategy in June 2022, we have been pursuing 19 engagement objectives with approximately one in three of the companies we invest in. Those engagements are either directly led by our investment managers or in collaboration with internal and/or external parties.
We believe that it is through engagement activities such as these that the investment community can aid or hasten the transition to a more sustainable economy. As long as corporate engagement is deployed in the right way, there is no reason why it can’t enjoy the same success as the grassroots campaigns that have transformed society. Responsible investment without engagement isn’t very responsible at all.
Risk warning: Any investment incurs risks, including the risk of not getting back amounts initially invested. Fund, legal and regulatory documents available on assetmanagement.pictet must be read before making any investment decisions.