Corporate stewardship is increasingly recognised as an important concept across the investment industry, but how exactly does it generate value and what can investors do to maximise its potential?

Simply put, we think that good stewardship practices help companies sustain attractive returns on capital, by enabling them to lower their cost of capital over time. When companies with high returns on capital reinvest in their stakeholders, this virtuous circle, or “flywheel” effect, increases the potential to sustain and improve financial returns and stewardship, and ultimately enhance share prices. A stewardship-driven investment approach can help optimise that potential by: 

Putting stewardship centre stage — In our experience, companies that balance the pursuit of growth with the needs of employees, customers and the supply chain and who value the environment in the pursuit of profit may potentially achieve better and more sustainable long-term outcomes. When companies are led by an engaged board and a strong management team, they allocate capital wisely and invest for the long term and in the best interest of all stakeholders. With robust stewardship, they have greater potential to reinforce their competitive advantage and sustainably enhance returns over time. 

Extending the investment horizon — A long-term focus directs research towards companies that have dominant market positions, stable industry structures and sustainably high returns on capital that compound over time. We believe that the stability and persistence of returns is often underestimated by the market, as the less measurable but equally important benefits of stewardship accrue over decades. A company that reinforces its returns through ongoing investment in its stakeholders helps reduce the volatility of earnings and boosts the benefits of long-term compounding. A long-term focus has the potential to move a company from delivering a high return on investment over one or two years to achieving high returns year in, year out. Focusing on building culture, reducing employee turnover, investing in innovation and ensuring preparedness for the energy transition are all likely to help drive long-term payoffs.

Using a broader lens — A long-term focus on returns and stewardship aligns with building a diversified core portfolio where the main drivers of risk and return are stock-specific. This diversification and focus on stock selection reduces country, sector and factor biases and strengthens the potential to generate above-market returns (alpha) in a variety of market environments. 

Applying an active research-based approach — A robust stock selection process and engagement strategy together with a separate and intentional risk-aware approach to portfolio construction help ensure that the portfolio is built to navigate macroeconomic volatility despite owning names for the long term. We recognise that the value created by each of the companies in a stewardship portfolio will not be linear, so holdings will need rebalancing based on relative valuation. For instance, in our own portfolio, we aim to hold positions for 10+ years if returns and stewardship continue to meet our high bar, but the active weight of each position fluctuates significantly over its holding period due to our portfolio construction framework.

Stewardship strategies can also take advantage of the market’s inefficiency in valuing the more qualitative aspects of ESG, as these cannot easily be indexed or analysed from a quantitative perspective.

What are the hallmarks of a good steward?

In our view, attractive candidates for inclusion in a stewardship-driven portfolio can be found across all segments of the broader market. They are typically high-quality businesses that are leaders in their sectors and offer attractive and relatively stable return profiles. Specifically, we believe good stewards:

• Consider their impact on the planet and reliance on natural resources (the “E” in ESG). By embracing the circular economy and owning their externalities from raw material stage through to end of life, companies can strengthen the resilience of their business and help increase their long-term return potential. Additionally, preparing for the energy transition and lowering carbon emissions can support long-term returns by mitigating regulatory risks. 
• Care about their employees, customers, supply chain and communities (the “S”), which can contribute to lower employee turnover and a more engaged workforce, build customer loyalty and ensure more sustainable supply chains. 
• Have a robust governance structure (the “G”), which enhances their ability to allocate capital with a long-term mindset and a focus on continuous innovation that can help bolster their competitive advantage and pricing power.

In combination, we think that allocations to stewardship leaders are likely to translate into a diversified core equity portfolio that is generally less volatile than the broader market.

How does it work in practice*

The below two examples highlight the breadth of the opportunity set and the role of stewardship in supporting companies that not only achieve a high return on capital but also act responsibly towards all their stakeholders. 

• This global technology leader exemplifies what makes a company a good candidate for inclusion in a stewardship portfolio. The company, renowned for its high returns, core business resilience and ability to innovate and adapt, is less well-recognised for the strength and depth of its environmental work. However, for us, it stands out for its approach to achieving net-zero carbon emissions, setting a target to be carbon negative by 2030 and mitigating its current carbon footprint along with all the carbon it has emitted into the atmosphere since its founding nearly 50 years ago. That is a very noble agenda. The company has integrated this strategy into its own operations and procurement decisions and works closely with its suppliers to ensure that its entire supply chain’s carbon footprint improves.
• This global tyre manufacturer has embedded sustainability into its business strategy and is a true steward in responsible sourcing. The company trains over 100,000 farmers annually on deforestation and biodiversity risks and collects and shares important stakeholder information about deforestation across the supply chain community. And while its strategy to manufacture tyres to be more durable might suggest that it sells fewer tyres, this durability not only reduces waste but gives the company pricing and brand power. This, in turn, helps win market share, while being better for the planet. That’s a win-win for both returns and stewardship, epitomising how effective ESG leadership and thoughtful stewardship can build a lasting competitive advantage.

* The examples shown are presented for illustrative purposes only and are not to be viewed as representative of actual holdings. It should not be assumed that any client is invested in the examples (or stocks similar to the examples), nor should it be assumed that an investment in any of the examples has been or will be profitable.