- Equity Portfolio Manager
United Kingdom, Institutional
Change
The views expressed are those of the author and are subject to change. Other teams may hold different views and make different investment decisions. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. Forward-looking statements should not be considered as guarantees or predictions of future events. Past results are not a reliable indicator or future results. This commentary is provided for informational purposes only and should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell or the solicitation of an offer to purchase shares or other securities. Holdings vary and there is no guarantee that a portfolio has held or will continue to hold any of the securities listed
The value of strong corporate stewardship is gaining wider recognition across the investment industry. When companies are led by an engaged board and a strong management team, allocate capital wisely for the long term and act in the best interest of all stakeholders, they have greater potential to reinforce their competitive advantage and enhance returns over time.
Asset owners are increasingly drawn to investment strategies that combine responsible investing and competitive long-term returns. Stewardship grows in importance as you extend your time horizon. A long investment horizon and a high bar for inclusion result in a low turnover strategy that drives returns from investing in companies that incorporate ESG risks and opportunities into their business strategy to build long-term advantage in the pursuit of profit. But how do good corporate stewards create value over time and what constitutes effective stewardship investing?
What makes a good steward?
For us, good corporate stewardship means balancing the needs of all stakeholders in the pursuit of profit: investing in people, protecting the planet and investing in the resilience of future profits through innovation. A good steward will identify and mitigate material ESG risks and invest in material ESG opportunities in order to lower its earnings volatility, reduce its cost of capital and bolster its long-term return potential. Companies that consider their impact on the planet will prioritise the transition to greener sources of energy and reduce their environmental footprint (the “E” in ESG), driving more sustainable access to raw materials and reducing their risks from regulation. Companies that care about their employees, customers, supply chain and communities (the “S”) are more likely to reduce employee turnover, build customer loyalty, ensure more sustainable supply chains and promote broader perspective and challenge through greater diversity, equity and inclusion in their corporate culture. A robust governance structure (the “G”), improves a company’s ability to allocate capital wisely and operate with a long-term view to achieve more sustainable returns on capital. Good stewards invest in innovation to adapt and grow their business over time and strengthen their competitive advantage and pricing power by creating a “moat” that makes it harder for others to enter the market or compete.
A company that reinforces its returns through ongoing investment in its stakeholders has the potential to move from delivering a high return on investment over one or two years to achieving high returns year in and year out. Companies that can sustain attractive returns on capital in this way can, in our view, enhance their stock prices and lower their cost of capital over time. In turn, we believe high, stable returns allow these companies to increase their focus on good stewardship. This virtuous circle, or “flywheel” effect, sustains and improves financial returns and stewardship over time.
Stewardship investing: focusing on the long term
Effective stewardship investing takes advantage of the market’s tendency to be overly focused on growth in the short term. As Figure 1 shows, on average, investors turn over stocks every 10 months, while Wellington’s stewardship strategy seeks to hold companies for a decade.
A successful stewardship approach that is focused on the long term is anything but static. Managing the portfolio involves deep research into the companies held or considered for inclusion. It requires an informed dialogue with boards and management teams to help ensure that a company's business model is built with a long-term view towards innovation and sustainability, prioritising returns over time rather than focusing on the next quarter's earnings. Active engagement with boards is critical in helping to identify, sustain and increase a company’s flywheel effect over the long run.
Figure 1
Stewardship strategies can also take advantage of the market’s inefficiency in valuing the more qualitative aspects of ESG. ESG is not something that can easily be indexed or analysed from a quantitative perspective, so the ability of asset managers to undertake deep analysis of ESG data from the bottom up is a crucial component of stewardship investing.
Constructing a stewardship portfolio
While many sustainable funds have a notable style bias — they often tilt towards growth or tech investing — the long-term focus of stewardship aligns with building a diversified portfolio that is balanced in terms of its sector exposures and 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 increases the potential to generate stock-specific, above-market returns (alpha) that can result from strong stewardship.
In our view, strong candidates for stewardship investing that prioritise the business, stakeholders and shareholder returns over growth can be found in any high-return and less cyclical sector. Good stewards are typically high-quality businesses, which could potentially result in stewardship portfolios being less volatile than the broad market, helping to produce more stable and consistent outperformance over time.
Strong investment credentials in ESG, fundamental research capabilities and deep sector expertise are essential skills for asset managers to engage with companies and research proxy issues from a stewardship perspective. Of course, ESG is an evolving concept, so it’s important to constantly engage on different topics and push the agenda forward to hold company leadership to account on the material issues that differentiate leaders over time. Building long-standing trust creates the goodwill to access both management teams and, importantly, boards, enabling high-level and deep two-way dialogue on strategy and execution.
During our engagements, our ambition is to share best practices and encourage change. And if progress isn’t forthcoming, divestment is always an option. For instance, we've divested companies that weren't embracing the type of robust climate strategy that we thought was appropriate for their business and their risks, or that weren’t managing and allocating capital in a way that appeared to be responsible or sustainable.
Exemplary stewardship in practice*
A global technology leader exemplifies what makes a company a strong 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, 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.
Equally impressive is a global tyre manufacturer that has embedded sustainability into its business strategy and is a true steward in responsible sourcing. The company is extraordinarily thoughtful about how it manages risks around deforestation, rubber sourcing and labour. For example, it trains over 100,000 farmers annually on deforestation and biodiversity risks and has developed its own app to collect important stakeholder information about deforestation in the 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 strong 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. Actual holdings will vary.
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