Harnessing the power of engagement in stewardship investing

As an active manager, I am a long-standing believer in the power of engagement in driving good stewardship. Ongoing engagement is a core element of our stewardship-focused approach, and the numbers speak for themselves — in 2021, we carried out 143 engagements across 95% of the holdings in our Global Stewards strategy. Below I share some of the insights we have learned over the years.

Why engage?

Companies that are the most adept at balancing their impact on people and the planet with the pursuit of profit can, in our view, build a long-term advantage. As a team, we strive to invest in these “good stewards” because we view stewardship and investment returns as intertwined. Pursuing high standards for governance and sustainability practices can enhance resilience and profitability over the long term.

We believe that regular conversations with management and boards enable us to assess a company’s corporate culture, adaptability and responsiveness and ensure that incentives are aligned with sustainable long-term targets. Above all, regular dialogue allows us to hold management teams and boards accountable for their actions.

We prioritise engagement on the material issues that are most likely to have a financial impact on companies or affect their operations, such as talent diversity, modern slavery in supply chains, building resilience to physical climate risks, and establishing targets to reduce greenhouse gas emissions and mitigate climate transition risks. We also seek to understand companies’ long-term strategy and share our views on material topics such as capital allocation, risk management and ESG, as well as focusing on issues related to ethics and corporate culture. In my view, the strong links between stewardship and return on capital over the long term make ESG factors a particularly important area for active engagement to influence a company’s long-term success.

Maximising the benefits of active engagement

As active managers, I think engagement gives us a valuable opportunity to supplement our knowledge about the companies we invest in and enhance our influence over their long-term success. Our engagement focuses on gaining differentiated insights, assessing and influencing the risks and opportunities facing a company, encouraging transparency improvements and influencing behavioural changes that we believe may impact the future profitability and resilience of a company.

To maximise the impact of engagement and drive value for companies, I believe it is critical to be able to act as a credible and informed partner for boards and management teams, bringing a wide range of perspectives and insights to the table. In our case, we greatly benefit from Wellington’s collaborative culture and the cross pollination of ideas between our specialist investment, research, stewardship, proxy voting and ESG teams.

Successful engagement, in my view, also means taking a genuinely long-term approach. Companies are complex organisations, and they need the necessary time to put in place long-lasting changes. Our long-term investment approach — we seek to hold companies for 10+ years — gives us greater ability to raise awareness of issues that are important to us as fiduciaries of our clients’ assets and to influence change.

This patient approach should, however, be coupled with clear accountability. In our portfolios, we aim to actively use the voting rights we hold on our clients’ behalf to express our views to the board and hold them to account on material topics. If escalation through private engagements proves unsuccessful, investors may consider using public engagement tools such as voicing concerns on an engagement topic in the press or through a letter-writing campaign with other shareholders. From our perspective, we believe building a constructive but candid partnership with the companies in which we invest delivers the best long-term results, so we carefully weigh any decision to engage publicly on a case-by-case basis. In certain cases, I think it is also important to recognise the limits of engagement, and being an active manager gives us the option to divest where we believe our engagement has ultimately been unsuccessful.

Aligning engagement with the “lived experience” of companies

I think it is important to recognise that companies operate within a specific context. While we have a clear set of engagement priorities, we tailor our approach to engagement, recognising that each company faces a unique set of challenges and respecting different cultural and social norms. In our approach, we can lean on our career industry analysts across equity, fixed income and ESG research, who bring extensive knowledge of their industries and long-term relationships with management and board members. Further, to facilitate assessment, we group companies into six broad sectors that we believe have similar ESG priorities (Figure 1): consumer; financials; health care; industrials; power; and technology, media and telecoms. For example, in the consumer sector, our engagements focus on adaptability, conduct and reputation, customer satisfaction, product safety and supply-chain management. In addition, we use a proprietary “scorecard” to help us compare companies in an “apples-to-apples” way through our engagement.

Figure 1. Stewardship materiality: broad ESG priorities by sector

Engagement in practice: supply chains and climate change

• Supply chains
  With their complexity and lack of disclosure standards, supply chains are a “blind spot” for the market — we’re regularly struck by how few companies really know about and take accountability for their entire supply chain. And today’s disruptions demonstrate the vulnerabilities that have emerged from squeezing every ounce of efficiency from sourcing strategies and inventory management.
  
  Good stewards must have a sustainable supply-chain strategy that includes dependable logistics, ample merchandise and a reliable stream of production inputs, along with a clear understanding of the carbon footprint of the aggregate operation and human capital practices among their suppliers. Many companies are in the early days of building this resilience, and their preparedness varies greatly.
  
  Environmental risk is high in supply chains because they are often the source of a large proportion of a company’s total emissions. We work with companies to address this risk as part of our commitment to achieving net-zero emissions. The social risks in the supply chain are just as critical. While companies are often far removed from the extraction and cultivation of their raw materials, they should still be held to account for the labour employed through the chain. Labour abuse or exploitation can be well hidden, yet growing evidence suggests that it’s pervasive in global supply chains. Mitigating modern slavery risks has a direct financial impact by improving a company’s resilience, lowering potential disruptions to supply, reducing negative headline risk and brand damage and lowering the likelihood of unexpected costs and fines.

• Climate change
  Climate change is also a key component of our company engagement, and we encourage all our holdings to commit to net-zero carbon emissions targets in alignment with the Paris Agreement. Companies with low direct emissions are still accountable for indirect emissions from upstream and downstream activities, including the carbon costs of goods they purchase, transport costs and the energy and waste costs from the use of the products they sell. Strong stewards anticipate changing regulation, adapt and take advantage of evolving incentives and engage with changing customer preferences. Where possible, we encourage the companies we hold to undertake improvements such as process innovations to cut fossil-fuel-intensive inputs, shifts to lower-carbon logistics, longer product life cycles to reduce waste and innovations to lower energy intensity.
  
  While there are risks and costs associated with climate change, there are also opportunities. Companies with a strong climate strategy can be first movers who are better able to adapt and profit from the low-carbon energy transition. Wellington’s collaboration with Woodwell Climate Research Centre and the Joint Program on the Science and Policy of Global Change at the Massachusetts Institute of Technology has enabled us to deepen our engagement on climate-related issues and better assess the risks and opportunities by bridging the gap between climate science and finance.

Adding value through engagement 

We hope that sharing Wellington’s insights and research helps companies to navigate the increasingly demanding list of risks that management teams and boards are now facing. Equally, developing strong relationships with companies through regular engagement gives us the opportunity to champion and support long-termism and challenge insular thinking.