Asset owners are, rightly, frustrated with how many investment managers actually “do” stewardship. Rather than engage assertively with managers about their stewardship performance, however, asset owners are outsourcing these responsibilities to engagement overlay providers (EOPs). This strategy can address some ESG problems at a limited number of outlier companies, but it fails to address ESG related systemic risks. Five years after the Stewardship Code’s adoption in the UK, ShareAction found that, while the code has catalysed many improvements, it “has not led to any significant behaviour change amongst a substantial rump of asset managers”. Even the Financial Reporting Council, which introduced the Stewardship Code, admitted that the code isn’t working.
As the clock runs down on our ability to prevent global warming beyond 2°Celsius, EOPs could be playing a much more powerful role. Already, EOPs are a compelling offer for asset owners. They have specialist staff on a range of ESG issues, they vote consistently on ESG issues and they can educate asset owners. They will engage with troublesome stakeholders and manage their expectations, providing a reputational barrier. They compensate for the inherent weaknesses of traditional asset managers when it comes to stewardship (clients don’t pay for it, consultants don’t benchmark it, and mandates aren’t lost or won on it). Generalising, managers also have more conflicts of interests and lack appropriate skills—stock picking has little to do with stewardship. Moreover, they are often ill-equipped to manage campaigner pressure and could even be a lightning rod, drawing campaigner attention to clients.
So it’s easy to see why sensible asset owners would hire an EOP. But from a systems perspective, the story is less rosy. In systems dynamics jargon, this is a “fixing the burden” archetype—solutions which address the symptoms but which also make the fundamental solution less effective.
This systemic solution calls for the messy work of relationship building among players with different goals and interests. Asset owners should collaborate to change the behaviour of their fund managers. Mandates must be written with explicit ESG criteria, even for passive strategies; managers who are poor stewards and who don’t show prompt remedial action should loose mandates for not exercising their fiduciary duty.
Individual asset owners don’t have the resources or confidence to advance this agenda, and this is where a repurposed EOP sector comes in. At their best, EOPs employ senior staff with corporate strategy, investment, and NGO experience and have experience of doing engagement well. Their inter-disciplinary teams can be powerful advocates for change at individual companies but their impact would be magnified by working at the institutional investor level. EOPs are in an ideal position to help asset owners ensure their traditional fund managers exercise their stewardship responsibilities, especially if investment consultants added stewardship performance on systemic risk issues to how they evaluate fund managers. In so doing, asset owners could deliver messages to companies via investors who are much bigger and have greater geographic proximity than EOPs. This is particularly important in markets like Australia, Asia and North America where there is cultural resistance to European investors “lecturing”.
On the climate front, for example, EOPs could be the lead agents in taking climate resolutions to an industrial scale (ie where at least 25% of a sector is covered) and where all high impact sectors, not just fossil fuels, were covered. This requires some changes in the business model of EOPs which in turn requires asset-owner clients to take the lead.
Your views are welcome.