“Investors’ active ownership strategies provide good examples of ambition levels to influence portfolio companies to become more sustainable and, in turn, enable real world change,” says Frida Femling, CIO and Co-founder of esgaia.
Author: Christopher Jacklin
13th of December, 2021
Sustainability has become more in focus on a global scale than ever before. No matter if you discuss sustainability in relation to environmental, social, or governance (ESG) factors, during the last few years, a need for change has become increasingly highlighted by events such as the global spike in wildfire activity (1,2), rising anxiety and depression rates due to Covid-19 isolation measures (3), and controversial company governance during the pandemic, such as paying out dividends or big bonuses when state aid has been obtained and not repaid (4).
The question is, how can we solve these multi-parametric issues as a global community? Well, if the age-old saying “money makes the world go ‘round” holds true, then “the money” could be a good place to start.
In the investment world, a shift towards “green” or “sustainable” investing is evident. Global sustainable investments now top $30 trillion USD, which is an increase of 68 percent since 2014, (5) with sustainable assets under management (AUM) estimated to reach $53 trillion USD by 2025 (6). From a geographical perspective, Europe leads the global market in ESG AUM, followed closely by strong progress in the US and assumed future developments in Asia. “The term ‘ESG’ has spread out from the investment world. It helps investors evaluate the sustainability performance of companies and their investments,” says Femling.
Take the example of ESG ratings. There has been incredible growth in investor utility of these ratings, which serve a multitude of use cases, ranging from inclusion in valuation models and investment decision-making to screening, thematic investing, and index construction. Usually, these scores are not determined by the investors themselves, but rather by third-party rating firms. Hans Taparia, Associate Professor at the New York University Stern School of Business, points out that there are some challenges with this system. According to Taparia, ESG ratings do not normally reflect the effects of a business’ operations on the environment and society, but rather they measure “the degree to which a company's economic value is at risk due to ESG factors” (7). A problem with evaluating ESG criteria in this manner is exemplified by the recent addition of Philip Morris International (PMI) to the Dow Jones Sustainability index (8), despite the fact that PMI sells billions of cancer-causing cigarettes yearly and have an overwhelmingly male-dominated Board of Directors (11:2, male: female) (9).
A second challenge with the current ESG ratings industry is that rating firms implement different methodologies, which result in ESG scores that are ultimately subjective and vary across firms. This subjectivity leads to a divergence in a company’s score depending on which rating firm has done the calculation (10). Furthermore, because ESG ratings are aggregates of environment (“E”), social (“S”), and governance (“G”) risks, a company that receives a low-risk score in one area might face high-risk in others, which could still lead to a relatively low-risk aggregate score depending on the weight assigned to each risk/factor. Taparia exemplifies this through Coca Cola, who has received low ESG-risk scores despite selling addictive products that have been linked to major causes of diabetes (11, 12). “Companies can still receive relatively low-risk ESG scores even if, for example, they are involved in business activities that are conceivably incompatible with a sustainable and just transition,” says Femling.
“Esgaia makes it easier for investors to manage their active ownership activities.” - Frida Femling, CIO and Co-founder of esgaia
Femling and her team are creating a platform to promote active ownership by facilitating the ESG-engagement process for investors. According to her, active ownership differs from ESG-integration. “We define active ownership as a strategy where investors use their ownership to encourage sustainable change. It means that investors can, for example, push a company to raise its minimum wage by engaging in a dialogue with the company, or by using their vote at the AGM. An ‘ESG-integration strategy’, to make a comparison, is when investors account for companies’ or funds’ ESG credentials when investing,” says Femling.
From an impact perspective, the notable difference that Femling highlights between the two responsible investment strategies are that active ownership, as the name suggests, is a method of using your rights as a shareholder to voice concerns and engage companies to make sustainable changes, whereas ESG integration focuses on the capital allocation effect by seeking impact through investing in more sustainable companies. Despite the differences between active ownership and ESG integration, it is clear that both strategies work synergistically. For example, rating information around exposures and management levels can be used by investors as input for engagement to de-risk target portfolio companies. “For example, given the many IT security breaches in recent years, investors are increasingly engaging with companies concerning the implementation of more robust IT security policies and systems, which can reduce the risk of breaches in the future and, in turn, minimize the risk of negative effects on shareholder value,” says Femling.
“Esgaia makes it easier for investors to manage their active ownership activities,” says Femling. Offering investors a purpose-built, independent solution promoting best practice, Esgaia already has investors with over €235B in AUM active on the platform. The solution enables investors to record, track and coordinate tasks across investment teams, automate reporting, and collaborate with other investors to increase influence and efficiency. Esgaia also offers a collaborative feature where investors from different firms can co-create and drive engagements. This allows both large and small investors to pool their capital together to increase legitimacy and power when engaging with companies.
The need for sustainable corporate change is evident, and active ownership will be one important catalyst to increase the speed at which it happens. Femling believes that the strategy should play a more prominent role in the development of responsible investing, and she is encouraged by the many market drivers speaking in its favor. For example, the UK’s Financial Reporting Council (FRC) UK Stewardship Code, through which there is an increased focus on engagement and active ownership highlighted in the twelve guiding principles aimed at setting high stewardship standards for asset owners and asset managers, as well as for the service providers that support them.
“Sustainability has gone from something that was trendy to something that is crucial to your investment strategy and to any business’ survival. If investors and companies don’t focus on sustainability, they will have a hard time to compete and stay in business,” says Femling.
Keywords: ESG, ESG integration, active ownership, investment stewardship, corporate engagement, sustainable investing, fintech, asset management
Jean M. Twenge, Cooper McAllister, Thomas E. Joiner. (2021). Anxiety and depressive symptoms in U.S. Census Bureau assessments of adults: Trends from 2019 to fall 2020 across demographic groups, Journal of Anxiety Disorders, Volume 83, 102455, ISSN 0887-6185, https://doi.org/10.1016/j.janxdis.2021.102455.
Global Sustainable Investment Review 2018, Global Sustainable Investment Alliance, 2018, gsi-alliance.org.
Berg, Florian and Kölbel, Julian and Rigobon, Roberto, Aggregate Confusion: The Divergence of ESG Ratings (May 17, 2020). Available at SSRN: https://ssrn.com/abstract=3438533 or http://dx.doi.org/10.2139/ssrn.3438533
Malik VS, et al. (2010). Sugar-Sweetened Beverages, Obesity, Type 2 Diabetes Mellitus, and Cardiovascular Disease Risk. Circulation [Circulation], ISSN: 1524-4539, Vol. 121 (11), pp. 1356-64; Publisher: Lippincott Williams & Wilkins; PMID: 20308626, Database: MEDLINE
Rachel K. Johnson et al. (2009). Dietary Sugars Intake and Cardiovascular Health: A Scientific Statement From the American Heart Association. Circulation. 120:1011–1020.