This is an article about common obstacles perceived by institutional investors practicing active ownership. It highlights the benefits of collaboration and presents minor activities to overcome the barriers and to build an active ownership strategy. Active ownership is herein defined as the use of shares to influence companies in which an investor has invested, and is also referred to as stewardship.
Institutional investors are taking on the responsibility of investing their clients' money in sustainable companies to generate long-term value. Market trends show that there is a growing desire among these clients to better understand how their money is being invested. Clients want to know if their investments are sustainable in terms of Environmental, Social and Governance aspects (ESG). To meet this trend and satisfy demand, investors must take action to adjust their operating models. Investors have been hiring ESG analysts and sustainability experts and have provided relevant education to increase the level of knowledge in investment teams. This is an important shift, that needs to be encouraged.
In Sweden alone, billions of dollars are invested in companies that do not commit to integrating ESG factors, have a high carbon emission footprint, and are not in line with the Paris Agreement. Investors have the option to exclude these companies from their investment strategy. Another option is to influence them by being active owners. The latter strategy is considered to be a more effective strategy than exclusion, and the goal is to influence a company to enhance and preserve the value of the investors’ investment. The goal is to change the corporate strategy or improve its sustainability performance.
Esgaia has come across several organizations that are at the forefront of this and have a thorough integration of active ownership in their investment strategy. These organizations are sources of inspiration and define active ownership as a key tenet of sustainable investing. There are also a large number of institutional investors that are in the early stage of active ownership implementation and are currently seeking an approach to practice it. There also exist investors not yet exercising active ownership at all. They are usually experiencing cultural, regulatory and practical barriers to comply with their active ownership responsibilities.
The main reason investors do not engage with their investee companies is that they believe the costs outweigh the investment benefits. It is time-consuming and often requires resources in form of ESG analysts, new employments and/or education. Costs are linked to a lack of knowledge and competence of active ownership, which is often the case for smaller investors. Another obstacle to active ownership is when the investor holds a smaller investment in a company, thus the investment is too small to influence the company. This is often due to portfolio diversification (to yield higher returns and to spread out the risks), but also because the investor is too small to gain financial power.
Another obstacle to active ownership is free-riders. Being a market leader of active ownership presents a free-riding incentive. This means that other investors, from whom it is not worthwhile to engage in active ownership, benefit from the work of leading investors. All investors benefit from the dialogue, but the leading investors bear the cost of those free-riders.
Develop a strategy to overcome the obstacles, and meet the need
Establishing an approach to active ownership can be difficult, but smaller activities can be undertaken to overcome some of the barriers. The strategy should outline the general approach to active ownership, and a plan to overcome potential barriers.
Investors holding smaller investments may have lower financial power compared to investors holding larger investments. To overcome this obstacle, collaboration with other investors can increase the success of the engagement for smaller shareholders. In this case, investors pool their capital in collaborative engagements to have a stronger voice. Collaboration can occur directly with other shareholders, or through investor initiatives where investors come together to target several companies on specific ESG-issues.
Another benefit of collaboration is the sharing of costs, which is intended to reduce the barrier of costly engagements as an individual investor. When collaborating with other investors, it is important to take the responsibility that active ownership requires, in order to avoid becoming a free-rider.
To be successful with collaborative engagements, all shareholders must have a clear and shared understanding of the targeted issue. There needs to be good coordination and clear milestones to work towards together.
Collaborating with other investors can also increase knowledge sharing to some extent. However, overcoming the barrier of deficient knowledge and competence still requires resources. Acquiring knowledge in the field of active ownership is time-consuming, but it is easily accessible through several sources. UNPRI (1,2) is a great source of active ownership material and presents strategies and best practices for successful engagements .
Esgaia guide investors that are at the initial phase of active ownership. We help investors to establish an approach to active ownership by providing a platform that facilitates work progress. Our mission is to become the standardized solution for active ownership and to increase the amount of work that is put on active ownership. We want capital to drive sustainable change.