For financial professionals only
There’s an ongoing debate for ESG investors: engage or divest? Those in the engage camp may invest in ESG laggards and encourage them to improve, while others would divest and re-allocate their capital to ESG leaders. What are the arguments for each view?
Engagement – the carrot
Engagement involves continually communicating with companies to assess how they’re managing ESG-related risks and opportunities – aiming to encourage improved behaviours over time.
Given the urgency of the climate crisis, we need to rapidly cut emissions to limit global warming its forecasted catastrophic consequences1. Engagement can make a difference. Sarasin, one of our Ethical solution managers, has been leading an engagement with NextEra2, the biggest renewable energy distributor in the US3. NextEra is is already committed to reduce carbon emissions by 40% by 20254. Sarasin is encouraging the company to set more ambitious targets. NextEra has now committed to reporting in line with the Carbon Disclosure Project and the Taskforce on Climate-related Financial Disclosures, due to make a net zero pledge by early 20224.
While selling company shares is a way to protest against how it’s being run in the short-term, doing so means losing voting rights and selling to another investor who may not be particularly ESG-focused. Engagement can be more effective in driving long-term, real change than divestment.
With engagement, investors can maintain a broad, well-diversified portfolio – investing in companies with some exposure to high-emitting areas like oil, cement or utilities, as long as the company responds well to engagement and decarbonises. Compare this to an investor with a strict divestment policy who would avoid these companies and hold a more concentrated portfolio.
Engagement can be a means to generate outperformance. As a company improves its ESG practices, many risks are reduced, and company growth prospects could improve.
Divestment – the stick
Other investors prefer to either not invest in or sell companies who aren’t managing ESG risks appropriately. Some oil companies are behind in reducing their emissions5 and there comes a point when investors lose patience. Two of our ethical fund managers, Sarasin and Edentree reached this point a few years ago and divested from Shell and Centrica respectively6 & 7. Money talks, so divesting can be a strong signal of investor disapproval where engagement has failed. As more investors divest from a company, its share price falls and it will be forced to take action to improve this.
Divesting has the advantage of simplicity. If you want to avoid fossil fuels in your portfolio, a simple check can make sure there’s no exposure. It’s harder to monitor how effective a fund manager is in agreeing appropriate engagement milestones and working with a company to achieve them, often over several years. There’s a risk of “greenwashing” as fund managers could claim too much credit for actions a company may have taken anyway.
A middle ground
ESG investing often involves a degree of both engagement and divestment. For example, our fund research has shown that many fund managers have zero tolerance for companies failing to meet minimum governance and human rights standards, so will divest. But they may engage on issues like improving gender board diversity.
At Parmenion, we’re neutral about the balance our clients wish to strike between engagement and divestment. The PIM Strategic Ethical Active solution has 4 underlying Ethical Profiles to allow them a degree of choice. In our Profiles A and B (“Responsibility Leaders” and “Sustainability Leaders”), we’re looking for fund managers who are leaders in engagement, while Profile D (“Traditional Ethical Leaders”) has a strictly screened approach, with more focus on divestment. Our Profile C (“Ethical Leaders”) portfolio seeks balance between the two approaches, with a degree of engagement but a meaningful level of exclusions too. Therefore, our Ethical Profiles cover a range of approaches to cater for different client’s preferences.
(1) Climate change: IPCC report is ‘code red for humanity’, BBC News (09/09/2021) (Link)
(2) UK STEWARDSHIP CODE REPORT 2020, Sarasin & Partners (01/03/2021) (Link)
(3) How wind and solar toppled Exxon from its place as America’s top energy company, Quartz (30/01/2021) (Link)
(4) Environmental, Social and Governance Report 2021, NextEra Energy (20/03/2021) (Link)
(5) Management Quality and Carbon Performance of Energy Companies: September 2020 Update, Transition Pathway Initiative (01/09/2020) (Link)
(6) SARASIN CLIMATE ACTIVE FUND, Sarasin & Partners (01/05/2020) (Link)
(7) RESPONSIBLE INVESTMENT ACTIVITY REPORT 2019, EdenTree Investment Management (01/02/2019) (Link)
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.