Move on From All the Noise
Stewardship should be about supporting companies to enhance value and manage risk through active ownership, says Leon Kamhi, Head of Responsibility and EOS, Federated Hermes Limited.
For the best part of the last two decades, investor stewardship became largely conflated with ESG, as if investors only had a responsibility to look after their investments with regards to environmental, social and governance factors.
Going back to first principles, stewardship is simply about being an active owner of what you buy. As such it is an integral part of investing well. It represents concrete efforts to improve a company’s performance in line with the financial interests of investors, beyond what stock selection alone can achieve. When stewardship began to gain traction 20 years ago, it was designed to mitigate such risks and improve company performance.
Relevant social and environmental factors should be addressed
The UK’s Capital Markets Industry Taskforce is right to claim that stewardship should centre on “outcomes that promote a company’s long-term success and create value”. This should not however undervalue the importance of stewardship addressing issues of climate, nature, human rights and employee diversity and inclusion when these are relevant to a company’s long term, enduring (dare I say ‘sustainable’) performance. After all, ignoring such factors could mean missing out on valuable opportunities; and in the worst cases, overlooking material risks that can reduce value.
The key is for stewardship objectives to not be detached from what is most relevant for a particular business. The focus needs to be on business improvement, not virtue signalling by companies and investors alike.
We only need to recall the devastating environmental impact of the Deepwater Horizon oil spill in 2010, the largest ever, to know this. The contamination of a vast body of water and coastline in the Gulf of Mexico, partially due to governance failures by the management company, led to the death of substantial numbers of animal species, as well as damaging human health. BP’s share price consequently fell by more than half in the 60 days following the accident.
Similarly, in 2013 the collapse of the Rana Plaza factory in Bangladesh, a production site for clothing brands such as Primark, killed more than 1,100 workers with thousands more injured. This rightly led to a greater recognition of supply chain risks by shareholders.
Overlooking the integration of these material factors into one’s stewardship practices can lead to catastrophic consequences, for companies, the environment and society.
Effective corporate governance crucial to quality business decisions
Corporate governance is the crucial foundation for company boards to take key decisions. We need boards that have the right skills but are not run as a club, with corporate structures that protect minority interests and simple remuneration schemes that incentivise executives to make decisions in line with the investor interest.
Poor corporate governance has often led to misdirected capital allocation. Companies used investments to build empires, rather than achieve financial returns and add value for shareholders. Paradoxically, the emergence of best practice corporate governance guidelines has led boards to become over risk averse.
Six Continents, once a constituent of the FTSE 100, became a prime example of this approach 20 years ago. As the owner of familiar British hotel and hospitality names, such as InterContinental, Crowne Plaza, Holiday Inn, All Bar One and Harvester, it became eager to invest in new hotel brands for little purpose, other than ‘empire building’. As active owners, a group of asset owners engaged the board to focus on returns to capital invested, not simply growth and expansion for its own sake. The company took these concerns on board and agreed to consider returning £1billion to shareholders.
Increasing role of policy engagement in stewardship
The so-called universal owner – institutional investors who are widely invested across the economy – also have a fiduciary responsibility to their beneficiaries to strive to address systemic issues and opportunities that impact the performance of their overall investment portfolio.
This can be done through policy engagement with governments, standard setters, regulators and other policymakers on topics such as corporate governance, competition, accounting, climate, employee rights and to improve the investment industry itself. Key for an institutional investor is to remain laser focused on the interests of its beneficiaries and not stray into politics.
To further the financial interests of a universal owner’s beneficiaries, stewardship can only go so far at an investment-by-investment level, as the company needs to deliver financial performance. It is for governments to ensure any externalities – which matter to the universal investor – are addressed by companies or governments through policy interventions.
Looking forward
We now need to return to the essence of investor stewardship: ensure purposeful corporate governance to underpin beneficial business decisions, which create value and manage risks. This will enable high-performing businesses and long-term value for shareholders.
As we enter the next chapter of stewardship, I would encourage it to evolve in four key ways:
- Focus on business improvement and – as part of that – achieving real world environment and societal outcomes by making engagement less transactional, more holistic, and better related to the business.
- Encourage purposeful corporate governance to act as a catalyst for profitable business growth, meeting the needs of the transition to net zero rather than be over risk averse and box-ticking.
- Complement stewardship of investee companies through outcome-oriented policy engagement to deliver on investors’ financial interests, not individual political agendas.
- Improve connectivity between engagers and fund managers, integrating the two disciplines within an investment manager with a unified goal of wealth creation.
Having a strong stewardship offer is a key service differentiator between asset management firms. We expect clients to increasingly see the value enhancement and preservation that active ownership can bring to complement the returns which can be achieved by a fund manager through judicious investment. In time, stewardship will be considered an essential, rather than optional, part of investment management.
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