Investor Stewardship at a Crossroads

Rickard Nilsson, Head of Stewardship Success at Esgaia, considers how asset owners can maximise long-term impact at a time of regulatory uncertainty.

Capital markets play a key role in influencing resource mobilisation. At a time when political division is delaying needed policy action, investors find themselves at a crossroads over how to act amid regulatory uncertainty.

Capitalism is governed by existing hard and soft law. As intermediaries with obligations to clients and end-beneficiaries, institutional investors are bound to play by those rules. Trying to play a more ethical game in anticipation of a developing rule book will put an organisation’s competitiveness at risk.

How can investors position against this, and implement a stewardship strategy that maximises impact over the long term for both clients and society at large?

The purpose of investor stewardship

The investment stewardship ecosystem reflects a complex web of stakeholder relationships and interests. From the underlying assets and the institutions owning them to clients, civil society, and the public sector, a myriad of actors influence industry practices, norms and policies.

From an investor perspective, the stewarding of assets generally entails selecting a board of directors who in turn assign and oversee management for the strategy and daily running of the asset. Investors can then choose to monitor and engage the asset, e.g. to build trust and align on longer-term plans. Engagement dialogues also play an important role in setting expectations and as an accountability mechanism when performance is lacking.

As evidenced in literature, and by the experience of many investors, good management practices are not adopted by many organisations because of cognitive, knowledge, incentive and capability barriers. Unsurprisingly then, research suggests that successful investment stewardship can increase returns, lower risks, and empower real-world outcomes – but needs to become more effective to have the intended impact.

The current state

Historically, investment stewardship has focused on individual company performance, generally perceived as high-cost monitoring. Normally only investors with large stakes would have sufficient ‘skin in the game’ to engage with a firm and undertake restructurings that truly increase productivity and investment efficiency. Today, practices are changing with institutional investors representing the single largest category of investors in public equity markets, and with the majority of portfolio performance due to overall economic development.

Most institutional investors’ portfolios now consist of hundreds, if not thousands, of holdings. Therefore, it seems obvious that investment stewardship should focus on reducing non-diversifiable/ market-wide

All About the Outcomes

Measuring the impacts of stewardship is far from simple, even as technological innovation begins to smooth the way. 

When it comes to driving sustainability-related performance at portfolio companies, stewardship is one of the most effective tools currently at investors’ disposal. 

As evidenced during ESG Investor’s Stewardship Summit last month, asset owners are increasingly focused on the outcomes of high-quality engagement – as opposed to the number of engagements undertaken each year. 

“Asset owners are increasingly attuned to the fact that financially material risks linked to system-level issues – such as climate change, biodiversity collapse or social instability – are largely undiversifiable,” Clara Melot, Stewardship Specialist at the UN-convened Principles for Responsible Investment (PRI), tells ESG Investor. “As fiduciaries, they may have a legal obligation to consider what they can do to mitigate risks and act accordingly – this is where outcomes-focused stewardship comes into play.” 

If an investor has engaged with a carbon-intensive company on its climate-related ambition, a positive outcome may be that it sets decarbonisation targets to include Scope 3 emissions, or that it develops and publishes a transition plan aligned with the UK-based Transition Plan Taskforce’s guidance.  

In contrast, a negative outcome may be that the company refuses to raise its ambition, or ditches climate solutions funding altogether.  

The importance of measuring and disclosing such outcomes is also coming into sharper focus thanks to an increase in frameworks, codes and regulations requiring investors to provide robust disclosures on their stewardship activities with portfolio companies.  

However, despite emerging technology-driven tools designed to streamline the engagement process, measuring the effectiveness of stewardship outcomes remains challenging for asset owners and asset managers for a plethora of reasons – such as a lack of standardised metrics, accurate attribution, limited visibility, to name but a few. 

“Asset owners have always been keen to take an outcomes- and materiality-focused approach to stewardship as part of their fiduciary duties,” notes Caroline Escott, Senior Investment Manager for Active Ownership at UK pension fund Railpen. “This approach is fundamental to help asset owners make the most of a finite level of stewardship resource and ensure they push managers on the critical issues that matter most to