Investors won’t be able to meet ambitious sustainability objectives if they rely on traditional active ownership to get public companies to change their practices.
The concept of “universal owners” — asset owners that have become so large that they own a representative slice of the entire stock market — makes it difficult to avoid systemic risks like geopolitical instability or climate change that have become embedded in portfolios through broad diversification.
That leaves active ownership — through proxy voting and engagement — as the principal means to influence decision-making and governance at individual companies.
For instance, on climate change, it is in the interest of a universal owner to engage with portfolio companies to guide their climate strategies and responses. More than half (55 percent) of global investors feel their investments can significantly influence the energy transition.
Yet, in practice, investors need to accept some limitations. For example, success rates for environmental engagements are variable, and even when they are part of collaborative efforts, they average at most around 50 percent. The scope of an investors’ ambitions matters, too. Engagements seeking to achieve significant operational changes are less likely to succeed. A push for environmental disclosures can be an easier win, albeit with more limited real-world impact.
In recent working groups, FCLTGlobal members have expressed frustration with the complexities of proxy voting. “Know what you own” is impossible with more than 10,000 public stock holdings. As a result, there is an overreliance on proxy agencies for voting recommendations and an undifferentiated position on company engagement. Staffing up and investing in internal talent to meaningfully engage with portfolio companies seems the only way to effect change. But this is a costly proposition.
Some investors, like Norges Bank Investment Management, have adapted by focusing on engagement with select companies and industries. NBIM’s engagement approach is informed by the nature and severity of the issue and an assessment of their ability to influence the company, including the size of their investment and previous dialogue. This makes a daunting task much more manageable.
Among many large asset managers, proxy voting and engagement are as much a business decision as they are a portfolio management decision. US- and Europe-based asset managers have been diverging on their support of ESG-related proxy votes, with more funds in the U.S. backing away from ESG resolutions. Platforms that allow institutional clients to vote their own shares have been gaining in popularity, which places the responsibility on asset owners.
All of this together — flagging support for environmental and social resolutions, frustrations with complexities, and variable success rates — has contributed to significant soul-searching among large investors. What are their sustainable investment goals, and how can they best implement them as long-term shareholders?
From Universal to More Concentrated Ownership
One thing that seems obvious is that investors love shortcuts. Is there a better way to influence positive outcomes with portfolio companies?
Some of the world’s largest and most influential investors are stepping up their sustainability ambitions and building internal capabilities to source deals and manage investments directly, especially in private equity, real estate, and infrastructure. A natural evolution of this trend would be to extend this to public equities.
Yet, to do this effectively, investors need to shrink their holdings to a more manageable number. Concentrating portfolios has been a way for investors to better understand holdings, direct management to save on fees, and internalize proxy voting processes.
Some large asset owners have expressed their aim to invest significant stakes in small and mid-cap companies, sometimes gaining board seats. The New Zealand Superannuation Fund boosted its stake in Euroclear to 8.7 percent, making the company one of its largest holdings, while a law passed recently in New Zealand will allow the fund to take controlling stakes in entities, increasing its ability to “drive positive environmental, social, and governance outcomes.”
Other funds have created special mandates or are using sustainability criteria to filter the universe of companies to a more concentrated portfolio. In 2020, Sweden’s AP4 started to build a team for fundamental equities selection within the most carbon-intensive sectors of their global equity portfolio. One of their aims was to concentrate holdings in these sectors on a smaller selection of companies at the forefront of the transition to climate-neutral operations. NZ Super shifted 40 percent of its overall public equity investment portfolio to a low carbon index, which “will be cheaper to run, and more manageable for us when looking to identify and engage on responsible investment issues.” ABP has tightened its sustainability screens, expecting the total number of investable companies to decrease by half.
These trends are indeed something to watch as asset owners seek to step up their sustainability initiatives and increase their impact in financial markets. The first step is recognizing that the perspective of large investors is narrowing and that a systemic view on sustainability is, in some cases, giving way to more nuanced, precise, and focused actions.
Joel Paula is a research director at FCLTGlobal, a non-profit organization whose mission is to focus capital on the long term.
