We had the privilege of welcoming Ian Robertson, CFA, to our first event for the 2024! Ian is a leader in the investment industry with a notable career dating back to the late 1990s. He is currently pursuing a DPhil part-time at the University of Oxford with a focus on corporate governance and responsible investment. His first published paper won the Best Student Paper at the United Nations-backed PRI's 2017 Academic Conference. Beyond academia, Ian has played key roles, including serving as the Board Chair of the Responsible Investment Association and founding OxProx, a social enterprise spin-off dedicated to advancing responsible investment practices. In his talk, Ian discussed the relationship between ESG issues and investment portfolio decisions, explored potential gains of divesting and shareholder engagement, and highlighted the role of proxy voting by institutional investors as a fundamental aspect of engagement. In this blog post, we want to summarize our learnings from Ian's research findings and insights on responsible investment.
ESG Strategies: From Screening to Shareholder Activism
Responsible investment is about integrating environmental, social, and governance (ESG) issues into the process of analyzing companies and picking stocks for investment portfolios. It goes beyond just choosing which stocks to buy; it involves actively engaging with those companies after investing to encourage them to improve their ESG practices. Investors thus take on the role of both selectors and active participants, pointing out where companies could improve or have overlooked ESG issues. The difference between ESG integration and screening is crucial. Screening simply filters out investments based on ethical preferences, while integration takes a deeper approach by considering all ESG factors. This method is about evaluating a company's value and potential for return with ESG factors in mind, allowing investors to decide how these issues affect the company's price and its future performance.
Ian explained further that owning shares in a corporation grants an investor two main rights: economic benefits, profits from rising stock prices and dividends, and ownership rights, which allow investors to engage with the company to improve both financial returns and the company's ESG performance. These ownership rights enable shareholders to influence corporate actions and ensure that management decisions align with their interests. Historically, the practice of using ownership rights traces back to the period following World War II. Back then, individuals often held shares directly. They received physical stock certificates and dividend checks by mail, and actively participated in corporate governance through the election of directors and auditors. However, the rise of mutual funds and pension funds has since intermediated the investment chain. As a result, direct voting by retail investors has diminished. This shift towards electronic records and diversified portfolios has made active ownership more challenging for the average investor. Despite these changes, the significance of ESG issues has continued to escalate. Fortunately, institutional investors have stepped up to advocate for better corporate governance.
Active and Passive Management Under the ESG Lens
To manage their assets, investors choose between two options: active management, where selected fund managers pick stocks to try to beat the market, and passive management, which involves fund managers following a market index without trying to outperform it. Passive management is becoming more and more popular. However, one issue with passive management is its inability to incorporate ESG factors into security valuation. Since passive funds simply replicate an index, they generally do not exclude or include companies based on their risk / return tradeoffs, unlike active funds that can adjust their portfolios to reflect valuations that reflect both financial and ESG considerations.
The difference between active and passive management also shows up in how ownership rights are used. Passive investors, despite the strategy's limits in ESG integration, still have the power to impact corporate practices through proxy voting. Active managers, meanwhile, not only pick stocks aiming for better financial returns but also have the chance to push the companies they invest in towards better ESG practices. This can include voting on shareholder resolutions or having direct conversations with company management about ESG issues.
The role of ownership rights in active versus passive management highlights an important aspect of investing today. No matter the approach, owning shares gives investors the ability to influence corporate behavior and outcomes. While active investors might have a more direct route to use this influence through selective investment and engagement, passive investors can also make a difference through their voting power. Yet, the question remains: do they exercise this potential?
Investigating Institutional Investors' Proxy Voting Patterns
Ian's research aims to answer this question. In his doctoral thesis, he investigated how major institutional investors—pension funds, active, and passive managers—use their proxy votes to influence ESG issues. He categorizes these investors by asset owners, active managers, and passive managers. This segmentation reflects the classic division in modern portfolio theory between those who directly manage their investments and those who choose index-based strategies. Interestingly, Ian notes a significant variance in the support for ESG shareholder proposals across these groups, with asset owners showing around 70-75% support, active managers at about 45%, and passive managers displaying the least support.
Further, Ian explores different aspects of voting patterns based on geographical proximity and political affiliations. For instance, he investigates whether pension funds are more likely to support companies that are geographically closer, such as how the California State Teachers pension plan might vote on companies like Apple, which is based in the same state. Ian observes that institutional investors tend to support more shareholder proposals within their jurisdiction, possibly due to better understanding and knowledge of local companies.
Additionally, Ian examines the political dimensions influencing ESG voting patterns, contrasting how pension funds in Democratic versus Republican states respond to ESG proposals. His initial observations suggest a divergence in voting behavior based on political leanings, with Democratic state pensions showing consistent support across sizes, and Republican state pensions displaying a trend where smaller funds might vote more in line with political ideology, showing less support for ESG proposals. As these funds grow larger and require more professional management, their voting patterns appear to converge with those of Democratic states.
Ian's framework introduces an important concept in responsible investment: leveraging the Markowitz efficient frontier to enhance investment returns while minimizing risk through proactive shareholder engagement. Asset owners actively participate in meetings, activism, and the voting of their proxies to enhance returns and reduce risk. Passive managers find themselves in a unique position. Their success in nudging companies towards better performance naturally boosts the overall index and benefits all who are invested in it. However, since they match the index, they do not gain a direct competitive advantage over it. Active managers, on the other hand, carve out their niche by aiming to beat the market. Through strategic proxy votes and engagement they can gain a direct competitive advantage.
To wrap up, Ian’s exploration of responsible investment and proxy voting offers valuable insights for both seasoned investors and newcomers to the field. His research highlights the important role that all investors play in shaping corporate behavior and fostering sustainable business practices. By studying the variance in ESG proposal support among different investor types, Ian's work encourages a more informed approach to responsible investment.
Yunus Isik, VP (Academics), Chief Editor