This article was originally published on Finsbury.com
However, like so much in life, the real world is far more complicated and harder to categorize. First, many activist campaigns are not about financial engineering in any sense. While activists sometimes do campaign on platforms that include (or perhaps consist principally of) cost-cutting, far from all of these are imprudent cost reductions at the expense of long-term growth. More important, many activist campaigns focus on building the business through better organizational structures and/or more effective focus on improving the quality of goods and services. Indeed, the latter type of activist investor policy has been in the ascendant among leading activist investors for several years now.
But even so, a focus on organizational, operational and product improvement seems a far cry from socially responsible investing. So, it attracted some notice when Trian Partners modified its website last year to add a statement embracing ESG and a compendium of ESG highlights at its current portfolio companies. For example:
“Trian believes that environment, social, and governance (ESG) issues can have an impact on a company’s culture and long-term performance and that companies can implement appropriate ESG initiatives that increase their sales and earnings.”
“We also believe that the consideration of ESG factors enhances our overall investment process.”
Trian’s ESG investment policy does not seem significantly different from the ESG investment policies of many leading institutional investors, particularly the largest index investors (e.g., BlackRock, Vanguard and State Street). Indeed, the examples of its ESG investing that Trian provides on its website could as easily have been posted by a conventional institutional investor highlighting its ESG initiatives, such as promoting diversity in the workforce, director independence, board refreshment, emission and waste reduction and adoption of supplier codes of conduct.
The similarity of Trian’s ESG policy to that of other major institutional investors suggests it has two complementary purposes.
First, an increasing number of institutional investors believe that a company’s economic performance and stock market valuation is frequently dependent on specific ESG issues inherent in its business model and are thus integral to any investment decision involving the company. (It is natural for Trian as a value investor to subscribe to this investing policy.)
Second, the success of Trian’s activist business model depends on support for its company specific campaigns from traditional long institutional investors. In this view, Trian’s very public embrace of ESG investing can be viewed as courting, in particular, the three major index investors (all of whom are staunch supporters of ESG investing), as well as state and local pension funds, union pension funds and other core corporate governance activists who almost universally champion ESG investing.
More recently and far more dramatically than Trian’s embrace of ESG investing, Jana Partners published a joint letter with CalSTRS calling on Apple to recognize the potential dangers to children and teenagers of too frequent use and abuse of their iPhones and to implement a far-reaching program of research on the effects of excessive social media use by youngsters as well as far more sophisticated and effective programming choices on iPhones to enable parents to limit the devices’ usage by their children.
In addition, Jana announced that it was planning to raise a new fund, called Jana Impact Capital. According to a press report, the new Jana fund is targeted at $1.7 billion and would invest in companies that “are good bets but could do better for the world. The fund’s board of advisers includes the recording artist Sting and others who have a track record of pressuring companies on environmental, social and governance issues.”
The Jana and CalSTRS campaign at Apple, and presumably the investment thesis of its proposed Impact Fund, are clearly of a different order from Trian’s approach to ESG investing. Jana is not merely taking ESG into account in its investment analysis, it is going a significant step further by using one or several ESG issues as the fulcrum of its activist campaign. The obvious questions are what is Jana hoping to accomplish and what are the possible impediments to its goals?
An obvious answer would be to foster positive ESG change at a target company thereby enhancing the value of Jana’s equity position. There are, however, at least two underlying problems with this explanation.
Will the ESG issue championed by Jana resonate sufficiently with other investors to motivate the target company to adopt the proposed policy change without requiring more aggressive moves by Jana? The answer is more complicated than it might initially seem. It is probably yes, if there is broad institutional investor support and the change doesn’t materially alter the company’s business model. But if that’s the case, how likely is the change to produce a sufficient up-tick in the company’s stock price to justify the activist campaign?
On the other hand, if the company rejects the proposed ESG change, will it matter to enough shareholders to give credence to more aggressive agitation by the activist? Historically, ESG issues have not been viewed as sufficiently connected to value to create this sort of leverage for its proponents. Will Jana be able to identify ESG issues that have so much appeal to institutional shareholders that the ESG issues can serve as the fulcrum for a threatened or actual proxy contest?
There is, however, another, somewhat cynical, explanation of Jana’s ESG strategy. As one commentator speculated:
“The [Apple campaign] will almost certainly help [Barry] Rosenstein [the head of Jana] as he seeks capital allocations from public pension funds for his traditional activist fund and its more aggressive, less friendly agitations….Also, it could help Jana Partners gain support for its campaigns in the form of votes of big institutional investors…The [Apple] campaign fits squarely within the category of…ESG, an investing category that sizeable public pension funds such as CalSTRS as well as the primary index funds, including Vanguard Group, State Street, and BlackRock, are concentrating on heavily.”
This speculation about Jana’s motives also notes that the Jana’s new fund will not charge investors the traditional hedge fund “2 and 20”—that is a fee equal to 2% of the investment plus 20% of the profits. Rather, according to press reports its fee structure will be just 2% of invested fund with no success fee.
The supposition is that the proposed fee structure illustrates that Jana is not counting on its ESG activism to achieve profits of the same order as its more traditional activist investing. Rather, Jana’s principal purpose is to create a “halo” effect that will advance Jana’s traditional activist investing model in terms of support for its activist campaigns by and its asset gathering from the larger index investors and state, local and union pension funds.
The more cynical explanation of Jana’s strategy has its flaws, as well. It ignores that Jana’s business model, both as an asset gatherer and as an activist investor, is wholly dependent on its ability to provide outsize returns for its investors. Creating an ESG fund that doesn’t and isn’t intended to do this may adversely affect its conventional asset gathering. Moreover, Jana’s credibility and success as an activist investor is clearly based in large part on its history as a successful and to be feared opponent. A history of issuer friendly ESG investing (as it seemingly is positioning its Apple foray) and/or of failed activist ESG campaigns will not burnish Jana’s record.
If Jana’s strategy and the success of that strategy are murky, so is the playbook for its corporate targets. Right now, the strategy is too new and uncertain to make useful predictions, let alone develop prototype company response playbooks. At least initially, a company that is targeted by an activist ESG campaign will have to evaluate its situation against a relatively blank slate in terms of prior experience. Moreover, its response will have to be tailored to the precise ESG issue it is facing and the economic consequences of its acceding to or contesting the proposal. For Apple to embrace the Jana/CalSTRS proposals would not be the same as Exxon agreeing to an ESG-based proposal to cease its ocean-based oil drilling and production. The only sensible advice for companies worrying about the implications of Jana’s attempt to create an ESG-based version of activist investing is simply to “stay tuned to the program.”
This article was originally published by The Conference Board Governance Center and the Harvard Law School Forum on Corporate Governance and Financial Regulation.