Institutional Investor Engagement: One Size Does Not Fit All
This article was originally published on Finsbury.com
The contours of engagement circa 2018
Institutional investor engagement had its origins at Pfizer about 20 years ago as an experimental, if not quixotic, once-a-year meeting of corporate governance officers from major institutional investors with senior management and (horrors!) selected board members. Since then engagement has become a dominant theme in the corporate governance playbook for both companies and investors.
Countless articles have been written about, and hours of corporate governance advisers’ time has been devoted to, the implementation of engagement policies with institutional investors. What was once a nascent cottage industry has grown into a full-fledged, world-wide industrial complex. It is populated by growing and increasingly prominent investor stewardship and corporate governance teams at domestic and foreign institutional investors, corporate governance officers and staffs at US and European public companies, and corporate governance specialists at law firms, investment banks, proxy solicitors, PR agencies and other more specialized consultants.
While there are many minor variations on the theme, the majority of corporate engagement policies emphasize the desirability, if not necessity, of having one or several board members as key participants (e.g., the lead director, the chair of the compensation committee and/or the chair of the governance/nominating committee).
Additionally, the company team is usually coached to stay away from the detailed strategic, financial and performance discussions that predominate in company dialogues with portfolio managers and equity analysts. Rather, the emphasis is typically placed on articulation of the board’s broad strategic vision, board composition and refreshment policies, senior management succession planning, and the correlation of executive compensation with stock market performance and achievement of the company’s basic strategic goals.
In short, the company’s engagement script is typically tailored to the investor stewardship teams at major passive investors (particularly BlackRock, Vanguard and State Street, which together represent almost 20 percent of the entire equity market) and at those large actively managed investors that have delegated principal responsibility for proxy voting to governance professionals rather than to portfolio managers.
These investor stewardship teams fit a common pattern:
They are quite small in comparison to the huge number of world-wide portfolio company votes they cast in a year
They are principally focused on big picture environmental, social, and governance (ESG) issues
They lack the skill-sets and manpower necessary to deal in depth with company specific issues of strategy design and implementation, capital allocation, M&A opportunities, and operational and financial performance.
The result is a one-size-fits all quality to ESG centric engagement policies prescribed by advisors. Unfortunately, the ESG centric engagement paradigm fails to take into account those actively managed investors that allocate proxy voting authority in whole or in part to their portfolio managers and fundamental research teams.
An alternative engagement paradigm
The ESG-centric view of best-in-class engagement practices has recently been challenged by publication of engagement policies by two leading actively managed investors—T. Rowe Price and Alliance Bernstein. The engagement policies of these two firms makes clear that there is an alternate paradigm for engagement—one that is not ESG centric, but rather portfolio management centric.
The stated engagement philosophies of both T. Rowe Price and Alliance Bernstein are remarkably similar:
T. Rowe Price: “Engagement, proxy voting activities, and assessment of a broad range of investment considerations—including environmental, social, and governance (ESG) issues—are integrated into T. Rowe Price’s investment processes. Based on our view that these issues are important investment considerations, our engagement program is driven by our investment professionals and usually focused on a matter material to the investment case….The central focus of our engagement program is at the company level. Generally, we do not identify broad themes and then engage with multiple companies on the same issue. We believe our company-specific approach results in the highest impact because it is aligned with our core investment approach_: active management rooted in fundamental investment analysis_ (italics in original).”
Alliance Bernstein: “As global investors, we are committed to engagement with companies around the world…we believe that the bulk of the responsibility for deep company-level active engagement will fall on traditional active equity managers. A commitment to in-depth, in-house research is essential. It uniquely positions an active manager to leverage company-specific research, analyst backgrounds and industry research to drive engagement with management teams, catalyze improvements and ultimately support stronger stock returns.”
Portfolio-management-centric engagement has a far different style and substance than ESG-centric engagement.
Investment professionals not only participate on the front line in portfolio company engagements, they run the engagement, except to the extent it involves specific ESG issues where other staff at the investor has special expertise. As a result, company engagements are research driven, not generic.
Engagement is an on-going two-way dialogue, not a once or twice a year “box checking” exercise. In appropriate cases, the portfolio management team will challenge management and suggest changes in strategy, operations or financial management. The object in every case is to help the company improve its business and economic performance with the avowed goal of increasing the value of the investor’s stake.
Because portfolio management centric engagement is about helping to improve a company’s performance and value, it is principally a management, not a board, function. Meeting directors is important only when issues focus squarely within the board’s purview, not management’s, and are viewed by the portfolio managers as directly related to the company’s ability to create shareholder value. No “brownie” points are awarded for director participation when not relevant to the discussion at hand. Nor for obvious reasons are portfolio managers anxious to have advisors participate unless their presence is essential to the dialog.
Most importantly, portfolio management centric engagement does not focus on achieving abstract ESG goals for their own sake, but rather on assisting company management and the board in creating greater shareholder value. While many portfolio management centric investors care deeply about ESG issues (and have published voting guidelines detailing their views on many of them), they view ESG as part of a more holistic investment analysis. Unlike typical investment stewardship teams, they will raise ESG issues only when they conclude the issues have a bearing on the company’s actual performance.
Put simply, engagement in 2018 should not be a one-size-fits all process. Different investors care about different issues, and it is highly desirable to know what those issues are when planning a specific engagement, rather than learning about them during the engagement.
This is true for the key index investors—BlackRock, Vanguard and State Street—as well for other large index investors in the US and internationally. There are differences among these investors in terms of their priorities and goals for engagement that should be considered by every portfolio company undertaking engagement with its key investors.
This is most certainly also true for actively managed investors which, like T. Rowe Price and Allied Bernstein, view engagement as part of the investment/research process which drives their portfolio decisions. Not all portfolio-management-centric investors will have the same view of a portfolio company; one may respond well to engagement on an issue whereas another portfolio management centric investor may not be concerned.
In addition, because portfolio management centric engagement focuses on a company’s fundamentals, it is a uniquely management driven process, typically requiring participation by senior management and the traditional investor relations team. The make-up of the engagement team is obviously quite different from that needed for ESG centric engagements, which has largely become the province of the company’s governance officers and its board.
The critical point is that engagement is a process of communication. And like all communication driven endeavors, it must start with the audience and the reason for the communication. Only when these two essentials are known, can the message be crafted and the messenger identified.
This article first appeared in the The Conference Board.