Engagement versus exclusion

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?? This week: We like to say that money talks, but what should it be saying about ESG and sustainability? There are, broadly, two ways investors are wielding capital to influence corporate behaviour.

The first is exclusion, which is simply deciding which companies get your money and which ones don’t. Investors with exclusion policies might decide to cease all investments in certain non-green sectors. Companies in those sectors might therefore struggle to find capital and would be incentivised to shift towards greener businesses.

This is a fairly straightforward approach, which is why it’s a common feature of many ESG funds and indices. It’s also become somewhat of a litmus test to demonstrate seriousness about sustainability.?The problem with exclusion is that it can drive window-dressing behaviour. In fact, divestment as a greening strategy has been criticised — and quite reasonably so — as the wrong way to solve a real problem.

That’s why there are many advocates for the alternative to exclusion, which is engagement. The theory there is that it is more impactful for capital to buy a seat at the table of the carbon-spewing businesses and then use that position to work with the companies and get them to become green.

It’s a popular stance among fund managers. From an investment framework and mandate perspective, it’s much less restrictive and gives fund managers the flexibility to find the best way to hit their primary objective of achieving returns. From a marketing viewpoint, engagement also makes it easier to justify charging for alpha — the outperformance that is typically attributed to the fund manager’s value. “You can’t get this kind of impact by simply tracking an index!” is what the fund managers might tell clients.

It is true that engagement has the better potential to create impact. It’s also true, however, that not everyone who claims to pursue an engagement approach is able to do so effectively. The size of an investment in a company obviously matters.?Some companies are also not responsive to external investor pressure – especially in Asia, where numerous listed companies are majority-owned by deep-pocketed founders or families.

?? Top ESG reads:

1. More listed companies in the Asia-Pacific are now aware of the possible conflicts between actions to cut emissions and push back biodiversity loss, a National University of Singapore study finds.
2. Singapore has waived the goods and services tax (GST) for the issuance, transfer and sale of voluntary carbon credits.
3. The United Arab Emirates (UAE) should give oil and gas players a bigger role at next year’s COP given their prominence in the UAE’s economy, said JP Morgan’s Chuka Umunna.
4. Opinion: COP needs a major reboot amid rising frustration with a system that isn’t doing enough to cut greenhouse gases.
5. ESG raters will be asked to apply a voluntary best practice code in Britain’s first step toward regulating the sector.
6. Goldman Sachs will pay US$4 million to settle US regulators’ claims that its asset-management unit didn’t properly weigh ESG factors in some of its investment products.

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