A core component of our role is to understand what best practice looks like, and what it doesn’t look like, when it comes to sustainability. I’m sure most fund managers that run ESG- or sustainability-focused strategies at least mildly enjoy calling out corporate greenwashing when they see it.
But there is often a collective wince on our team when we hear a company begin a meeting by describing itself as having ‘sustainability in its DNA’.
Such misappropriation of biological terminology can be somewhat forgiven, however, when it is backed up by hard data and accompanied by steady performance and progress on ESG impacts.
Asking the right questions and taking time to understand a business in its entirety helps identify signals that indicate genuine integrity, and experienced fund managers will come to know over time whether sustainability is truly integrated.
Monitoring and engagement are an essential part of active stewardship, irrespective of whether funds are ESG or sustainability focused, although the bar will obviously be set that much higher for such strategies.
While fund managers all have their own interpretations of what makes a portfolio sustainable, none can promise perfection; all companies continually make choices that balance the needs of many stakeholders, and, occasionally, even great businesses with the best of intentions, policies, governance and culture make mistakes.
Responding to mistakes
When a company does find itself the subject of such shortcomings, the first response should be to analyse the facts. Selling positions in companies as a knee-jerk response to a controversy is not the best course of action because it is through engagement that investors can help to ensure mistakes are resolved and prevented from happening again.
Responsible fund managers will look for a clear initial response from the company that includes details of the issue in question and the process for any internal or third-party investigations. This can take time, which can be used to go beyond the company line and any media hype; hearing views from other stakeholders and gathering wider perspectives can be critical to understanding the issue.
At the end of this process, we need to see a company take responsibility for any failings, along with swift, corrective action, to be confident that harm will not be repeated. The type of controversy, focusing on the severity as well as the likelihood for change, is key; issues concerning culture, for example, can be hard to rectify quickly. Being clear about what we need to see from a company in response to a mistake so we can continue to back them, as well as what would prompt us either to reduce the position or divest completely, assists engagement.
The decision of whether to divest from a company subject to a controversy should come down to the lines already drawn by a fund manager’s investment process, such as where a company no longer adheres to stated investment criteria or the issue is material so that the initial investment thesis no longer stacks up.
Clients might use these situations to assess the integrity of a fund manager’s investment process, checking how a company made it into funds and whether specific failings could have been predicted. Such events might also highlight the resilience of processes for escalating engagement, the extent to which fund managers leverage their stewardship position, and whether they are genuinely committed to fostering fundamental change with engagement informing investment decisions.
Honest communication from fund managers to clients when these issues arise is also important and can help to build long-term trust. Fund managers with greater transparency, and who explain the outcomes of engagement and the resulting investment decisions, would seem to warrant greater trust. Investment teams who are open about where they might have got things wrong themselves, and are willing to learn from and improve their engagement, signal best practice: like the companies in which we invest, we are only human after all.