The concept of financial stewardship is not new. Nearly 30 years ago, the Cadbury Committee was established by the Financial Reporting Council (FRC) and other bodies to address the fall in investors’ confidence around the transparency and accountability of companies. The Committee published a Code stating that ‘we look to the institutions in particular to use their influence as owners to ensure that the companies in which they have invested comply with the Code’.
Since then, there have been several reviews, iterations and amendments with one of the most recent publications being the UK Stewardship Code 2020 by the FRC.
Often, stewardship is a misunderstood and ignored part of the investment process. In its 2019 review of UK master trusts’ responsible investment policies, Share Action identified that “master trusts are largely over-delegating stewardship to their asset managers without sufficient oversight”. However, it is in these long-term investments that stewardship arguably matters most. Long-term investors have a significant interest in encouraging and supporting successful long-term strategy in the companies they invest in. Equally, where beneficiaries are involved, stewardship is a key part of fiduciary duty – voting and engagement are directly aligned to the duty owed to beneficiaries.
But are we getting it right and how can it affect positive change for long-term investors?
The first issue is that stewardship is poorly understood.
If you Google “define stewardship”, the result is “the job of supervising or taking care of something, such as an organization or property.” The word is often associated with care for natural resources or old houses and is not a familiar concept in relation to investment processes that buy and sell shares based on margins.
The UK Stewardship Code 2020 defines stewardship as “the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society”. The requirement is clear: assets should be responsibly allocated to create long-term value and sustainable benefits. Stewardship therefore means the way that asset owners care for the assets entrusted to them by beneficiaries.
Secondly, stewardship gets confused with ESG.
ESG (environmental, social and governance) investing is sometimes understood to either be the same as stewardship, or to implicitly include stewardship activities. The two concepts are undoubtedly linked – ESG investing is responsible investing for the long-term and ensuring that investments help to create a better future world for beneficiaries. This is very similar to stewardship.
The risk of seeing ESG investing and stewardship as one and the same is the subsequent belief that by implementing an ESG investment strategy, stewardship responsibilities are automatically met. However, stewardship relates more to the action and ongoing dialogue with the underlying assets that the ESG investment process has chosen. Yes, the concepts are intrinsically linked but stewardship needs to be viewed as separate in order to receive the attention it deserves.
Also, stewardship requires action.
The Occupational Pension Schemes (Investment) Regulations 2005 define stewardship as encompassing “engagement and voting”. It is not enough to implement an ESG investment strategy that aligns to investment beliefs and monitor its performance – stewardship goes beyond this. Stewardship activities include investment decision-making, monitoring of assets and service providers, engaging with investee companies or asset managers, collaborating with other industry players and exercising rights and responsibilities under fiduciary duty. For many long-term investors, this is an arduous task but one that absolutely aligns with the long-term nature of the underlying investments.
Finally, asset managers and owners often struggle to see how stewardship can effect change.
It is often argued that the only way to truly effect long-term positive change is through active investment management such as using exclusions. However, stewardship is a powerful tool that can be used to bring about sustainable benefits for investors:
- The rise of passive investing means that these mandates hold larger and larger proportions of shares in companies. This therefore translates to having a bigger voice when it comes to effecting company change as well as the opportunity to join with other passive investors to pass resolutions that benefit the company and investors. A good example is the resolution at Barclays coordinated by Share Action.
- ESG, and particularly climate change, will continue to be issues that investors want to address and will want to see the companies they invest in manage properly. Companies that mismanage or ignore these issues will find it hard to raise capital and remain viable.
- Many values-based investing styles give firms a period to “comply” with ESG requirements or good firm practice. If after this period, there is no improvement and the company is still resisting engagement, the investor sometimes chooses not to hold that stock any more. Withdrawal of this type of funding can prove catastrophic for some firms.
- Raising market standards. Passive investors own thousands of companies across the globe. Investing in the whole pie rather than just the pieces means that as an industry, standards around corporate governance and investing for the long term will rise. Equally, in the reporting space, reporting on investor engagement and voting is gaining traction and becoming a hygiene factor. The more asset managers and owners publish and are transparent on how they vote and engage, the easier it will be for it to become industry standard.