Divesting holdings in certain companies that are performing poorly on ESG grounds now isn’t necessarily smart in the long term (despite the feel-good factor of doing so) and has the potential to make the situation worse according to Mercer’s chief investment officer, Pacific, Kylie Willment.
She admits the argument is a complex one, but in essence it boils down to if you have “skin in the game” you have the ability to influence the decisions which are made in these companies by firstly engaging with them and secondly, if it comes to it, exercising voting rights to force change.
Her argument for how divesting can make the situation worse revolves around the fact that ultimately your shares will be sold to someone else and there’s no guarantee that they are going to have the same ESG concerns as you are – at best there will be no change in the real economy.
And, at worst, if everybody divested from say, fossil fuels today when we don’t have new technologies for a future energy mix in place and we haven’t transitioned workforces to those new technologies that could create a recipe for economic and social chaos.
A complex situation
Adding to the complexity, when it comes to superannuation assets under management, which make up more than half of the value of the portfolios Willment is responsible for, is the fiduciary duty aspect which binds the fund to act in the members’ best financial interests.
Willment takes a long term view of this issue and in her opinion ESG considerations will have an impact on long term return generation, arguing taking a stance today is ultimately in the best financial interests of members because of the potential costs of doing nothing.
She said the firm had spent considerable time over the past year building a new tool called the analytics of climate transition which looks at where companies in portfolios are, not only in terms of emissions today, but also where those companies, or collectively industries are, on their potential to transition to new forms of energy.
“It gives us some real rich information, because we believe that high emitters today, some of the highest emitters, today, if they take the right actions to transform their businesses, and migrate towards new technologies, or build and develop some of the climate solutions, then actually, they can be some of the solutions of tomorrow,” she said.
But she hastened to add it was not always the case and if those companies didn’t take actions that would impact their investment case at some point they would have to either “adapt or die”.
“A climate transition plan is key to supporting an emissions reduction target. Developing a plan includes setting current emissions baselines; assessing portfolio opportunities for emissions reductions; setting targets for reductions milestones; and, agreeing implementation plans that can be integrated within strategy and portfolio design decisions,” she said. “High carbon intensity, low-transition capacity companies, however, should be down-weighted or sold.”
In terms of flexing Mercer’s influence over companies Willment said there were two approaches.
Firstly she said based on the information that the inhouse research tool provided they look at what is in the portfolios and have “deep conversations” with their investment managers to understand why they are still holding certain stocks and what actions they are taking on Mercer’s behalf to “engage with the companies and get those companies on the transition spectrum”.
“Some of our most powerful influence as a multi manager is to engage with our investment managers and set very high expectations for them on how we’re wanting them to engage and or vote on our behalf,” she said.
“And then we oversee them and get them to report back to us on the kinds of activities that they’re taking, and what kind of successes and influence they’ve had through those engagements.”
Then there’s direct engagement, something the company employs where it feels it has the most influence, generally with the top 20 ASX-listed companies.
“We’ll be engaging with them expressing our views asking questions around what they’re doing to manage these [ESG] risks and through our voting activities, where we oversee in house those top 20 ASX votes, and from time to time, where it’s necessary, we will step in and do what we call a super vote, which means we essentially can override the underlying investment managers and instruct the vote,” she said.
It’s not only climate issues the company looks at, for example, they are also looking across the portfolios and seeing what countries or industries are at higher risk of modern slavery.
“As part of our ongoing conversations with our investment managers, [we talk about] where we think they might have exposure for either the portfolios or the supply chain of the companies. And we’re trying to understand what they’re doing on our behalf to address and work with the companies. We do screen the portfolios for UN Global Compact breaches,” she said.