ESG: A driver for company change?

Engagement with businesses can encourage positive change and also ensures ESG remains prevalent throughout the investment process, as Chris Murphy and James Balfour explain.

ESG: A driver for company change?

With a heritage rooted in insurance, Aviva Investors’ strong, proactive stance on governance issues should come as no surprise. And, as long-term investors, the group believes investments will be more successful if managers understand how companies perform on any environmental, social and governance (ESG) issues, ranging from board diversity to climate change.

“It isn’t a surprise that businesses that practice good governance and operate good structures on the board, or those that run open management and value staff wellbeing, are less risky at an investment level,” explains James Balfour, co-fund manager of the Aviva Investors UK Listed Equity Income strategy.

In particular, he notes well-run businesses that promote responsible and sustainable investment practices and values are proven to be more efficient and successful over the long term. This typically translates into superior long-term share-price performance, and therefore client outcomes.

Responsible investment philosophy

Aviva Investors operates a firm-wide approach to ESG, adopting a responsible investment philosophy underpinned by an overall belief and firm set of commitments that all portfolio managers abide by. 

Focusing the investment approach across four core pillars: integration, stewardship, avoidance and market reform

These commitments go further than simply modelling data and focus the investment approach across four core pillars: integration, stewardship, avoidance (which includes divesting positions when unmanaged ESG risk factors fall outside of the firm’s tolerance or where company engagement fails), and market reform.

Supported by over 20 in-house ESG experts that are integrated into each investment division, the firm operates its own proprietary ESG data-modelling tools to provide fund managers with an assessment of ESG risks on an absolute and relative basis. The firm also takes its roles as stewards seriously and undertakes extensive ‘proactive’ and ‘reactive’ engagement with investee company management and boards to monitor ESG factors and encourage best practices. In addition, Aviva Investors encourages its fund managers to use their positions to advocate for policy reforms that address market failures and help build more sustainable capital markets.

While ESG is a central pillar of the investment process, the fund is not an ethical fund by the strictest interpretation of the term, and both Balfour and lead manager Chris Murphy have the final say on stock selection. This means that the portfolio will include stocks that may not have a ‘perfect’ ESG score. However, Murphy says some stocks may also be revalued by the managers if they believe their ESG plans will impact their bottom line, for example. 

Off-the-shelf ESG scores can also be misleading

“While the insight into ESG issues and trends help us to understand the risks and open the door to new opportunities, off-the-shelf ESG scores can also be misleading,” explains Murphy. “We will come across companies with fairly good scores that still undertake shocking business practices.”

On the other hand, some companies are flagged as being poor on the ESG front. Often there is a reason for that, notes Murphy: “They may not have certain details about their carbon footprint in their accounts for instance, or they may have screened badly for succession planning or diversity. This is where our ESG analysts can help us actively speak to them and fill in some gaps or engage with the business and encourage change. It is one of the advantages of having such a large ESG analyst team to support us: together we can drive that engagement properly.”

Engagement and change 

Balfour believes engagement is the key to ensuring ESG remains prevalent in the investment process and is more powerful than simply using ethical screens to exclude stocks. 

We need to use our position to support these companies

“We need to use our position, and the firm’s influence as a large institutional investor, to support these companies,” he says. “It is far more effective for us to be able to meet with them regularly to engage and encourage change, rather than walk away from them completely and ignore wider environmental or governance issues.”

Murphy agrees, and points to oil companies such as Royal Dutch Shell or BP as an example. “For most of our lives, we haven’t had a viable alternative to oil,” he explains. ”Although we don’t hold a lot of [the sector] in the fund for a number of reasons unrelated to ESG, we do have some exposure. That allows us to talk to them about their commitment to things like green power and ask if they are going far enough.

“By engaging with them in their plans we can better understand how they plan to still be relevant to the world in 50 years’ time. It is still an oil company we are investing in, of course, but we are trying to shift their focus to future proofing and limiting the business’s environmental impact in the longer term,” he adds. 

Below, Chris Murphy and James Balfour of real-life examples on how ESG considerations have been integrated into their investment process.

Circular economy

  • Unilever: Unilever announced a new plastics strategy in October 2019, making it the first major global consumer goods company to commit to an absolute plastics reduction across its portfolio. We engaged directly on this issue with the new CEO Alan Jope when he came in to see us in July last year, and also collaboratively as part of the Plastic Solutions Investor Alliance (PSIA). 
  • Compass Group: We engaged with the CEO on the issues of plastics and climate change.
  • Housebuilders: In light of the increased public/government emphasis on quality of build and customer service initiatives, we have had dialogue with Countryside (and Bellway) to understand their strategies and priorities for investment.

Climate change

  • BP: We co-filed a resolution at BP this year, asking the company to disclose how material capex decisions are in line with the goals of the Paris Agreement and to set appropriate emissions reduction targets. We met with the company’s CEO and chairman to discuss the implementation of the resolution, which was adopted with 99 per cent of all votes at the last AGM
  • BHP: We voted in favour of a shareholder resolution asking the company to sever its membership of trade associations that actively lobby against climate policies.

Board composition

  • Ted Baker (previously held in the fund): We voted against the chairman due to a lack of independence and concerns over his handling of the recent controversies.

Renumeration

  • Cineworld: We voted against the significant proposed increases in 2018 following the Regal acquisition, preferring to see evidence of success first.

Key risks

The value of investments and the income from them will change over time. The Fund price may fall as well as rise and as a result you may not get back the original amount you invested.

Equities Risk: Equities can lose value rapidly, can remain at low prices indefinitely, and generally involve higher risks — especially market risk — than bonds or money market instruments. Bankruptcy or other financial restructuring can cause the issuer's equities to lose most or all of their value. 

Target outcome risk: Any outcomes stated as targets are not guaranteed and may not be achieved.

For further information on the risks and risk profiles of our funds, please refer to the relevant KIID and Prospectus.

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Important information

This document is for investment professionals only. It is not to be distributed to or relied on by retail clients. Except where stated as otherwise, the source of all information is Aviva Investors as at June 12, 2020. Unless stated otherwise any opinions expressed are those of Aviva Investors.

They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.

The UK Listed Equity Income Fund is a sub-fund of the Aviva Investors Portfolio Funds ICVC. For further information please read the latest Key Investor Information Document and Supplementary Information Document. The Prospectus and the annual and interim reports are also available on request. Copies in English can be obtained free of charge from Aviva Investors UK Fund Services Limited, St Helen’s, 1 Undershaft, London EC3P 3DQ. You can also download copies from our website www.avivainvestors.com

Issued by Aviva Investors UK Fund Services Limited. Registered in England No. 1973412. Authorised and regulated in the UK by the Financial Conduct Authority. Firm Reference No. 119310. Registered address: St Helen’s, 1 Undershaft, London EC3P 3DQ. An Aviva company.