Why engagement has evolved from 'puzzled frowns' to key ESG investment tool

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Why engagement has evolved from 'puzzled frowns' to key ESG investment tool

A few short years ago, talking to clients or potential clients about our comprehensive engagement programme often led to puzzled frowns, says KBI Global Investors' Eoin Fahy.

It was clear that many did not understand what engagement was, or indeed why an investment manager would see it as important.

And yet recently, when I was presenting to a very large potential client and began to explain how central engagement is as part of our investment process, he impatiently told me to move on to something else as, "Everyone does engagement these days. Don't waste your time talking about that", he said.

Over the next few years I expect to see another significant step change in the field of engagement, in which it will increasingly be seen as an important investment tool."

So, when thinking about the ways in which engagement will develop in the coming years, there is no harm in remembering that in no more than five years, engagement has moved from being new(ish) and somewhat radical, to being assumed and taken for granted. Today no self-respecting investment manager would fail to engage with the companies in which it invests - at least they wouldn't admit to not doing so!

Over the next few years I expect to see another significant step change in the field of engagement, in which it will increasingly be seen as an important investment tool - a way to enhance investment performance, whilst at the same time bringing about environmental, social or governance benefits.

As a firm, our core statement with regards to Responsible Investing states up front that, "we believe that the use of ESG factors has positive effects on the risk and return of investments." That of course is not the view of all investors, but an increasing number have moved away from the old, and surely now outdated, view that there is a trade-off between performance and ESG.

And if you do believe, like us, that investment performance can be improved by focusing on the ESG performance of investee companies, then engagement has to be seen as an investment tool.

Not a ‘hygiene factor' or standard you commit to for good PR.

Not an activity, separate to the investment process, that is undertaken solely to improve the environment or society.

Not something that is a minimum requirement in order to qualify for one of the many SRI labels, or which a large client insists upon as part of their standard requirements.

Rather, a tool which enhances investment performance, and at the same time, often achieves significant benefit for the environment or society.

Why do I believe this is the path for engagement in the years ahead?

Well, we know that investment managers go to great lengths to squeeze out every last basis point of investment performance.

In that context, it seems highly unlikely that they will continue to overlook the opportunity to enhance returns by directly interacting with investee companies, asking those companies to improve some aspect of their ESG performance.

Certainly, we believe in the value of engagement, and our portfolio managers enthusiastically embrace the process.

Sometimes it can be as simple as pointing out that having no female board members is likely to reduce the variety of inputs and experience at board level, while also deterring some investors and depressing the share price. We might explain to a company that investors increasingly punish companies that don't disclose good quality carbon emissions data and inform them of the tools and expertise available to its management team if they move to address that or other climate change related issues.

To us the future for engagement is as an investment tool which will be firmly centred in the investment process. This has implications for all investment managers - many of whom currently carry out engagement in a way which is entirely separate to the investment process. Expect to see investment decision makers leading, or at least centrally involved, in all engagements, as they are on all other aspects of the investment process. And expect the response of investors to be a lot speedier (and perhaps more brutal!) if they are not happy with the responsiveness of investee companies.

This also has significant implications for companies. Companies can expect to see much more engagement being driven by the key investment decision makers, not ‘just' by ESG specialists in large investment firms. In the current engagement model, failure to engage with investors may have little actual impact on whether the investors continue to invest in the company, but that is certainly not the case if the key investment decision makers see the company as failing to engage on an issue that will hurt investment performance.

By Eoin Fahy, head of responsible investment, KBI Global Investors.