Even the companies which I consider most responsible still have many environmental, social and governance aspects which they can improve. Addressing companies with too many or to demanding change requests does not seem to be very smart (see Shareholder Engagement on Environmental, Social, and Governance Performance). Therefore, I selected a few not too invasive engagement topics. Unfortunately, recent scientific research did not reveal which topics to focus on. That is why I developed and documented my own shareholder engagement approach (see: Shareholder engagement: 21 science based theses and an action plan).
Different engagement focus than others (Active or impact investing?)
Similar to many other investors, I include greenhouse gas emissions. Different from many others I focus on “the emissions a company is responsible for outside of its own walls—from the goods it purchases to the disposal of the products it sells” (“Scope 3”). These are often much larger than direct emissions (see Corporate Value Chain (Scope 3) Standard | GHG Protocol). Many other shareholder engagement activities try to link top management pay to ESG-achievements. I expect that this will lead to a higher pay gap between top management and ordinary employees and should have a negative effect on the social rating of the company. Therefore, I ask for CEO pay ratio disclosures. According to my information, very few other shareholders address this topic. Interestingly, new research reveals that such as disclosure can also make employees more satisfied (see Employee Responses to Increased Pay Transparency: An Examination of Glassdoor Ratings and the CEO Pay Ratio Disclosure).
My main focus is what I call stakeholder engagement, though. I specifically ask companies to regularly survey employees and customers and evaluate suppliers regarding ESG-topics. Thus, I hope that these other stakeholders may also engage with the companies I am invested in to improve their ESG-aspects. Unfortunately, agreement with corporate ESG efforts by employees, customers and suppliers is not part of typical ESG ratings. But if companies follow my advice, they may get valuable ESG-feedback from these stakeholders, and they also can monitor changes in agreement over time.
Currently 87% response rate
I started to contact all invested companies at the end of December 2022. I initially typically asked five questions which were rather easy to answer because I mainly asked for existing and planned disclosures and activities. The replies to my questions should not have taken much effort by the companies.
Until today, I received answers from 26 of the 30 companies (87%), although I am only a very small investor for these companies. Only two companies from the UK and the US and one from Australia (now divested) did not reply although I typically sent more than six emails to at least three different investor relations or C-level employees.
In terms of response rate, I consider my engagement activities successful. Implementation of some of my recommendations has been signaled by only 2 companies so far and from the others I wait for additional feedback. Even if my recommendations are adopted, true change may take some time.
Engagement or divestment or both? (Active or impact investing?)
I have to decide what to do if there are no replies by the companies I want to engage with or if the replies are not satisfactory for me. The easiest way would be selling the respective stocks.
The companies I am investing in are active in production and services which are aligned with sustainable development goals (SDGs) and ideally “pure SDG plays”. They also have good best-in-universe E, S and G ratings. There is only a limited number of such companies to invest in. I want to have 30 stocks in my portfolio and this year’s list of companies which fulfill all my investment criteria includes only around 50 stocks. I do not expect the other 20 companies to be more responsive to my engagement efforts than the first 30 ones.
For this reason, divestment is not my first choice of action. If I divest, the likelihood that I want to reinvest in divested companies in the future is rather high. That may especially be the case after a more ambitious sustainability strategy is approved. Therefore, I plan to stay engaged with companies even after I may have divested.
I can stay invested and try to make public when companies are reluctant to react to my engagement proposals (“naming and shaming”). For example, I can address my large LinkedIn Network of (sustainable) investment professionals, NGOs etc..
My preferred option is to try to convince the companies I am engaging with in private conversations, that my recommendations are in their best interest. I will try to do that in basing my recommendations on current scientific research as much as possible (see e.g. Stakeholder engagement and ESG (Special Edition Researchposting 115)). Also, I want to find other investors who support my recommendations to show the target companies that I am not the only one with these specific suggestions.
No collaborative engagement platform for small- and midcaps?
Small funds such as mine can hardly afford the services of professional potential engagement partners like ISS. Instead, I looked for not-for-profit organizations with a focus on companies worldwide and a broad coverage of potential engagement topics. I checked the engagement activities of UN PRI (see Resolution Database | PRI (unpri.org)), Share Action (ShareAction | Harness the power of investment) and As you Sow (As You Sow is Promoting Corporate Accountability Through Shareholder Action) and Shareholders for change (https://www.shareholdersforchange.eu/).
I could only find very few engagements with companies from my portfolio, though. The reason probably is that typically shareholder engagement focuses on very large companies and often on companies which are not very good regarding ESG issues. My fund includes only small and midcap companies which have very good E, S and G ratings, though.
Active share >98% versus small/midcap ETFs (Active or impact investing?)
Therefore, I looked for other responsible investment funds focusing on small and midcaps. I started with ETFs to find a fitting benchmark and determine the investment overlap with my mutual fund which is managed without a benchmark.
I first looked at www.morningstar.de for “Aktien weltweit Nebenwerte” (Global small cap equities) and found only three potentially fitting underlying indices: The MSCI World Small Cap Index with >3400 stocks, the MSCI World Small Cap ESG Index with >1400 stocks and the MSCI World Small Cap Socially Responsible Index with approximately 800 stocks. Within “Aktien weltweit Flexcap” (Global equities flexcap) there was only one potentially matching (diversified) underlying index, the MSCI World Size Factor with >840 stocks. The World Size Factor index has an average market capitalisation of about 10 billion USD, the small cap indices have close to 3 billion USD and my fund has about 7 billion USD.
The overlap of my fund with the MSCI World Small Cap Socially Responsible Index is only 7 stocks (<1% of the index universe) and 12 with the MSCI World Size Factor index (<1,5%). This means that my fund has a so-called active share of >98%.
Active fund managers which are benchmarked to indices typically do not deviate much from their benchmarks. Overlap of their portfolios with my fund portfolio and therefore shareholder engagement collaboration potential seems to be very limited.
Few active funds with significant overlap with my fund (Active or impact investing?)
In the next step I explicitly searched for “active” funds which are not aligned to such benchmarks and with significant portfolio overlap with my fund. Too actively managed funds often do not use shareholder engagement because their holding periods are short. Therefore, I specifically looked for funds which are known to be active in shareholder engagement. In the UN PRI resolution database, I found one fund company and specifically one of their funds with a – in general – similar global small cap ESG plus engagement approach and 4 common out of 69 stocks which amounts to almost 5% of their portfolio. I also found an “impact” fund managed out of the Netherlands with 3 of 42 common stocks (7%). Managed out of Germany the fund with the highest overlap had only 2% stocks in common with my fund (3 stocks).
I contacted the US and the Dutch fund manager regarding a potential shareholder engagement cooperation, but I am not sure that I will receive positive responses given the small size of my fund and the little overlap. In addition, there are potential legal risks regarding shareholder cooperation with the legal term “acting in concert”.
In addition, I can try to identify the largest investors for the stocks of my fund by analyzing corporate disclosures. I do not think that this approach will help me a lot because these investors are very likely large and rather traditional asset managers. These investors typically have little interest and thus very few resources available to engage with small and midcaps regarding sustainability topics.
Summary: Ideal small/mid-cap satellite investment
In summary, I am happy that currently I am in active contact with 26 of my 30 investments. As expected, change is difficult to reach. I am disappointed, that most engaged companies are not very open to publish sustainability achievements as they occur. The typical answer is: We expect to publish the information in our next ESG, sustainability or annual report. Since most of these reports are typically published in the first or early second quarter of the year, the next publication date often lie several months ahead. I dot really understand why companies are so reluctant to publish e.g. newly determined Scope 3 levels or targets as soon as they become reliable or official.
In looking for collaboration partners, I did not find an inexpensive global platform for engagement with small and midcap companies. That is not too surprising. But more and more responsible investors may look for companies which are aligned as much as possible with the SDG. Such companies are typically small or midcap companies. So maybe there will be an impact engagement platform somewhere in the future. So far, I did not find many other asset managers which focus on the same companies as myself and are interested in shareholder engagement for sustainable goals.
What is bad for collaboration is good for marketing purposes. I discovered that there seem to be no consequently sustainable ETFs available which are directly competing with my fund. Also, there are only very few publicly available traditional mutual funds with a global small/midcap focus. There are even less global small-/midcap funds which concentrate on the most sustainable investments including social topics. Thus, my fund is not only one of the very few diversified impact/engagement oriented small/midcap mutual funds. My fund is also one of the very few globally investing concentrated respective high conviction funds in the traditional investment space. Since there is so little overlap with any fund I could find, in my opinion, my fund is an ideal add-on (satellite) candidate for almost any investment portfolio.