Companies with good corporate governance outperformed those without by some 24 basis points a month, according to a study released in November by asset manager Hermes. The research looked at the impact of environmental, social and governance (ESG) factors on equity returns in the MSCI World Index from December 31, 2008 to June 30, 2018.
Good governance provided the biggest uptick in shareholder value of all factors, despite it seemingly being eclipsed by a focus on environmental and social issues in recent years.
How governance is viewed by asset managers is constantly evolving, says Will Oulton, director of responsible investment at First State Investments.
“In the earlier days of responsible investment, there were specific governance funds,” he says. “Those tended to be activist funds, run by managers that were often confrontational in getting companies to shake up their boards, with the goal of improving long-term value.”
That approach remained niche as activist funds were seen as disruptive, requiring specific skills and were resource-intensive.
Now, Oulton says, the view from investors is more nuanced: less aggressive and more constructive.
“It’s just more common now to monitor, engage and use voting rights to improve corporate governance,” he says. “Stewardship is now seen as an obligation of an asset manager.”
It’s also uncommon to separate governance out from environmental and social issues in engagement, he says.
“All companies are exposed to environmental or social risks and opportunities, so if those running the companies are not taking those into account, it’s simply poor governance. While it may just seem part of business, governance is really the foundation or constant within how ESG issues get managed.”
Not all asset managers seem to have made the connection, however – that responding to climate-related issues or social issues is good governance and therefore value-generating.
Take the proxy voting in US carbon-intensive industries of the 2017/18 season.
While Larry Fink, chief executive of BlackRock, began the year saying that the firm would take greater responsibility for its role as a shareholder and push companies to consider environmental issues, it supported only 23% of shareholder proposals connected to climate reporting (better than the 8% last year).
JPMorgan supported 21.4% of climate change-linked proposals. At the opposite end of the spectrum, Legal and General and Goldman Sachs supported 84.6% and 80% of climate proposals respectively. Pimco has increased its support of climate change reporting from 35% last year to 75% this year.
According to 5050 Climate Project, an organization that tracks shareholder voting, the lack of voting by both BlackRock and Vanguard was consequential.
“General Motors and Ford both fund and support the Alliance of Automobile Manufacturers, which successfully lobbied the Trump administration to roll back fuel-economy standards,” it says in its 2018 asset manager climate scorecard report, published in September.
“BlackRock and Vanguard each own more than 5% of each firm. At both companies, BlackRock and Vanguard voted against resolutions asking for reporting on the company’s future fleet emissions in light of weakened corporate average fuel economy (CAFÉ) standards. [While at Chevron], repeating a pattern from past years, a vote on methane emissions reduction targets that received 45% would have passed with a majority if BlackRock or Vanguard, each of which own over 6% of the company, had voted in favour.”
In October, it became even more obvious that asset owners must pay attention to company board governance of environmental factors. The Attorney-General of the State of New York filed a lawsuit against Exxon Mobil, alleging that Exxon defrauded shareholders by omitting to provide material information in its public disclosures about how climate change might affect its business.
Exxon’s stock price fell on the announcement.
Good bad returns
Disconcertingly, however, returns in the technology sector do not appear to correlate with good governance. In the six months to April 2018, poorly governed tech companies outperformed better-governed peers. The report lists Facebook, Amazon and Apple among other examples. It raises the question as to why shareholders are not putting more pressure on these firms to improve governance? Is it simply because they are happy with returns?
Oulton says shareholder engagement with boards and the motivation behind it is not always obvious, pointing out that the easy way to see how asset managers value governance is to look at how they use their votes.
First State publishes all its votes in real time for example, and regularly discloses where it has voted against the guidance of proxy voting advisers as well as against management.
(Some asset managers simply follow proxy voting adviser decisions.)
The Hermes report also showed that some companies with poor or worsening social practices had consistently underperformed their peers by 15 basis points each month since the beginning of 2009.There were discrepancies in the results however. Tobacco companies score poorly on social factors but delivered strong returns before 2017.