With more than £100 billion in assets invested, F&C believes taking note of non-financial matters is good risk management
F&C Investments has earned a reputation for being a responsible investor since launching the UK’s first ethical fund in 1984.
Twenty-two years later, in April 2006, the London-based asset manager became one of the founder signatories of the UN Principles of Responsible Investment, an initiative to encourage shareholders to consider the environmental, social and corporate governance performance of the companies in which they invest. Today all £104 billion of F&C’s assets under management are invested with so-called “ESG” – environmental, social and governance – criteria in mind.
Director of corporate governance George Dallas heads the governance aspect of F&C’s research, voting and engagement with the 4,000 companies in which it invests. The 17-strong governance and sustainable investment team of analysts, of which Dallas is a member, also screens companies for the company’s stewardship funds. These ethical investment funds, which exclude stocks in certain companies or sectors for moral reasons, are worth £3.4 billion, or about 3 per cent of F&C’s overall portfolio.
For the remaining 97 per cent of investments, F&C analysts and asset managers consider a company’s social, environmental and governance performance only after the stock has been picked for its financial potential. Dallas says: “If the decision is made to invest in a company, then the discipline of voting and tracking the firm looks at ESG criteria.” He describes these criteria as “means of understanding risk better” because they “broaden the vector of issues that you look at”.
The governance issue that is of most concern to investors is executive pay, says Dallas. He often meets UK companies to discuss pay before annual general meetings, as companies are anxious to avoid votes against management. The discussions tend to develop into broader conversations about the company’s strategy because of demands to link pay to performance.
Dallas says investors that care about good governance are not “so doctrinaire that we are not open to a good explanation”, which means not punishing companies that fail to meet the letter of the UK’s Combined Code, or corporate governance guidelines.
This year, for example, F&C supported BP’s pay plan even though it included director retention grants that were not linked to company performance. Having met directors, Dallas accepted their explanation.
This is the “comply or explain” system working well, Dallas says, adding: “It can have the effect of getting investors who otherwise might have been inclined on the basis of principle to vote against a company to make a more intelligent decision.”
UK corporate governance is “reasonably healthy” because companies are widely held and their owners are largely concentrated in one place – London – Dallas says. Comply or explain works less well in continental Europe, he feels, because block shareholders, being in a position of control, are less inclined to hold management to account. Minority shareholders, having less impact on governance, are “less diligent stewards of the comply or explain system”, he says. “The system loses its integrity when the explanation is superficial or boilerplate or when investors do not scrutinise it properly.”
Shareholder’s voice
Dallas is a keen supporter of “one share one vote”, or the principle that a shareholder’s voting rights should be proportional to the size of their holding in a company. He argues that when investors are not engaged, managers are more likely to waste their money. He warns: “Entrenched management can hide a multitude of sins.”
The threat of a company having passive shareholders is, ironically, the greatest danger posed by the rise of sovereign wealth funds, Dallas says. Policy-makers in Europe and the US have expressed alarm at the possibility that these state-owned investment vehicles from China and the Middle East could use their shareholdings in western companies to further political interests.
This has led sovereign funds that have invested in Wall Street banks to declare that they will not take voting rights. Dallas says: “In some ways it is safer for them to say, ‘We don’t want to cause controversy’. But it could potentially create problems where you have big pockets of ownership in certain institutions, like banks, that are silent.”
Dallas encourages sovereign wealth funds to join the International Corporate Governance Network, an association of institutional investors that could help these funds learn how to be engaged investors. He says sovereign wealth funds should also consider signing up to the UN Principles of Responsible Investment. F&C already undertakes engagement work, for a fee, for investors whose money it does not manage but who want help with their commitments to be responsible investors under the PRI. Clients include Dutch pension fund PGGM, which represents health and social workers, and the private fund of UK retailer John Lewis. Dallas says teaming up in this way when F&C asks companies to improve their governance practices is effective because it “broadens the punch”.
Companies uncertain about their non-financial risks would be wise to keep on their toes.
