UK asset owners review into stewardship misalignment finds ‘substantial divergence’ on shareholder values
Different notions of stewardship, cultural values and fiduciary responsibility have created misalignment between the interests of UK asset owners and managers, a much-anticipated review has found
While some misalignment exists between interests of an influential group of British pension funds and asset managers' stewardship strategies, there are multiple reasons for this.
That is the most important conclusion in the much-anticipated UK Stewardship Review, initiated by the UK Asset Owner Roundtable and shared with Net Zero Investor today.
The group said more research and analysis is needed to fully understand what the reasons are behind varying degrees of misalignment between some of UK's biggest pension funds and their asset managers.
Therefore, a "pro-active and constructive" dialogue between asset owners and managers, which kicked off with a first meeting on 12 October, will continue in 2024, said Faith Ward, who chairs the roundtable and is also chief responsible investment officer at Brunel Pension Partnership.
"I am optimistic about the willingness of participants in the process to address the perceived gap [between asset owners and managers]," she stressed.
Following a challenging AGM season, with some of the biggest oil and gas firms backtracking on their net zero pledges, asset owners expressed growing frustration that their stewardship efforts on climate are not aligned with those of their managers, who tend to display more conservative voting patterns.
Ward initiated an investigation into the potential for misalignment by commissioning Andreas Hoepner, professor of operational risk, banking & finance at University College Dublin to conduct some research.
In the report released today, Hoepner's sets out his final conclusion which highlight some nuance to the perception of misalignment.
The most important questions was: were asset owners and asset managers (still) aligned in their voting?
The aim of review was to understand how asset owners' long-term interests had been served by their managers while they exercised their stewardship and proxy votes at major oil and gas companies, set within the global universe of the Transition Pathway Initiative (TPI).
Specifically, UK asset owners had been concerned that, despite unequivocal warnings from the United Nations and the IPCC of the risks of delayed action on climate change, short-term interests of asset managers may had trumped long-term interests of pension funds.
UK Asset Owner Roundtable member Diandra Soobiah, Nest’s head of responsible investment, stressed that point today, as she responded this morning to today's report.
“We are not looking for short-term, unsustainable performance, but to invest in companies that can navigate systemic challenges, like the climate crisis, so they can continue to grow and help drive investment returns over the longer term."
Soobiah said it is "key" for pension funds to “have in place clear voting principles and be selective in who you work with. This will help ensure that asset managers use their voting rights effectively to hold companies to account in the management of climate change risk and accurately
represent investors’ long-term interests.”
Review key focus areas
Hoepner was asked to study three separate datasets. Firstly, he studied the actual votes cast by asset managers between 2015 to 2023 for TPI universe oil and gas companies and correlate them with the equal weighted average of asset owner voting instructions as contributed by the ten participating asset owners.
"This method allows us to define alignment as 'voting like a UK asset owner' rather than voting for or against any specific resolution type," the report stressed. "To set a realistic threshold, we define “misalignment” itself as the correlation of the least correlated individual asset
owner to the equal weighted asset owner average, which is 60%."
Hoepner's main conclusion: he did observe some misalignment between UK asset owners and asset managers, but to varying degrees.
Interestingly, he found that misalignment was more of an issue in recent years, and applied more to shareholder resolutions than for management motions.
Also, Hoepner said misalignment was more of an issue in the U.S. than in Europe and, on average, for non-participating than for participating asset managers.
Hoepner was also asked to review the voting rationales provided by asset owners, asset managers aligned with asset owners and asset managers misaligned with asset owners.
He came to find that "only very selected asset managers publicly reason like asset owners and some asset managers somehow see voting and ESG engagement as mutually exclusive and appear to fear the loss of access to management if they voted against management."
Moreover, among asset managers, there appears to be "a substantial divergence as to their interpretation of shareholders’ and even society’s interests," Hoepner and his team wrote.
"Some asset managers are aligned with asset owners, while others have fundamentally different views that may be consistent with short term commercial interest but do not reflect scientific evidence," they said.
Responding to the findings, Shipra Gupta, Investments Stewardship Lead, Responsible Investment Strategy & Execution at Scottish Widows, said today that “we know that asset owners can make a difference and consistent messaging across the investment chain is key. It starts with consistent messages from asset owners to asset managers, and then from asset managers to companies."
Gupta dded: Companies need to get the same message around their transition plans from all their institutional investors through engagement and voting actions, across routine and shareholder resolutions.”
Another question that was put forward to Hoepner was to conduct the level of ESG engagement success across all relevant issuers. The report splits this into "three different engagement process types."
Firstly, a “textbook style” persistent, long duration, large scale engagement with considerable progress, followed by type 2, a “quick fix style” engagement which is characterised by less consistency, shorter duration, and more mixed progress.
Finally, type 3 engagements are “jumping the bandwagon style” as they appear to target only firms that already have been improved by others, the report wrote.
The different types of engagements differed to such a degree, and per region and sector, that the report did not draw any specific conclusions about this.
In fact, overall, Hoepner concluded that "while all three analyses indicate a varying degree of misalignment between UK Asset Owner roundtable long term interests and asset manager stewardship processes and the first analysis also offers a distribution of the degree of misalignment, none of these analyses inform causal reasons for the observed misalignment."
As potential reasons for misalignment, Hoepner pointed at cultural and political differences as one of the main reasons.
"The participating asset owners are all UK based while most participating asset managers are not UK based, which may lead to a slight
cultural misalignment," he wrote.
Therefore, he plans to extend the equal weighted average of asset owner voting instructions to include asset owners from other jurisdictions such as the EU or the US to investigate the extent to which cultural misalignment leads to stewardship misalignment.
Another reason may be "some rather fundamental misunderstanding as to the relevance of stewardship and voting itself or the urgency of climate change as a key priority theme within stewardship," as the report put it.
"Such a misalignment could have led to insufficient resource allocation to stewardship which might explain misalignment due to a lack of attention," Hoepner wrote.
He stated that a further reason for interests not aligning, namely "a conceptual misunderstanding of fiduciary duty itself."
Hoepner said: "Following the prudent man rule, asset managers should target a high or even optimized return per unit of risk ratio. Engagement, if successful, has been found to be significantly risk reducing and hence aligns very closely with fiduciary duty."
He added: "If an asset manager or its portfolio managers, however, is largely or predominantly incentivised by return or alpha, then the risk aspect is either ignored (return) or limited to classic risk factors such as beta, or size (alpha) with no consideration given to climate change as a
systematic risk factor."
The report goes on to single out another potential reason, "a conceptual disagreement as to the most effective combination of stewardship processes."
The researchers stated that "from the voting rationale review, it is evident that some asset managers appear to see voting and engagement as mutually exclusive while others view it as much more complementary."
This led them to conclude that "if those asset managers which view voting and engagement as mutually exclusive or conflicting would be more misaligned, then this would explain the misalignment."
In fact, if such managers would furthermore "be more successful in engagement as observed in the ESG engagement review,
then there would be a case for tolerating an extent of voting misalignment at the benefit of ESG engagement success."
The final reason focused on governance issues, as the report stated this may be more systematic in terms of stewardship governance, as asset managers and financial firms owning them tend to have many more commercial relationships with the issuers than the asset owners whom the asset managers serve.
For instance, an asset manager may manage the corporate pension fund or might be owned by a bank whose investment bankers have a
strong fee track record with the issuer.
"Such financial conflicts of interest of asset managers with respect to issuers may be another reason why some asset managers are misaligned with asset owners," Hoepner wrote.
"While we cannot study this with respect to all potential financial conflicts of interest without much better disclosure of such conflicts of interest as part of routine stewardship disclosures, standard academic databases allow us to investigate if those asset managers for whom a selection of conflicts of interest are known display a stronger misalignment with asset owners for those firms where they are conflicted," he stated.
He went on to warn that "while it is very unlikely that any one of these reasons applies exclusively, only further research will allow us to understand which reasons are valid and to what extent they jointly apply."
Hoepner and his team based a lot of their observations on the meeting asset owners held with asset managers on 12 October.
The gathering was attended by the likes of Aegon UK, Amundi, Aviva, Baillie Gifford, BlackRock, Border to Coast, Brunel Pension
Partnership, Cambridge Endowment, Chronos, Church of England, FCA, FRC, JP Morgan Asset Management, Lazard, LGIM, LGPS Central, Lothian, Merseyside Pension Fund, Nest, Oxfordshire County Council, Pension Protection Fund, Scottish Widdows, Schroders, Tesco Pensions, TPI, UBS Asset Management and Universities Superannuation Scheme (USS), among others.
The meeting was also attended by Adam Matthews, chief responsible investment officer of the Church of England Pensions Board, who said this morning that "Our interests require us to take a long-term view on key systemic risks such as climate change."
He added: "Simply put, investor stewardship, engagement and voting that prioritises the short term is not aligned to our interests and only serves to make an orderly climate transition less likely.”
Fellow roundtable member Leanne Clements, head of responsible investment at People’s Partnership, went even further and said that "we have reached an impasse with respect to net zero stewardship and we are running out of time. Urgent action is needed from the entire stewardship chain to address the misalignment issue."
Clements called for "a complete dismantling of failed status quo approaches to stewardship is needed by the fund management industry, with voting escalation not seen as a 'last resort' approach used on an exceptions basis, but rather a powerful signal to companies of what investors expect of them."
She continued by saying that "a continued lack of industry action seriously undermines the financial sector’s ability to deliver not only its own net zero commitments, but more importantly, better outcomes for savers.”
One of the next steps, as recommended in the report is 1-1 meetings between UK Asset Owner Roundtable’s members and their
investment managers to discuss those managers’ voting decisions at global oil-and gas company AGMs.
Clements supports this move as “fund managers have on balance been quite conservative in their approach to voting escalation, and normally like to see engagement-driven improvements across a significant number of companies for the issue in question before they decide to use their vote of dissent for the remaining laggards."
Moreover, the report urges the UK Asset Owner roundtable to develop a set of stewardship expectations for asset managers.
Clements said this is needed "as companies are still, largely speaking, lagging with respect to their net zero strategies, this would mean voting against management more often than the industry feels comfortable with. That is one of the major barriers that we need to get over before we can see meaningful progress on the issues raised in this report."
She concluded that "a completely different mindset to voting escalation is needed.”
Asset managers response
Responding to today's report, Caroline Le Meaux, head of ESG Research, engagement & voting at Amundi said that she believes that every sector and economic player must take "immediate action" to accelerate the transition.
She acknowledged that "asset Managers such as Amundi, thanks to their size and scale, have a crucial role to play in supporting them on this journey. Active dialogue, voting, and engagement with companies can positively influence their overall strategy and help them
achieve their environmental transition.”
In addition, Ashley Hamilton Claxton, head of responsible Investment at Royal London Asset Management, stressed that "we take our voting and
engagement responsibilities seriously. Ensuring our actions fit with the mandates set by our clients is of primary importance to us. We look forward to continuing our interaction with the UK Asset Owners.”