Investment managers who want companies to adhere to sustainable business practices need to apply more pressure by meeting with boards of directors, said a group of experts. 

“It wasn't common practice 15 years ago and it is now in Europe, but less so in Asia,” said Dr. Hans-Christoph Hirt, an executive director of Hermes EOS who leads a stewardship team that meets with boards to mitigate risk and enhance returns. “The U.S. is a little bit behind the U.K. in the practice, but it's happening all around the world and also in emerging markets.” 

Using proxies and buying environmental, social and governance (ESG) research isn’t enough to get companies to improve their sustainability practices, according to panelists at a Federated Investors and Hermes Investment Management roundtable discussion at the Lambs Club in New York City this week. U.S.-based Federated last year took a majority stake in Hermes Fund Managers, headquartered in London and known as a pioneer on ESG issues.

The “Being Good Is Good Business” discussion in Manhattan was a preconference event before Hermes/Federated ESG Investing and Stewardship: Risk-Return, Conscience and Fiduciary Duty symposium.

“Conversations with boards of U.S. companies have to be about the long-term sustainability and profitability of their business,” said Hermes Investment Management CEO Dr. Saker Nusseibeh. “When we talk about engagement, we mean purposeful dialogue with a company, pursuing objectives and really trying to change the company on material issues.” 

Material issues can include the physical impact of climate change, risk and compliance, and health and safety management, as well as leadership and culture, Hirt said. 

For example, since Wells Fargo bank settled lawsuits related to retail banking sales practices, Hermes’ EOS team met with the board of directors and co-filed a shareholder proposal asking for an independent chair. The bank’s board subsequently mandated an independent chair in its bylaws. 

“We have a wonderful system where every company we engage with, we track progress made on the objectives and log the information, which is then made available to all the investment teams and to our clients,” Hirt told a room full of financial journalists. 

Although most of the team is based in London, Federated has plans to recruit and put more of their steward team on the ground in the U.S. 

“We expect to have conversations with more U.S. companies,” said Hirt who hopes the effort will result in stronger compliance systems, better governance, increased reporting, improved sustainability of particular product lines and increased diversity in board composition. 

American shareholders often focus on using proxy voting to hold companies accountable for sustainable practices, but Europe’s mandate on ESG investing may serve as a model for U.S. regulation in the future. In particular, the European Commission is proposing that investment advisors be required to ask clients directly about their sustainability preferences and take them into account when assessing the range of financial instruments and insurance products to be recommended.

In fact, according to MSCI, regulators' focus globally has been shifting: Before 2018, regulations focused mainly on corporate issuers, but last year 80% of the more than 170 regulatory or planned quasi-regulatory measures targeted institutional investors.

Federated Vice Chairman Gordon J. Ceresino noted the stewardship team will not impose ultimatums on C-suites. “We are taking a proactive approach to ESG by using terms like improve long-term sustainability,” Ceresino said. “When companies are not responsive, you probably don’t want to invest.” 

Ceresino added that Federated has not applied ESG factors to its portfolios long enough to determine resulting alpha. “The group of portoflio managers at Federated is very open minded,” he said. “You have those who will be early adopters, using ESG factors in 2019. What you hope to see is a momentum gaining inside your organization. It won’t be imposed on anybody. It will be up to each portfolio manager to test the factors and decide.”