Enhancing Investment Stewardship | Deloitte Luxembourg | Performance Magazine (2024)

Driven by the sustainable finance agenda, investment stewardship or 'active ownership' is central to demonstrating a firm’s asset management capabilities. While always an important part of long-term value preservation and creation for active investment firms, its role in enforcing sustainability-related change has brought the function to greater prominence. This has led to greater scrutiny on stewardship activities, not just from clients and regulators but also a myriad of other non-related interested parties such as non-governmental organizations (NGOs), climate groups, and the media. This article explores the recent drivers of change including requirements for greater transparency and considers best practices for the stewardship process more generally, including wider operating model implications.

A brief history lesson

The concept of investment stewardship is borne out of the philosophy that intervention is required to ensure that assets maintain or enhance their value over time, or at least do not decline due to neglect or mismanagement. As stewards of clients’ money, investment firms can use their influence to maximize long-term value through formalized or targeted inventions with investee companies. This takes the form of exercising voting rights or engagement with investees or issuers. Engagement is a key aspect of stewardship and is based on informal and targeted dialogue with management and boards of investee companies. Historically, engagement has focused on strategy, risk management and corporate governance as additive factors for investment decision-making, including long-term buy or hold decisions. However, in recent years the significant growth of sustainable finance and its analogue Environmental, Social and Governance (ESG) integration, has brought greater prominence to the consideration of ESG factors within the stewardship process.

Drivers for change

Unsurprisingly, regulation has been the key catalyst for change over the last 3 to 4 years, driven by an agenda to enforce that asset managers and asset owners provide greater transparency on how they invest and encourage long-term participation in the life of companies as part of building a sustainable economy. This drive for transparency has led to a much higher standard of reporting, with the two most impactful recent initiatives being the EU Shareholder Rights Directive II (“SRD II”), and the principles-based UK Stewardship code (“UKSC”). Although voluntary, the UKSC is seen as a standard bearer for stewardship in the UK with an increasing number of signatories.

These standards are driving firms to enhance their stewardship processes, approach and methodology with increased formality and robustness. Investment firms are encouraged to set forth their principles for engagement; frameworks like the European Fund and Asset Management Association (EFAMA) Stewardship Code have been developed to bring a level of market consistency. The key change from the core stewardship regulation is an emphasis on demonstrating the outcomes of key engagement and voting decisions.

It is no longer enough to engage with investee companies and disclose voting records; at the heart of the regulation is an emphasis on well-defined intent and clear outcomes. This, in turn, is driving change through the engagement value chain, enforcing greater rigor on all forms of interaction with investee companies, a focus on enhanced data collection and a need for better analytics and reporting. Firms are having to evaluate their stewardship operating model to ensure they have the requisite structures in place across all teams involved throughout the process. UK and European regulators have been at the forefront of pushing this change; however, like other sustainable finance regulations, these changes span across all markets in which a firm invests.

A wider remit

With the sustainable finance agenda elevating the status of investment stewardship, the function plays an even greater role for active investment managers. First, the function now plays a key role in outwardly expressing a firm’s view on key ESG issues. Voting history has long been a public record and provides outsiders with a view on how likely firms are to vote for or against management proposals, as well as highlighting a firm’s view when voting on controversial issues. The additional focus given to ESG in recent years has brought stewardship activities into the spotlight like never before. Consequently, it means firms must be extra diligent in how they reach decisions, especially where there are trade-offs involved between taking a stand on environmental or social issues versus possible financial materiality.

Second, with sustainability risk now a core component of investment analysis, stewardship data can act as an important qualitative input to the investment process. For example, an analysis of voting records can highlight shareholder concerns on a variety of issues and bring to light possible material controversies. Equally, analysis on engagement activity can highlight which investee company management is more receptive to investor engagement, which can be useful if active ownership is a core lever in meeting net-zero targets, as well as offering the potential to add long-term value where this is material to the asset.

Last, the enhanced level of transparency on engagement activities has led to a need to be more formalized across all parts of the stewardship process. This is especially important for firms that are using active ownership as a tool to meet their net-zero commitments, such as under initiatives like Net Zero Asset Managers (NZAM). Every interaction with an investee company can have significant importance, especially where it provides context or evidence for external reporting on stewardship activities, e.g., evidencing progress against net-zero Key Performance Indicators (KPIs). When adequately captured, all engagement activity can be additive to subsequent stewardship reporting, as well as investment decision-making, and is critical for efficient annual reporting under SRD II and UKSC.

People & organization

With this ever-greater focus on investment stewardship to drive value and sustainable outcomes, firms are considering key enhancements to ensure it can deliver its new remit.

A continued trend in recent years is the expansion of stewardship teams; however, hiring has not been the only way that firms have looked to meet the new demands on the function. Some larger asset managers with a diverse geographic spread of investments have looked to hire or redeploy stewardship analysts in specific locations in order to develop specialist market intelligence. This can form part of a hub-and-spoke model that combines regional analysts with a central hub that provides management and coordination, along with undertaking voting action. There is also a trend for greater specialism in the stewardship function with analysts having sector expertise or strong knowledge on thematic issues. For firms with less resources, some level of specialism within the team can be beneficial, while combining this with wider industry group participation and external collaboration where appropriate.

More broadly, outside the stewardship function, there is an overarching requirement to ensure closer internal collaboration and coordination between all teams involved in the stewardship process. This can span everything from periodic planning and prioritization of engagement targets between front office and stewardship teams, to closer links between stewardship analysts, front office, and reporting teams to contextualize engagement activities and write case studies. For many leading investment managers, active ownership is an extension of the investment function with greater alignment and conference between the stewardship team and portfolio managers as a general part of long-term asset management. This operational proximity provides the added ability to share insights on sustainability and governance matters. For global asset managers with diversified portfolios, it is even more important to have local insights into investee companies. For large investors this can mean having stewardship specialists geographically dispersed, located close to markets where the firm has significant exposure but usually with hubs in major financial centers.

Data & technology

Forward-thinking firms are making the investment in the required tools and technology to streamline the stewardship process. At a minimum firms require adequate data storage for the ever-increasing quantity of data that supports the process, including both internal data capture and external ESG data such as voting records from Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis). A key differentiator is the ability to draw out insights from this data set to support decision-making and provide the audit trail for how decisions were reached. A range of off-theshelf solutions offer these data and analytic capabilities. However, some firms are looking at bespoke solutions that offer greater flexibility, as well as integration with other proprietary ESG solutions. For any tool to effectively support the whole process, it ultimately needs to work for all stakeholders from front office to reporting functions and, hence, requires full consideration of present and future requirements.

All elements of the stewardship process need to be pulled together for reporting. In this respect, it is not just annual regulatory reporting that requires a large degree of input, but also institutional client reports and even content for client requests for proposals (RFPs). This requirement for qualitative content can strain already stretched resources and will necessitate greater process efficiency.

While most firms have applied tactical solutions to get over the line with the initial tranche of enhanced stewardship reporting, it is now time to focus on how this can evolve into a production line for future reporting. Technology is a key enabler; centralized data management and targeted automation can bring efficiencies once content is developed and standardized. However, short-term process efficiencies can be driven by defining clear roles and responsibilities across all teams involved in content creation. In this regard, workflow tools can bring immediate benefits and ensure ownership over all aspects of report production. One further option is to outsource reporting; while there is still a reliance on providing key inputs, the heavy lifting involved in report creation, production and quality assurance can be provided by a third-party. The range of options in this space is increasing.