…Andre Shepley, a researcher at TruValue Labs — whose independent reports flag environmental, social, and governance factors with material impact on companies’ value — says investors who paid attention to ESG could have saved themselves from the dive in Omega Protein’s stock.
A report TruValue produced for Institutional Investor shows Omega Protein’s ESG score — a proprietary rating of risk factors — dropping in 2012 and 2013 thanks to what it calls environmental and operational negligence. “Ultimately, ESG underperformance vs. its sector led to a 20 percent decline in its stock,” Shepley writes in the report.
“Way back in 2011 there were a series of different things that showed how negligent their practices were,” he says. Still, the company’s largest investors — BlackRock and Dimensional Fund Advisors — were passive shareholders that didn’t do anything about it. “A large point here is there were no shareholders engaging in conversations with management,” Shepley notes.
All of the big passive players have paid a lot more attention to governance in recent years, after being criticized for not voting their shares even as their stakes in companies grew. But critics say they rarely dig into the issues faced by individual companies, particularly the small ones, relying instead on third-party advisers for guidance on voting. The low fees index funds charge don’t cover extensive research, and the funds aren’t making active decisions about their holdings. If they did, they’d be called active managers.
That’s changing. Index funds are increasingly doing independent research to determine how to vote and to uncover the major issues facing a firm or sector, and they’re holding meetings with a growing number of companies. BlackRock, Omega Protein’s largest investor when it was public, is doubling the size of its corporate governance team over the next few years. It takes what it calls an engagement-first approach and sees proxy voting as just one part of its process. State Street Global Advisors has also ratcheted up its work on governance, including a high-profile push for more diversity on boards.
BlackRock engages with companies behind the scenes on issues that it believes affect their value long-term, whether it’s macroeconomic trends or societal issues like climate change. A company with production facilities that could be affected by rising sea levels as the climate warms needs to mitigate that risk. BlackRock doesn’t make recommendations to companies, but it asks questions about how management is accounting for litigation risks, what steps it is taking to support the responsible use of its product, or how it plans to improve its safety record. A spokesman says BlackRock gives companies time to make changes and then, if little progress is made, will express its view through its vote. It can’t sell its holdings, but BlackRock believes it has even more influence because it’s the ultimate long-term shareholder.
The spokesman says BlackRock won’t comment publicly on any of its conversations with companies. According to proxy advisor ISS, in 2017 BlackRock always voted with the management of Omega Protein, except on “say on pay.”
After the February mass shooting at Marjory Stoneman Douglas High School, BlackRock CEO Larry Fink addressed the issue of index funds investing in gun manufacturers. Many thought Fink — who said BlackRock would hold discussions with gun manufacturers — was highlighting the meetings to make a point about the moral and ethical arguments of investing in these companies. But Fink was being pragmatic. The business of gun manufacturing or retailers selling weapons — whatever an investor’s personal view — may not be viable if these companies fail to address safety and weapons access. Index funds could then make the case to use their shareholder votes to press for change. A spokesman for Dimensional declined to comment.
“Our market-based system is not designed for those types of investors,” says John Streur, CEO of the Calvert Group, an ESG pioneer. “If shareholders are purely passive, that section of the market gets taken out of play.”
But there were also active managers who owned Omega Protein. One activist manager says it looks at environmental or social issues only if they will affect the long-term value of a company it owns. It determined after researching the issues at Omega Protein, however, that it was doing nothing wrong. The manager did believe the company wasted money on an expansion into the human-nutrition business and missed an opportunity to benefit from a change in regulations.
Although the activist firm wasn’t an obvious ally of environmentalists and other advocacy groups, it pushed for changes to the board that benefited all shareholders. The manager launched a proxy contest against what it felt was an entrenched board that didn’t have the skills to execute a strategic plan for Omega Protein. Twice the company unilaterally passed measures to limit shareholders’ rights.
During the proxy contest the manager needed votes on its side and reached out to the major index funds as the stock was dropping. But the index funds can’t be stereotyped when it comes to how they deal with governance and other shareholders in the companies they own, says one official at the activist firm. One large passive manager, for example, meets face-to-face with firms; some generally vote with management; and others put a lot of weight on recommendations from proxy advisers like ISS.
As index funds gain larger stakes in companies, activists have fewer natural allies. “In the past we would be able to go to management before a fight and tell them we had 40 percent of the votes in our back pocket,” says the official. But that 40 percent was made up of active managers, whose market share is dropping. “There are basic things that companies can get away with when they have lots of index holders.” Landry declined to comment on the activist fight.
And that force is growing. Assets are flowing from active into traditional market-cap-weighted index funds, but also into newer smart beta and factor-based products. Algorithms programmed to find certain characteristics pick securities to invest in, and the strategies arguably are actively managed. But it’s doubtful computer-run funds will be active in corporate governance.
Proxy advisers such as ISS and Glass Lewis have been criticized for a lack of transparency given the quiet power they wield in corporate America. But many say the companies have been upping their game and are producing more-thorough reports, which in turn sway thousands of major shareholders who vote based on their recommendations.
For now, it’s still the advocacy groups, not investors, that are most likely to push for change…
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