July 17, 2020

Owning companies and engaging with management is a proven means of driving positive change. We know this because we practically invented the strategy. We also understand that this includes the reality that divestment may be required. It’s how engagement and divestment work together that highlights the effectiveness of NEI’s RI approach.

At NEI we have always contended that engagement with management on ESG issues, through the power of ownership, is a more effective means than divestment when the goal is to drive change. This approach is baked into the philosophy of our Responsible Investment (RI) Policy. We see divestment not as a separate strategy, but as a part of a greater more comprehensive approach to RI.

Recent research from Scientific Beta1, supports the logic of this belief, contending that ownership/ engagement and divestment are actually mutually reinforcing.  Here’s the case in a nutshell:

“A shareholder who engages with a company without signalling a willingness to draw a red line – by exit in case engagement fails – will enter the negotiation in a weak position: the possibility of divestment is in that sense a prerequisite for effective engagement. Conversely, engagement can make divestment campaigns more effective: noisy exits can be more impactful than silent ones. Therefore, far from being mutually exclusive, both engagement and divestment are mutually reinforcing.”

 To be clear, at NEI we have always held out the possibility of divestment when engagements aren’t progressing or when a company we own takes on significant headline risk. It’s just that we have always focused on the ownership and engagement part of the equation. As one of the pioneers of corporate engagement we have demonstrated the effectiveness of this approach. It is how we have helped companies address their ESG for over 20 years.

So we’re not really that far off from the reinforcing claim made by Scientific Beta. While they view engagement and divestment as a tandem approach, we view the process as circular: begin with company ownership decisions based on peer-compared ESG factors. Then, where appropriate, move on to corporate engagement to address specific ESG challenges. And finally, divest only if a company runs into significant ESG challenges or indicates it has no interest in taking its ESG risks seriously. That essentially closes the loop, while leaving open the prospect of re-starting the process if the ESG profile of the company – or its appetite for meaningful engagement – improves. And there are additional tactics related to engagement, such as the filing of shareholder proposals, that make the ‘to engage or divest’ decision much more nuanced than this research suggests.

What the Scientific Beta research really tries to make clear is that everything should work together. All at once, as opposed to in stages. They call it ‘ESG filtering’ and describe it as follows:

“In contrast to ESG mixing strategies, straightforward ESG filtering, i.e., removing the worst ESG

performers from the investable universe, concentrates divestment on the ESG laggards. It sends

unambiguous and predictable – and therefore actionable – signals to all companies. In combination with ESG engagement, in particular through collaborative ESG campaigns, we argue that ESG filtering sets the ground for an effective ESG investing policy.”

That’s exactly what NEI has put into practice with our RI program. Our proprietary ESG evaluation framework segments companies into ESG leaders and laggards, then uses those distinctions to both identify candidates for engagement and establish an aspirational ESG bar for them to reach. In NEI’s RI program, evaluation and engagement are explicitly designed to closely work together.

Rather than hold out divestment as an overt stick, we prefer the ‘carrot’ of partnership, collaboration and shared goals. The key difference comes down to tenor.  After all, we’re investors first and foremost. Our goal is to maximize the value the companies held in NEI’s funds create for our investors. That means entering our engagements optimistically. We have the expectation that our company collaborations will make a positive difference – in how companies operate, in the impact they have on multiple stakeholders, and, of course, in their performance as investments. None of that is likely to happen through divestment – or even the threat of divestment, which Scientific Beta believes can be a leverage point in corporate dialogues. We believe that to think otherwise is to abandon the abundance of opportunity to create value while affecting change. For us engagement will always be our first priority.

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  1. ESG Engagement and Divestment: Mutually Exclusive or Mutually Reinforcing? Scientific Beta, May 2020