➤ When persuading companies to cut their emissions or have more sustainable operations, there's more value in engaging with companies than divesting from fossil fuel companies altogether.
➤ Vanguard Group is pressing companies to develop a clear approach to ESG issues such as climate change.
➤ A one-size-fits-all approach on ESG matters is not appropriate, according to John Galloway, Vanguard's global head of investment stewardship.
Vanguard Group Inc. is one of the largest investment management companies in the world with $8.5 trillion in global assets under its management as of the end of 2021. Its investment stewardship program aims to constructively engage with companies on environmental, social and governance issues, including understanding the risks of climate change and how it might impact long-term shareholder value.
The investment manager published an article earlier in 2022 that outlined disclosure expectations for companies with significant coal exposure based on concerns about the business-model resilience of those companies.
S&P Global Market Intelligence spoke with John Galloway, global head of investment stewardship at Vanguard Group, about the organization's approach to ESG issues. The following conversation has been edited for clarity and length.
S&P Global Market Intelligence: Can you tell us about Vanguard's approach to engaging with companies and how that might compare to a divestment approach on ESG issues?
John Galloway: As head of investment stewardship for Vanguard, my team and I are responsible for the stewardship activities for our firm’s equity index funds. By design, those index funds are going to buy and hold the companies that are in the underlying index for as long as they're in that underlying index. So, divestment isn't an option.
We also believe that active involvement and engagement with the companies in the portfolio, as opposed to taking a divestment strategy or avoiding the asset class, actually leads to better returns in terms of investor protection. We see the value of ongoing engagement in terms of the progress that companies make over time in response to us and other investors.
We also see real downsides and limitations of a divestment approach when you factor in the fact that holders of public equities don't necessarily control what happens to those assets if they're divested out of a public company into a private company. Moving something out of the public sector into private hands doesn't actually address the underlying risk to investors or the environment or society. It just actually makes it more opaque.
We're also very conscious of the fact that the transition to a low carbon economy is going to be really complicated and require different companies and sectors to take different actions. It's reliant on governmental and policymaker actions, changes in the regulatory environment and unknown market reactions, all of which make us confident that our approach of staying invested and actively engaged with these companies will lead to better outcomes.
We hear a lot about the difficulty of measuring ESG factors. What are some of the challenges for Vanguard and the everyday investor to go from supporting ESG issues to measuring and comparing companies on these issues?
There are lots of things that are early days here. One of the implications of that, for Vanguard, is that we take a constant case-by-case approach to assessing what we think is in the interest of long-term shareholder value at the company in question. We don't have any one-size-fits-all prescriptions.
That's driven in part by the fact that we don't think there's clarity on what that one-size-fits-all solution might be. You can see that in our policies in a couple places. It's seen in our approach to board diversity, where we don't set fixed quotas. We are focused on understanding the board of the company and the board's approach to board diversity, what it views as the appropriate strategy. It's all grounded in our fiduciary duty to our investors in our funds to ensure that the companies in question are looking to maximize shareholder value.
We don't insert our judgment for what right is or what perfect is. We look to understand the progress companies are making against their own stated strategy. That starts with making sure they have a strategy, and that they're disclosing that strategy.
Vanguard recently released a published article that included disclosure expectations for companies with coal exposure. Can you briefly describe that release and tell us the expected consequences for companies that don't meet these expectations?
The piece on coal wasn't a new policy, per se, but more reducing to paper the conversations we've been having with companies in the sector for some time. You can expect us, over time, to issue similar insights on other sectors as the materiality of the issues becomes clearer or more significant.
The expectations are relatively straightforward. This is a sector where the science is clear — there's scientific consensus around the need for a decrease in the use of thermal coal and coal in total.
COP26 didn't go so far as to say a phase-out, but they said phase down. For us, that's a clear indication that we want to understand, from our portfolio companies, what each company's strategy is for delivering enduring shareholder value in an environment where there's going to be a constraint on the usage of coal.
We're not dictating a particular path. What we're looking to understand is what the company's board is doing to oversee the strategy. Then over time, we'll look to see the success or failure of that strategy.
We see tremendous value in our kind of active engagement with companies. We are confident that for most companies that active engagement is enough to get the company moving in the direction that is the kind of established best corporate governance practice.
That said, in places where we see companies fail to adopt what we consider good corporate governance practices or fail to evidence that they are providing appropriate oversight or appropriate disclosure to the market, we have the opportunity and the power to withhold our vote from supporting directors. In cases where there are shareholder proposals on the ballot that might go in the direction we think is appropriate, we can support those shareholder proposals. We have a range of tools in our stewardship toolkit.
As we head into 2022, what do you think are some of the greatest challenges when it comes to ESG investing, both for the companies trying to tell their story and the investor who is trying to figure out the best place to invest?
I'll tell you one anecdote from one of our portfolio company CEOs that I joined an engagement with. We were talking about science-based targets. He stopped the conversation and said, "Are you saying science-based targets with capital letters or lowercase letters?"
It resonated because it's a conversation we have too. This is a large oil and gas company, [and the CEO said,] "Our entire business is based on science. Everything we do is science-based. If you're asking me whether I can commit my company to a target that was done by a particular advocacy group, that's a different answer than saying, 'Are you following science and setting your targets, and are you willing to disclose the scenarios that you're planning against and the underlying scientific assumptions in those scenarios?'"
That's one of the areas that are tricky in this space. Sometimes the headline or the assertion by an advocate, while well-intended, might not be purpose-fit for the company in question or the sector in question. One of the things we do is really encourage our portfolio companies to provide both quantitative and qualitative disclosure of their strategy, particularly in areas where there is no consensus for how to define the data.
What sort of momentum do you see when it comes to a focus on ESG issues in investing over the next few years?
I'll tell you from Vanguard's perspective. We don't have an agenda beyond the fiduciary duty to our clients. We've long been focused on questions of risks and opportunities that our companies face. For us, it isn't about adopting an ESG approach, as much as applying our long-standing approach on investment stewardship to emerging issues.
I think there's no doubt that the risks associated with climate change are both existential to the planet and have significant materiality to many of our portfolio companies, if not all portfolio companies. So we think it makes good sense that investors and companies are very attentive to those issues.