By Sean Hagerty, managing director, Vanguard, Europe

Vanguard’s core mission is to take a stand for all investors, to treat them fairly and to give them the best chance of investment success. It’s something we’re deeply passionate about. It’s why we believe investors should keep their investment costs low and choose funds with broad market diversification.

Broad market diversification means being invested in companies across every market sector. Yet, investors are increasingly calling for asset managers to divest from certain companies in their portfolios on environmental, social and governance (ESG) grounds. But is that the only approach?

Our analysis1 of ESG equity funds relative to the broad underlying market found that the majority did not produce superior returns2. Nevertheless, we do understand that for some investors, owning certain companies is not consistent with their values. This is particularly true in the context of climate change.

That is why Vanguard does offer funds that screen out certain companies. However, we also believe there must be room in ESG investing for owning and engaging with portfolio companies in a broadly diversified index fund. By remaining invested in companies and encouraging them to take positive action on material ESG risks, we believe we can deliver long-term, sustainable value for investors, and society at large, without having to divest from those companies.

Own and engage

As one of the world’s leading providers of index-tracking funds, Vanguard places great emphasis on our investment stewardship programme. Our global stewardship team is focused on safeguarding the investments of Vanguard’s 30 million investors worldwide by encouraging the companies in which we invest, and their boards, to oversee and mitigate all material risks to long-term shareholder value, including material ESG risks. 

Vanguard index funds are near-permanent owners of securities in thousands of public companies globally. We believe that our month-by-month, year-on-year engagement with boards and management teams, backed up by our ability to vote on issues and director appointments at company annual general meetings (AGMs), can help establish good governance practices, deliver meaningful change and support long-term value creation. Our engagement and advocacy mean that we are a lead voice on key governance matters such as board diversity, board independence and governance structures, as well as on increased oversight of specific ESG-related risks, disclosures and risk mitigation.

In the case of climate change, we believe it is better to own, engage and encourage boards to manage climate risks through the transition to a low-carbon economy, than it is to exclude and divest. Investors who rid themselves of carbon-producing assets risk selling them on to those who might not want to engage and encourage change, which may not help—and may frustrate—the just and orderly transition to a decarbonised economy that the investor hopes to achieve.

Addressing the risks to shareholders presented by climate change is one of our stewardship team’s top priorities, which is why we talk to companies about their plans to reduce greenhouse gas (GHG) emissions and improve their climate-related disclosures as they adapt to a lower-carbon future.

We will hold boards accountable for the clarity of disclosure on their plans and the progress against those plans. As an advocate for standardised disclosures, we have been a long-standing supporter of the Taskforce on Climate Related Financial Disclosures (TCFD). We also welcome the recent announcement of a new International Sustainability Standards Board that will develop harmonised global sustainability disclosures in the interests of all investors.

We encourage companies to develop the appropriate action plans to protect shareholder value in the face of any anticipated material risks, which could include significant stranded assets or physical climate risks, reputational damage, harm to customer relationships, damage to their competitive position or the impact of future regulations. We believe this approach can best serve the interests of investors, rather than simply divesting from companies considered to have a poor ESG profile and passing the buck elsewhere.

ESG choices

We recognise that ESG can mean different things to different people. Despite our strong views on the merits of owning and engaging across the whole of the market, we appreciate that our approach may not be for everyone. We know that some investors would rather screen out companies from their investment portfolios based on their personal values or views on risk. Still others may want to entrust their money to an active manager that selects investments according to ESG risks and opportunities.

We want to cater to investors in a way that continues to treat them fairly and delivers the best possible investment outcomes, in line with their personal values as well as investment goals. That is why Vanguard engages with the companies in which we invest, allocates capital to companies based on a variety of ESG considerations in our active funds, and offers funds that allow investors to avoid certain ESG risks.

That’s also why, when we design ESG products at Vanguard, we:

  • Are fully transparent about the design of each fund, so investors know what they’re getting.
  • Continue to deliver value to investors (because labelling funds ‘ESG’ is not an excuse to charge unjustified higher fees).
  • Set appropriate performance expectations.

Whichever way investors wish to express their ESG preferences, we will remain true to our four investment principles (goals, balance, cost, discipline3) and core purpose to treat investors fairly and give them the best chance of investment success.

 

1 Research originally published in the Journal of Portfolio Management: Plagge, J.-C. and D. M. Grim. 2020. 'Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds.' JPM Vol 46 Issue 3 Ethical Investing: 123–140. Performance of US index and active equity mutual funds and ETFs that indicate the use of ESG factors, as determined by Morningstar. Time period observed: 1 January 2004-31 December 2018.

2 Defined as factor-adjusted gross alpha.

3 For more, see 'Principles for investment success'.

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