Activist Investors Leverage ESG to Improve Stocks

Corporate non-financial disclosures are providing activist investors with insights into the inside workings of listed companies, enabling them to make a clearer valuation assessment prior to taking an equity position. The integration of Environment, Social and Governance (ESG) factors enables a company to better manage current risk and prepares for future risk. These factors help companies identify new opportunities for growth in a fast changing world.

Disclosures specifically relating to ESG offer investors with a toolkit that they can apply to portfolio companies to enhance their medium-term value. Both activist and long-term investors increasingly advocate for the implementation of an effective ESG strategy to their portfolio companies.

“We devote our attention to ensuring that (these) risks, and the board's oversight process, are consistently and comparably disclosed to the market.”

Vanguard, 2019

Activism as Collaboration

Activist investors want to collaborate with corporate executive leadership teams to build ESG factors into strategic planning and risk management processes. Their goal is to enhance internal corporate governance processes with ESG tools to mitigate downside risk and enhance the long-term value of a company.

This approach is being employed by passive asset managers like Vanguard and BlackRock to impact focused activist hedge funds such as ValueAct. Consequently, corporate executives are increasingly receiving information requests from investors asking for greater disclosures. Executive leadership teams must be prepared to provide greater non-financial disclosures and to demonstrate they have effectively implemented ESG factors within their governance and risk management processes. Companies can prepare for this shift in investor expectations by understanding why they are adopting an investment thesis that includes ESG factors.

Activist Approach to ESG

Under the leadership of Jeffrey Ubben, the hedge fund manager ValueAct Capital has adopted a strong ESG approach that it takes to portfolio companies. Its investment thesis proposes that effective ESG implementation:

1. Offers an effective risk management framework
2. Creates a new lens for strategy development and growth opportunities
3. Addresses the demands of stakeholders (i.e., customers, employees, communities, and investors)

Sector-level analysis by Barclays and UBS support ValueAct’s assumption that companies with effective ESG processes (e.g., ongoing stakeholder engagement, positive workplace culture, and operational excellence) will benefit from above-average returns. Additionally, corporate case studies also support their investment thesis.

How AES Implemented ESG and Created Long-Term Value

In January 2018, ValueAct took a stake in AES, a global energy company with generating capacity around the world, with a focus on shifting the enterprise toward cleaner energy resources. Over the next 12 months, the company made a series of changes to accelerate the transition of its business model:

• Announced a broad reorganization, including asset divestitures primarily related to coal plants
• Committed to a target of decreasing reliance on coal from 41% of supply in 2015 to 29% by 2020
• Established a carbon intensity reduction target of 70% by 2030
• Published its first Climate Scenario Report in accordance with guidelines set by the Task Force for Climate-related Financial Disclosures
• Aligned its mission statement with its commitment to transformation, ”Improve lives by accelerating a safer and greener energy future“

The impact of its transformation was rewarded by investors: The company’s price-to-earnings multiple increased from around 9 times in January 2018 when ValueAct invested to 14 times by March 2019. And its stock price outpaced a basket of its industry peers.

Corporates leaders should prepare to engage with a new type of investor: the long-term activist.