With environmental, social and governance (ESG) investment themes springing up around the world, the pressure on institutional investors to become active and responsible owners is growing.

Indeed, Colin Melvin, chief executive at Hermes Equity Ownership Service (EOS), reports increasing interest in responsible ownership from European pension funds.

"There are two reasons for that: One is that pension fund executives feel more responsible for the assets they invest in, so there is greater understanding of what it means to own companies through shareholdings and the responsibilities attached this. The other reason is the opportunity arising from active ownership, as pension funds are likely to raise the value of invested companies through a process of engagement and dialogue and therefore add to the value of their fund. These two arguments are the drivers behind the interest in EOS but also responsible ownership in general," says Melvin.

And the demand for responsible ownership is spurred by ESG drivers such as the UN's principles of responsible investment (PRI) launched 18 months ago, he adds.
In addition to the PRI, Dutch TV programme Zembla - that earlier this year accused some pension funds in the Netherlands of behaving badly, by, for example, investing in companies that manufacture cluster bombs or use child labour - and extensive media coverage of climate change have also been responsible for the sharp demand growth in 2007, according to Karina Litvack, head of governance and sustainable investment at F&C Asset Management.

She says: "Our Responsible Engagement Overlay (REO) approach was a steady product during the last seven years but following Zembla, interest has just taken off."

"In the 1990s, we were a niche. Active and responsible ownership started to grow more rapidly around 2000, but it is really the last two years that have delivered outstanding growth. Today, both fund-of-funds and asset managers like to implement ESG issues and be transparent about it," says Magnus Furugard, president and managing director of Sweden and Denmark-based Global Ethical Standard Investment Services (GES).

And Melvin and Litvack report that their services have for the first time been actively approached by clients this year.

However, most demand comes from PRI signatories and concentrates on regions that boast a large number of developed pension funds such as Scandinavia, the Netherlands and the UK, says Melvin. Litvack and Furugard also report a lot of interest from Austria, Germany and Switzerland.

Furugard says 50% of GES clients such as pension funds, foundations and asset managers - all of various sizes - are based in the Nordic countries, with a further 35% headquartered in rest of Europe and the remainder stemming from Australia and the US.

"Our clients are mainly large funds at the moment. But we have been approached by small funds and are currently in discussion with them. Their interests do not really differ although perhaps some of the larger funds come under more external pressure to be responsible owners," adds Melvin.

"Both small and large pension funds use REO. But in order for an overlay strategy to be affordable, pension funds need to be of a certain size, so many small ones would have to band together such as in the UK's Local Authority Pension Fund Forum. Large pension funds often have some in-house resources for active ownership issues, but they still outsource some of it, while investors without in-house capacities tend to fully outsource the service," says Litvack.

In fact, most investors choose active ownership services with their 15-20+ staff teams due to capital and resource constraints.

The services offered comprise engagement, voting services and public policy consultation on behalf of institutional shareholders.

But in order for engagement to take place, it must be expected to add value to the invested company.

"It is about working with companies on behalf of the owner to the common goal of a more valuable company. Some of our universe's 4,500 companies are failing and will continue to fail but our task is to identify the ones with potential for improvement. We will stop engagement when we do not get anywhere after say several months, but that does not happen very often," Melvin says.

"For us the only justification for our engagement is that it falls within our mission to enhance and protect shareholder returns. We do not, for example, tell tobacco companies to stop producing cigarettes, because it would put them out of business. Instead we talk to our tobacco holdings about factors relevant to their business success, such as their advertising or political lobbying policy," says Litvack.

"We do not sell stocks unless the client instructs us to do so. Instead we can take a number of actions to increase the pressure on a company such as a shareholder resolution. However, in the wake of Zembla we have been asked to provide an engagement service that includes divesting. And that turns up the pressure to yet another degree because we can tell a company that we have instructions from our client to divest unless they see evidence of progress," she adds.

GES offers negative screening services on top of its engagement service.
But Furugard says: "Some institutional investors choose to exclude companies based on screening. However, more and more asset owners like using engagement as their strategy."

According to the three services, the future is bright, and expansion is a target.
"A key task in developing the service is the sustainable growth of the service itself. And as it brings in additional revenues, we use that to expand the service, maybe adding another 5-10 people over the next three to five years," Melvin says.