Activist investors: Muscular stewardship

The recent proxy campaign ahead of Exxon’s most recent AGM is by no means the first time that activist investors have worked together with mainstream institutional investors. This March, Belle Salle Takadanobaba in Tokyo’s Shinjuku district was the location of a proxy showdown at an extraordinary general meeting of Toshiba Corporation. The EGM was notable as such events are a rarity in Japanese corporate governance, as well as in the fact that shareholders opposed management by supporting a motion to investigate alleged wrongdoing.

That motion was tabled by Singapore-based activist investor Effissimo, which had amassed 9.9% of stock. Also notable was Effissimo’s array of institutional investor supporters, including CalPERS, Norway’s GPFG pension fund and Legal & General Investment Management (LGIM).

Effisimo, which specialises in building stakes in Japanese companies, highlighted a litany of compliance, strategy and corporate governance failures at Toshiba over the years. It claimed these failures continued under Nobuaki Kurumatani, who was appointed Toshiba’s first outside CEO in 2018 to shore up the conglomerate’s reputation, and who was eventually ousted this spring.

Institutional investors have for many years emphasised the power of behind-the-scenes engagement, particularly in countries like Japan. But the Toshiba case is just one of many in recent years demonstrating the changing dynamics of corporate governance as mainstream institutional investors – including pension funds and index managers – realise the power of coalition-building around a common cause, and of momentum around that cause.

Working with activists such as Effissimo is an increasingly attractive tool in the corporate governance armoury of non-activist and long-term investors. Sometimes support comes at a distance.

Tactical alliances
When in 2018, Daniel Loeb’s Third Point backed an alternative slate of directors for New York-listed Campbell Soup Co, seeking to oust long-standing family members, the move was described by Campbell’s board as “aggressive and short-sighted”.

Ultimately, APG, the €573bn Dutch pension asset manager, backed a compromise in the form of a combined board. In the same year, APG also supported Elliott Management’s proposal for a competing slate of directors for Gruppo TIM (Telecom Italia).

Claudia Kruse, APG’s managing director for global responsible investment and governance, affirms that “activist investors have for some time sought to work with long-term investors to effect change”. She says that as “long-term investors we review all proposals very carefully and on a case-by-case basis”.

Kruse continues: “The hedge fund investor motions that we spend most time on tend to be competing board candidates, or entire boards. These situations arise when a hedge fund or activist disagrees with the strategic direction a company is taking. In many cases a compromise is reached, whereby some hedge fund nominees are included in a combined board.”

Last December, two members of perhaps one of the most prominent investor coalitions, Climate Action 100+ – the UK’s Church Commissioners and the California teachers’ fund CalSTRS – lent public support to Engine No 1, a shareholder vehicle behind a campaign called Reenergize Exxon. The campaign ultimately attracted enough votes to get two of its slate elected to Exxon’s board, according to preliminary results accounced following ExxonMobil’s AGM on 26 May.

Engine No 1, founded by technology investor Chris James, is supported by the likes of Jennifer Grancio, former iShares global head of distribution and Michael O’Leary, a founder member of Bain Capital’s social impact investing strategy. Lazard has estimated that by about April, Engine No 1’s proxy battle had incurred costs for both sides of an estimated $65m (€53m).

Investors including CalPERS, New York State Common Fund and LGIM announced they would back the motion, which was also supported in part by BlackRock and APG. For CalSTRS, supporting Engine No 1 is part of what it terms an “activist stewardship” policy – combining engaged ownership with deep financial analysis.

Short or long term?
Lazard reports just under 200 new activist campaigns each year on average since 2017 in its Q1 2021 Review of Shareholder Activism, with the aggregate new capital deployment of just under $40bn in 2020 (see figures 1 and 2).

Activists are increasingly difficult to define as a cohesive group. They may account for only about 0.3% of global AUM, as calculated by the Boston-based asset management, corporate and asset owner-sponsored think tank FCLT Global, but they are a noisy bunch, whose high-profile activities sometimes attract the attention of politicians and regulators.

They differ in their make-up – ranging from established hedge funds like Elliot Management, Pershing Square or Third Point, to vehicles like Engine No 1 – set up, initially at least, for a specific purpose.

Activists’ tactics vary – from the outright aggressive to the more or less cooperative – but they are united in a desire to effect specific changes to companies’ boards or strategies by building concentrated stakes in companies. Some are akin to value investors. 

Effisimo was careful to note prominently in its presentation on Toshiba that its interests “are aligned with that of all shareholders: to increase Toshiba’s long-term corporate value”. This statement is significant, as activists are most commonly associated with driving short-term shareholder returns (see panel).

Many rely on loud, sometimes nakedly confrontational tactics, which often receive wide press coverage and which also serve as a platform to build momentum and support for their proxy campaigns. This can attract the attention of politicians and regulators.

Last April, the French regulator AMF set out a policy to increase transparency by lowering the first notification threshold on activist stake-building and to increase information on activist’s exposure through debt instruments.

But ultimately, the regulator said in a statement that activism should be encouraged: “The active involvement of shareholders in the life of listed companies is a necessary condition for their proper functioning and sound governance.”

AMF went on to note that the “challenge therefore is not how to prevent activism, but how to set limits and make sure that it is able to control excesses”.

ESG and long-term activism
Within the broad universe of investor activism, there are a few examples of activist funds with long-term value creation objectives. These funds see themselves as constructive in their dealings with corporates, in contrast to short-term-focused activists with more aggressive behaviour. 

One of the most notable among this niche is Cevian Capital, the $14.5bn (€12bn) European activist fund manager. Cevian – founded in Sweden in 2002 by Lars Förberg and Christer Gardell and chaired by the UK investment management veteran and former minister Paul Myners – is the largest of such funds in Europe.

The firm’s high-profile campaigns of recent years have included a strategic transformation of the Switzerland-based industrial engineering giant ABB, a revamp of the Sweden-based telecoms equipment company Ericsson, and a comprehensive restructuring of engineering and steel conglomerate Thyssenkrupp.

Earlier this year, when Siemens’ CEO Joe Kaeser stepped down, he praised activists, including Cevian, for their attempts to push corporate boards to do better for shareholders.

 What separates Cevian from other activists is that its strategy is long-only and its average holding period is five years. It also avoids aggressive confrontations with corporate boards, particularly in the media. Cevian’s own professionals sometimes serve on the boards of its investee companies.

The rise of Cevian’s reputation as a ‘constructive activist’ within Europe’s broader investor community mirrors the way investors are taking an increasingly active role in corporate governance.

This March, Cevian publicly announced that it would target companies with poor ESG behaviour, calling for executive remuneration to be linked to ESG objectives and an end to ‘ESG box-checking’ practices.

Chris Hohn’s TCI Fund Management has developed an explicit focus on pushing for greenhouse gas-related disclosures through ‘say on climate’ proposals which it says it will table for “hundreds of companies” in coming years. Indeed, the number of ‘say on climate’ proposals has steadily increased in the last couple of years (figure 3).

The move could be seen as a sign that the once separate concepts of investor activism, shareholder stewardship and ESG investing are all converging, ushering in a new era for public companies. 

Increasingly, ESG is where long-term investors like index funds and activists are finding common ground. In its most recent report on activists, Lazard noted “highly diversifying tactics regarding ESG matters”.

 “Over the last couple of years, ESG considerations have clearly begun to impact companies’ business opportunities, revenues, costs, risks, employee engagement, societal attitudes, and corporate valuations,” says Harlan Zimmerman, senior partner at Cevian Capital.

“Improving companies’ ESG performance and situation is a clear and important source of long-term value creation.”

Upping the index game
Passive ownership of global corporations has grown to an unprecedented size. Due to their huge influence within markets, index investors are under pressure to raise their stewardship game.

NGOs and other interest groups frequently single out index investors for particular actions or inactions – such as the failure to support activist motions on issues like climate change.

BlackRock’s engagement team consists of about 45 people globally, up from just 13 in 2008, with plans to boost it to as many as 60, as IPE has reported.

 Following revelations in 2018 that it held simultaneous short and long positions in the collapsed UK outsourcing company Carillion, BlackRock and others have had a motive to prove their credentials in investment stewardship.

“You’re seeing even more scrutiny of shareholder resolutions, which means that a lot of asset managers are under scrutiny in terms of what their positioning is on these resolutions,” says Marion Plouhinec, senior investment stewardship manager at LGIM.

Robert Walker, global co-head of asset stewardship at State Street Global Advisors (SSGA), says passive owners are often wrongly portrayed as not doing enough on such issues. “We actually spend time looking at the content of each resolution and assessing whether companies are dealing with the issues in hand,” he says. 

“Often the resolutions are asking companies to speed up work that they are already doing or to force changes that would be destructive of value.”

According to BlackRock’s Q1 Stewardship Report, since January this year, the company has voted against 53 directors and 47 companies for climate-related concerns. It has also supported 75% of environmental and social shareholder proposals.

In 2020, Amundi voted against management in 20% of resolutions globally and against 31% of resolutions on remuneration. 

“We often voted against long-term incentive schemes that did not have ESG KPIs,” says Elodie Laugel, chief responsible investment officer at Amundi. “In 2020, due to the COVID crisis and the need to focus on long-term growth as well as balancing the different stakeholders’ efforts, Amundi has been particularly vigilant about the balance of executive compensation.” 

In 2020, Laugel says, Amundi voted in favour of 79% of social, health and human rights-related shareholder resolutions as well as 86% of climate-related shareholder resolutions presented at the AGMs in which it participated.

Moving corporate governance from the periphery to the core of the organisation sends an important message that an index manager is taking stewardship more seriously. At LGIM, for instance, CEO Michelle Scrimgeour and CIO Sonja Laud both sit on the investment stewardship committee – along with the head of stewardship and four non-executive directors of LGIM. The committee meets quarterly and has overall responsibility for developing and implementing engagement and voting policies.

Selective bedfellows
Index managers can find strong partners in activist investors in their stewardship activities on some occasions. Sometimes they may contact activists directly over an issue in the public domain once they have established a position but also on occasion suggest target companies directly to activists.

Walker says SSGA is often approached by other investors that are targeting specific initiatives and companies, especially regarding their plans to tackle climate change.

Zimmerman says collaborations between activists and index funds are growing in number and significance. 

“It’s natural for index funds and other long-term owners to support the initiatives of constructive activists – at least the ones they believe are credible, and that are focused on the long term, as opposed to just short-term financial engineering or putting companies in play.

“This support is often valuable in getting things done, particularly if there is any resistance on the side of the company.”

LGIM has supported several activist campaigns in recent years. Alongside Effissimo over Toshiba, recent examples this year include Chris Hohn’s TCI over ‘first say’ on climate resolutions for Spain’s Aena, and Amber Capital at the AGM of Lagardere.

“You see activists sometimes pushing for the same things that we’ve been pushing for over many years,” says Plouhinec, emphasising corporate governance change in particular. “Activists are aligning their demands with those of long-term institutional investors to a greater extent and are therefore increasingly supported by the traditional shareholder base,”

In 2019, LGIM sided with Paul Singer’s Elliott Management in the case of Hyundai, supporting resolutions on an increased dividend, separate remuneration and governance committees, and the appointment of new directors.

Index managers are also cautiously becoming more public about their positions on particular issues. Although this is far from the often-aggressive media positioning that activists sometimes favour, a clear signal ahead of an AGM can send a powerful message to other investors that a coalition is building.

Plouhinec says LGIM is increasingly pre-declaring votes. “We do that because we find it a powerful engagement tool,” she says. “It’s a way of flagging to the market a particular interest on a specific resolution and triggering additional scrutiny by the market on these resolutions.”

While most index funds are growing their efforts, stewardship remains a challenge because of the sheer number of companies they own. They must focus their corporate governance activity carefully, since they cannot allocate in-depth resource uniformly to good effect across a global stock portfolio of over 4,000 single names, although all large investors make use of proxy advisers such as ISS and Glass Lewis.

As Walker notes: “Once we buy a company, we have to hold it until it leaves the index. Therefore, as a long-term owner of capital, engagement and understanding the ESG characteristics of the companies that we own is core to our stewardship approach. That is why we are pushing companies to disclose data as a first step in our stewardship activities.”

Zimmerman says:  “Index funds do a lot through their policies, but these are designed as global or sector-based. They have more difficulties with looking after individual companies.”

Walker acknowledges the limits of SSGA’s ability to join shareholder initiatives due to resource constraints. 

Focus on the AGM season also risks downplaying ongoing engagement work that does not receive attention, and which can also be more effective. “The truth is that engagement happens throughout the year,” as Walker puts it.

 “We spend a lot of time talking to our investee companies and carry out proprietary analysis to understand what they are doing, and if we don’t think that they’re doing the job, we communicate that to them directly.

“The notion that we should be active or join activist stewardship practices disregards the work that we are already doing. On climate, specifically, we believe our stewardship strategy works.”

Wider benefits
Zimmerman acknowledges that index funds are having an impact but he says: “Companies that are simply underperforming their peers or their potential, cannot be an urgent priority for them. And yet, improving the operating margin of a company, for instance, creates a lot of value for everyone. Engaging with a company on that front takes quite a lot of research, knowledge, conviction and credibility.”

Citing evidence from a 2018 paper by Gantchev, Gredil and Jotikasthira published in the Review of Finance, Zimmerman argues that investor activism has a systemic impact that is greater than the impact on target companies.

This is because the peers of companies targeted by activism may seek to improve operational performance to preempt being targeted themselves. From that perspective, Siemens may be a case in point, having carried out or planned several spin-offs that were well-received by the market. 

 Zimmerman says: “Index funds and other broad owners of the market are the greatest beneficiaries of activism. They not only benefit from improvements at the companies that are targeted, but also benefit from the improvements that other companies make to pre-empt activism.”

As universal owners, pension funds and index fund managers are exposed to all manner of downside risks arising from corporate governance or management failings, and they cannot, like activists, build out concentrated stakes that give real clout. But concentrated engagement through activism can benefit them and other shareholders indirectly.

Temporary alliances with activist investors on a selective basis are clearly a useful tool for both sides. But caution is needed to avoid reputational fallout. After all, pension fund and index capital will still be invested after an activist leaves the stage.

Some cases are indeed hard to call – such as the ousting earlier this year of Emmanuel Faber as CEO of Danone – a company noted for its focus on sustainability and high ESG ratings – by investors including Artisan Partners, a PRI signatory that held 3% of the stock, on grounds of poor financial performance but also for governance failings (Faber was chairman and CEO).

Ultimately, long-term investors could act as a counterweight to some of the shorter-term instincts of some activists in the way they selectively choose to add their weight to some proxy motions but not others.

“If the Little Engine’s ‘Reenergize Exxon’ campaign succeeds, it could be the prelude to many similar ones by other funds to the benefit of shareholders and society at large” - Robert Eccles and Colin Mayer

Writing in Harvard Business Review in January, Robert Eccles, former professor of management practice at Harvard Business School and Colin Mayer of Oxford Saïd Business School, said: “Engine No 1 is part of what might become a major shift in equity markets…. If the Little Engine’s ‘Reenergize Exxon’ campaign succeeds, it could be the prelude to many similar ones by other funds to the benefit of shareholders and society at large.”

If long-term investors are to establish and maintain credible stewardship policies and capabilities, they are likely to continue to work with activists and other types of actors – including ones they may not have pursued relationships with previously.

They may not always be able to distance themselves from controversy – and will often fail to drive change – in their campaigns to promote good governance, better long-term corporate strategy and behaviour, and ultimately better returns for beneficiaries.

Ultimately, they will have to take a long-term view on the terms of success in corporate stewardship as the failures will be as numerous, if not more numerous than their frequently hard-won successes.

This article has been amended to include the preliminary results from ExxonMobil’s AGM on 26 May 2021.