We analyse and consider governance factors when we assess a company's quality, and integrate that with environmental and social themes in our investment process. But that doesn't make the process simple.
Our approach begins with the identification of "red flags", which could suggest inappropriate controls, lack of oversight, or the misalignment of incentives.
We might look at whether the company has been investigated for its accounting policies; how the independent auditors expressed a qualified opinion of accounts; whether we voted against any remuneration proposals; or if independent directors only make up a minority of the board. A lack of third-party whistleblowing mechaisms would also be a red flag.
Abrdn has developed an in-house ESG score based on this systematic approach to assessing both companies' operational and governance performance. Quantitative scores are not sufficient in isolation but when aggregated they can start to paint a picture and help identify where more work is required.
It’s a Duty to Engage
The next step is to engage with the board in order to get a better understanding of the most material governance factors and focus on practical solutions. We might want to ensure boardmembers' skills and experience get a proper outing, with the former in particular necessary when engaging with a large or complex company.
For example, the UK speciality chemicals company Croda (CRH) has invested in its life science division over the last few years in order to capture the high-growth opportunities it sees. In light of that, we welcome its decision to bulk up life sciences experience on its board to reflect that shift in focus.
At Abrdn, equity teams operate a proprietary ESG scoring system called "ESG Q score", which takes a forward-looking view that is informed by engagement and an understanding of how companies manage their most material ESG risks and opportunities.
We use both these ratings schemes (the house ESG score and ESG Q score) to manage governance, and Dunedin Income Growth Investment Trust will not invest in companies with a below-average ESG Q score or an ESG house score in the bottom 10% globally.
The Future of Governance
We think there are two major governance trends.
Firstly, we are likely to see executive remuneration remain a key topic. Our investment desks and dedicated active ownership team review corporate incentives schemes to assess whether management incentives align with shareholder interests. Together, these teams engage with boards on management remuneration in cases where we feel pay is excessive or untransparent. If our work does not provide sufficient clarity and comfort, then Abrdn will vote against the remuneration policies.
Secondly, there has been a big shift in awareness and understanding of climate change over the years, and this has led to an increase in climate-related engagement. Many investors are choosing to collaborate through net zero alliances, ClimateAction 100+ or working groups within the Institutional Investors Group on Climate Change.
As such, there is increasing pressure on asset managers to demonstrate action on climate commitments. At abrdn we are focused on real-world decarbonisation by investing in transition leader and climate solutions companies. As such we are engaging with the highest carbon-emitting companies and setting time-bound milestones against which progress can be measured.
By Rebecca Maclean is manager of Dunedin Income Growth Investment Trust (DIG)
The companies cited in this piece are selected for illustrative purposes only, and do not form an investment recommendation or indication of future performance
