The Evolution of Investor Stewardship: Investor Views on What’s NOT in Company Financials and Why It’s So Valuable

December 4, 2024

Introduction

In recent decades, institutional investors have greatly expanded their assessment of risks and opportunities at both the company and portfolio levels to go beyond a narrow analysis of financial statements such as the balance sheet and income statement. Through frameworks variously referred to as corporate governance, intangible value analysis, and increasingly, investor stewardship, this type of inquiry allows the investor to gain a wider perspective on what drives returns. Over the past decade, the consideration of environmental, social, and governance (ESG) factors has also fallen into this category.

At its core, this expanded assessment allows fiduciaries to perform due diligence and assess issues before they become problematic to company operations, as well as better understand the drivers of growth and value creation. Examples include evaluating the qualifications of a company’s board to ensure a prudent mix of expertise, analyzing how a company treats its workers to maximize productivity and gain access to the best available talent, and engaging with companies to determine how environmental pressures translate into financial risks and opportunities.

Forging relationships with company leadership and regularly communicating with them also allows investors to respond more quickly to company crises if problems do arise in their portfolio investments. Casting informed proxy votes on issues such as director elections, executive compensation, shareholder proposals, and corporate actions such as mergers or changes to company charters or bylaws are prime examples of good stewardship. Institutional investors – and to some extent, even corporate executives and boards – are increasingly relying on a wide variety of stewardship metrics and data to gauge company performance (also here and here). These metrics not only have the capacity to impact financial performance in the long run but also often reflect risks and opportunities that, while material to company performance, are not yet quantifiable or adequately reflected in earnings and company assets or liabilities.

This report aims to capture the essential elements investors look for when they consider forward-thinking stewardship in their investments, the ways they link stewardship to financial value, and the challenges they face now and, potentially, in the future. It uses data from survey interviews with more than two dozen institutional investors, whose ability to participate anonymously allowed them to share their views candidly.

Methodology

This report is based on survey interviews with 29 institutional investors, including 17 asset owners (e.g., pension funds) and 12 asset managers. Participants represented a broad geographic range within the U.S., with assets under management (AUM) varying from tens of billions to hundreds of billions of dollars. Participation in the survey was voluntary, which introduced the potential for self-selection bias, but care was taken to invite investors with a variety of views on stewardship and corporate governance.

The survey topics spanned the breadth of responsibilities for stewardship teams, including:

Information about their fund management, including their AUM, location, and management style, and whether they invest in passive, active, or a combination of active and passive portfolios;
Their current use of governance data and providers, including the metrics and issues that are most important to their fund;
How stewardship is conducted at the fund and by whom;
Whether they’ve been affected by so-called anti-ESG laws or legislation (also here);
Whether the fund has experienced media attention or reputational impacts due to their stewardship work, and how they have responded; and
Their view of how their organization’s policies and strategies are likely to evolve over the next one to three years.

For context, some investors use the term “ESG” as a shorthand for evaluating the unique extra-financial risks and opportunities each portfolio company or potential investment faces. The term “ESG” has been used for more than 20 years to signify issues that have an indirect but substantial relationship to the financial statements and present opportunities for shareholders to engage with companies. However, many have criticized the term “ESG” for oversimplifying risks, elevating issues that are not materially financial, and politicizing investment issues. The term “ESG” is generally used to refer to environmental, social, and governance issues. Environmental criteria assess how a company is positioned with regard to various risks and opportunities stemming from environmental stresses and regulations, social criteria evaluate how companies manage issues relating to employees, suppliers, customers, and the community, and governance criteria examine factors such as company leadership, executive compensation, audits, internal controls, and shareholder rights.

The survey’s conversational format allowed participants to freely discuss topics or bring up aspects of risk analysis and investment that were not directly asked in the structured questions.

Fund Management Insights

Typically, the majority of assets held by the asset owners in our survey were passively managed, with between 50% and 67% of their equity funds tied to indices, most often the Russell 3000. These investors emphasized that indexing makes their stewardship and governance responsibilities more critical, as the fund remains a long-term shareholder regardless of performance, controversies, or governance issues at individual companies. As one asset owner noted, “There is no investing away from those risks.” Several asset owners reported having small allocations to portfolios that comprised companies specifically selected on the basis of stewardship concerns, such as investments in diversely owned management firms or businesses (and often, portfolios with allocations to climate-responsive companies), but these accounted for no more than 5% of their AUM.

By contrast, asset managers demonstrated a much greater variety of management styles, with some managing 100% of their equity assets actively (pursuant to a variety of investment selection strategies), while others had a significant proportion invested in passively managed funds. All asset managers incorporated some level of active management, with at least one portfolio explicitly incorporating ESG factors into investment decisions, which they said were popular with some clients. All of those surveyed stated that their stewardship practices were essential to achieving good long-term performance across their portfolios.

Several of the investors surveyed cited studies finding that a focus on factors like stewardship, corporate governance, and sustainability is linked to improved company financial performance (also here and here). Most discussed the consideration of risks and data around workforce issues – including diversity, a living wage, internal pay equity, health and employee wellness, and the use of broad-based incentive structures – as important considerations in their conversations with companies. They also cited other social concerns such as opioid impacts, pharmaceutical pricing, and human rights. For the environment, investors frequently cited climate, water use, “forever chemicals” such as PFAS (per- and polyfluoroalkyl substances) and phthalates, and plastic pollution as serious risks, especially for certain industries and companies. Many see their efforts to discuss these factors with boards and management as a key facet of lowering risk to their funds. They noted the importance of managing these risks, as well as the opportunities that can arise in addressing them, in terms of future profitability for the companies and industries most affected by these issues.

Data and Metrics

Nearly all investors agreed that stewardship is essential for identifying and managing a wide range of investment risks. These risks often include environmental liabilities, social unrest or scandals, and governance failures – all of which could damage a company’s financial performance. Investors expressed confidence that by factoring in the risks, and the attendant opportunities that often arise, they could gain a more comprehensive understanding of a company’s long-term viability and value.

There has been significant discussion on the variability of ratings and data services for ESG factors, with intense debate over whether this diversity of opinion reflects a healthy ecosystem or disarray and a lack of cohesion in the field. Several of the surveyed investors resisted the idea that they blindly follow ratings or recommendations from external services, with one asset manager explaining:

Most people don’t understand that we don’t just use someone else’s ratings or data to make decisions. We review the data ourselves, and make our own algorithms–we don’t rely on someone else to tell us what is a good or bad factor or metric.

Other asset managers and owners echoed this sentiment, expressing frustration over market participants misrepresenting or exaggerating investors’ reliance on recommendations from proxy voting advisory firms.

Every investor we surveyed relied on multiple data providers, with the majority using more than one proxy advisory service. Over 70% of asset owners reported using services such as Institutional Shareholder Services (ISS), Glass Lewis, MSCI ESG Ratings, and Bloomberg, in addition to others like Sustainalytics, Refinitiv/LSEG, and S&P Global Trucost.

When asked to identify the most critical issues, metrics, or data for their funds, nearly every asset owner and manager highlighted board composition and qualifications as top priorities. While executive compensation, human capital management, and climate issues were also commonly cited, more than 90% of respondents placed the highest importance on board composition and qualifications. Shareowner rights was the second most-cited priority.

Stewardship and Its Connection to Financial Performance

Investors desire the ability to evaluate and compare risks across companies, peers, asset classes, and the market, especially regarding systemic risks that passive investors encounter when they become universal owners. As one asset manager put it, “Stewardship is part of the fundamental risk assessment that is embedded in very traditional approaches to valuation of risk and return.” One asset owner noted how they try to capture issues even when they aren’t immediately apparent on the income statement or balance sheet but could be material to the investment:

You don’t see governance on the balance sheet unless you look closely. But if you do an evaluation of governance, you can tie it back to where it might intersect with the balance sheet, either positively or negatively at some point in the future.

Another described stewardship as supporting their fund’s efforts to achieve superior performance:

We always had the link to performance in mind for everything we do, every vote we make, and every company conversation we’ve ever had. In our program, we look for things like overboarded directors, board independence, board qualifications, pay for performance and pay design. We are always aiming for the link to value and seek high-quality empirical studies on this and even issues like financial auditing, internal controls and transparency in auditing.

Many discussed frustration with what they see as ESG co-opting the discussion on stewardship issues, and respondents’ views on ESG as a framework for addressing environmental, social, and governance risks varied from positive to negative – even among individual respondents’ answers. Some investors have been vocal that the “anti-ESG” movement is born out of a fundamental misconception of how investors identify and respond to ordinary risk factors. But investors in this study repeatedly brought up the political contexts that have become associated with these issues and noted that the lack of a clear definition for “ESG” has contributed to confusion and misconceptions. What is viewed as “ESG investing” is sometimes confused with impact investing or socially responsible investing (SRI), which aim to create social or environmental impact alongside financial returns and may purposely sacrifice market-rate returns to achieve those goals. One participant said, “Everything I do is from an investment lens. Don’t call it impact. That’s really not the intent.”

Common themes emerged from these discussions. Most investors focused on risk analysis with tangible financial impacts, as the following quotes show:

Asset owner: “We examine both risks and opportunities, but we’re fiduciaries and ultimately we’re looking for strong risk-adjusted returns, and analysis of board policies and a detailed consideration of how management is responding to issues like climate change, water risk issues, and even inflationary pressures is a tool that helps us do that.”
Asset owner: “There are a lot of shareholder proposals for issues such as pay gap reports that are still getting a lot of support, and issues like majority voting. Both of these represent that it is still very much important to investors to understand risks and exercise their rights. Things grow more complex over time, not less, so sharper analysis is needed.”
Asset owner: “Voting for the board is the most important thing we do. They stand between us and all the risks and opportunities our investment will face. If we don’t have the right people with the right skills, we will lose money, either in a relative sense to how we could have performed, or in a very real, absolute measure of value destroyed.”
Asset owner: “We’re trying to capture issues that aren’t immediately apparent on the income statement or balance sheet, but are potentially material to the investment.”
Asset owner: “I get really upset when I see dual-class shares, coupled with supermajority voting provisions, coupled with onerous advance notice bylaw provisions. These are techniques to abridge our voting rights. We can’t act to protect value if something goes awry at these companies. We’re dead in the water.”
Asset manager: “We want to drive returns and have a strategy to support the American economy. We’re looking for growth. It can’t be about morals or emotions, because whose morals? That presents as a big warning sign to rational investing. When you start to introduce other objectives, you stray from what is rational, and what is defensible to your clients as a fiduciary.”
Asset manager: “We’re seeing real impact on insurers and their quotes. The risks have changed, and they’ve increased. We need a pragmatic approach to climate.”
Asset manager: “What is actually affecting value and risk is often a topic du jour. There needs to be some rigor. Should we be pursuing sugary beverages? Probably not. Maybe more so plastics, because the risks are so different and much more about the externalities of the waste itself. These will be extremely significant.”
Asset manager: “If the executives and board are doing their job, you don’t have to come in with a bunch of solutions. You can come in and monitor, but you don’t have to supplant yourself in the role of the board. Telling people how to do their business is not what we need. We need to have them disclose their strategies to us so we can evaluate the job they’re doing, not do it for them.”

Most of the investors dislike the term “ESG,” saying it oversimplifies their stewardship roles. Several expressed that it allowed governance issues to be overshadowed by environmental and social concerns:

Asset owner: “I get it, I get why it exists, but I personally hate it. So many people view ESG as environmental, and if you really extend the ESG piece outward past what laymen think of it, it covers geopolitical risk and so much more, and it’s been pigeon-holed to just a few categories.”
Asset owner: “The G of ESG is becoming more prominent. Investors really see governance as an important mechanism in discussions of natural, human, and financial capital.”
Asset owner: “Honestly, we mainly focus on the G. If you get the governance right, then the board and executive team are the ones who have responsibility and the right information for solving the E and S issues. Too much focus has been on investors trying to micromanage these issues, but we lack a lot of the necessary context to do that.”
Asset manager: “A ways back, the focus on ESG shifted to be about the E and S, and we forgot G. The term is an over-simplified shorthand for risk, but it became all E and S and then moved to less material things. G is forgotten.”

Stewardship and the Impact of Criticism and Certain Legal Frameworks

Most states do not have laws or executive orders that prevent public funds from considering ESG factors in investment or stewardship activities. However, many investors in these states still reported being affected by a broader anti-ESG movement, especially due to the prevalence and extent of anti-ESG efforts across other states, including some proposals within their own states that ultimately did not pass.

Asset Owners
While most asset owners in states without this type of stewardship or ESG-related legislation reported that the anti-ESG movement had not significantly altered their work, some noted that the backlash had prompted their funds to commit more resources toward investing and stewardship. Although anti-ESG efforts didn’t shift their core goals, nearly all investors reported an increased compliance workload due to the need for additional reporting, responding to public records requests, media inquiries, and for over a third of respondents, substantial efforts related to subpoenas or legal inquiries.

Several asset owners explained that anti-ESG campaigns made it clear their funds needed to improve communication about how they use data to evaluate investments on issues like corporate governance, geopolitical risk, and workforce issues so the public and beneficiaries better understand their link to performance. Even asset owners in Democratic strongholds where there’s little risk of future anti-ESG legislation felt it was crucial to explain their actions to stakeholders. One asset owner noted, “We are not affected by laws but sense the rhetoric in the environment so we proactively respond and engage our stakeholders.” Another commented:

Nothing has really changed for us, but we are trying to be more vocal about why we incorporate these risks into our investment process. We’re a long-term investor and we have a responsibility to manage these risks. It’s a responsibility to show that we’re managing to financial factors, and financial factors only.

For most asset owners, stewardship issues are addressed via voting and company engagement rather than at the investing level through stock selection. None of the asset owners reported having significant holdings in portfolios specifically created based on stewardship ratings or criteria. Several managed or invested in small portfolios aligned with ESG-type investing principles, typically accounting for 5% or less of their total AUM.

Two asset owners from states without anti-ESG laws in place mentioned that while proposed legislation failed to pass, they had worked closely with internal communications teams to inform the public and legislators about the potential impacts of such laws. Beyond these two cases, the remaining asset owners expressed little concern about future legislation impacting their work. Feeling shielded by their state’s political climate, they were confident in the industry’s future and ready to rebut claims that their stewardship efforts are in any way unsuitable for investors.

Some investors, however, noted impacts on the industry, with concerns that other affected investors might reduce their stewardship efforts. One asset owner said:

I understand the challenge for asset managers that are trying to run global businesses with lots of different constituencies. Ultimately, it’s throwing sand in the gears. It’s a distraction; it takes up time. [Pursuers of anti-ESG] don’t have an alternative; they’re just trying to impede without offering alternative or helpful constructions. It’s political pressure driving this when it should be viewed through a financial lens.

Asset Managers
Asset managers reported various impacts from anti-ESG legislation and the broader anti-ESG movement. While none of the asset managers indicated that their actual investment practices had changed due to these campaigns, most said they had significantly altered their communications and outreach around their portfolios and stewardship issues. Many expressed concerns about attracting unwanted attention or scrutiny, and thus were more reserved about marketing ESG-related initiatives.

Although most asset managers said they have at least one ESG-specific portfolio and clients are generally satisfied with these investments, 72% of surveyed managers indicated that anti-ESG rhetoric had led them to modify how they marketed ESG portfolios and handled related voting activities. The changes were not necessarily anti-ESG in nature, but reflected a redoubled focus on materiality and clearer communication with stakeholders. They felt committed to demonstrating the financial connection between the metrics they use for portfolio management and performance outcomes.

Several asset managers expressed optimism that the anti-ESG movement would compel the industry to clarify investment practices and reduce “greenwashing,” where funds are marketed as ESG-friendly without substantive backing. Some managers welcomed the chance for regulatory or market-imposed discipline to distinguish genuine ESG efforts from superficial marketing. Several managers have been fined recently by the Securities and Exchange Commission for such violations (also here and here).

However, many asset managers were pessimistic about the probable impact of anti-ESG efforts over the next one to three years. Seven managers expected that anti-ESG sentiments would influence their organization’s policies and strategies in the near future, while several more said they were unsure. Despite these concerns, most managers anticipated that their own organizations would continue operating as they had before, particularly those with global clients, citing that international reporting frameworks continue to move forward. As one asset manager explained:

Asset managers and owners have a global mandate. There are many other nations and reporting frameworks that are moving forward such as [the International Sustainability Standards Board], so the appetite for data and analysis will only continue. The borders dissipated in importance long ago. We will continue to exercise a lot of care and ensure the way we communicate abroad is consistent with the realities here.

Legislative Impact on Stewardship Programs for Asset Owners in States With Anti-ESG Laws

Twenty-two states have passed laws that have affected ESG investment activities in various ways. These laws include barring the use of ESG factors in investment decisions or proxy voting, prohibiting discrimination against companies based on ESG criteria, or creating lists of prohibited investments for state entities (commonly referred to as “blacklists”) based on evaluations of companies that are perceived to be boycotting specific industries. However, many of these laws include exceptions for investment decisions based on material financial factors, making it unclear whether most investors would be in violation given how they use ESG data.

Four asset owners from states with anti-ESG laws participated in this report. They each described the impact on their investment practices as mild or negligible, stating that the primary effects were increased compliance and staff costs. One asset owner explained that their state law prohibits the consideration of ESG factors in investing unless there is a financially material reason to do so. Since the fund in question already aligned its stewardship and investment functions with financial performance, the law essentially codified their existing practices:

Very few investors want to sacrifice returns for ideology. Our state anti-ESG law basically mandates that we cannot invest on the basis of ESG issues, unless there is a material rationale for doing so. This is what we do and what we’ve done all along, so it really hasn’t changed or limited how we invest.

Another asset owner said, “We continue to drive the development of the data and support of the business case for this work. We keep financial impact front and center in our conversations.”

None of the asset owners in states where anti-ESG laws were in effect had current or prior funds or portfolios that were explicitly selected, invested, and/or managed as “ESG” funds.

Voting on Shareholder Proposals

Support for shareholder proposals that address social and environmental issues is markedly down in the last several years (also here and here). Many survey participants observed that shareholder proposals have become more frequent and prescriptive in recent years, and anti-ESG proposals (that mainly seek for companies to avoid consideration of environmental and social issues) have risen significantly as well. Some investors indicated that the decline in voting support is a natural outcome of stewardship and investment professionals growing frustrated with the sheer volume and detailed nature of these proposals. As one asset owner said:

I have a lot of problems with the level of detail in some of these shareholder proposals. It’s not that the issues aren’t important, but it’s that the proposals themselves go too far in mandates of what the company should do. I’m not comfortable with that, but often I don’t like that voting against a particular issue makes it seem like I don’t think that issue is important. It is. I just don’t want the overly prescriptive solution that’s been presented.

Another asset owner said:

Our support is down sharply, by double digits, each year for the last three years. We support very few shareholder proposals now, especially on E and S issues. We’ve had feedback from our trustees that they believe these proposals have become less focused on shareholder value and more prescriptive than is necessary.

One asset manager said:

Proposals have shifted the conversation. It’s been hijacked to focus on the wrong things. Support for the environmental and social shareholder proposals often doesn’t matter. Shift the focus to voting on directors on their performance. Use the tools you have, and a prime tool is voting for directors. Because really, it’s backward that everyone is trying to solve environmental and social issues without the knowledge that the board has. So it becomes about board accountability, and that has to be judged by their behavior and decisions.

Investors Facing Subpoenas or Legal Inquiries

Half of the asset managers and nine out of 17 asset owners reported receiving subpoenas or other legal requests for information on their stewardship activities and programs. Three additional asset managers declined to answer, and one was unsure. These investors discussed the impact of legal actions on their firms, with one saying it was alarming for a member of their fund management to be called for congressional testimony and expressing concern that the industry was being “unjustly criticized” for breaching fiduciary duty. Three asset managers also noted that their policies had changed in response to these legal pressures.

Four asset managers reported direct response costs exceeding $100,000, while another estimated costs around $50,000. The largest portion of these costs was attributed to fees for hiring outside counsel. In addition to legal expenses, most firms also reported significant staff time dedicated to handling these inquiries, with the upper range equating to between one-half and one full-time equivalent (FTE) position over the course of a year.

One asset manager described receiving an inquiry from an official in another state that had passed an anti-ESG law:

The law indirectly affects us, and the main effect has been holding up adoption of guideline changes. Diversion of staff time is also a big effect. We got an inquiry asking us to explain why we voted for a climate proposal impacting an oil company headquartered in their state, but we supported the proposal in part because the company’s management supported it. We tend to side with companies in this regard. But it shocked us to receive an inquiry implying that we were discriminating against a company whose management we were in agreement with. This creates industry confusion even in cases where [asset] managers want to support businesses in the states that created these laws. It asks [asset] managers to second guess and micromanage the risk management and opportunity processes of companies in the very states proposing these laws.

Five asset owners also reported significant costs related to outside counsel and reallocation of staff resources. Three of these owners estimated response costs exceeding $100,000, primarily due to legal fees. All asset owners affected by subpoenas or legal inquiries described dedicating substantial staff time to handling these responses.

Public Records Requests for Asset Owners

All but two asset owners reported significant public records requests related to stewardship issues in their programs. Four owners estimated the annual costs exceeded $100,000, while the remaining asset owners with substantial requests described the costs primarily in terms of staff time, ranging from “moderate” to the equivalent of one-quarter to one full-time employee (FTE).

Voting Choice Programs for Stewardship Engagement With Clients

Several asset managers mentioned that they are also implementing and/or exploring voting choice programs to enhance investor and beneficiary engagement. As technological and logistical advancements rapidly emerge, more asset managers see voting choice programs as a way to improve client engagement (also here) and potentially reduce criticism that asset managers control investments and stewardship activities without sufficient input from clients. Additionally, some asset owners who use asset manager services have been directed to expand or begin using pass-through voting in efforts to pull back voting authority from asset managers to whom they had formerly outsourced authority on certain portfolios.

Conclusion

The insights gathered from this survey show that investors believe stewardship is a critical tool for measuring risk and financial performance. The rise of anti-ESG sentiment and associated legislative measures have created a new landscape for some institutional investors, introducing increased scrutiny, legal challenges, and public relations considerations. However, most investors’ core approach to investment and stewardship remains largely intact and value-focused. Institutional investors continue to view these issues, particularly those within governance and shareholder rights, as critical to evaluating and managing long-term risks and opportunities, maintaining that these considerations are essential to fulfilling fiduciary responsibilities.

Many respondents indicated that clearer communication with beneficiaries and refined strategies will be essential moving forward, particularly in maintaining trust with stakeholders and addressing political challenges. Institutional investors are continuing their commitment to long-term risk management and responsible investment practices via stewardship functions like proxy voting and company engagement.