Engine No. 1 expects more bold proposals from shareholders after the high-profile success of the activist impact investor’s campaign that changed the board at oil and gas giant ExxonMobil.

Michael O’Leary, managing director at Engine No. 1 was interviewed  at the UK Sustainable Invest and Finance Association (SIF)’s Autumn Conference. Prior to joining Engine No. 1, O’Leary, worked at Bain Capital, where he was a founding member of the private equity firm’s social impact fund and an investor focused on consumer, technology, and industrials.

We're delighted to hear from our keynote speaker @EngineNo_1 Managing Director @thisismichaelo on the importance of collaborative investor engagement, and how this should evolve in the years ahead.

A recording of our conversation will be available on our 'Knowledge Hub.' pic.twitter.com/nhHon3B1Tb

— UKSIF (@UKSIF) November 24, 2021

O’Leary said Engine No. 1 was  built on the simple idea that the long-term return from companies depends on the value they create for their workers, employees, customers, communities and the environment, which can be measured. Shareholders have traditionally looked at financial measures such as net income but these metrics should be broadened to include measures such as  carbon emissions, wages, diversity and the health impact of a company’s products.

“If we can add up all those different sources of value we can better understand the company’s long-term risks and opportunities,” he added. “Companies that are more focused on these issues will be the ones to win and Engine No. 1 can work as active owners to try and improve that impact and help create long-term value.”

Engine No. 1 is essentially made up of a concentrated equity fund and an index fund and votes its shares to engage with companies within its ‘total value framework.’

Total value framework

The firm said in a white paper that the total value framework is a data-driven approach that puts a tangible value on a company’s environmental, social and governance impacts and then ties those impacts to long-term financial value creation. It integrates reliable, independent ESG data into mainstream financial reporting and attempts to understand and accurately predict how ESG performance affects future valuations.

Chris James, founder of Engine No. 1, said in a statement: “Through our prior investing experience, we had seen strong correlations between ESG impacts and economic outcomes. When we used newly available data in our analysis, it became clear that these correlations are consistent for most companies, proving that ESG data is as core to the investment process as financially driven analysis.”

O’Leary continued that ESG investing in public markets has historically been focused on exclusion and the divestment movement deserves credit for making climate change a front and centre issue. However, there is an opportunity for investors who want to take an active approach and drive change as the scale of the climate change challenge means nearly every industry has to change including the the way we generate energy, grow food, build cities, move people and goods and heat homes.

WHITE PAPER: The @EngineNo_1 Total Value Framework

Co-authored by @whenisz, founder of the @Wharton ESG #Analytics Lab, this white paper directly ties environmental, social, and governance (#ESG) impacts to financial value creation. https://t.co/weMujbIJwq#AnalyticsatWharton

— Analytics at Wharton (@WhartonAnlytcs) November 11, 2021

“Our approach is that if you want to impact big public equities, you should take your seat at the table,” said O’Leary. “You should use your voice, you should roll up your sleeves, and then try and drive change.”

ExxonMobil

In June this year a third director nominated by Engine No. 1, and supported by CalSTRS, the giant pension scheme for California public school teachers, was elected by shareholders to the ExxonMobil board.

CalSTRS said in a statement: “Shareholders have the power to effect change at even the most resistant companies and contribute to the sustainable value of their investments.We will continue to actively engage companies in our portfolio to prepare for the global transition while maximizing returns for California’s educators.”

O’Leary continued that Engine No.’s strategy at ExxonMobil, long before it launched a public campaign in December last year, was to put new directors on the board who all had deep energy experience.

“One of the shocking things for a lot of people when we talked to  them during the campaign was that the board had all these incredibly impressive former executives, former CEOs of Fortune 500 companies, but none of them had deep energy experience,” he said.

Therefore the board could not adequately question management assumptions about ExxonMobil’s long-term strategy.

“We were lucky enough to start with a core group of partners, including CalSTRS, and ultimately included folks like the Church of England and big index providers like BlackRock, Vanguard and State Street,” said O’Leary.

He explained that one of the influential stories behind Engine No.1 using active ownership was the situation at NRG Energy in the US. Former chief executive David Crane set ambitious net zero targets and started investing in renewable energy but was forced out by hedge fund Elliott Management who appointed new board members,  including a climate change denier

“A true transformation in the making was stymied because investors who cared most about climate change, and should have been there to defend David Crane, had fled the stock,” said O’Leary. “There is a bigger role for investors to say I own shares which means I am accountable for what the company does.”

Too many #sustainable #funds exclude companies that need to change rather than working to change them. We’ve seen the power #investors have to transform companies—but we’ve also seen how that power can be wasted. Take your seat at the table. Explore $VOTE: https://t.co/E8NWFjAWU1 pic.twitter.com/pXDaF4PJTv

— Engine No. 1 (@EngineNo_1) July 29, 2021

One of the aspects of ESG investing that O’Leary finds most frustrating is the focus on asset management portfolios.

He said: “I think we all have to take a step back and say, who cares if the carbon emissions of our portfolio change if the carbon emissions of the planet are not changing ?”

Engine No.1 aims to use transparency to highlight the impact that it is making.

Another frustration for O’Leary is that many fund managers profess to care about ESG but their voting records do not match their words. His favourite example is a gender empowerment focussed fund that has voted against 80% of gender diversity-related proposals.

Shareholder proposals

“In many ways this year was a banner year for shareholder voting with a record number of ESG proposals,” he added. “I think you’ll see more bold proposals going forward from investors, given the success of our activist campaign.”

In addition to the environment, he expects more shareholder campaigns on workforce issues; diversity, equality and inclusion.

“I’m excited  to see this growing focus on the power of shareholders to drive change from within and I think that will  continue to grow over the coming years,” said O’Leary.

Heightened investor focus on #ESG risks and opportunities is having a meaningful impact on voting decisions, @HarvardCorpGov's 2021 Annual Corporate Governance Review finds. Twice as many environmental shareholder proposals that reached a vote passed compared to 2020. (1/3) pic.twitter.com/wKeQ7GQApJ

— Climate Action 100+ (@ActOnClimate100) November 26, 2021

The Harvard Law School Forum on Corporate Governance said in a blog that the 2021 proxy season produced record high proposal submission levels, average support levels and passage levels.

“These results reveal that investors’ heightened focus on ESG risks and opportunities is having a meaningful impact on voting decisions,” added the blog.

For example, 33 environmental and social proposals passed, the highest number on record and an 83% increase compared to the 2020 proxy season.

The forum said there was also record-breaking support for shareholder proposals focused on political spending, plastic pollution, greenhouse gas emissions, deforestation and board and workforce diversity, as well as management-supported proposals relating to climate change, diversity, equity and inclusion (DE&I) and human rights.

BlackRock markedly shifted its voting practices this season according the study, in line with revisions to its voting guidelines indicating its intention to increasingly support shareholder proposals addressing material ESG issues.

“Our review of its voting on the 36 environmental proposals in the 2021 season indicated approximately 50% support compared to approximately 13% for such proposals in 2020,” said the study.

Vanguard also supported approximately 47% of proposals voted upon, compared to 21% of such proposals in 2020.

“Remarkably, however, notwithstanding the marked shifts in support seen at Vanguard and BlackRock, they continued to be among the institutions more likely to vote in accordance with managements’ recommendations,” added the report.

Northern Trust, Alliance Bernstein and Norges Bank were the most supportive of the institutions across the climate-focused proposals.