State Street Flexes Its ESG Proxy Muscle

ESG’s roots come from the Quakers, and the idea of not putting your money in areas that don’t share your values. As such, most forms of ESG and socially responsible investing (SRI) use screening to avoid “problem” stocks or sectors. Early instances of ESG portfolios didn’t hold weapons, tobacco, gambling or other so-called controversial stocks. Now, advanced screening methods allow for managers to sidestep those stocks that don’t meet certain minimum ESG metrics.

Overall, the vast bulk of ESG investors use this style of divestment portfolio management. The massive Norwegian Pension Fund’s recent decision to sell/remove oil stocks from its portfolio is a prime example.

But there is another way to do ESG, and it’s quickly gaining steam with some managers and institutional investors – and that is promoting and forcing change at a company. Just like an activist investor – think Carl Icahn or Bill Ackman – will target a poor-performing firm, meet with management, and use legal/proxy voting to extract value, some ESG managers are doing the same with ESG. Not enough gender diversity in management positions? We’re going to pressure you to add some. Using too much water in your operations? Let’s work to change that.

For the average retail investor, this is nearly impossible to do. But for larger institutional investors or asset managers, it becomes much easier.

While public and private funds, such as CalPERS, have started to use their muscle to invoke ESG changes, State Street recently unveiled that it was now getting into engaging ESG investing. In a letter to various portfolio companies, President and CEO Cyrus Taraporevala wrote that the asset manager is changing its approach when it comes to engaging with corporate boards. And thanks to recent events like the pandemic, climate change and social issues, it can no longer be ignored.

Similar to sentiments echoed by BlackRock’s CEO Larry Fink, State Street isn’t looking at ESG changes so much as value statements, and more as necessary for better returns. In the letter, Mr. Taraporevala wrote, “For us, these issues are matters of value, not values — opportunities for companies to mitigate downside risk, innovate, and differentiate themselves from competitors. To that end, we view the use of our voice and our vote as central to our fiduciary responsibility to our clients to maximize long-term risk-adjusted returns.”

With that, State Street will begin using its voice by targeting firms with the worst carbon emission numbers and push for change. Secondly, State Street is demanding that all the firms it holds have at least one woman as well as one person of color on their boards. Aside from meeting with management to discuss these issues, State Street is using its voting power to dismantle boards and remove CEOs and top brass who don’t meet its requirements.

The significance is that State Street is one of the largest asset managers on the planet. The firm had $42.6 trillion in assets under custody and/or administration and $3.9 trillion in direct assets under management. That’s a lot of equity voting power.

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State Street officially announced its plans for proxy voting and targeting firms that don’t meet its SRI requirements this year, which is a big deal. Ultimately, it provides credence to the growing ESG movement and the potential for the investing form to provide better risk-adjusted returns. Moreover, companies will no longer be able to sit and just talk a big ESG game or perform potentially “risky” behaviors anymore. They are going to be held accountable.

And with BlackRock – and its $10 trillion in assets under management – also pushing for similar ESG goals, real change is coming.

For investors, State Street flexing its proxy muscle could lead to better overall long-term returns and reduced risk across the board. This will be good news for investors’ portfolios. With the proxy season just getting started, it will be interesting to see how this plays out and when it starts providing rewards.

In the end, with more asset managers, pension funds and endowments starting to use their voices and votes to push for ESG, the next wave of engagement investing is on.

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