How ETFs are managing ESG engagement

Without the option to divest, engagement is the only effective lever available to sponsors of passive ETFs that wish to influence the long-term direction of underlying companies, Thomas said. And too many are willing to let management off the hook.

“ETFs for too long have been predicated mainly on low management fees, which means they can’t add on extras,” Thomas said. But if portfolio managers are serious about performance, “then engagement is not an add-on, it’s a necessity.”

At BMO Global Asset Management, head of responsible investment Nalini Feuilloley and her team work with portfolio managers and analysts across the company’s funds to ensure investee companies understand BMO GAM’s expectations on ESG issues.

“Once we’re invested in a basket of securities, we can leverage that position to actually have meaningful dialogue with those individual companies to try to effect change and improve their ESG performance,” Feuilloley said. “We don’t necessarily disclose on behalf of what fund we are engaging. We look at our exposures across all of our funds — ETFs, commingled funds, mutual funds or whatever vehicle where we have exposure — and we do it in the name of BMO GAM as the portfolio manager on record.”

Using that approach, almost one-fifth of BMO GAM’s votes on AGM agenda items at Canadian investee companies went against management, according to the firm’s 2022 proxy voting report, the most recent available.

BMO GAM put its weight behind 53% of shareholder proposals related to climate action and social equality, generally supporting calls for racial equity audits and proposals demanding enhanced disclosure on climate strategy and targets.

While Feuilloley acknowledged that BMO’s assets under management get companies’ attention, she said there’s room for boutique players to engage as well. “Issuers might not give as much time to smaller investors as they would bigger institutional investors who represent a larger share of their pie, but I would say boards and management of public issuers, especially these days, are very open to engaging on sustainability or ESG issues.”

Even when ETF sponsors exercise their proxy voting rights, it can be a relatively blunt engagement tool for investors, according to Tim Nash, president of Good Investing, a fee-for-service financial planning firm in Toronto that focuses on sustainable investing.

With a significant proportion of shareholder-initiated ESG proposals unsupported by larger asset management firms, Nash said individual investors with more activist mindsets may disagree with how fund managers vote. “But right now, they don’t get any say,” he added.

Some firms are coming up with ways to involve individual investors. For example, BlackRock Inc.said earlier this year that it would expand its “Voting Choice” service — originally available only to institutional clients — to retail investors with holdings in the company’s largest ETF, the iShares Core S&P 500 ETF in the U.S. The program allows investors to choose a voting plan from proxy advisers Institutional Shareholder Services Inc.and Glass Lewis & Co.that reflects their level of support for ESG considerations, including options that prioritize climate proposals and another that is generally supportive of issuers’ management.

“If there is more customization available, so that the shares from one ETF are not voted the same way across the board, then it would allow investors to feel a more direct sense of ownership and control over their proxy votes,” Nash said.

In Canada, Nash said he would like to see more ETF providers teaming up and outsourcing their engagement function to a specialist service provider.

“The question is how much would it cost, and whether investors are willing to pay a few more basis points for more proactive engagement,” he said.