Sacha Sadan: ESG is now mainstream

He also discusses Legal & General's hunt for humility and honesty in the annual report and how they are working to improve engagement between firms and their owners.

Why do you believe that companies and investors’ responsibilities extend beyond their direct stakeholders to society as a whole?

Companies are intrinsically linked with their societies as a whole and specifically by their most important stakeholders – their employees.

Let us take an example such as climate change. If you are a company and you do not consider what effect climate change might have, it could dramatically affect your business model within the next 10 to 15 years. Whether it is directly or indirectly, it is linked to the success of your own business.

The reason why an investor, such as LGIM, gets involved now becomes clearer. We look after millions of peoples’ pensions and we want those pensions to be paid over the long-term and the dividends to be strong. If the companies are not thinking about these longer-term effects, then they will end up with lower dividend payments.

So companies have got to be aware of the society they operate in. If you do not look after society, the government may end up implementing a massive regulatory tax to compensate, which then affects your business capability in a different way.

Why is this issue getting a lot more attention now, than perhaps five or ten years ago?

In the past, people have had to explain that concepts such as environmental, social and governance (ESG) issues, active ownership and socially responsible investment (SRI) are not niche investment concerns.

“There may be a disconnect between what the company thinks the investor wants to talk about and what they actually want to engage on”

The global financial crisis had an impact here, but also societal attitudes and the modern generation. This generation is asking where their food comes from, whether companies are using unfair labour practices and if they are paying their fair share of tax. This sentiment, coupled with social media and other factors, make these higher-profile issues.

And of course, politicians are not naïve. They look at focus groups, at what could win them votes and therefore bring these issues higher up the agenda.

All of those factors have collided to bring ESG concerns into the mainstream. They are on the front pages of the newspapers, where in the past it would be only in a subsection of the business pages – diversity is a great example, or the gender pay gap, which is regularly the first item on the news.

The world has changed, for all those reasons and more. My team at LGIM feel pretty fortunate that the structure of where we sit in the organisation makes it easy for us to be as vocal on these issues as we are.

It is all about conflicts of interest – there are some amazing people doing similar jobs, but they are sitting three levels below the CEO or have managers who may prefer they did not shake things up.

And let us face facts – sometimes the actual company they work for has governance practices that are not too good themselves and therefore they feel embarrassed to shout loudly when they have not got their own house in order.

For these reasons, we feel comfortable that if we are not happy with something for our clients, we will say something. We put our clients first – everything we do is about looking after our clients’ money and improving governance practices across markets.

Do you worry the attention on non-financial assets – such as purpose, culture, sustainability – is a bit of a trend and companies are paying lip-service until public attention shifts?

Of course we can box tick on these issues, but most companies realise now that ESG issues are a vital part of how they are going to survive and thrive.

Companies are competing in a really hard world against other amazing companies, who also want the best graduates and management executives, and people are more than ever wanting to work for a company they believe in. Talent remains the long-term driver of corporate success.

“Most companies realise now that ESG issues are a vital part of how they are going to survive and thrive”

I do not think the issue of diversity is going away, for example. Diversity is a business decision; if you do not have the right people at the top and that diversity of thought, you will not overcome the challenges you face as the world around you changes. Blockbuster called Netflix a ‘small niche business’.

And we have had many examples of that over the years, but we have got more technological change to come in most industries. There will always be winners and losers, like there are with most things in life, but if companies are not acting authentically on this, they will be at the wrong end. And they will be at the wrong end of investors like LGIM, who will push them to do better.

You can pay lip service to ESG issues, but you will lose in the end.

What are the crucial indicators of good governance that, as an investor, you look for in a company?

It starts from the top: what kind of management team and board of directors a company has. We look for the all-important humility: whether the annual report talks about things that are not perfect, or if it considers everything through rose-tinted glasses. We take note of when the directors come to meet us, if they open and constructive.

Companies will not always get things right. Life is hard. It is hard in my job and it is certainly very hard running a global company. But the question is whether they are trying, whether they are open to new ideas and whether they can make challenging decisions. Because what they should be trying to do is to win, not just to look good. We can tell the difference.

With issues like a board effectiveness review, there is a clear difference between one that is a paragraph long and says ‘our board functions effectively’ and another that says ‘these are seven things that we can do this year to make our board even better. Here are the five that we identified last year and we have managed to implement all of them’. That is a good sign of a company that is trying.

What is it that you go straight to in the annual report to tell you something about that company?

One is the chairman’s statement – again whether it shows humility.

The strategic report is of course vital; what is this company trying to achieve? The purpose statement can be very small, but can be very useful, and then, as mentioned, there is the board effectiveness review.

If you look at those four things and you feel that they are trying in those areas, that gives you some input into what you would ask next. It is like anything – you need to ask questions and get involved. One cursory look at anything is never enough, but it is a good starting point to where we could go next.

The other one, of course, is executive pay. We look at how much stock the management own and how they get incentivised and over what period.

After quite a few years in the business, I know of some CEOs who have still got under 20% of their salary in stock. That is no kind of commitment. We like skin in the game. Many good CEOs have two, three, 400% of their salary in stock and are fully aligned with their shareholders.

What are some of the things that you regularly see companies doing in annual reports which frustrate you?

Boilerplate language. You see different companies using the exact same words. Saying things like ‘our most valuable asset is our employees’ but then not really talking about what things they are doing to look after them or show any reason why they genuinely believe this.

Equally, where a company cuts and pastes things from the year before. I mean that is just lazy When you read an annual report, it does not take long to work out whether a company has tried with the process; to see whether it is all joined up, or whether it is just individual sections – where everyone has written their bit and then just bolted it together, without a core message that runs cohesively and coherently throughout.

That difference really does shine through.

The main reason for producing an annual report is to give the shareholders, once a year, a view of how the company has performed and what they are striving to do on behalf of their shareholders.

From the investor perspective, could the current annual report process be improved?

I think the current process is the right way. But we could be more innovative; for example: with interactive elements or charts, graphs and pictures.

We do not want too much information too regularly, because we want the company to be running the business. We already have been pushing against quarterly reporting, because that means the business has to jump at a pace it does not work at.

An oil and gas company or a pharmaceutical company does not make 13-week business decisions, so they should not have to report every 13 weeks to their investors.

That said, if you are a really short-term retailer and Christmas is the most important period, of course we want to know about your performance after Christmas.

But most companies run on longer-term pipelines. So we do not want companies to keep updating information – we do not need a live view, we just need to know that the company is being run the right way. Tell us at the end of the year we have had six bad things and six good things, and net we are okay.

“Sometimes companies and investors speak different languages. It is in all of our interests to work better at this”

We have got to be careful that just because technology is available, we do not encumber the business with even more things that do not help them create value for our clients.

What are the main areas that you are looking to engage with companies this year?

We always go back to first principles, because otherwise you can get yourself tied in knots. Directors and chairmen are employed to run the companies on shareholders’ behalf. We should not be second-guessing what they are doing.

We would not be very good at it anyway. We like to be involved in the succession planning and the nominations of the people at the top of the organisation. Because if we get that right, everything else should fall into place.

We do look at laggards and we have to do the ‘management by exception’ rule. We look at companies that are not performing as well as they can be – and I do not just mean financially – over a longer period of time.

An example would be, why does that company have an all-male board in 2018, when many investors, including ourselves, have been pushing on this for so long? Or why is the gender pay gap so big in one company compared to the rest of the sector? We would look at that and then we would challenge the company in engagement.

How can we foster better dialogue and relations between companies and their owners?

Most investors care about their companies that they invest in and most companies do want to meet their shareholders, but sometimes we speak different languages – or at least have done in the past. There may be a disconnect between what the company thinks the investor wants to talk about and what they actually want to engage on.

It is in all of our interests to work better at this, so I would not use a blame game. And we, as investors, are all trying to up our game by adding more resources to focus on these issues.

We have pushed very hard with The Investor Forum, which has been set up to try and collaborate more, and have strategy and stewardship meetings, so that a company can meet 20 of its investors in one go. This saves time but also means the message comes across in a consistent fashion.

In September, we will have another non-executive director day at LGIM, where we get the directors who, because they are not the chairmen, do not always get to meet shareholders, to come in – there were 70 last year – and discuss with them what we think are important issues.

We are extremely proud that we have won the ICSA award for best investor engagement three years in a row [2017, 2016 and 2015]. It is always nice to win awards, but particularly with this one, because the ICSA awards are mainly about listed companies – and of course we do vote against some of these companies! But we always try to explain why.

So we are trying to be better, but I am aware that we are not perfect. The mood between the two parties is improving, however there is more work to be done.

Interview by Henry Ker, editor of Governance and Compliance