Are divestment and engagement compatible in responsible investment strategies?
Scientific Beta challenges the common perception that investors must choose between divestment and engagement to influence companies' ESG behaviours in their « ESG Engagement and Divestment: Mutually Exclusive or Mutually Reinforcing? » article.
They also examine the effectiveness of ESG mixing strategies, such as ESG integration, in comparison to ESG filtering, and conclude:
- Divestment and engagement are not mutually exclusive but mutually reinforcing strategies in promoting ESG outcomes.
- Divestment can influence companies by raising their cost of capital, thereby limiting their ability to invest in projects deemed harmful by the investor and incentivising management to improve ESG performance.
- Engagement, when managed and executed properly, can also improve the ESG and the financial performance of investee companies.
- The possibility of divestment strengthens the position of shareholders in engagement by providing a credible threat if engagement fails, making divestment a prerequisite for effective engagement.
- ESG mixing strategies, such as reweighting or optimisation based on ESG scores, can lead to divestment but may send muddled signals to companies, potentially undermining engagement efforts.
- ESG filtering, which involves removing the worst ESG performers from the investable universe, sends clearer signals to companies and, when combined with engagement, can be more effective in inducing change.
Ultimately, combining clear divestment criteria and active engagement may be the most efficient approach to influencing corporate behaviour.
The rise of collaborative engagement campaigns, in which existing and potential shareholders join forces, is a testament to the fact that divestment does not end the opportunity for an investor to engage with a company.