Constructivism: A Collaborative Approach to Stewardship
Our goal when investing is to be value makers. We believe constructive stewardship serves this aim well. Such stewardship is not just about the discharge of a duty. It is also about collaboration and understanding. It gives us an analytical advantage and can act as a source of alpha generation. This approach to stewardship is consistent with how we allocate capital and our culture of long-term investing because it allows us to learn more about and more effectively influence the companies in which we invest, which we believe will ultimately accrete value for our clients and help us achieve the best risk-adjusted returns we can for them.
In the investment industry, the prevailing wisdom seems to be that the stewardship decision is a binary one: You are either an activist or you are passive. We do not agree. There are many forms of effective stewardship. Academics from Oxford published a note on the four forms of stewardship: conservatism, opportunism, constructivism and activism. The diagram below outlines the key features of each approach.
Source: Four strategies for effective engagement | Responsible Investor (responsible-investor.com)
At MFS, we are in the constructivism camp. This does not mean we are afraid of escalating when necessary, but we think that the best outcomes are more likely to be achieved through strong relationships and regular dialogue with the companies that we have chosen to invest in.
Below you can find case studies of our stewardship in action.
Case study: “Common prosperity” in China
One of our ESG-dedicated analysts gave an internal presentation about “common prosperity” in China. The phrase is a Communist Party slogan meaning the effort to bolster social and economic equality. The team’s presentation focused on the financial materiality of common prosperity, highlighting the emphasis on creating inclusive economic growth driven by domestic consumption. Other topics discussed included the difference between wealth and income inequality, labor market reforms, worker protests and social security and benefits. The team discussed where we might be exposed in some of these areas and provided an analysis of employee productivity versus wage growth for MFS-held securities. The team also went over potential risk factors for some of these securities, including high employee turnover, labor controversies and government subsidies. We will continue to stay abreast of common prosperity developments in the coming years.
Case study: American chemical company
Building on earlier thematic research on the future of packaging, our team has continued to research different packaging opportunities and recycling technology. As part of this research, we identified a chemical company that is aiming to develop molecular recycling capabilities at scale. The company has perfected this technology over decades in other use cases, which gives it a unique opportunity to help close the loop by making certain plastics infinitely recyclable in an energy efficient and environmentally friendly manner. This new opportunity was a key driver of our analyst’s decision to upgrade the stock to a buy, as consensus does not appear to be giving the company credit for the potential 20% long-term EBITDA lift from this revenue stream.
Case study: North American oil and gas companies
As our team continues to evaluate the energy transition, we have found investments in the oil and gas industry that we favor. More specifically, several of our strategies have invested in a US exploration and production company with assets in the Permian Basin in the United States. As a result of the company having some the best US shale rock, potential long-term growth and a strong balance sheet, we expect the company to produce some of the cheapest oil with among the lowest emissions per barrel. Given this possibility of capital return to the business, we believe the company is a good investment for our clients. In spite of our decision to own this company, we are intentionally avoiding taking an excessively positive or negative view on the energy sector, instead focusing on individual fundamentals on the company level, as is our investment team’s heritage. For example, one of our Canadian energy analysts recently downgraded several Canadian midstream companies on concerns regarding slowing growth and terminal value concerns related to the energy transition.
Case study: Where we didn’t get it right
Sustainability considerations are complex and nuanced, and it is important to understand the different dimensions and how they relate to each other as well as other financial factors. For example, environmental considerations can have significant social impacts, such as the displacement of communities due to climate change or the economic repercussions for areas dependent on fossil fuel extraction. Furthermore, the importance of the materiality of a given sustainability factor can vary based on the company’s industry, geography or stakeholders. Stakeholders such as customers, employees and investors may also have different priorities when it comes to sustainability considerations, which can have varying effects on the financial aspects of these factors.
We highlight this nuance because investing is inherently difficult, and even the most skilled investors do not get it right every time. To illustrate this complexity, we share the following examples of where we didn’t get it right and learned valuable lessons. We believe that this type of self-reflection will lead to better investment decision making in the future.
In 2021, we had serious concerns about the culture and work environment at an American software company. These concerns led our analyst to move from a buy to a hold rating and certain portfolio managers sold the stock. The company’s next quarterly report justified our concerns, as the company’s culture appeared to hurt its ability to deliver new titles on the timeline the market expected. This led the stock to fall substantially. Unfortunately, shortly after that event, a major technology company agreed to acquire the company. This example highlights that even being “right” about a financially material sustainability topic may not always mean you should sell or pass on a given security. Instead, to produce the best outcomes for our clients, we need to consider all fundamental factors together, attempting to not under- or overemphasize any factor.
Separately, we have been long-term owners of a German pharmaceutical company that manufactures health care and agricultural products. The company has faced severe controversy in regard to the health impacts of its chemical products, which the company began to manufacture after an acquisition. The acquired company faced several controversies, and our view upon acquisition was that the parent management team would be a more responsible owner of the new subsidiary’s assets and products, some of which are highly sought after (e.g., seeds that resist drought). Unfortunately, we did not appreciate the risks associated with litigation related to these products, in spite of deep ongoing research into the topic and the risk. Our expectation was that the legal risk would be smaller than it has proven to be and that other positive aspects of the business would offset it, which has not been the case so far. Again, this example highlights the complex nature of financial materiality, and the need to accurately account for all relevant fundamental factors.
MFS may incorporate environmental, social, or governance (ESG) factors into its fundamental investment analysis and engagement activities when communicating with issuers. The examples provided above illustrate certain ways that MFS has historically incorporated ESG factors when analyzing or engaging with certain issuers but they are not intended to imply that favorable investment or engagement outcomes are guaranteed in all situations or in any individual situation. Engagements typically consist of a series of communications that are ongoing and often protracted, and may not necessarily result in changes to any issuer’s ESG-related practices. Issuer outcomes are based on many factors and favorable investment or engagement outcomes, including those described above, may be unrelated to MFS analysis or activities. The degree to which MFS incorporates ESG factors into investment analysis and engagement activities will vary by strategy, product, and asset class, and may also vary over time. Consequently, the examples above may not be representative of ESG factors used in the management of any investor’s portfolio. The information included above, as well as individual companies and/or securities mentioned, should not be construed as investment advice, a recommendation to buy or sell or an indication of trading intent on behalf of any MFS product.
Index data source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.
Statistics included in this report are calculated based on accounts for which MFS clients have fully delegated proxy voting authority pursuant to the MFS Proxy Voting Policies and Procedures. With the exception of the meetings voted statistics listed on page 47 of this report, all voting statistics exclude instances where MFS did not cast a vote. Statistics also do not include instances where an MFS client may have loaned shares and therefore was not eligible to vote. Statistics are calculated on a meetings-level basis. All engagement statistics listed above include only those managed by the MFS proxy team.
As an active manager, please be advised that the companies named in this report may no longer be held by an MFS client at the time that this report is published.
The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.