Morningstar - Q1 2021 - 44

Strategies

How Sustainable Funds Vote
Proxy results show a range of support
for key ESG resolutions.

PROXY

Jackie Cook and Jon Hale

By incorporating environmental, social, and
governance information into their analysis, sustainable funds may offer investors a more thorough
assessment of investment opportunities. As
owners of individual stocks, equity funds also offer
additional, if sometimes underappreciated,
benefits of a sustainable investment. These include
direct engagement with company management
about ESG-related concerns, voicing support for
better corporate ESG practices, and proxy voting on
ESG issues. Those who invest in sustainable
equity funds combine their assets with those of
their fellow fundholders and enable the fund
to use these assets to influence corporate behavior.
While it is relatively easy to compare sustainable
funds' risk-adjusted performance with relevant
benchmarks and peer groups, it isn't easy for
investors to assess how well a fund is handling its
ownership activities. Analyzing how a fund votes
its proxies on ESG issues is one way to do it.
All mutual funds must disclose their proxy votes for
the 12-month period between July and June
by Aug. 31 of every year by submitting form NP-X
to the SEC. While many funds provide a link
to their votes on their websites, it is a complicated
and time-consuming task to compare the proxy
votes of multiple funds across multiple issues.
In this article, we summarize sustainable funds'
ESG proxy voting. Using Morningstar's

data identifying sustainable funds, 2020 proxy
season votes reported in NP-X filings, and
company proxy ballots, we evaluate how
sustainable funds voted their proxies on a series
of key votes on shareholder resolutions
pertaining to ESG topics.
We find that sustainable equity funds tended
to support these measures at a higher rate than
did other funds, which is in keeping with our
expectations that sustainable funds, in general,
use proxy voting as a tool to express their concerns
about material ESG issues. However, we also
find considerable variation in levels of support for
key proxy votes among sustainable funds. This
variation is related to whether the fund is advised
by an asset manager with a greater commitment
to sustainable investing. Investors, therefore,
cannot conclude that all sustainable funds behave
the same on this important dimension of
sustainable investing.
A Key-Vote Approach
Every year, thousands of items are put to
shareholder vote via the corporate proxy ballot;
most are proposed by management, some
are proposed by shareholders. Morningstar tracks
all resolutions across all ballots that come to
a vote at U.S. companies-about 35,000 ballot
items a year. Management nearly always
recommends a vote for its own resolutions, many
of which are not controversial, and against
shareholder resolutions, many of which
raise concerns about management's approach
to ESG risks. As a result, most management

resolutions pass easily, and most shareholder
resolutions fail to reach a majority.
Shareholder resolutions push companies to
do better across a range of ESG issues. Examples
include resolutions on climate change that
ask companies to be more transparent about the
climate risks they face and their strategies to
reduce their carbon footprint. Others may ask that
policies be put in place that nurture diversity
and inclusion across workplaces or request that
audits be conducted of the treatment of
workers across supply chains.
A shareholder resolution does not need to earn
majority support to have an influence. In
fact, such resolutions are considered advisory, so
even a majority vote does not bind management
to a specific course of action. Vote outcomes
are a signal to firms about shareholder sentiment
on the issue and, as some resolutions may
reappear on a ballot in subsequent years, about
the direction in which that sentiment is heading.
Resolutions can serve to open discussions
between management and shareholders. The
influence of a proxy vote can extend to other
companies, as well. When an issue receives strong
support at one company, its peers also take note
and may take steps to address the issue.
In 2020, 186 ESG-related shareholder resolutions
appeared on proxy ballots. Average support was
28% of shares voted. Twenty ESG-related
resolutions achieved the support of a majority of
shares voted, breaking the record of 14 set in
2019. Sixty-seven of the 186 ESG-related resolutions
received at least 40% of the vote of minority
outside shareholders.1 We have identified these as
key votes and used them as the basis for our
analysis. There are many nuances to interpreting
a proxy voting, but using key votes focuses on
those resolutions that clearly resonated across a
company's shareholder base.
Collectively, the key votes highlight the main
shareholder concerns in the 2020 proxy

1 At some companies, large blocks of shares are owned by controlling or affiliated shareholders-such as founders or parent companies. We eliminated the impact of these " affiliated
holdings " because these would almost certainly have been voted with management and against the resolution and would not necessarily represent the interests of outside, or nonaffiliated,
minority shareholders.

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Morningstar - Q1 2021

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