YLDE - ClearBridge ESG Investment  Strategy Q2 2023 Portfolio Manager Commentary

2023-07-22 04:30:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• ClearBridge is guided by fiduciary principles and votes proxies in the manner that we believe will be consistent with efforts to maximize shareholder values, at times voting against management and at times against proposals that are overly prescriptive or unnecessary.
• ClearBridge takes a fundamental-driven approach to proxies, with portfolio managers bringing company-specific knowledge to bear on issues such as executive pay, use of controversial technology and biodiversity.
• Social-themed proposals from shareholders of large public companies have been increasing in recent years, requiring increased due diligence to properly weigh intentions and potential consequences.

By Robert Buesing, Naveen Jayasundaram, Michael Kagan, & Mary Jane McQuillen

A Fiduciary-Driven and Thoughtful Approach to Proxy Voting

Why Is Proxy Voting Important?

The U.S. proxy season, most active between April and June each year, is when the majority of companies hold annual shareholder meetings. These meetings give shareholders a chance to review financial performance and to vote on resolutions made by both management and shareholders that address important issues affecting each company, called proxy votes. Broadly, issues include corporate governance, such as the election of board directors and management pay, as well as social and environmental matters that may be relevant to a company’s operations, products and services.

Shareholder proposals in 2023 have focused on a wide variety of environmental and social topics, with climate change, political spending/lobbying, human rights, diversity, equity and inclusion ((DEI)) and health/safety foremost among them. ¹

ClearBridge takes a fundamental-driven approach to proxies on behalf of clients, with portfolio managers bringing company-specific knowledge to bear on these and other issues. In voting proxies, ClearBridge is guided by general fiduciary principles. Our goal is to act prudently, solely in the best interest of the beneficial owners of the accounts we manage. We attempt to provide for the consideration of all factors that could affect the value of the investment and will vote proxies in the manner we believe will be consistent with efforts to maximize shareholder values.

At the same time, along with direct and ongoing company engagement, proxy voting is an important part of our approach to positively influencing companies through active ownership. ClearBridge’s votes on proposals filed by shareholders or by management are an effective way to signal confidence in the companies we own or to suggest the need for a change in policies, disclosures or related aspects of a company’s business.

Independent Voting, Informed by Company Fundamentals

A key part of ClearBridge’s approach to voting proxies is how portfolio managers take an active role. Some models of voting treat proxies as a largely administrative responsibility, so committees may be staffed with generalists with no investment experience. Other models simply hire a third-party proxy adviser. We would consider that an abdication of our fiduciary responsibility: we believe as fiduciaries the investment teams should have informed opinions on the proxies we vote, similar to the informed opinions we require to invest in or exit a given security. At ClearBridge, proxy voting forms an essential part of the fundamental investment and ownership process.

Pushing for Pay Equity

In some cases, our votes signal the need for companies to improve sustainability practices such as pay equity. These cases often involve voting against management, as we did in the case of Netflix’s ( NFLX ) proposal to ratify named executive officers’ compensation, a so-called “say on pay” vote. This was also a case where we took into consideration other stakeholder views; the Writers Guild of America reached out to us directly to share its perspective, given its current contract negotiations with major studios.

While this input did not sway our vote directly, we ultimately voted against this proposal due to 1) the magnitude of compensation, which for co-CEOs amounted to over $74 million including salary, stock and eligible bonus (the Writers Guild of America asked for $68 million for ~12,000 people), 2) the need to better tie bonuses and equity compensation to performance criteria, and 3) the ability for Netflix executives to receive an unusually high portion of their compensation in cash, instead of equity stakes, which we believe is a form of compensation more aligned with long-term value creation. Consistent with our active approach to ownership, we shared detailed feedback with Netflix on this proposal following the annual general meeting.

Supporting Biodiversity

Plastic pollution is ubiquitous, threatening ecosystems and biodiversity, a term that, in the context of sustainable investing, refers to the way ecosystems, which provide humans basic needs like food, fuel, shelter and medicine, may be positively or negatively affected by industry. This year Amazon.com ( AMZN ) received a shareholder proposal requesting it to issue a report on pollution from plastic packaging, including an assessment of its efforts to reduce the impacts on the environment.

In weighing our vote on this proposal, while we acknowledge that the company has made progress in reducing its packaging materials, we noted Amazon does not provide an overall baseline amount of plastic used throughout its supply chain. Although it disputes the filer’s claims regarding its plastic use, it does not provide competing data that allows investors to assess its progress. Meanwhile, several of Amazon’s peers have announced goals specifically around single-use plastic reduction. Although Walmart’s and Target’s sustainable packaging goals focus on private label products, we believe Amazon should be able to monitor third-party seller plastic use, given its knowledge of every item sold on its site. Amazon’s third-party marketplace has been growing faster than its first-party sales for the past several quarters, making it all the more important for the company to work with third-party sellers on surfacing their plastic usage data, even if not all of them are measuring that information today.

Concern over the environmental damage caused by plastics is rising and regulations are likely to go into force in many jurisdictions that would limit the amount of single-use plastic packaging that can be used. Additional disclosure would help shareholders gauge whether Amazon is appropriately managing risks related to the creation of plastic waste. We believed a vote for this proposal and against management was warranted in this case.

Companies Are Making Progress on Topics of Social Proposals

Proposals on pressing social topics saw less support in 2023 than in previous years, with median support for social proposals falling from 32.5% in 2021 to 24.1% in 2022 and 18.2% in 2023. ² However, this is not necessarily a sign of waning interest in these topics — indeed, the number of social proposals has been steadily increasing (Exhibit 1) — but can reflect a higher number of proposals submitted and the effect of company engagements on behalf of active owners like ClearBridge helping companies make progress on several fronts. In social topics as diverse as facial recognition, animal welfare and child labor, ClearBridge holdings have been making progress, and our votes signal our confidence in the companies we own.

Exhibit 1: Social and Environmental Proposals Continue to Increase

In 2023, a filer requested that Amazon disclose a third-party report on the company’s Rekognition facial recognition system. We found, however, Amazon’s oversight and guidelines for the technology to be sufficiently robust. Its Nominating and Corporate Governance Committee has oversight over corporate social responsibility practices, including risks related to human rights and ethical business practices, as well as risks related to operations and engagements with customers, suppliers and communities. In its Acceptable Use Policy, Amazon clearly prohibits using its services in an unlawful manner. Amazon states that it supports and has suggested guidelines for developing governmental regulations around these technologies.

Amazon has also established guidelines for customer use of facial recognition technology, specifically with reference to law enforcement agencies, including human review; a 99% confidence score; reliance on the technology as a starting point and not the sole determinant in taking action; transparent use of the technology and safeguards in place; and trained personnel using the technology. It has also published additional resources for guidelines on using facial recognition for public safety cases, and in June 2020 announced a one-year moratorium on selling the use of Rekognition to law enforcement to give Congress time to develop regulations around the technology. The company has now indefinitely extended this moratorium. In addition, Rekognition is an image analysis service, not a surveillance system, and similar tools are available from many other vendors. We believed a vote against this proposal was warranted.

Prioritizing Shareholder Benefit

Sometimes we may deem proposals to have little to no benefit for shareholders, even while we agree with the spirit of the proposal. For example, this year global snack food and beverage company Mondelez International ( MDLZ ), which operates under brands such as Oreo, Ritz, Toblerone and Cadbury, received a proposal requesting that it disclose updated cage-free egg benchmarks. The company outlines its animal welfare policies and goals, and it states its commitment to the Five Freedoms of animal welfare. It has a goal for 100% of its egg supply globally to be cage-free by 2025, excluding Ukraine and Russia. As of the end of 2021, it reports that 39% of eggs supplied globally were cage-free and 100% of the egg ingredients purchased in the U.S. and Canada were cage-free.

Overall, Mondelez appears to be making progress on its cage-free egg goal and discloses adequate information about its animal welfare policies. Although it makes interim goals for some of its other commitments, such as its climate targets, those targets tend to stretch over a longer time period, making interim goals more useful. Shareholders are unlikely to benefit from the requested update to such short-term goals, especially as Mondelez annually reports its progress toward its goal, which is set to be completed in 2025. For these reasons, we voted against this proposal.

Similarly, we voted against a proposal at Mondelez that asked the company to adopt and report on targets to eradicate child labor in its cocoa supply chain. Cocoa is a key ingredient in Mondelez’s chocolate products. ClearBridge has engaged Mondelez for several years on responsible sourcing in its cocoa supply chain, and believe it to be a leader with its Cocoa Life program, which launched in 2012 to improve sustainability in its cocoa supply chain in areas such as deforestation, improving cocoa farmer incomes and enhancing child protections. In a 2019 company engagement, we discussed its new commitment to source 100% of cocoa for its chocolate brands sustainably through Cocoa Life by 2025, up from 43% at the time. As of the end of 2022, this number is 80%.

The company also has goals for its Child Labor Monitoring and Remediation Systems (CLMRS) to cover 100% of Cocoa Life communities in West Africa; this number was at 74% in May 2022. In a late 2022 engagement we discussed Mondelez’s expanding its Cocoa Life spending by $600 million, up from $400 million. It noted farmer net incomes had increased by 15% in Ghana and 33% in Ivory Coast over the past decade, but there were still systemic challenges for cocoa farmers.

Overall, in-depth knowledge of the company and years of engagement on the topic leads us to believe Mondelez has set and progressed on meaningful targets which are not substantially different than those asked for in this proposal; for this reason we voted against it.

Proxy and Engagements Form Part of Active Ownership

ClearBridge proxy voting and company engagement go hand in hand as part of an active ownership strategy; our engagements can continue conversations with companies on sustainability topics raised by past shareholder proposals.

While engaging Mondelez on its 2023 proxy items, for example, we also caught up on topics from past proxy discussions, such as 2019’s proposal to report on deforestation in Mondelez’s supply chain. Large-scale deforestation results in reduced biodiversity (forests contain the vast majority of Earth’s amphibian, bird and mammal species) and destroys valuable carbon sinks able to help combat climate change.

ClearBridge voted against that proposal, finding the company had a comprehensive set of initiatives in place to reduce the deforestation impact of its cocoa supply chain. In 2023 the company found that, based on satellite images, there had been minimal deforestation since 2018 when it started working on pro-environmental community investments and education initiatives. It is also seeing positive progress on reforestation, growing local incomes from non-cocoa sources.

A Comprehensive Proxy Voting Policy Supports Consistent Voting

The ClearBridge Proxy Voting Committee, comprising mainly portfolio managers, analysts and legal/compliance personnel, meets at the beginning of each year to review the upcoming proxy season and to make amendments to ClearBridge’s Proxy Voting Policy to reflect our latest views on corporate governance, environmental and social proposals. The committee also meets after the proxy season to review and reflect on the proposals and votes that took place that year. Moreover, the investment teams will engage with the investee companies (and shareholder proposal proponents) throughout the year on proxy matters and vote rationales, and to ask questions.

While investor support for environmental and social proposals overall went down from 2022 to 2023, one of the more common reasons for certain votes against shareholder proposals was due to the “language” in them: proposals were poorly worded, overly prescriptive or deteriorative to shareholder value. This underscores the value of the Proxy Voting Policy to ClearBridge’s investment teams, as well as the direct involvement by the portfolio managers in voting on proposals that fall outside the policy. ClearBridge maintains a 100% vote record.

Robert Buesing, Director, Senior Analyst for Consumer Staples/Durables

Naveen Jayasundaram, Director, Senior Research Analyst for Media and Internet

Michael Kagan, Managing Director, Portfolio Manager

Mary Jane McQuillen. Head of ESG, Portfolio Manager

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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