Vanguard Active Insights Morning 2022: A focus on sustainability

Register to hear from the exceptional talent behind Vanguard’s four new active ESG funds, as they look to share their views on sustainable investing with advisers at our virtual active insights morning on 12 May.

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Joshua Woodruff and Adam Levison, senior investment directors, Oversight & Manager Search, Vanguard

Recognising how ESG risks, like climate change, can erode shareholder value over time, Vanguard regularly engages with current and prospective external fund managers to assess their ESG practices and understand how ESG issues inform their investment processes.

This applies equally to firms which do not have explicit ESG mandates with us as well as those which manage ESG-specific active funds, such as our long-standing partner Wellington Management Company, which manages the Vanguard SustainableLife range of funds.

Vanguard’s Global Oversight & Manager Search (O&MS) team is tasked with understanding how all of our active portfolio managers regularly incorporate financially material ESG considerations into their security selection processes.

The O&MS team consists of more than 20 professionals within our Portfolio Review Department. It is dedicated to doing this as part of its wider due diligence programme for external managers and is incorporated as part of the four pillars of assessment that we have traditionally used to guide our search for active managers: firm, people, philosophy, process.

How stable is the firm? What is the calibre of the investment team, including the portfolio manager? What inefficiency in the market is the team trying to take advantage of? How long has the team been investing this way? These are the types of questions that help O&MS to uncover whether a fund manager will be successful at managing portfolios over the long term.

Part of this process involves the consideration of a portfolio manager’s focus on ESG issues in the context of financial materiality and in the best interest of clients. Issues related to the way a company is managed and its effect on the environment and society can damage its reputation, impact profits and harm a company’s share price. ESG isn’t just about risk though. It can help highlight opportunities too.

The team is not looking for adherence to any single, predefined approach. It values diversity of thought, which is why it recognises that each portfolio manager is likely to have his or her own approach for integrating ESG considerations into their research and decision-making process to ensure that they allocate capital wisely.

The O&MS team’s assessments of our external fund managers include how they gather ESG information, how they structure their ESG research efforts, the extent to which both qualitative and quantitative factors are considered in their analysis and how the portfolio manager votes proxies (shareholders can vote by proxy on the issues which affect a company’s financials even when they are unable to attend a shareholder meeting in person, which is particularly helpful for fund managers with a global mandate).

The team discusses with each firm recent examples of how ESG-related issues have influenced investment decisions. At the individual security level, have there been any changes to the investment thesis? What is the long-term viability of a business model? To what extent are companies which are deemed to have weaker ESG credentials, trying to pivot into other areas?

For example, a primary topic of conversation among portfolio managers investing in metals and mining companies has been decarbonisation and how the potential movement away from coal energy could impact management strategy relating to future capital allocation decisions. 

The objective of the O&MS team is not to be prescriptive and to tell a portfolio manager what he or she can buy or sell. It is about ensuring that they have done their due diligence on a security. The team expects to hear their rationale for holding a stock and how they engaged with company management on ESG issues.

At a more holistic portfolio level, O&MS works with a portfolio manager to understand how ESG and sustainability is integrated in a way that is intrinsic to his or her investment philosophy and process.

The team also uses MSCI and Sustainalytics, leading independent providers of ESG-related research, to conduct analysis on each portfolio. This effort enables the team to quantitatively assess ESG risk exposure at both the individual holding and overall fund level.

Additionally, the O&MS team provides periodic reporting to Vanguard’s senior management panel led by Vanguard’s CEO for each fund, outlining each portfolio manager’s ESG philosophy and practices.

The portfolio managers which manage Vanguard’s active funds have a wide range of investment approaches and areas of focus, from growth to value, large-cap to small-cap, and quantitative modeling to bottom-up fundamental stock research. The same is true for the firms’ approaches to ESG integration.

While Vanguard does not prescribe a particular method for managers to incorporate ESG risks and opportunities, we are pleased to have some of the industry’s most respected and forward-thinking investment teams applying their unique perspectives to the portfolios they manage for Vanguard.

How do we manage proxy voting for our externally managed funds?

In 2019, Vanguard granted full proxy voting responsibilities to each external portfolio manager for the portions of the funds they manage. This enables portfolio managers to integrate their proxy voting activities and company engagement into their investment strategies.

While each portfolio manager follows its own policies and guidelines that govern proxy voting decisions, Vanguard has carefully selected managers whose principles and processes align with the objectives of the funds they manage. By aligning investment management and stewardship, Vanguard believes that good corporate governance practices can create and protect shareholder value over the long term.

ESG-specific mandate: Wellington Management Company

When selecting active managers for specific ESG mandates, Vanguard’s O&MS team is looking for breadth and depth of dedicated ESG and sustainability resources alongside more traditional equity and fixed income resources.

That is why Wellington was chosen to manage our SustainableLife range of funds. Vanguard looks to ensure that a portfolio manager’s process and philosophy stand up to scrutiny and this is where we believe that Wellington shines.

Wellington is one of our largest external advisory partners, both by total assets under advice and number of mandates. One reason why is Wellington’sunique internal structure. It is a research and investment-led firm with dedicated, centralised resources not only for equities and fixed income but also for ESG and sustainability. There is no chief investment officer, and the firm is a community of investment boutiques, which fosters a wide range of approaches.

The concept of collaboration is very strong and culturally embedded into the firm. Within the SustainableLife range of funds, ESG analysts have an important role to play. The ESG team helps the portfolio managers to understand the wider corporate culture of the underlying companies, as well as environmental, social and governance issues.

This means that there are multiple perspectives on a single security. In our view, this level of input to identify risks and opportunities in a portfolio and among companies held within a portfolio goes above and beyond the typical financial and fundamental analysis that other firms might conduct.

We believe that it is Wellington’s overall investment process, and strong research capability in particular, that gives it an ‘active edge’, or competitive advantage.

Our long-term approach to manager selection and oversight – the same long-term approach we advocate for investing – is built around three core principles that underpin our approach to active management: keeping costs low, tapping into quality talent, and having patience. 

By following these three principles, applying the four pillars we use to assess active managers: firm, people, philosophy, process and incorporating ESG considerations, we feel we can identify active managers who are best placed to deliver long-term value to clients – whether within a non-ESG or ESG-specific mandate.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall.

Investments in smaller companies may be more volatile than investments in well-established blue chip companies.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

The fund may use derivatives in order to reduce risk or cost and/or generate extra income or growth. The use of derivatives could increase or reduce exposure to underlying assets and result in greater fluctuations of the Fund’s net asset value. A derivative is a financial contract whose value is based on the value of a financial asset (such as a share, bond, or currency) or a market index.

Some funds invest in securities which are denominated in different currencies. Movements in currency exchange rates can affect the return of investments.

For further information on risks please see the “Risk Factors” section of the prospectus on our website.

Important information

This document is directed at professional investors and should not be distributed to, or relied upon by retail investors. This document is designed for use by, and is directed only at persons resident in the UK.

For further information on the fund's investment policies and risks, please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The KIID for this fund is available, alongside the prospectus via Vanguard’s website https://global.vanguard.com/

The information contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document is general in nature and does not constitute legal, tax, or investment advice. Potential investors are urged to consult their professional advisers on the implications of making an investment in, holding or disposing of shares of, and the receipt of distribution from any investment.

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