State of Play: Effective Stewardship and Reaching Net Zero

Where are we on the road to net zero? And how can investors help companies along the transition? In this episode of the All Angles podcast, Franziska Jahn-Madell, Director of Global Stewardship at MFS, explains recent developments in the transition to net zero and describes how investors can constructively engage with companies. Fran also shares her thoughts on stewardship megatrends and questions the industry should be asking companies but aren’t (yet).

Vish Hindocha:

Hello, and welcome to another episode of the All Angles podcast. In this episode, we invite back Franziska Jahn-Madell. She's the director of stewardship at MFS, and in this episode, we'll talk about the state of the net zero transition, we'll talk about some of the other adjacencies in stewardship.

We'll actually explore what some of the work we've been doing as MFS with academics and other institutions and think tanks around the resourcing, the efficacy of constructivism and stewardship and how stewardship teams are operating today, and land on some of the things that Fran thinks maybe are the subtleties that investors and asset allocators may be missing today. I hope you gain from this conversation as much as I did. Thanks for listening. Fran, welcome again to the All Angles podcast. Thank you for coming back.

Fran Jahn-Madell:

Thank you for having me.

Vish Hindocha:

We first recorded our conversation and published it in May ‘22. It was two years ago. That conversation centered around stewardship, in particular in the context of net zero.

And I feel like so much has changed in the last two years, and yet net zero and stewardship continue to be incredibly hot topics with all of our clients and all of our stakeholders in the industry.  

How would you characterize where we are in the net zero transition today, two years on from before? Where are we? What are some of the good news stories? And where are some of the spots where we need to do more work?

Fran Jahn-Madell:

Yeah, absolutely. As you know, Vish, I'm an optimist so I'm going to definitely start with the good. I think news flow, political issues in our home country, the US, have distorted, sometimes, the good news. I suppose human behavior always focuses on the bad news, so I'm going to really lean in on the good news. If we think about OECD emissions, they have fallen for a solid decade, so you shouldn't forget that, that we are on the right trajectory.

Emissions are decoupling in China and in the global South. So again, really good news. If you look at, for example, the business-as-usual scenario for the IEA in 2015 when the Paris Agreement was signed, temperatures were pitched at 3.6, and now the IEA business as usual scenario is at 2.4. So again, it's going in the right direction. And also, if you look at cost curves, for example, for new technologies, which is a great interest for us engaging with industrial companies that we feel are really moving quite fast now, they are steadily falling, which is going to enable other industries to decarbonize their scope three. And companies are talking about that. Two years ago, they didn't want to talk about scope three. They thought investors like us would punish them. Now they're really positive and see that they are gaining momentum with their supply chain in specifying their ask that we gave them two years ago.

You can also see that in the numbers on the science-based target initiative. When we signed up to the net zero asset manager initiative in 2022, two and a half thousand companies had signed up or committed to said targets. Now we have 5,300 that had their targets validated and 300 that are committed to doing so. So it's really good news from the perspective on the ground from the practitioners. I think, of course, faster climate action is needed. We can't be complacent, but the numbers on the ground are looking better.

Vish Hindocha:

One of the things that I found really interesting recently in some of the work that you and your team had published was, sort of, there was a myth out there of can you actually achieve economic growth and see a decline in emissions?

And actually to your point, over the last 10 years, we have seen economic growth in countries in the global South or even developed countries and seen a decline in emissions at the same time. So it's sort of proving that you can grow economically and control your emissions and invest in the renewable future.

What are some of the other kind of megatrends that you see in the stewardship arena kind of more broadly in terms of what's evolved over the last couple of years? And what are some of the other things that you're thinking about today?

Fran Jahn-Madell:

So definitely. Nature, it's not really an adjacent task for us to deal with, but more that hugs climate as such. For example, with the staples companies that we will use as an example in our new net zero progress report, deforestation is hugely important. On nature, I suppose the concerns we still have is data. How can we really quantify what the core risk and opportunities are? Regenerative agriculture, how can we embed that in the conversations we have with companies like Danone or Nestle Plastic as part of a nature topic as really important.

And I know there are really exciting new technologies like bacteria eating carbon that is then made into ethanol that Danone is now using in their plastic bottles. So again, stuff that is potentially really changing the landscape but that just needs to be scaled. I think in terms of other system risks that we've been pushed a little bit harder by clients now is antimicrobial resistancy. We focus primarily on climate for now as data is getting better. I suppose data in terms of climate around physical risk is still a big question, how reliable that is. If you look into Bloomberg, every company is at risk, at physical risk at the moment, so it's quite difficult to differentiate between the good, the bad and the ugly. And that's really our job, that we find the ones that are winning the race and the losers that are on the downward trajectory, whale oil, coal oil, horses and cars. We've seen it in the past. So we need to do that for our clients' long-term interest.

Vish Hindocha:

One of the things I'm proudest of in MFS net zero progress report is that we talk about the ugly side. We talk about some of the challenges and some of the hurdles that we and others in our industry are facing when it comes to really understanding things like the efficacy of transition plans or how you engage with certain companies that operate in legal jurisdictions or in different entities and they have to make, again, very long-term capital allocation decisions whilst the political winds may be moving around quite a bit.

What are some of the lessons that you feel like we can share with our audience in terms of things that we've learned through that? And maybe if there are some examples from the consumer staples work, which I know will be a focus of the forthcoming report, anything that's specific to that sector.

Fran Jahn-Madell:

What we learn on a day-to-day basis is how fast it's moving, how many new technologies are coming up. Now AI, for example, with data center issues are causing us concerns on carbon intensity of the tech sector. How can we deal with that in terms of our investments, but also as MFS®. As a corporate, what do we have to consider? Is co-use going to increase because of AI usage? Of course it has a lot of positive as well, AI, for example, in the utility sector where, for example, leaks can be detected more easily, or for the railway companies. But I suppose from an internal perspective, just to give a little bit of insight, we really have learned how important it is to look at it from a sectoral basis and very company specific. So often, transition reports, decarbonization reports from companies are analyzed from the outside, not really detecting the sort of individual quirks that the company have, the portfolios that they're considered, mergers and acquisitions that they might have in mind.

So we really want to understand it from a credibility perspective, so we've developed our MFS transition plan credibility framework, really questioning whether management is set up in the right way that they can deliver credibly on the targets they have set. So the science-based targets that the company discloses to the science-based target initiative is our starting point, and then we want to understand where can the company credibly take it. And that also includes financial credibility. So I've talked to fascinating companies, one small machinery company in Germany, for example, that was super, super ambitious in terms of their sustainability targets. And they had asked their suppliers to also set a science-based target by 2026, which is great as such from the outside, but what happens to those suppliers that can't meet these criteria, that haven't got the means, that potentially haven't got the understanding, that haven't got management credibility?

Are we at risk or is the company at risk to destroy their supply chain by being too stringent? So that would be a point where we might question those management decisions that are being made there and dive deeper in with them if they have, for example, a three-strike policy with that specific supplier, how they're supporting them financially if they give them consultancy hours to really think about how to measure their greenhouse gas emissions. We also think about competitiveness in terms of credibility, this company acting maybe too fast in comparison to the pack. Of course, we want to encourage them to think about all angles, pun intended, with regards to their transition plan, but also take stakeholders into account how are employees brought in and so forth. Is it going to be possible? Because if the transition plan isn't going to work out in their favor, what does that do to their reputation?

And to that regard, sometimes we might be positive about the company turning around a bit because we appreciate. Like we are learning, they're also learning through new data, new insights, failure on technological development. Some of the technologies that the industrial sector is using or is predicting to use is not very clear in terms of scalability. Technological credibility is really important. I saw 10 years ago that technological experts saw that carbon capture and storage, for example, was, in terms of feasibility at a scale of one to 10, at seven. That's now often been downgraded to a three. So you can see there is still quite a lot of moving parts in terms of where different industries are going, what they had hoped they would achieve, and what they might not have.

Vish Hindocha:

One of the things that we talked about last time, and again it links with this, is the fact that we, you and the team take a much more constructivist approach to engaging. And there are obviously different forms of engagement, and that is probably the primary mechanism that we use.

I know that since we spoke last time, we had some of the researchers and the academics who are based in Oxford and St. Gallen's University as well come in and work with us and really understanding and helping our understanding advance on what does it mean to be a constructivist engager, particularly in the realm of climate change and net zero. What are some of the learnings that you take away from that, given your role? What are some of the things that others in similar positions might be able to take away and some of the key ideas that came from that body of work?

Fran Jahn-Madell:

It definitely helped us to ground our approach more at MFS, I would say, in the way that it's very fluid. We as a stewardship team talk to companies. Most of the time, we have analysts and PMs in meetings with us, and it reaffirmed that the most important thing is not always the impact or the target of an engagement but also is deeply rooted in understanding the behaviors of the company and understanding how to set strategy with the company rather than, again, an outside perspective trying to really force the company to move in step with our asks. I think that came out of that study and was really reassuring that actually, very, very specific timelines and execution points are not always helpful, like we just talked about granular technological developments. And I think that's why companies really value our sometimes guidance, sometimes just conversations. And the nudge theory, it will deliver results.

I think it also encouraged us to be more open with clients around when we might not be able to absolutely pinpoint what has happened in the one engagement meeting on the 31st of December or whenever you like. So it was empowering in a way to give our engagement approach an academic name of constructivist engagement where we really try to be thoughtful and authentic in the way we talk to our investing companies. And that doesn't mean that we don't stand our ground when we feel a company is potentially neglecting, for example, effectiveness on the board, which we are really concerned about.

So just going a little bit outside climate or when we are concerned from a broader perspective on diversity, that we will escalate to vote against a company if we feel. So it's not about nicey-nice, but really being intentional around strategy setting on a specific company. I suppose also what else I learned from an MFS perspective is we need to still get better at marrying our bottom-up approach, which is part of the constructive framework, with a more organizational high-level strategy on these systemic risks that we see and will affect our risk and return.

Vish Hindocha:

One of the really interesting things in interaction that you and I had with that academic team was the epiphany moment for them as doing the project was also that it's really tempting to think about top-down frameworks and a very kind of checkbox or a checklist way of thinking through, is this transition plan effective, or how should I do an engagement? And what is the right order and sequencing? I think what they had appreciated is the bottom-up and the amount of autonomy afforded to the specialists in our team that are engaging one-to-one with those companies to be able to reflect the nuances and the behavioral biases and the cultures and the norms that we see opposite the table in order to in a constructive way. And one of the things, I think, that was helpful is they ended up defining this spectrum of you've got pure autonomy, and then you've got pure top-down structure.

Now the right answer is probably somewhere in the middle and the sweet spot for different organizations, I think, is likely to be at different points along that, and we've just got to make sure that we are consciously making a choice of where that is for us. And again, I felt a lot of really terrific work was happening bottom-up in pockets but could we as an organization have a better organizing structure to coalesce and to synthesize and to make sure that we're learning best practice and sharing it systematically across our platform, which is a really interesting thing that I know you and I have talked about a lot.

You mentioned there are some specific topics that often clients ask us for, but this is also a sort of subtlety that I think some of our stakeholders, [inaudible 00:19:30] stakeholders can often miss, is that actually there is real power in the bottom-up, more idiosyncratic, more autonomy approach. We don't want pure autonomy and lots of different things happening everywhere, but there's a balance to be struck, and it's not all top-down frameworks either.

Fran Jahn-Madell:

I think since we've done the study, what's really working well in terms of overall systemic risk, and it's hard to translate that for clients, is that the sector specialists are working across sectors. So of course, as we've mentioned before, climate as a systemic risk, AMR, antimicrobial resistancy, as well as nature, it can't just happen in the energy sector or in the industrial sector because they are part of the supply chain. They have to be customers of green hydrogen. The industrial gases might be developing these technologies, but they also need customers. And that overlap of deep integration, understanding where issues might be in terms of hurdles for customers to purchase green hydrogen or carbon border adjustment mechanisms that are punishing imports into Europe, that's really working well. I think we have to get better and definitely need clients' guidance on how they would like evidence of that to be presented to them.

It's not just in the numbers of engagements with individual companies. Conversations with asset owners are important that we are not going to address climate if we are just talking at individual issue level, but really need to think about the broader thinking. I suppose there sometimes is a disconnect in the reporting requirements that we get from our clients, and I appreciate why they do that. We ask companies also to report externally, but the asks are often so specific and not necessarily relevant to the overall outcome, which doesn't mean that we don't want to report every single company engagements, but I think that the connection would be where really good conversations could happen with our clients. And some already take us up on it, and others are more interested in the quantitative disclosures.

Vish Hindocha:

I was with a Canadian client a couple of weeks ago, and they asked a really, really good question, and one that I know that has been sort of floating around the industry for a while, and one that I know that you've been involved in, which is resourcing.

So we have the privilege of sitting on top of a very large global research platform, 300 full-time investors engaging with companies. We have the privilege of being an active manager, so we only have to own companies that we really like to begin with, and yet there is always this tension between we don't have an infinite amount of resource, even a team as large and committed as ours with the selectivity that we get to enjoy over the things that we choose to own. And so this question that was coming around was one of resourcing. So lots of managers, lots of their investment managers, lots of their suppliers are talking a really good game about how they're engaging, how effective that engagement approach is. And I think what was underlying the question was, how do I know? As a buyer, how do I know that you're doing an effective job? And how much do I just have to trust that you're doing it?

And how do I measure that? How would you respond to something like that? I know that the PRI and the Thinking Ahead Institute have done some joint work which you've been involved in directly around resourcing of stewardship and 2.0, and the work is going to be published soon. Any thoughts you have around how should people judge the resourcing and the effect of resourcing of something like stewardship?

Fran Jahn-Madell:

Yeah, no, it's a really good question, and we discussed how one can quantify that in the Thinking Ahead and PRI working group, which was part of the stewardship 2.0 work that they do. And it really depends on the model of a stewardship team. And as you said, we execute a lot of the stewardship through our analysts and even our PMs that have high conviction on a specific stock that they're really interested. Sometimes we have in stewardship meetings with a company maybe between five and 25 investors from the platform, depending on how much they own. We started off with conviction level around how big a stewardship team should be at the working group. The outcome, and you can all see that in the new report that's coming out next Monday, 14th of May, is that most stewardship team directors like myself think the stewardship team should be double the size, and that was quite a collective group of investment managers and asset owners that were part of that group, so the Thinking Ahead Institute concluded it should probably be even bigger.

I think to get a very specific quantitative number on what the exact amount of full-time employees should be for a team is quite a difficult one. I can't imagine a Survey Monkey survey for our investment team would be very well received. How many minutes did you spend on Tuesday the 7th of November on this specific engagement? We don't want the analysts and PMs to see stewardship as an administrative burden. We want them to see the joy and the outcome and the conversations as a core. So I think that the best way for clients to approach this subject is to ask for a number, but also ask for confidence score in terms of how confident are you in the number that you're giving so they can make that more relative rather than focus on that absolute number. And then have conversations with the manager and say, "Where do you think you block us on the team are from the academic perspective?"

Without living and breathing an organization, it's quite hard to imagine how unstraightforward some of the recruitment processes are, right? If I have a business need, I make a business plan. It's not necessarily that there is a predefined budget for the entire organization at the beginning of the year that I can allocate so much to my team for. And I think that's what the working group thought that was the case.

And you also asked about in terms of effectiveness. We want to use our resources on the team very effectively, so often collaborate with others of our peers, whether that's asset owners or other investment managers. We're very intentional about which group we choose. We are that intentional that we review that every year, whether our mission and vision are still aligned with the different collaborations that we have. And if you imagine you look at one, say a big steel company that we have engaged with, there are so many moving parts, and for us at MFS to understand each one of those is very time consuming. So to split different works in the working group that is sort of going in the same direction, and we always make sure that we represent our own view rather than everyone on the working group is very effective.

The big steel company I'm talking about has operations in India, in Europe. Europe has different environmental requirements now with the carbon border adjustment mechanism coming in. So to parcel that out makes great sense to me. Another part of our collaboration is sector of work where we try and connect, for example, the food or cosmetic industry with the hurdles that the chemical industry sees in terms of selling green products to these customers. So that is very interesting to understand from our peer organizations, whether, for example, Colgate or any of the other cosmetic companies are leading in that where we might not be invested in but still have a good insight into best practice. So really using our overall sustainability infrastructure to be more effective, yeah, it's great.

Vish Hindocha:

We've talked about some of the subtleties that people may miss in the marketplace, be that over quantification and things like that. As I reflect on the last two years, I feel like the spotlight on stewardship has grown bigger, which is a great thing. The need for transparency has grown bigger. I feel like I'm feeling less and less the exclusion versus engagement debate. I think, in a way, the debate has moved on where we realize that effective ownership practices are a really useful mechanism for most long-term investors to think about financial results and returns and due diligence and all of that information that you just talked about, as well as impact, that's what they want to do. Is there anything that you think about that people are missing? What are the questions that people should be asking but aren't yet?

Fran Jahn-Madell:

I suppose over the last two, three years, companies as well as ourselves are more comfortable about disclosing what doesn't work. So that's always a standard question I use. In terms of scope three reduction, what are you worrying about? What is not making sense to you yet? And surprisingly, most companies are quite open about it, and that definitely wasn't the case a couple of years ago. So really diving into the listening. And maybe again, for our consultants and clients, that would be something really listening deeply rather than just going down a tick box of surveys.

And I know it's difficult for clients and consultants, they have many of us and they need to compare, but I think the devil was in the detail. And not every team is the same because it's not the same people, so paying attention to maybe the human aspect of the investing companies we have. And we have done that for years on governance, how effective governance is, but also how hard some people try and what they need to pass on to their board. For example, can I help them with getting something done internally by asking the right questions?

Vish Hindocha:

Yeah, I like that a lot. One of the things we were talking about before we started recording was trust and this idea of it's quite brave to be open with your vulnerability and the things that aren't working, and you're asking for that bravery from... You are asking for that from the investing companies, clients, consultants. Our stakeholders, our customers could be asking that of us. And I suppose it's incumbent on all of us to create the sort of brave space or the psychological safety, whatever we want to call it, around allowing that discussion to happen, because only really when that discourse happens that we are able to be open about the challenges that we collectively face can we really start to get to the devil that's sort of in the detail. Other than through time and through repeated contact, is there anything that you've found? Just in your role in engaging with companies, how do you create that environment where they're able to be more open, more vulnerable about some of the things that aren't working and thinking about how do we do that in other realms of our work as well?

Fran Jahn-Madell:

Well, it's always striking a balance of positive feedback, as well as constructive feedback, really making sure that it's intentional, considerate. My model of feedback... I needed to learn that quite hard. So I'm making myself vulnerable for you now because from Eastern Germany. So I make sure that everyone in the organization understands how important it's to think about something landing before. I think people are not considerate or intentional about how things can land with people. So it's the same in terms of developing that relationship that I know before I go into a company engagement, what have they done really well? And I point that out to them. "I'm really chuffed that you've had your science-based target validated. Congratulations." So the tone is set well.

It doesn't necessarily have to be 10 engagements a year, but if they know you appreciate, and maybe weave in, "I appreciate that you might not be the expert on that, but can we set up a meeting with Gavin in a couple of weeks so I can check in with him." That they feel understood and that they feel I understand organizational structure, I think is really important, as well as for us internally to appreciate how people are weaved together.

Vish Hindocha:

Is there anything that you've read recently or anything that you would recommend to listeners, anything that's really inspired you or moved you in any way?

Fran Jahn-Madell:

My new recommendation is going to be a repetition of another slow book that I've read. It's called Baumgartner. And I've got another very favorite author in the US, Paul Auster, who unfortunately just died two weeks ago. And it was this last book and a life reflection shorter than Thomas Mann, but it's very moving. It's very philosophical. And what I love about it the most is not all strings in the story tie up at the end, which I think is a perfect summary of what life is about. It doesn't all make sense and it doesn't always tie up at the end as life is. And I think slow stories, especially in our fast-moving industry, helped me sometimes to just step back.

Vish Hindocha:

Fran, that's a wonderful way to end, which is not all the strings need to necessarily tie into a neat bow. I'm sure you'll be back and lots of this thing operates on a continuum. So thank you again for your time and your generosity-

Fran Jahn-Madell:

Thank you.

Vish Hindocha:

... of insight of being here today. We really, really appreciate it.

Fran Jahn-Madell:

Thank you so much for having me.

Speaker 3:

The views expressed are those of the speaker 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 an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.

This material is intended for investment professional use only and not intended for retail investors.

The views expressed are those of the speaker 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 an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.

Please keep in mind that a sustainable investing approach does not guarantee positive results and all investments, including those that integrate ESG considerations into the investment process, carry a certain amount of risk including the possible loss of the principal amount invested.

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