The 2016 proxy season, building upon trends that emerged from last year’s annual meetings, may prove to be pivotal for investors focused on environmental, social, and governance (ESG) issues.

“I’ve seen more uptake in the last 18 months than I’ve seen in the previous 17 years,” says Joe Keefe, president and CEO of Pax World Funds. “Shareholder proposals and proxy issues are received very differently now.”

For years, the term “activist investor” most often correlated with large shareholders battling with management over stock buybacks, dividends, and corporate strategy. Increasingly, ESG activism by public interest groups has gained relevance by offering investment funds that screen companies for such issues as conservation, diversity, climate change, and how they treat workers. Their pitch: caring about these issues is the mark of a well-run company.

Proof they are onto something: BlackRock and Goldman Sachs Group are among the big Wall Street firms that joined the ranks of Pax World and Ceres by launching investment products that take into account environmental and social issues.

During an interview last week at Compliance Week’s Boston office, Keefe credited recent momentum to an evolving definition of materiality, one that understands ESG issues are relevant when assessing how companies perform and manage risk over the long term. “We are seeing a sea change in the way materiality is viewed,” Keefe says. “Increasing numbers of investors see issues like climate change and board diversity as material to the future of a business.”

A variety of factors contributed to this tipping point, many of them data-driven. “There is a lot more research now that underscores the notion that ESG issues have financial materiality,” Keefe says. “When you integrate these issues into the construction of an investment portfolio, not only are you not sacrificing returns, it may indeed be beneficial to portfolio performance.”

“I’ve seen more uptake in the last 18 months than I’ve seen in the previous 17 years. Shareholder proposals and proxy issues are received very differently now.”

Joe Keefe, President & CEO, Pax World Funds

Investors are also correlating gender diversity on boards and senior management with improved company performance and greater profitability over the long term. “Go back a few years, and there may have been a study here or a study there. Now there is a pretty compelling body of research,” Keefe says. “Those studies were by professors. Now, the last four studies I’ve seen were by UBS, Morgan Stanley, TIAA-CREF, and Harvard Business School. There is a mainstreaming of the research that is happening.”

Another success factor for ESG advocates is a recent push by investors for companies to focus as much, if not more, on long-term sustainability as short-term profitability.

“A lot of people feel the financial crisis was the product of short-term thinking,” Keefe says. “Climate change is the ultimate product of short-term thinking. As the poet Lawrence Ferlinghetti wrote, ‘… man burns down his own house to roast his pig.’ People realize that a lot of our problems result from an excessively short-term focus and want to take a longer view. In some ways, sustainable investing is ultimately an effort to get corporations to integrate long-term strategy into their business models.”

Connecting idealism to returns is driving the push for gender diversity. “There is a lot of data now suggesting that companies with more women in senior leadership perform better,” Keefe says. “That’s a significant change in sentiment.”

The trend goes beyond the bubble of ESG-focused investment firms. A recent report by the International Monetary Fund blamed a “high degree of groupthink” for failures to correctly identify risks leading up to the worldwide financial crisis. A byproduct of that crisis, the Dodd-Frank Act, included a mandate that federal banking regulators and the SEC have a formal policy for assessing the diversity policies and practices of the entities they regulate. Internationally, Germany is among the nations paving the way for gender equality with a regulatory quota demanding that at least 30 percent of board positions be held by women.

In April 2015, public pension funds, supervising $1.12 trillion in assets, petitioned the SEC to adopt a rule requiring corporate disclosure of board nominees’ gender, racial, and ethnic diversity. More recently, Pax Ellevate Management filed a rulemaking petition seeking a requirement that companies disclose gender pay ratios on an annual basis or, in the alternative, provide guidance on voluntary reporting of these ratios.


The following is from a Feb. 1, 2016 leter from Pax Ellevate Management, investment adviser to the Pax Ellevate Global Women’s Index Fund, petitioning for annua disclosures of gender pay ratios.

We regard gender pay inequality as a material risk to investors. We believe that companies that are best able to take advantage of the talents of the entire workforce— not just the male half—are better positioned to add value to investment portfolios, while those that discriminate are vulnerable to litigation, regulatory and reputational risk. Pay equity can also be a key driver of greater gender diversity in corporate leadership, and numerous research studies show that gender diversity has been correlated with superior financial performance over the long term.


For investors, pay discrimination can have significant impacts. In the United States, the EEOC lists 1,880 wage enforcement/litigation actions related to gender discrimination lawsuits are usually settled out of court, but many of them, particularly class actions, can be quite costly, and the time and expense involved in defending such lawsuits can be substantial. More generally, companies that do a poor job of retaining and motivating their workforces can be at a distinct competitive disadvantage.


As investor interest in gender diversity has grown, companies are increasingly reporting on executive and board diversity. The SEC has accordingly issued guidance to companies in its amendments to item 407(c) of Regulation S-K, requiring disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director.


Just as concern over board and management diversity has grown, so has concern over the disparity between executive pay and median pay at corporations, which was addressed in the Dodd-Frank Wall Street Reform and Consumer Protection Act, and has now also been implemented in an SEC rule. We note in this regard the discussion of compensation policies and their relation to risk management in Regulation S-K Section 229.402. While neither the new pay ratio rule nor Reg S-K specifically addresses gender pay disparity, the logic behind the disclosure of both is the same: companies that discriminate against any class of employees, or allow large pay disparities to exist among classes of employees, bear increased regulatory, litigation and reputational risk.


We believe that the materiality of gender pay ratios clearly falls within the definition of materiality as set forth in the SEC’s Staff Accounting Bulletin No. 99: “A matter is ‘material’ if there is a substantial likelihood that a reasonable person would consider it important.” In a competitive global economy, we consider pay equity to be an increasingly important indicator of a company’s ability to attract, retain, motivate and develop a first-class workforce, which is critical to business success. Reasonable investors would consider such information important, and therefore it should be disclosed.


Accordingly, we request that the SEC require that companies disclose gender pay ratios on an annual basis, or in the alternative, provide guidance to companies regarding voluntary reporting of pay equity ratios to their investors. The new SEC rule on pay ratio disclosure already obliges companies to collect the data that would be needed to report on gender pay ratios, thus alleviating any burden associated with additional data collection. We believe that reporting pay ratios by gender is a natural next step in providing investors with a more complete picture of how companies are managing compensation issues. Moreover, such disclosure is a critical step if we are to advance pay equity and fairness among men and women, which will be good for businesses and good for the overall economy.


Source: Pax Ellevate Management

Further proof that gender diversity is no longer a fringe issue? Even the U.S. Chamber of Commerce, a longstanding defender against legal and regulatory business burdens, has joined the cause. A March 9 letter to Rep. Carolyn Maloney (D-N.Y.) expressed support for the Gender Diversity in Corporate Leadership Act, legislation she sponsored that would require the SEC to establish a Gender Diversity Advisory Group to study and make recommendations on strategies to increase gender diversity among the members of the board of directors at public companies, and to require issuers to make disclosures to shareholders with respect to gender diversity, and for other purposes.

“The bill’s goal of promoting gender diversity in the boardroom of American businesses reflects the reality that women, who historically have been statistically underrepresented among corporate boards of directors, possess invaluable insights, experiences, and management skills that can and should be deployed to support the corporate goals of our nation’s producers, innovators, and employers,” the letter says, although it did caution against diversity quotas.

For its part, Pax World Funds is putting its money where its mouth is on gender diversity. On March 8, it announced that its Pax Global Women’s Leadership Index fund outpaced its comparable broad market benchmark, the MSCI World Index, over a two-year period. The index consists of equity securities for companies around the world that “demonstrate a commitment to advancing women through gender diversity on their board, in senior management, and through other policies and programs.” Among companies in the index companies, women hold 30 percent of board seats and 23 percent of senior management positions, as compared to 12 percent and 16 percent, respectively, for companies in the MSCI World Index.

A question to ask, amid pressure to diversify boards and management, is whether doing so will drive out talented leadership already within an organization. “Most advocates for better governance would argue for term limits or age limits on boards,” Keefe says. “When you do that, do you lose good people? Yes, but there are other good people waiting to take their place. You are not going to significantly increase the gender diversity of corporate boards without having some sort of normalized turnover.”

How, exactly, does Keefe think that gender diversity creates a business benefit? In his view, having just one woman on a board doesn’t accomplish much; at least three members are needed to spark behavioral change. “Diverse groups make better decisions than no-diverse groups over time,” he says. “Different perspectives lead to different conversations, which sometimes lead to different decisions.”

A trend observed during the past two proxy seasons is that company leadership is more inclined to reach out to shareholders directly and work with them before concerns turn into proxy warfare. Keefe agrees with the assessment. “We are finding that, more often than not, they there is an openness to having a dialog,” he says. “Are companies still sometimes resistant, of course, but I have seen a dramatic change.”  Companies are evaluating their brand and reputation and would rather be viewed as “a leader, not a laggard.”

As regulators pressure companies to create and foster a “culture of compliance,” Keefe sees an even more important role for he and his peers. “For compliance officers, the culture where they work either helps them or is a barrier and obstacle,” he says. “A company’s culture is going to improve the more diverse it is. A diverse group is less likely to look the other way, more likely to ask difficult questions, and more likely to question the assumptions underlying the way you have always done business. Our issues can affect culture and a CCOs biggest challenge is culture.”