The Activist Investor Who Bested Exxon Is Attempting To Reimagine Index Funds.
Engine No. 1, a small activist investment firm that won three seats on ExxonMobil's board of directors earlier this month, is launching an exchange-traded fund aimed at reshaping the index fund.
Its Engine No. 1 Transform 500 ETF will replicate a low-cost broad market index fund while also giving investors a potentially powerful voice in corporate governance. At a cost of only five basis points per year, or 0.05 percent, Engine No. 1 will provide active corporate governance oversight on the constituent companies held in the ETF by a team of investors who recently won one of the largest proxy battle victories in corporate America.
Engine No. 1 pledges that, similar to its campaign against Exxon, it will hold corporations accountable for their environmental and social impacts through active voting on shareholder resolutions. Additionally, the firm's investment team will actively monitor boardrooms' performance on issues such as environmental stewardship and will work as active shareholders to improve their long-term financial performance. Along with environmental impacts such as carbon emissions and climate change, Engine No. 1 will focus on issues such as gender and racial equity, political spending transparency, and the promotion of safe workplaces paying a living wage.
“It's a broad market cap exposure, but our value is driven by our active ownership,” Yasmin Dahya Bilger, Head of ETFs at Engine No. 1, tells Forbes. “It enables all investors to have a seat at the table and contribute to the transformation of businesses.”
The ETF will invest in a market-cap-weighted index of the 500 largest companies in the United States, which will track the Morningstar US Large Cap Select Index. Unlike a passive Vanguard S&P 500 Index fund, investors in the ETF will also receive a team of active investors who will vote carefully on shareholder issues, establish rigorous boardroom goals, and have the ability to successfully run change campaigns if necessary.
“Much of what passes for ESG investing in the public markets today is focused on diversifying investors' exposure across sectors or companies, but not on changing the underlying businesses,” adds Michael O'Leary, managing director at Engine No. 1. “We decided that instead of focusing on which companies we own or acquire, we would instead focus on the impact we can have as active owners of those companies.”
When Engine No. 1 went up against Exxon earlier this year, few outside observers gave the small $250 million-asset firm a chance. After all, Exxon is America's most illustrious oil and gas driller, and the activists owned less than 1% of the company. It joined a long line of small fry investors who attempted to take on Exxon through shareholder campaigns, but its success in electing three directors was due to a novel approach.
Engine No. 1 developed a case for Exxon's shareholders, arguing that the driller's financial performance was nothing short of scandalous. They detailed tens of billions of dollars wasted on acquisitions, ill-timed stock buybacks, and uneconomic drilling programs, concluding that continuing with the status quo would lead to Exxon's demise. Forbes discovered last year that Exxon was one of a group of former blue-chip corporate icons in America that had leveraged its balance sheet to the hilt, with no payoff. Our research revealed that Exxon's net debt-to-revenues ratio increased tenfold over a decade.
Additionally, Engine No. 1 combined a scathing economic argument with an environmental one. Exxon argued that its wasteful spending came at a cost, citing its failure to invest adequately in renewable energy and low-carbon infrastructure. Utilities are increasingly prioritizing renewable energy production in their capital expenditures. Major corporations and landlords are closely monitoring and reducing the carbon footprints of their businesses. Automobile manufacturers such as General Motors and Ford have staked their future on the electric vehicle, not the combustion engine. They contended that Exxon had not invested sufficiently to keep up with these changes.
Engine No. 1 found a receptive audience for these arguments among Exxon's deeply unhappy shareholder base. The firm's campaign was aided by a team of seasoned investors who possessed the credibility necessary to garner support from major index funds and mutual funds.
Charles Penner, the firm's campaign manager, previously worked at activist hedge fund Jana Partners. Chris James, the founder, founded two multibillion-dollar investment management firms. Jennifer Grancio, the CEO, was instrumental in establishing BlackRock's wildly successful iShares business. Michael O'Leary, managing director, collaborated with former Massachusetts governor Deval Patrick to establish Bain Capital's Double Impact Fund. They nominated qualified board members who possessed the credibility necessary to garner support from institutional investors such as Vanguard, State Street, and BlackRock.
Engine No. 1 will now package this expertise and experience into a low-cost index fund to complement its existing ESG hedge fund. The Engine No. 1 Transform 500 ETF will trade under the ticker symbol VOTE, emphasizing its mission of corporate transformation.
The firm has already received significant assistance: An unnamed institutional investor will contribute $100 million to the fund as a seed investor. Additionally, it has partnered with Betterment, a $31 billion (assets) robo-advisor, to include the fund in its ESG portfolios.
“Last year, we noticed a particularly glaring disparity between the index funds that gathered all of these assets, such as Vanguard and BlackRock. They tended to have truly inexplicably poor voting records when it came to climate- and sustainability-related shareholder proposals,” explains Boris Khentov, SVP of Operations at Betterment.
“To be able to take part in these types of campaigns and know that my portfolio is contributing to them feels truly transformative. We believe that this product is revolutionary and will establish a new category of products,” Khentov continues.