What is not an ESG at this point?

Mitali Prasad, portfolio manager & research analyst at Trillium Asset Management; Edward Allen, managing director and head of ESG & climate client coverage at Americas, MSCI

Transcription:

Lynnley Browning: (00:08)
Obviously there are distinctions between all of them, those names, but in the minds of investors, they're all kind of one and the same kettle of fish. So Mitali, maybe you could start by speaking to the really explosion of the ESG label.

Mitali Prasad: (00:31)
Absolutely. Thank you again. Lynnley, and I'm happy to be here. So Lynnley brought up a great point. That ESG definitely seems to be exploding my background is I've been working with Trillium Asset Management, which some of you may know or may not know is a investment advisor that has been actually, one of the founding, actually the founder of Trillium was the founding mother of socially responsible investing back in 1982. So we've been doing, what we call socially responsible, sustainable and responsible investing for the last 40 years, more recently of course, E S and G environmental, social and governance metrics are kind of just getting much more, into the mainstream and to us, it is a positive indication of people recognizing maybe that environmental, social governance metrics actually have a true implication in terms of making investment decisions, so I do see it as a positive line that there are more and more people getting aware of it. I think what it does do though, is create confusion for the average investor that is out there as to what truly is ESG. In our minds, It's being used as a catchall, a big tent kind of acronym where everybody can go wonder and say that they're doing, ESG investing from our perspective. What we really think of ESG investing is really three buckets. And I can go into that a little bit in more detail, but really thinking about ESG values, the value orientation as we investing in, companies, the second would be really thinking about ESG integration, which is using ESG data integrating it with your fundamental financial data and using that to make investment decisions. And then the third would be really thinking about it from the perspective of ESG impact and how do we then engage with these companies to create a positive impact, whether it be on the ecosystem or obviously on shareholder value. And at Trillium, we believe that these are not mutually exclusive. We do all three, but I think others may have different definitions and classifications. And I think that's where the conclusion lies

Lynnley Browning: (02:51)
Edward, from the perspective of MSCI, maybe you could explain a little bit about the role of benchmarking gauges and the indices in propelling the ESG ecosystem. Sure.

Edward Allen: (03:13)
Well, thank you yeah, so for those not familiar, if you're not familiar with MSCI, we do a number of things. We're one of the leading providers of indexes, but we're also the leading provider of ESG data research, and analytics in the marketplace. So yeah, I would completely concur. It's a horribly messy place right now in the world of sustainable investing, which we use as a, sort of the big catch all for a number of different strategies and themes, but in the world of benchmarking, there's been absolutely a proliferation of benchmarks of indexes ESG and or climate indexes. And I think you've seen those predominantly used as the basis of financial products and in the us market, we see those proliferate in exchange trade funds, to some extent still passive mutual funds, and there's a real place for them. But one of the things that I think can confuse investors is each one is constructed quite differently. And it's really, I hate to say, but it's really up to the financial professionals, whether it's the firm marketing that product or the investment professional really tasked with evaluating that product for the end investor to use, but it has become much more difficult given the explosion of the number of indexes, the number of ETP providers in the market. So I do com completely agree. It's a very messy place right now.

Lynnley Browning: (04:33)
It's a, Deluse of data of data points and of synthesis of these data points, how is a financial advisor supposed to make sense of by what one estimate are 11,000 perhaps indexes, ESG benchmarks, and then to really drill down and see what a fund actually owns, even if it's just a tiny sliver of something, typically ESG funds will make it easy to see only their top 10 holdings. And those are usually pretty much in line with what an investor who buys into that fund signs up for, but dig down look under the hood, look in those dusty nooks and crannies, and you can find some pretty darn surprising things looking for those things and ferreting them out takes an enormous amount of time. How is an investor? I'm sorry. How is an advisor supposed to tackle that task?

Mitali Prasad: (05:43)
Sure. I'll be happy to take that question. And I think to start off, obviously as an advisor, understanding really the investor's objectives is really, a key priority, right. And at that point, you're really trying to understand what is it that the investor is looking for in terms of whether it's value, alignment, whether they're expecting the investment firm to actually engage with the companies to make a positive change, and I think understanding some of those priorities for the client is really important, questions to ask, I think as an advisor, what would you ask the investment firm? I think is really critical to figure out again, going behind the curtain, really figuring out what is it that the fund is trying to do. So if you're investing, for example, in a passive ESG fund, as a client, you would actually find that there may not be value alignment. There may not be the engagement that you maybe have been expecting. So companies like Trillium, we actually do provide a lot more transparency. We actually have impact reports that we come up with once every six months, that actually outline, how many client engagements we've done, whether we've put forward shareholder proposals, and what kind of outcomes we've gotten. And it is really encouraging to see, the kind of work that we do and in terms of the corporate responses as well, and then to kind of track that and to see, what kind of changes we've been able to make longer term. So I think that transparency, if you can ask that from your the investment firms that you're investing in, I think that's really

Edward Allen: (07:31)
I would agree, I think in our case, the ETFs are underpinned by indexes. Our index methodology is transparent. It is most often posted on our website, but that's still a lot of information for an individual investor to try to comprehend, to look at the ETF. Then look at the underlying index. Those indexes are sometimes customized a lot of times by the sponsor. So it is really, as Matt said, important to talk to the actual investment advisor to understand how is this constructed? What is the purpose? Because the name ESG does not imply an ethical investment. It doesn't imply that it's a climate friendly fund. It's not meant to be philanthropic the way again, that M S C I, and I think actually the same, we use the same categories as Trillium would be to look at characteristics that are non-financial and for a portfolio manager, to look at that alongside financial characteristics to make a better informed decision. And it gets highly politicized if you're an ESG fund. Okay. what does that mean? Are you making an ethical stance? Are you, taking a values tilt, but no, it's really understanding things like a company's supply chain, looking at things like their labor relations, looking at things like bribery, fraud, corruption, these are not ethical choices. These are just common sense ways to evaluate companies. But I think some of the products these days have really blurred to take a word from a recent article Lilly, blurred some of what the actual fund is meant to do.

Lynnley Browning: (09:01)
Let's talk a little bit, and you just alluded to this Edward, the, for lack of a better term, what one might call the backlash against ESG? It's always kind of been brewing and percolating to my mind, rightly or wrongly. It seems to have kind of come out of the woodwork and, roughly the past, maybe four to six weeks, you have Elon Musk trashing, ESG, you have Mike Pens trashing ESG, you have, energy heavy and rich states like Texas and Virginia saying, well, we're not gonna invest state funds with companies that, have an ESG agenda that excludes oil and coal companies what's to make of this backlash and the challenge it puts to advisors who then have to explain that as well to clients.

Mitali Prasad: (10:07)
Sure. So yes, we have seen this backlash more recently against, this ESG kind of phenomena. And I would, again, step back and say that companies like ours and there are other, true ESG players in the industry who are, who have been doing it for a long time or, and have been doing it to bring about positive changes as I mentioned, shareholder value obviously, but also stakeholder value where we consider the ecosystem where we consider the employees the communities and the suppliers that these companies are interacting with. And with that creating longer term stakeholder value as well. The distinction more recently has been with a lot of funds where maybe to some extent you can say that they've been greenwashing as in saying that they do ESG by slapping on an ESG screen, maybe on top of what they're already doing. And not truly thinking about ESG from the lens that we think about it, which is, sustainable and responsible investing, and I think that is the distinction. To some extent, I do feel like this backlash in some ways, hopefully will help bring out those names that are not truly ESG oriented and are just kind of doing it because it's the latest fad that they think of it as, and it's a marketing ploy for them again to the extent that more and more investors do start believing in ESG and start doing truly what we believe is important in terms of identifying criteria that help lead to better outcomes, both in terms of corporate behavior, press economic community behavior. I think that is a long term positive. And if it shakes out the industry a little bit for now I think it really is imperative upon us as the incumbents in this industry to really educate and tell the investors and the clients, what true ESD really means.

Edward Allen: (12:04)
Yeah, it's a super political issue in the United States. It's you mentioned Texas and West Virginia. These are clearly states that have a large constituent base of folks working in metals mining or extractive industries the elected officials are dependent on votes and in their minds, they're looking out for the best interests of the residents of their states or counties. And so that conflicts with maybe a place like California, which is taking a much different stance. So, You don't, see this so much this lack of cohesion in the European union, there's a much more one view as opposed to where the economy, where the block needs to go, but it is politicized. And those in those who politicized and those who are in the political spaces are quite visible. And so when you get people, as you mentioned, making statements that picked up by get picked up by the press, it tends to make news. I think it's important, not every oil company is a bad ESG player, the way that MCI looks at and rates companies, we rate them within an industry. So you could be an oil or coal company and, get a good ESG rating because we're doing it relative to other oil and gas companies. And that's the point you may not in a portfolio, want to exclude an entire sector. You wanna know, from a non-financial perspective, IE supply chain, pending regulation, how does one coal company relate to another coal company? And so that's what we're providing. We're preventing data to asset managers to use, to make better informed investment decisions. But I think the, really the misconception is ESG means we're anti oil and gas, we're anti fossil fuels and that it could be, but it depends on the investment product you looking at.

Lynnley Browning: (13:55)
So I'm wondering that what you're addressing Edward is, what seems to be a disconnect between what appears to be a perception by ordinary retail investors that sustainable funds, ESG funds, their purpose is to make the world a better place or not make the world a worse place, that's not what you're describing. What is the purpose of ESG and how can the industry communicate its purpose and mission to ordinary investors?

Mitali Prasad: (14:28)
Can I just take that as, because as you mentioned, oil in gas, cetera. So I think one of the things we also think about when we think about ESG investing is there is ESG data and thanks to people like M S C I, there is a lot of data that they're kind of providing on different companies and on different metrics, it is up to the ESG investors, then people like us to really use the data and figure out what we do with that. And, for us the data integration piece into our financial metrics is just one part of the puzzle. What we are doing then beyond that is goes really towards that engaging that I've talked about and really thinking about values orientation as well. So for the record we at Trillium actually we've talked about investment and engagement, kind of as two different sides of the same coin. So for oil and gas, coal, et cetera, we've decided coal was never something that we invested in oil and gas. Some of the energy companies we were investing until a few years ago, and then it really became clear to us that that was not a sustainable, fundamental long term model. So we have decided to actually not invest in traditional fossil fuel unless they are really engaging in energy transition. And we've defined certain cases for how that energy transition works, including, CapEx in renewable projects, no further, CapEx investment in, existing fossil fuel kind of production et cetera. And instead we are focused on really looking at companies that produce either equipment that help facilitate that transition that, renewable energy sources, solar, wind energy, et cetera. So again, those are different, strategies that I think different funds can adopt. And I think that goes back to that initial discussion we had of investors really trying to understand what is it that the company that is running the strategy, what is it that they're really trying to do?

Lynnley Browning: (16:27)
Let's talk about the S E C, which wants to regulate how companies describe and disclose to investors and shareholder's their ESG efforts and activities, the sustainability industry has had kind of a genius response to the SEC, which is that, well, you can't regulate something you haven't defined yet. It's a clever response. How does the regulatory framework here play out? Does the S E C find itself, do you think, in a position of putting the cart before the horse talking about regulations before it talks about definitions, how can we get to common definitions that can be used, for the commission?

Edward Allen: (17:29)
So I'll do my disclaimer here, these opinions or my own and not of my companies. I look, in a lot of senses, the Europeans have moved much more quickly down the path of regulatory reform and the U.S Can look at that as a blueprint for what could and could not work, so for in the EU, for instance, there there's, I would point to two things. There's something called SFDR. And if anyone's an asset management firm in the audience and you sell products into the EU, it's a regulation to which you need to comply, and you need to self classify all of your investment products, on three levels of ESG, either nothing integration or moving more towards impact, they've just proposed a rule, which is around suitability. This is under MiFID. So if you're an advisor there and you have to do the standard suitability questions about risk tolerance, time horizon, you now proposed have to start to ask questions about ESG preferences. So I think here in the us, there's, three proposals, one, I can speak more on the record too. There was a proposal around companies to do climate disclosures. We are at MSCI and full support. There needs to be standardization in the market. It's a hot mess right now, and there needs to be some level of really comparability for investors to understand the carbon emissions footprint risks for companies. The rule that I think you're, referring to, that was just proposed. So we don't have a view on this yet, but it's the names rule. And so right now, if you are a fund, you need to try to accurately describe the name of the fund and align it with what's in the fund. But that rule does not apply to strategies. So growth, value, income, things that have been subjective, what the SCC is proposing. So they're opening a consultation is that those things now start to get defined, and that would also include, items around sustainability. So that that's open for discussion. I don't know that there's an answer yet. We don't have an official view, on that from our perspective but, I think the S sec is certainly looking to what the EU is doing.

Lynnley Browning: (19:44)
We may have just a few moments left to take a question or two from the audience. Does anybody have a question?

Speaker 4: (19:53)
Yeah. You want me to wait for Mike or just Yell out?

Lynnley Browning: (19:55)
There we go.

Speaker 5: (20:06)
Thanks. How would you how would you grapple with the argument that public divestment from brown assets is just pushing them into the hands of private equity, potentially, making them even browner and less visible?

Mitali Prasad: (20:21)
Sure. so again like I said, I mean, this is definitely something that we've thought hard and, long about in terms of how do we address that whole issue. And we've been engaging with a lot of these companies over, myriad of issues over, a long period of time. I think with the energy companies, the way we've thought about it is that companies that are willing to engage for example, with us and kind of address the issue that there is climate change is real. I mean, you'd be surprised as to how many of these big oil companies have actually even have lobbyists denying that and working in Washington on that. So to the extent that they actually accept it and then start coming up with a plan around it. So we are not saying that, no, we just let you guys be, and then you get taken over private equity and do your, what you're doing. So I think there is a path forward and, companies do have to acknowledge that is a true impact net zero is something that we are committed to and how do we move towards that transition? I think the fossil fuel companies, some of these extractive industries really have to be part of that equation. So we are very mindful of that and that's why, as I mentioned, we have this whole, outlook on energy transition. And how do we address some of those issues going forward?

Edward Allen: (21:36)
Yeah, it's a great question. We hear it a lot we, we just wrote a paper not too long ago, which is up on our website. Only 10% of coal companies globally are public. The vast majority are in private hands. And if you look at those, most of them where they're still doing new brownfield exploration are in India and China, most of them are state owned. So it's a, I mean, it's a great, it's a great question. You also questioned whether, is there an investment thesis to hold the company or you just holding it to engage and then it's really not, that's a value stilt. I think if you're only holding it to force change organizations like climate action, 100, that is the purpose, right. Is to effectuate change to prevent climate change, others who invest like engine number one and Exxon, they think that there's an investment thesis there. So they're, they're not necessarily meaning to do good, but they actually think that the company is, could be more profitable than they are the way it's managed today.

Mitali Prasad: (22:41)
Any other questions?

Speaker 6: (22:45)
Earlier this morning, we heard from a few direct indexing ESG focused companies. So to what extent do you think those are threats to your traditional index based ESG fund?

Edward Allen: (23:04)
It's a great question, I was unfortunately not in the session, but direct indexing, I think has really taken center stage at a lot of conferences. We're thinking long and hard about it ourselves. What I think to the traditional funds, could it be a risk potentially, but I also think you see a lot of M and A by those companies who are managing traditional ETFs, acquiring direct indexing providers. So you've seen this with Franklin Templeton. You've seen this with BlackRock, you've seen this with Morgan Stanley, so they're getting into the game either. They're doing it through acquisition or they are building on their own. And I think what you'll see is this is, again, my personal view, them rolling out a lot of managers who do traditional passive investments roll out their own product to the space for direct indexing. It's just, it's another flavor you need more size and scale to do that you, you can't do. I mean, some claim they do it at $5,000. If you talk to Aperio, if you talk to parametric you need more money. so it's not gonna work for, I think, smaller scale investors at this point.

Mitali Prasad: (24:13)
And I would just add that from our perspective, really active investing, is kind of much more of an engaged, engaging with the company for shareholder value, that is much more kind of again, creating more impact versus the passive ESG strategy. So that's just kind of our take, but to the extent that you are kind of including more companies in that passive index and companies realize what it means to get to, be part of that index there is some movement, in that direction, but active engagement to us is what really ESG should be hopefully about. So

Lynnley Browning: (24:49)
Do we have more time or are we up against our time limit? okay. Matalie, I'm wondering if you could tell us a little bit more I'm fascinated by the idea of Trillium 1982 founded by, the founding mother of the ESG movement. Tell us how, what ESG has meant for Trillium over these decades and how the definition has changed.

Mitali Prasad: (25:22)
Sure, yeah, so 1982 as I mentioned when Joan started, it really kind of started because some of her clients were coming to her at that time with the values based orientation and asking her to, help her come up with strategies and portfolios that did not invest in some of these maybe dirty industries looked at women empowerment, even back then when gender diversity sector were not topics that were being thrown around as much. So she kind of really started formulating some of those strategies and then really founded the company, with the idea of really the values based orientation and socially responsible investing over time, as we've seen, there's been a proliferation of the ESG kind of the acronyms that are other acronyms that are kind of thrown in, terms of the, obviously the SRI label that we've heard can be called socially responsible, sustainably, responsible investing, et cetera. So all of those are out there, but at the bottom line, in terms of, what we think of as ESG investing, what is now known as ESG investing, is that again, it's thinking about values alignment, really thinking about, and using the ESG data to create positive financial returns positive, long term shareholder value and generate alpha. And at the same time, engage with the companies that is something that consider really a part of our mission and fiduciary responsibility to engage with the companies to change corporate behavior. And that has been true. It was true in 1982, it's true today and remains a big part of what we do just as an example, in I think a year ago, or two years ago, we engaged with over a thousand companies. And by engagement, it includes dialogue with the companies. It includes shareholder proposals. it includes engagement in terms of going in with the coalition. So just the numbers and the number of companies that we engaged with over 800 companies. So that to tells us in terms of the kind of impact we can have and the kind of changes we can bring about just by the volume itself is, is pretty huge.

Lynnley Browning: (27:28)
Let's talk briefly and quickly about the fact that Europe has been much more cohesive and pulled together in defining and regulating ESG. What does this say about, American culture and values? Do Europeans have a better sense of the common good and Americans are all just everything's about me and needs to be personalized and we're all bowling alone. What is the deal?

Edward Allen: (28:02)
Wow. that's a tricky question that I don't know that I want to answer. boy you

Mitali Prasad: (28:08)
Started in your, if you haven't answer that.

Edward Allen: (28:09)
Yeah. I actually, I don't know that I could answer that adequately.

Lynnley Browning: (28:16)
Okay. I take a really quick stab because I'm being told that the next panel is chomping at the bed to replace our brilliant.

Lynnley Browning: (28:27)
Our Panel. Europeans have more resolved, Europeans have a greater sense of cohesive society and the commoning good compared to Americans. Yes or no. Can I should go ahead, go for it.

Mitali Prasad: (28:45)
I'll put myself out there. No, just because I cover European companies as well as well as well as looking at the domestic U.S Names I do feel in general, there is a much more of a push towards kind of even thinking about natural foods and, organic foods and energy efficiency, carbon reduction. There definitely is much more of a cohesive way of thinking around it in the U.S I feel it's become much more politicized in terms of it's left wing issues. If you're thinking about carbon reduction, it's left wing. If you're thinking about your supply chain or your raw materials it just, to me feels the politicization just seems to drive us from thinking about things that actually are material to the performance of the companies. And if you just bring it down to what really matters to generate performance long term productivity, long term value, all of these factors are relevant. So to, yeah so I do feel there is that difference in terms of how we the Europeans are looking at it versus the U.S for now.

Edward Allen: (29:46)
Yeah. I think else thinking about this, if you look at the demographics, and if you look at some of the industry spread United States is physically a very large country relative to a place like Europe. So France, Italy, Spain, they've got pretty much a lot of the same industries. You go to Texas to that example, you go up to Maine, very different. So the focus in each of these states is quite different. So I think that's one also one thing that keeps them a little bit more closer and focused on some of the sustainability issues versus our own

Lynnley Browning: (30:20)
Edward and hol. Thank you so much. This has been absolutely fascinating. Thank you. Thank you so much.