MASTERCLASS: Impact Investing - March 2017

Though impact investing has taken hold in the investment sphere, debates still persist over its definition and measurement. A panel of five impact investing experts joined Asset TV to discuss what impact investing means to them, how they engage in it, and what to expect as the practice continues to become more mainstream.

  • Doug Lopez - Principal & Portfolio Manager at Aristotle Credit Partners

  • Tessie Petion - Vice President - Responsible Investment Research & MIS at Domini Impact Investing

  • Amy O'Brien - Head of Responsible Investment at Nuveen

  • Ronald A. Homer - President - Access Capital Strategies at RBC Global Asset Management

  • John Adams CFP, CIMA - Senior Vice President - Investments at UBS Financial Services

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  • 01 hr 01 mins 14 secs
Gillian: Welcome to Asset TV, I’m Gillian Kemmerer. As the practice of impact investing becomes mainstream debates still persist over its definition and measurement. Today we have a panel of speakers here in the studio to show their insights on what impact investing means, how they engage in it and what’s on the horizon for the industry. Their areas of focus remain diverse, but their central focus is the same, doing well by doing good. Welcome to the Impact Investing Masterclass. It’s excellent to see a packed house here at the studio today. So thank you all for joining us. And I think it makes sense to start this conversation with definitions. And, Ron, I’m going to start with you, we’ve heard everything, impact, ESG, SRI, the acronyms are numerous. How do you define impact investing?

Ron Homer: Well, I define it by as investing as looking for a financial return that has also a component of social impact. So it’s actually something that provides social impact, social alpha and impact alpha.

Gillian: Okay, social alpha, that’s an interesting way of putting it. Tessie, to you now, obviously we’re talking about impact investing, but you use ESG factors in your overlay and portfolio analysis, how do you wrestle between the two definitions?

Tessie Petion: Well, I think one … the idea of impact investing is that we want to have, all investments have impact but we’re looking for positive impact. So we’re using our ESG factors to identify companies, identify growth, and that’s what leads to a positive impact.

Gillian: Excellent. Doug, tell us a little bit about how you choose to define impact investing?

Doug Lopez: Well, to me, impact investing is integrating the ESG factors, and to do the analysis. But I try to have a positive impact in terms of how a company is going to be behaving and acting in the real world.

Gillian: And that doesn’t just necessarily mean zero carbon for example, you invest in energy companies as well, but you’re looking at progress?

Doug Lopez: Yes. I mean with us it’s a big … it’s really more important to buy companies that are moving in the right direction, improving in terms of their impact as opposed to just buying the highest rated companies on an ESG basis.

Gillian: Okay, perfect. And, Amy, tell us a little bit about how you define impact investing.

Amy O’Brien: Yes. For us, impact investing is one of those terms that’s associated with the broader responsible investment umbrella term. And so we see impact alongside of ESG factors and engagement factors as part of this toolkit where we are trying to incorporate relevant environmental social factors and governance factors, alongside impact into our investment decision making process.

Gillian: And it will be interesting to hear how it’s evolved in terms of the way that you analyze those various factors and how you put them into the portfolio. Now, last but not least, John, impact investing, what does it mean to UBS?

John Adams: Well, in our portfolio management team we’re very aligned with what Amy was talking about, more client focused, the thing that we want to do is to make sure that clients have an opportunity to invest in a way that truly reflects their values. The largest impact that we believe that we’re making is consciousness raising. When company CFOs and CEOs know that we’re looking at hundreds of metrics that relate to their environmental, social and governance behaviors, when they know that there’s so much transparency in that we’re the owners of those companies and we’re making decisions based on some of the financial metrics and also some of the quality of management metrics, ultimately that improves the decision making process in the executive suite.

Gillian: Excellent. So we’ve gotten a nice suite of current definitions of impact investing and Tessie, I’m going to start with you here because Domini has been in this space for a very long time. How have you seen impact investing evolve since when you first began in it?

Tessie Petion: I think that one of the biggest things is that the definitions have expanded. So it’s really intuitive that a sustainable investment company is interested in renewables. I think what’s less obvious and what we have been able to see is that it’s not just investing at that point. It means looking at component companies that help connect electric companies to the grid. It means looking at asset managers that are investing in this space. I think the fact is we’re looking at impact in lots of different industries in lots of different ways and looking for ways to really get companies to think about mitigating climate change or incorporating diversity. And I think that we just have expanded the definition of what’s possible through investments.

Gillian: So the scope has gotten less obvious in a way?

Tessie Petion: Yes.

Gillian: Okay, interesting. And, Amy, what about you, how have you seen this space evolve?

Amy O’Brien: Well, it’s evolved significantly and really I would argue that these concepts date back decades with, in our own involvement in the impact space starting back in the 1970s when it was more about shareholder engagement. So we’ve seen a really a major evolution in the tools that institutional investors have applied over the years. we’ve also seen tremendous evolution and change in the products that we’re seeing now that are available to individual investors and advisors. And so that’s very exciting to see all the change. But it’s been a gradual steady change. But it’s captured a lot of attention now, due to some of the changes that were mentioned in terms of marketplace and certain client segments now connecting to this concept for the first time.

Gillian: Okay, interesting. So both the scope and the number of clients who are interested have increased over time?

Amy O’Brien: I believe so. And I think now we’re really poised to have the next level of growth for the industry in terms of millennial interest, interest from women and then other advisors are realizing that the client demand is there and now is the time to get, educated and engaged with clients.

Gillian: Okay. And so it’s not surprising that where the money is going that the industry is quickly following suit and creating products that suit it. Ron, how have you seen things change?

Ron Homer: Well, I think the nomenclature’s changed mostly, but the activities have been pretty much the same in many respects. I think there’s always been a desire to find new frontiers for investment. In the case of the products that I’ve been involved in, community development, since the 60s, it’s been … no, well, well before that, there’s been efforts to increase the flow of capital into underserved communities. I think the fact that people have more discipline about what they’re doing and they’ve discovered ways to match, as I mentioned, both the social alpha and the investment alpha where it’s not a trade-off but it can actually be a driver. So in many cases, solving a social need should lead to outperformance on the investment side.

Gillian: It’s interesting. And so often, and perhaps a long time ago those two things were seen as completely divergent and it was all about philanthropic etc, but here it’s united.

Ron Homer: So I think as long as you’re using investment in the financial terms, that it has to provide some underlying alpha generating, otherwise it’s an investment but it’s more in human capital or in soft investment.

Gillian: And also we talk about perceptions around that. John, how have you seen this space change? You’ve been in it for a while with UBS, what are the differences?

John Adams: Well, thematically it’s changed very dramatically. My first meeting with the Social Investment Forum was in San Francisco in 1993. And at that time Nelson Mandela had just been freed from prison and apartheid was breaking up and the next year we saw the free elections in South Africa. And that was something that the social activists in the social investment field had been very active in. And present at that meeting were Peter Kinder, Tim Smith who headed ICCR here in town, and Reverend Leon Sullivan, the author of the Sullivan Principles. And I actually did TV interviews, interviewing each of those people at that time, which was a great window into that moment. Well, if you fast forward, a decade ago, probably the biggest thing going on was the Carbon Disclosure project. And the idea of getting greenhouse gas emission information from the 5,000 largest companies and then the challenge from the CDP asking those companies, “Now what are you going to do? How are you going to lower your energy footprint and improve your emissions and reduce global warming input?” So that was the single largest shareholder action that had ever happened in history. Now what we see is that the United Nations has adopted the Sustainable Development Goals. And UBS just did a major whitepaper that was presented in Davos, that talked about integrating the Sustainable Development Goals into sustainable investing and aligning these.
And for me it’s a real thrill, today it’s International Women’s Day, it’s the number five SBG, there is currently a march right up the street in Central Park of women. And we are here talking about sustainable investing. So you couldn’t have picked a better day. So I think that the clear trend going ahead is that the investment community is probably going to align with the United Nations, which is the global community in helping to support the Sustainable Development Goals.

Gillian: And you’re right to point and in a very … finance has always traditionally been a male industry; we obviously have two female executives here which is excellent to see that representation. Doug, 10/15 years ago, could you imagine high yield investing and impact going together?

Doug Lopez: No, we couldn’t. So I’ve been managing the corporate bond portfolios for quite a while. And early on, I mean how it’s evolved to within our process has been; initially it was a negative screen. And these are the companies you can’t buy in the portfolio, but pretty much you could do whatever else you wanted to with the rest of the portfolio. So it wasn’t really a positive impact, it was really more just negatively screening out those identified as bad companies or bad issuers. Kind of to the point we previously discussed in South Africa, that was something that was screened out of a lot of portfolios in the early days. It’s evolved really more now into a positive screening process. So we actually develop ratings on companies based on the factors aligned with environmental, social and governance issues. And then we incorporate that into our regular investment process, which we feel has additive to all the portfolios because the companies that are well managed tend to do very well and score very well. So for us it’s really evolved from more of this negative initial screen to now where it’s fully encompassed within the investment process and leading to, we think, better decisions in the portfolio that have a positive impact.

Gillian: Now, it’s interesting to be talking about this, not just today but in the context of the fact that we are within the first 100 days of President Donald Trump’s administration. We have seen some changes, certainly some policy pivots in areas like environment and healthcare. Let’s start here, John, has it changed at all the way that you’re approaching impact investing? Are you keeping an eye on what’s happening in Washington? Are you saying, “Well, we’re going to need to pivot?”

John Adams: Well, we haven’t changed our approach. But what we’ve noticed is that financial advisors are telling us that clients are really talking about implementing, bringing the values to their money. And I think that the level of consciousness around ethics and values that has occurred since the election, that’s the great thing in America is that people may be polarized, but we’re all talking about what’s important. And up to this point we haven’t seen the broad conversation be about how you consume, how you invest your money, it’s been about how you vote. And now people are getting more active in all of those areas wherever they are on the political spectrum, I think you’re seeing people become much more activist about how they’re engaging. So we are definitely seeing an uptake, a large uptake in interest and activity in the sustainable investment space.

Gillian: Interesting, so seeing clients are voting with their dollars. Amy, how have you pivoted, or how are you starting to think about how you’re going to operate within this new administration?

Amy O’Brien: there’s a lot of opportunity, to follow up on John’s point, I think many investors are thinking about how they can express their values in their portfolio. They have become more involved civically and engaged in the political process. They’re now many of them shopping with their values and now this is the next frontier. So I think we have a lot of opportunity right now to continue to promote these concepts now that we have so much of a track record in this space, that we can go to a client and show them that they can achieve their investment objective alongside some of these factors that matter so much to individuals. And I think tying this to how the industry has evolved, for many, many years a lot of us spent time in very important work around the materiality of ESG factors. But I think it really is some of these thematic issues that are the hooks that get clients very interested and they want to see not just a do no harm strategy, but how can we actually be a force for good?

Gillian: So a sense of democracy and action within their portfolios, not just up until election night, interesting. Doug, how do you look at the evolution, and particularly from, let’s say the end of President Obama’s administration until now, has it changed the way you think about high yield?

Doug Lopez: Not really, to me I would agree with the prior speakers here. Basically I think it’s just really increased the awareness of the investment population, in terms of just getting your hands around what’s in your portfolio and actually understanding that. Perhaps maybe the potential for absence of some regulations is making people fonder about what they are missing in their portfolios, and they aren’t really focusing on. So we think it’s really increasing awareness. We’re not changing our process in terms of how we evaluate ESG factors that we’ve incorporated into our process. But we just think it’s really going to grow the asset class in terms of making people more aware. I think this is an area you can actually have a positive impact.

Gillian: Okay, Tessie, are you echoing the same sentiments? Have you shifted any focus on sector slightly based on the new administration?

Tessie Petion: No, we’re proceeding as normal. I think that it’s true that as everyone said, people want to put their money to work on their values. And what we have had is a lot more interest and a lot more interesting [inaudible] that are telling us to work on these issues where they feel the administration might not. So we’ve had a lot of people reach out to us about things like Dakota access and about pipelines because they’re worried about what happens with the EPAs has been the thing. So I think it’s just helped us focus on areas that we were already paying attention to. And has given us a little bit more of a push from our shareholders to make sure that we’re making our voices heard.

Gillian: Interesting. And, Ron, obviously President Trump has said a variety of things about lower and middle income communities that you’re working in, on one hand he says he has a commitment to cleaning up and
education. On the other we’ve some changes in healthcare. How are you thinking about investments there?

Ron Homer: Well, I agree with the other panelists, I think that the change in administration has created a focus on what you do is important and your values and a pro and con. So I think it’s heightened awareness. It definitely, a good portion, no matter which side of the political spectrum, a good deal of the issues that surface were around the unevenness of the economy. And so I think that helps people to figure out or at least be desirous of how to address that to make a better country. It will remain to be seen how the private sector can work with government and particularly in the area of sustainability and underserved communities. I think the deregulation and the lower taxes will obviously help some investments to increase [inaudible] spending. I think the areas of environmental, justice and social justice, we’ll see. I will say that I’ve been through a number of economic cycles and political cycles. And I think as government contracts, private sector tends to get more active and assert itself. And so I’m an optimist, I’m hoping that some of the contraction of government will create opportunities for entrepreneurs and well thinking people to fill the void.

Gillian: Many market participants have said since the administration came to power that there’s this renewal of animal spirits. It seems like there’s been a renewal of activist spirits as well, at least what I’m hearing across the panel. Let’s talk a little bit about measurement of impact. This is something that I’ve heard debated, you referenced Davos, we were there as well with Asset TV, this was one of the number one topics talked about among the impact investors that were there. So we’re going to pull up the results of a survey that was done in 2016, it asked 158 impact investors how exactly they measure their impact and what benchmarks they use. So let’s see it now. So for reference we have on the far left, proprietary metrics and frameworks not aligned to any external frameworks or methodologies. Second here, metrics that are aligned with IRIS, we then also have qualitative information that was used to benchmark impact, then standard frameworks such as GIRRS, GRI, SASB etc. And lastly, we had one respondent who said, “We don’t measure our social and environmental impact. So I think this is a really important question because a lot of your investors I am sure must ask you, “Okay, we’re impact investing, what is the impact?” So starting with you, Amy, how do you measure or benchmark impact performance?

Amy O’Brien: Sure. First I just want to observe that these results don’t surprise me. we have been working on I would call it the ESG ecosystem for decades now and impact measurement is still fairly in early days. I mean there are some very promising work that’s been done to date. But also we have some new concepts that are into the fold now, like have been mentioned, the Sustainable Development Goals and there are a lot of companies aligning around those. But actually there’s no systematic way to measure that. So I do think that we are still at early days. But clients want to know this information; I mean they’re interested in the ESG quality of a portfolio. But they’re also interested in the results. what positive social or environmental benefits came out, of my portfolio this past year or quarter? And so we’ve been very committed as a firm to, , continue to work on things like this and actually begin to think about new ways of impact measurement. I’d say as a practitioner in this space, I’d like to see more alignment around this. I think having common definitions of where we’re all heading is really important to the field, the credibility of the field and [inaudible] a way for us to organize and communicate with investors.

Gillian: So you are working on innovating new ways but you’re also saying the community together needs to come up with a benchmark that we can all rely on and compare against?

Amy O’Brien: Absolutely.

Gillian: Okay. Doug, what about you?

Doug Lopez: Yeah. This is definitely, it’s a difficult area in terms of measuring the portfolios and how you’re socially environmentally performing. So we have used a lot of external sources to try to score out our portfolio just to get a quantitative measurement is in MSCI ratings or [inaudible] different vendors that are providing information in that area. We’ve also scored out a workplace diversity on our own to score our portfolios relative to benchmarks that we’re in just to get an idea and to convey to investors that there actually is an impact in this portfolio, that’s been made and it’s not just being said that we’re going to do this and we don’t have any proof behind it. But still finding a lot of good data and information is difficult in this world. I know SASB is really pushing hard to get companies to report all the metrics for sustainability, similar to every other accounting type of reporting. But I know that’s not fully integrated. I know the UK came out and require data of all their companies. In the US, hopefully we get to that point. But that’s something that I think will really help facilitate more information flow, which will help show investors that we’re actually doing what we’re supposed to be doing in these portfolios.

Gillian: So one of the issues, correct me if I’m wrong, is opacity at the underlying investment level, that makes it even more difficult for the portfolio itself to evaluate. Tessie, what do you think about this?

Tessie Petion: So historically we have reported quarterly about our social impact. But I think one of the things that this chart points out is that it’s been largely qualitative. We’ll talk through that we filed a resolution with a company and the results of that. We’ll talk about the fact that we have encouraged a company to adopt lower energy bills. So I think that we’ll continue to see this kind of qualitative reporting because it’s part of the industry. I think that where we struggle is to translate that into specific quantitative metrics to say that by investing in this portfolio versus another portfolio you may have avoided this in terms of emissions. I think that that’s something that investors have been looking for. And that’s where the struggle is, to try to make that into a quantitative metric. But I think that on the qualitative side we’ve really tried to advance and tell our shareholders the way that we put their money to work.

Gillian: Okay. And, Ron, lastly, how do you measure impact?

Ron Homer: Well, I think one thing I’d like to draw a distinction between because I think ESG is a little different than impact investment in that ESG factors in environmental, social, governance factors in making your investment decision. Whereas when I think about impact investment it’s driven by a specific social goal. So in our case we’re trying to increase the flow of capital into underserved communities, they’re well defined. And it’s easy to measure because either you did or you didn’t. And we’re looking to do it in capacity building areas, home ownership, affordable housing, small business development, educational and healthcare facilities. And so for us we have a pretty well defined, we finance so many schools, so many hospitals, so many people bought homes through our fund or there are so many rental housing units created, so many small businesses. So there’s no ambiguity. We created our product also to meet a regulatory need for banks. And so we not only have a well defined way of reporting but we have a third party that validates it and says to a bank, “You either get CRA credit – Community Reinvestment Act credit for doing it because you did it.” So I think in the community development space it’s been … they’re fairly well defined metrics in terms of how to measure it.

Gillian: Okay, so a more straightforward impact there. We should talk a little bit about investment performance and impact. Now, I heard divergent points of view on this when I spoke with each of you before this panel. The question that I put to each of you when we spoke was to what extent do you find investors think that they have to sacrifice performance for impact? Now, some said, “Increasingly investors aren’t asking that anymore, it’s less of a factor.” I also spoke with some of you who said, “It’s not a question of will I give it up, it’s how much will I give up.” So I’d like to hear a little bit more from each of you about how you deal with the perception that many investors had or perhaps still have that when you want to achieve social impact, you have to give up a few basis points of performance. I’ll start with you.

John Adams: Well, thank you. The thing that we find is that clients and financial advisors are very open to listening to good objective information. UBS did a macro research study where they looked at many different whitepapers that were examining the effect on performance of sustainable and impact investing. And the summary, just to give you that, is that there was no definable improvement or decline when you took all of these studies into account. And so that kind of information, when people see in depth quantitative research that gives them an answer, what they can do is they can come out and make their own judgments, not based upon a rumor, but based upon some more empirical information. The thing that we think is really fascinating also is that there is a persistent experience among portfolio managers that there are risk control elements. And this intuitively makes sense if you look at the fact that environmental, social and governance behaviors of companies, if you were to eliminate the worst environmental liabilities, EPA super fund cleanup sites for instance. If you were going to diminish the amount of exposure to law suits on let’s say class ceiling issues, women inclusion in the marketplace, which has been a point of litigation. Some large law suits have been settled in that area. Well, if you can lessen the exposure in those areas, maybe you’re going to have less stock volatility. And we can look back at some pretty big single company events that have occurred.
And then there are some thematic events such as the financial crisis, where we can look at the linkages between executive compensation and the risks taken among banks prior to the financial crisis. Those are indicators that I keep hearing about in conversations with portfolio managers where they’re saying, “Yeah, we’re seeing some risk control.” Where we have avoided some of these issues by prescreening for environmental, social and governance factors.

Gillian: Interesting, so I framed the question about upside, but you’re talking about downside risk protection, equally important, so it’s an interesting point to convey to investors. Doug, do you find that you’re consistently faced with this question of whether or not your investors will have to give up a couple of basis points in the high yield space in order to get a positive social impact?

Doug Lopez: Yes, we do. I mean probably the person who mentioned, they asked me how much as opposed to whether we have underperformance or not. And I mean really when it comes to corporate bonds and especially in the high yield area, we’re really kind of a pioneer in that asset class. There’s not a lot of investors doing that. So it’s really more difficult to explain because most people don’t really follow it that closely. But I do know from an investment standpoint, the factors that we take into consideration from environmental, social and governance practices have a big impact on identifying who are the best managers and who are managing the companies that we’re going to be investing in, in the most appropriate manner. Do we some litigation, other issues that arise, I will tell you some of the biggest disaster in the market, whether it’s Enron, [inaudible] or WorldCom, I mean these were all governance issues that should have been addressed early on that were red flagged and things that would have been identified if more investors were paying attention to these areas. So when you look at a high yield company, one of the things, it’s a very leveraged company, so if you had bad management, a company can really suffer and go south really quickly because of that leverage on their balance sheets, so it’s not managed properly. And what we find is that the managers that manage their balance sheets appropriately also are managing the rest of their company very well. And in these areas of environmental, social and governance issues, they are scoring very high. So we see a correlation there. And I think over time people will come to appreciate that more.

Gillian: Okay. And, Ron, please.

Ron Homer: Yeah. I think that’s the biggest hindrance for this field growing is the confusion over whether there’s a trade-off or not. And I can tell you from RBC’s perspective; we look at ESG and impact investment as alpha activities. We look at ESG as an important way of evaluating companies on the equity side, because you not only have management risk but you have governmental risk. And in some of the areas like emerging market equities or international, in Europe they’ve been doing this for a long time. So to ignore these factors is to ignore a lot of risks. I mean I think people, what … I had hoped to screen Volkswagen for some of its governance practices, the same thing on the impact side. I think whether it’s private equity or high yield or even in how you would structure a mortgage backed security, you’re looking for inefficiencies, you’re looking for pricing where you can develop, that these people want to behave a little bit better, more favorable to the investor over time. And that will give you outperformance. So I think looking at behaviors, looking at environmental factors and social factors are all part of a good investment practice and actually if applied diligently should deliver outperformance. And so I bristle at that trade-off because I actually think it’s part of delivering excess performance.

Gillian: So they’re inextricably linked?

Ron Homer: And I would like to see the field evolve so that people make that connection as opposed to some trade-off, because I think that deprives the field of consideration and worthwhile investment.

Gillian: Yeah, a really good point. Amy, how do you think about this?

Amy O’Brien: So certainly we have examples of how we believe ESG has added value to the investment process, helped meet investor objectives, had a positive social impact. But I think I still hear this across the country and speaking at events and conferences and those who are perhaps newer to this space that the performance sacrifice or the zero sum game is really still a concern and a hindrance. So I do hope that we as an industry can send the signal to others that this is not about constraining a portfolio, just exclusionary screening anymore. And I think once we begin talking with these kinds of examples that we’ve all shared today, we can get the message across that this is what the field has become over time, and these are the proof points that are important.

Gillian: Interesting. So making it no longer synonymous with exclusionary? Tessie, how do you think about this, do you find investors are coming to you with the same misperception?

Tessie Petion: Yes, we get this all the time. And I think that to follow what she said, I think we have to make it more about just the avoidance of risk and talk about all of the companies that we identify before they hit mainstream markets. Because we’re looking for innovation and because we’re looking for growth and companies that are addressing societal needs. You know, I can think of many examples of companies where we were looking for a technology or we were looking for innovation and we identified it before it was part of the benchmark, before it was in mainstream. And so, I think that we have to do a good job of telling that story so that people understand that it’s opportunity, not just eliminating risk.

Gillian: Speaking of telling each of your stories, you’re all coming at this from a very different angle, which I think has already been highlighted. So I want to take a pause in the conversation and sort of direct some questions to each of you specific to your strategies. And, Amy, I’m going to start with you, you’ve already referenced this focus toward thematic investing. How has this impacted the way that you construct products? And can you name anything that you’re working on now that is really a reflection of this shift?

Amy O’Brien: Well, I think both the thematic and the outcome orientation and client preference and interest in those features has definitely impacted how we have been designing new products going forward, even making new types of reporting out about existing products. So one example is we have been launching a new set of ETFs last year. And so they are built on an investment strategy that we believe is a strong one that we’ve used in some of our Social Choice funds but we also included an element of low carbon criteria so that an investor could get information about the carbon footprint of that fund. And so trying to tie together the ESG side with an outcome side as well, so I do think you see climate change has been one of those themes that’s been important. But there have been other important themes. And I do think that is an important connection that clients make. They get a little bit of understanding, or the ESG speak is important as well and that criteria is important. But, what was that outcome? That I care about that issue, , what good did I do or harm did I avoid.

Gillian: And I remember the example we talked about previously to this conversation was about are you fossil fuel free. And I remember you said to me, “Well, what does that even mean?” So it’s an interesting distinction there.

Amy O’Brien: Yeah. So there’s a lot of term, this goes back to the term and definitions, and frankly, the importance of investors and advisors who serve them to really look under the hood when it comes to something that’s labeled sustainability or ESG or impact, and really understand, the intention of that strategy, understand how ESG or impact factors are woven into the research, the portfolio management and then sort the ongoing monitoring against progress. So there’s a lot to dig in under the surface here.

Gillian: Sure. Doug, speaking of fossil fuels, you are in the high yield space, it’s synonymous in large ways with energy, how do you evaluate energy companies in your portfolio? You’re not fossil fuel free, correct?

Doug Lopez: No, we’re not, so…

Gillian: So tell us a little bit about that?

Doug Lopez: So we don’t think fossil fuels are going to be going away any time soon. So we have to just find a better way to invest in those types of companies and to make the right decisions on who’s attracting these fields out in the most appropriate fashion. So we, within the high yield market, the energy space is anywhere from 15-20% of the overall market. So it has a very large impact on how you address that space when you’re managing a high yield strategy. So the way we do look at it is we’ve come up with some screens in terms of negatively screening out some areas. And then within the remainder of the energy space, you know, we actually look at the positive ones that are moving in the right direction in terms of the extraction, worker safety rules, you know, EPA and everything else. So the areas that we do screen out right away is in the areas of coal, you know, coal mining is out of the portfolio. We have those as a negatively screened out. Also oil sands up in, you know, in the northern part of the country. We think that that is a very invasive disruptive way to get the fuel out of the ground. And then also when it comes to the areas of IPP, in terms of Independent Power Producers, electric utilities, those types of companies, we’re screening for the companies that have the least coal fired electric utility generation. So we’re screening those out and scoring those. And some of those were eliminated out of the portfolio entirely.
So we’re looking at it from a number of different areas in terms of the IPPs, screened out some companies that are on coal and oil sands. And then the rest of them we’re really looking at the worker safety records, we’re looking at, you know, greenhouse gas emissions that are coming out. And we’re trying to take those and really find the companies once again that are improving and moving in the right direction. So there’s the companies that score extremely high and we put in all this information and do very well on their scores. But the bottom line is we want to find the ones where we actually have a little bit more of an impact. You know, we’re actually going in and encouraging them to continue to report data and improve their practices and be better stewards for the environment.

Gillian: Now, when we spoke previously, obviously energy companies are not the only companies that you’re looking at. Governance, among the ES&G factors, that’s what we really dwell on the most, can you give us an example of some of the governance factors you look at, at companies, how do you determine whether or not they meet your criteria for being well governed?

Doug Lopez: So we’re looking at the construction of the board itself obviously, you know, the separation of the duties of the CEO and the Chairman of the board. We’re looking at diversity on the board. We’re looking at outside directors in terms of having influence as opposed to having it all insiders where we seem to make some bad decisions when that happens. So we’re looking at those areas in terms of governance, then we’re just looking at standards within the workplace, in terms of, you know, how they manage their employees. And the communication there, the dispersion of pay amongst the executives and the actual workers. And to make sure they have the benefits and everything else.

Gillian: Okay. Tessie, you phrased this question interestingly, we have been talking a lot about the impact that each of you are having in the world. But you have impacts specifically on the companies you work with at Domini, so can you tell us a bit about that?

Tessie Petion: Sure. I think one we feel that our mission is to pick better companies but also to work to make companies better. And so we regularly vote against really out of control executive compensation packages. But it’s not enough to just send the signal and say, no, it’s also going to the companies and telling them why we voted against those packages. Or telling them why we voted against a board that’s consistently all men. One of the things that … we’re always going back to companies and giving them feedback, one of the earliest examples for us is that we filed a shareholder resolution with Apple back in 2004. And it led to their first supply chain policy. And you know, everyone’s like, “Well, yes, words on paper.” But the thing that what that did is it initiated a relationship with the company, that’s been very high profile and it’s allowed us to go back to the company each time if there are supply chain issues or each time there are issues on tax avoidance. I think that we really want to build a relationship with companies, whether or not we invest in them because we want to nudge them in the right direction. We work in the mid and large cap space so we know we’re finding companies that have room to grow and room to make themselves better. So I think we just always think of that as part of our process.

Gillian: And can you give us a sense of some of the factors that you screen for in these companies when you’re initially looking to make an investment?

Tessie Petion: Sure. So it really depends on an industry, I think one of the most interesting things about our process is that certain factors are really important. So if I’m looking at a pharmaceutical company, I’m thinking about safety, I’m thinking about pricing. But if I’m looking at an auto company I’m really focused on the union relationships. It really depends on the type of company that we’re looking at. And so we really want to make sure that we’re not looking at extraneous information. The thing that is most impactful about it being [inaudible] is that our access to capital initiatives or project financing. We’re really trying to key in to what’s most important about that industry or that company to make our decisions.

Gillian: Okay, Tessie, teed you up nicely, John. So switching gears a little bit, you called sustainability investing a form of democracy in action, what exactly do you mean by that? And can you give us some examples?
John Adams: Well, democracy in action to me means empowering clients, the investor themselves to express their values through their investments. It is that simple. We see quite a separation between individual investors and institutional investors. So if I could I’ll just take a minute to explain that. What we typically see for institutional investors is that the board or finance committee will define a set of rules in a written investment policy statement. And then their consultant designs the appropriate asset allocation and each sleeve might hire an asset manager in each sleeve of investment that’s here in the room. And those asset managers will sign a form at the beginning of the engagement that they’re going to comply with the investment policy. So it’s a formal process, every single quarter the investment managers are requested to report to that specific standard, so it’s highly customized democracy in action. What you find with the retail client space is that a firm like Doug’s or our portfolio management team has a set of guidelines that involve some negative screens, that may be fossil fuel exclusion for instance and maybe some integrated positive screens that have to do with women being on boards of directors, inclusion, community lending, these various factors. All of these are integrated into the process. But for an individual client they’re often not customized the way you would see in the institutional space. But for an individual that aligns with a set of values, they can look at each of our firms and say, “Yes, they are expressing my values and they can vote with their money.”

Gillian: Okay. And you gave an interesting example about gender diversity on boards. You said it also impacts performance; we’ve referenced this a little earlier. What’s some of the research you’ve done there?
John Adams: Well, I haven’t done the research, I’ve seen the industry research here in the United States that has shown an interesting and subtle factor, which is that older white males, guys like me typically have an education and skill set that favors certain types of experience. And what you find is that in diverse communities and where there’s women, experienced women executives, they have different skill sets. One that I recall from a recent study that I read showed that there is very kind of a low level of talent set in HR among the white guys set. And that women have a lot of those executive positions and when those insights and that experience is brought into a board of directors it fills out the talent set on the board. So that’s just one example. But you get a diversity of opinions. You get different ways of looking at conflict resolution between genders. And there have been studies in the industry that show correlation to performance. I can’t cite them directly, sorry. I apologize that I can’t give you that footnote so to speak. But I think it’s a very interesting topic, maybe Amy knows the answer.

Gillian: But an interesting interplay between impact and performance there. And lastly, Ron, obviously you are approaching this from a slightly different perspective. When you talk about providing access to middle and low income communities, what specifically are the types of things that you’re financing? And how do you look at actually structuring those products for investors to get involved in?
Doug Lopez: So as I mentioned, we’re looking for capacity building activities. So we start with home ownership. We believe that low and moderate income homebuyers who buy homes for shelter over time will outperform the universe of homebuyers for a lot of different reasons. I know contrary to when we had the bubble in housing, that wasn’t the mantra. But we have a 20 year track record showing that. We think within the affordable housing rental space there’s opportunity for agency type guaranteed loans that have better spreads than direct agencies. So it’s a way to fill out a Barclays Agg portfolio with agency type credit. We believe that there’s opportunities in the taxable muni area, that when you compare muni credit to corporate credit, with the same ratings that sometimes you get extra spread or less spreads. So what we try to do is find capacity building activities that help creative capacity in the low and moderate income communities, marry that with securities that are created from those activities. I think one of the unique things we do is to reach out to originators of these products and try to encourage them to sell to us an original issue as opposed to on street form. Because by doing that we help our clients get better execution, acquire the assets at a lower cost and within fixed income and highly liquid, that’s important execution, maybe all of it. And so I think that’s one of the unique things. And then the by-product of that on impact is that you’re empowering smaller institutions to access to capital markets at a more efficient price.

Gillian: Now, you’ve countered this with the examples you’ve given. But do you find that when you’re working with investors and you tell them what communities you’re focused on that they think it’s automatically associated with excess risk?

Doug Lopez: Yeah. So as I mentioned, it’s very hard to get new investors because they get clouded with all these preconceptions. I can tell you, we have a number of major public pension funds that not only have invested with us once but twice and sometimes three or four times since 2007. We have, I’d say 40% of our current investors have invested again. So we’d just like to expand that universe even more, but those investors who do find us and who we can explain our strategy and they look at our performance, and including many consultants who, if the client asks for something like this we’ll say, “Yes, we have something that meets it.” The problem is that, particularly with institutional investors, no one directly says, “I have an impact investment allocation.” So I think that’s one of the bigger issues is to find within an asset allocation mixed for institutional, you know, where do you fit it in?

Gillian: And I’d like to end on where exactly impacting investing fits into your portfolio and how you would speak to advisors on this front. I want to quickly bring in a viewer question from an advisor; her name is Winnie Sun, Managing Director of Sun Group Wealth Partners. She sent us a question about some changing demographics that may impact the impact space.

Winnie Sun: Hi! My name is Winnie Sun, Managing Director at Sun Group Wealth Partners in Irvine, California. My question is, given that millennials are now the largest generation, what are you doing in the scope of impact investing for this population?

Gillian: Now, my question to you, John, and obviously please answer this question, but to reframe it slightly, are you finding that your clients are coming to you and saying, let’s say, “My children are really interested in impact investing, or they’re just starting out”, how would you advise them?

John Adams: Well, financial advisors that come to us for investment management and the clients that we talk to are normally filling out a questionnaire that is asking them what their priorities are from completely insignificant to you have to put these values based screens in our portfolios or we will fire you. Which is a nice indication of interest, so the thing that we’re noticing is that people that just come to advisors because of reputation and performance, there’s a much higher level of interest when people are asked if they want to have ESG impact screening than what you see as the percentage of people that are doing it. That number increases very substantially if people are answering that they are on charity boards or they’re personally involved in philanthropy. If they’re volunteering or they’re giving, their likelihood to engage is much higher. We see the very highest numbers among the millennials. And those are people that are typically, they’ve come into some wealth, they’re interacting directly with their financial advisor and they are insisting that their values are represented. And those can be different. They can be from, you know, progressive democrats to conservative republicans. And the fact is they’re adamant and they are … it just seems, much more interested in having their consumer behavior, their politics, their investing all aligned. It seems like a generation of activists.

Gillian: Yeah, not surprising. And then when you mention their participation on boards, etc, it’s perhaps not so surprising that they’re also participating with their wallet. Amy.

Amy O’Brien: On this topic I think we have some work to do in terms of the investor client engagement. We’ve done a lot of research over the years. And one of the findings from a survey we did last year was that those investors who were the most interested in impact and responsible in ESG, are the least likely to have had a conversation with an advisor. And so I think the question is advisors are waiting for a client to come to them. And I think the demand is there. It will grow, perhaps because of some of the intergenerational wealth transfer, but just the greater awareness raising that we’re all doing, clients are going to continue to ask. And it’s up for advisors to have a productive conversation. I would argue that this is a real business building opportunity for advisors who want to be the ones to ask the question in the first place, rather than wait for that question to be asked.

Gillian: Makes them all the more integral to the clients and their families goals. Doug, tell us a little bit about how you see this space growing, whether it’s millennial demand now or if you’re seeing it impacting the way some of your clients are investing on behalf of their children etc?

Doug Lopez: Yeah, I mean I definitely seeing it impacting the flow of money. But it’s really early stages there obviously. And speaking of millennials, I have millennials in my house. And I will tell you, they are very interested and very involved in what we’re trying to accomplish here. So what can we do for the millennials? Well, we can create a more of a robust product and more robust process that incorporates the values that they want to see in these portfolios. So going from the days of the negative screening to actually looking at companies and all the decisions they’re making in the areas of ESG and applying those into their own companies in a more robust manner. I think that’s what we can do for them to provide them a better product. They’re coming; it’s going to be a big wave. In our world we look at supply and demand and technicals all the time. And it addresses the question of performance. Maybe today it doesn’t reflect itself in portfolios every day. But as we see the flow of money start to move in this direction the technicals are going to get pretty powerful, just like they have with consumer products. There’s companies are creating products now, they’re healthier, and they’re made the proper way and, you know, in a more environmentally safe way. So just like what we saw in consumer products, I think we’re going to see the same kind of movement into investment products. And I think those technicals are really actually going to start to really drive perhaps some of the performance on the companies, because they’re going to be rewarded for their higher ESG impact, you know, in the portfolio.

Gillian: If millennials are voting with their wallets it may increase the universe of companies that are suiting them and therefore suiting some of your investment objectives. Tessie.

Tessie Petion: Yeah. I think that the one of the biggest differences between millennials and previous generations is that previous generations were excited and didn’t know that this existed as a space. Whereas millennials are going to expect that people do this. And I think that for us having a very long history in this space is we have demonstrated a track record of how we have been in this space. But I also think that we’re able to evolve and speak specifically to their needs. But I do think that the expectation that companies are paying attention to it, they absolutely know or feel that their money should also be going in that same direction.

Gillian: Okay. And lastly, Ron, how do you think about this?

Ron Homer: Well, millennials by definition are interested in the future. They have a longer horizon. And so I think designing products that hold out the promise of a better future for them and for their families and for their community will be very attractive to millennials. So I think to the extent that there are investment products that align with a better future is part of their strategy, that’s going to be very attractive to millennials.

Gillian: We’re coming to the end of our discussion and I want to each give you the opportunity to explain to the advisor population watching, where exactly impact investing fits in their portfolio. I think very often the misconception as we have identified is that it’s a niche strategy. It sounds like that’s not necessarily the case. So explain to us from your point of view, and John, we’ll start with you, how does impact investing fit into an overall client portfolio?

John Adams: This is the most important question I think we could end with, just perfect in that there is often discussion about social investing that assumes that it’s a product. It isn’t. What social investing is, is simply one of the criterion that every person should look at when they’re making investment decisions and likewise, financial advisors when they’re looking at the choices the clients make, for instance, are they taking growth or income from their portfolio. What are the tax preferences, the risk suitability for their client? What are their charitable intentions? What are their environmental, social and governance values? If those are asked by financial advisors, clients are going to tell them the answer. And what you end up with, with a client that has strong social and environmental preferences, is that you can build now with the wide variety of products available, you can build competitive portfolios from the very safest Triple A bond portfolios to the portfolios that are invested in aggressive equity and venture capital strategies. Normally what you see are blended portfolios where financial advisors are combining multiple asset categories. And you can have socially responsible or sustainable and impact investing across all parts of the risk spectrum now. So financial advisors need to reformat their thinking and look at it as a client service. That’s the way to look at it, make your client happy.

Gillian: So it’s all part of better conversations first. Amy.

Amy O’Brien: And a similar point, I think maybe in days gone by this might have been viewed as a small percentage or an allocation, 5 or 10% of someone’s portfolio. But I think we have to recognize that we’re facing a time right now where a total portfolio solution will be required by those who are interested in this type of investing. it’s not so much a product decision anymore. It’s more of a process decision. I think all the different dimensions of ESG and impact can come into play with manager evaluation, with product evaluation. And so I think we have to equip ourselves. And certainly we have designed a lot of the products at TIAA Investments to be core portfolio holdings, to make the point that they don’t have to be niche products, but that you can actually build a portfolio around them

Gillian: So someone who’s going to their advisors and saying, “Make my portfolio 20% responsible”, someone who cares about that wants their whole portfolio to be.

Amy O’Brien: I think those days are going to be behind us soon.

Gillian: Sure. Doug, how do you think about it?

Doug Lopez: Well, I think the advisor community needs to really come to terms with the fact that this is something that’s involved and should be involved in every decision in every portfolio that’s being constructed for their clients. I think that you need to have the awareness of the client in terms of the amount of impact they want to have in their portfolios. And perhaps it’s, you know, in our firm, we’re incorporating it into every decision we’re making into the portfolio. It’s just the level of degree depending on what type of client that we’re dealing with and what their demands are. So having the ability to look at managers and actually maybe incorporate this into manager research with every manager you’re looking at, not just within the ESG space, but for every core manager that you’re looking at and incorporate the questions on, you know, ESG and how is that incorporated? Is that something you take into consideration? Then communicating that to the client and getting the sense from the client in terms of, you know, what level they want to be involved in that in their portfolios.

Gillian: Which makes those benchmarks and metrics across managers even more important to establish. Tessie.
Tessie Petion: I’d echo a lot of the earlier comments. I think that when we’re developing a product, our Impact Bond Fund isn’t intended to be the best ESG bond fund. It’s intended to be the best bond fund. And so I think that financial advisors really have to get away from this idea that of this subset it’s okay within the subset. We’re managing to meet our benchmark. And so it’s competitive and you actually provide an added benefit to your clients by saying, “It’s a competitive product and also it finances these things.” So I think that there has to be a shift. But yeah, this is not a niche and it can’t be a niche going forward.

Gillian: So it’s about broadening the way that advisors are looking at this suite of products available. Ron, last but not least, how do you encourage advisors to construct portfolios around impact investing?
Ron Homer: Well, I think I agree with the rest of the panel, that there are impact and ESG opportunities and processes across all asset classes. It can be a driver of helping increase performance, whether it’s private equity, private debt, high yield, emerging market equities, international stocks, I can’t think of an asset class that you couldn’t apply it. I think the opportunities may be somewhat limited, depending on the number of managers who have developed their impact processes etc. So I think that’s the variability. But I think the more that advisors ask for that and the more consultants, the more people that ask their consultants to find them, the more products that will be available.

Gillian: Well, thank you all so much for taking the time to educate our viewers on this growing and interesting space, when it’s only becoming increasingly important as the headlines move forward. So thank you so much for taking the time to chat with us today. And thank you for tuning in. From our studios in New York, I’m Gillian Kemmerer for Asset TV Masterclass.




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