Masterclass: ESG

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  • 01 hr 00 mins 35 secs
There's a growing demand for investments that address climate change and other environmental, social, governance issues. This panel covers opportunities for advisors, ESG adoption challenges, and what sustainable investors need to know as they evaluate the growing array of ESG strategies.
  • Brett Wayman, Senior Director, Impact Investing - Envestnet
  • Cheryl I. Smith, Ph.D., CFA® Economist & Portfolio Manager- Trillium Asset Management
  • Margaret Dorn, Senior Director - Head of ESG Indices - North America S&P Dow Jones Indices

Jenna Dagenhart: Hello everyone and welcome to this Asset TV ESG Masterclass. Today will cover emerging environmental social governance trends following the UN's climate conference, advisor opportunities, and adoption challenges, and what's next for ESG. Joining us now are three industry experts, Cheryl Smith, economist and portfolio manager at Trillium Asset Management, Brett Wayman, senior director, impact investing at Envestnet, and Maggie Dorn, senior director, head of ESG Indices North America at S&P Dow Jones Indices. Everyone, thank you for joining us. I'm going to start by stating the obvious here. But ESG continues to go more mainstream. What's driving this shift, Maggie? And how is the sustainable investing ecosystem evolving?

Maggie Dorn: Well, first and foremost, Jenna, thanks for having me on today. And thank you to my fellow panelists as well. I'm really excited to hear everyone's thoughts on the growing landscape around ESG investing. But to answer your question, Jenna, I think what is really driving this monumental shift around ESG investing and really pushing it more into the mainstream, I think it's really a direct result of how the sustainable ecosystem has evolved over the past few years. And what I mean by this is that historically there was this myth of almost an ESG versus performance trade-off that plagued the widespread adoption of sustainable investing. And in that mindset, that was very much commonplace amongst mainstream investors partly existed to the fact there were these more archaic forms of investing, like SRI or socially responsible investing, that were really prevalent many decades ago.

Maggie Dorn: And to some extent, those more archaic forms of investing did imply really less portfolio diversification, and therefore the possibility of lower investment returns. However, I think what has really evolved as of late is this emergence of new data, as well as combining that data with more innovative index construction approaches that are really designed to more closely replicate the risk return profile of an underlying benchmark. And that has ultimately meant that investors now have a much more expansive toolkit to integrate ESG into the core of their investment portfolios without necessarily having to sacrifice returns. And even in some cases, as some recent outperformance would suggest, that some of these types of investment approaches might even offer a pathway for more resilient and differentiated returns.

Maggie Dorn: So, really these new innovations and advancements in data coupled with this greater understanding of what the core application of more sustainable benchmarks can do, is really pushing ESG investing further away from what was this fringe type of an investment structure, that some of these earlier forms of sustainable investing once applied, and is really moving more into that mainstream sustainable core that ESG investing is becoming today.

Jenna Dagenhart: There's no denying the growth of assets and industry-wide interests there. Now, Brett, what are you seeing at Envestnet? And is it representative of these industry trends?

Brett Wayman: Yeah, absolutely. I mean, I think we're seeing that evolution in real time. When we look at the roughly a hundred thousand advisors that use the Envestnet platform, sustainable investing, impact investing, ESG, whatever the umbrella term you want to use, is one of the fastest growing parts of our business, especially on the managed account side. We're finding that this focus on personalization, on tailoring a portfolio to a client's values, on using ESG specifically to build more resilient and better portfolios, ESG is the risk lens, ESG is the opportunity identifier. We're finding that it's resonating not just with end investors who have been really driving the demand, but starting to resonate more with the advisors that we have. So that growth has been a hundred percent plus year over year for the past couple of years, where we look back four or five years ago, that wasn't the case.

Brett Wayman: There is such a niche allocation to what was the legacy SRI. What we found is that it's resonating for a lot of reason. One is this idea that we can have portfolios that reflect our values. But the second, and specifically with the advisors that we work with, I think the big reason that it's really resonating with them is because they can use it as a way to engage younger new clients to bring in new younger and more diverse advisors to help them build out their practice. And we look at the data. Envestnet it is hard as a big data company as well. And we found that those advisors that have over 10% of their book of business in some sustainable investing strategies or strategy are growing at about 45% year over year. Compare that with the advisors who are not using sustainable investing or using it below that 10% threshold, they're only growing at about 31% year over year.

Brett Wayman: So it's a huge difference and a huge incentive, I think, for advisors beyond just the resiliency of portfolio construction and the benefit of social and environmental outcomes, it's a benefit for advisors to think about when they're trying to maintain their client base, especially through that wealth transfer.

Jenna Dagenhart: Turning to you Cheryl, has the evolution of ESG and demand for it surprised you in any way throughout your career?

Cheryl Smith: First, thank you. It's a great opportunity to be here with Maggie, and Brett, and you Jenna. And I appreciate that opportunity. I feel like I'm in a bit of a time warp though, as I hear Maggie refer to fringe and Brett refer to old. And I would say I am not surprised because Trillium and I have been working to get this to the mainstream for 35 years. So we're not surprised. And I would like to disabuse of the notion that we were ever fringe, we were always interested in building a performance record that really showed that you could combine concern for environmental issues and social issues and how companies managed those in order to build a well diversified portfolio with good investment returns. So we're very happy to see this. We're not surprised about it. I think we could say we're slightly disappointed by firms that take it as primarily a marketing ploy.

Cheryl Smith: So I agree with what Brett said about younger people being very interested in this. And for us really the core is that it's about engagement. It's about having the clients be engaged with what's in their portfolio and having the investors be engaged with the companies that they're in, because it really is about creating more positive environmental and social outcomes as well as better governance by companies. So not surprised, happy, and I've been working for this goal for quite a long time.

Jenna Dagenhart: And Maggie, how has demand for ESG changed over the past couple of years, specifically fast forwarding towards the present? And how are investors accessing ESG strategies today?

Maggie Dorn: So let me first and foremost congratulate Cheryl, because I know all the work that they've been doing for the past several years has really gotten us to where we are today. And it's also really helped some of the demand shift around the application and the necessity of these various strategies. And ultimately what it's gotten us to is that investor preferences have really started to change, right? So especially if you start looking at the more recent crisis, both in terms of the pandemic and then on a broader scale, the climate crisis that we're now facing as well, it's really started to reshape the way investors think about their capital allocation decisions. And this has led them to seek out more sustainable investment approaches.

Maggie Dorn: And this is something that Cheryl could probably say that they've been looking to for quite some time, but I also think that there's a much greater understanding around the fact that ES and G data, ES and G metrics can provide a much wider lens through which investors can assess how a company behaves on a multitude of important issues. And ultimately use this, what is incredibly relevant and financially material data that has been informed by these environmental, social, and governance factors, to make a more informed investment decision. So we've seen this increasing investor preference translate into what can only be described as exponential growth in both active and in passive ESG strategies.

Maggie Dorn: And while index-based funds with ESG consideration have definitely grown in terms of both numbers and assets, they are still vastly outnumbered by actively managed ESG funds. But as some of the numbers indicate, more and more investors are really looking to these index-based passive strategies as these types of tools to implementing ESG, again, looking at the core of their portfolios. And I do think we will continue to see that trend.

Jenna Dagenhart: And I echo Maggie in thanking you Cheryl for making this such a mainstream thing along with the work of many others, so that we can talk about the exponential growth and host of other issues rather than simply what is ESG for this panel. Now digging deeper into investor preferences, Brett you threw out some really interesting data points earlier. Where is the demand coming from?

Brett Wayman: Yeah, well, it's a simple answer. It's coming from everywhere. And it's coming from investors more so than advisors so far. But that's always the way this work. The investors drive the demand and the advisors react to it and start to figure out how to incorporate that into portfolios. So we've been really encouraged to see the demand coming from every age and generation of investor, every demographic of investor, through every different channel, through broker dealers, and RIAs, family offices, bank trust, institutions. There's always this myth that it's the coasts that are driving this demand for ESG, West Coast and East Coast. But I'll tell you, I have just as many advisors from the middle of the country, from Kansas, and from Iowa, from Chicago, from Dallas, from Houston that are interested in ESG as I do from California or from New England. And again, that's another encouraging thing for us, is just the widespread demand for incorporating sustainability into portfolios.

Jenna Dagenhart: And Maggie, you mentioned this performance myth earlier. How have ESG Indices performed and how does that performance vary as you move down the various shades of green strategies?

Maggie Dorn: Yeah, so I think that the first point that I should mention is that there is this increasing body of evidence, both in the world of academia and as well in investment practice that ESG issues are again quite financially material and could in fact drive performance. However, the caveat to that is that as an index provider, ESG index performance is really dependent upon the investment objective of the index methodology. So for indices that are designed to closely track their underlying benchmark, ultimately the corresponding performance of that ESG index should in fact be quite similar to that benchmark over those longer periods of time.

Maggie Dorn: However, with that in mind, when we are designing these ESG index strategies, there really does remain that this trade offs between tracking error and ESG performance. So meaning that the deeper shades of green, or I've heard it referred to more recently as the more vibrant colors of the rainbow that you're looking to achieve, that the more likely you are to ultimately deviate from that benchmark performance, whether it be quite frankly positively or negatively, in order to really tap into those more sustainable or sustainability focused enhancements. So I'll provide an example. So we have ESG versions of the [inaudible 00:13:53] S&P 500 Index. One of the indices could be considered more of a lighter green. And we call that a flagship S&P 500 ESG Index.

Maggie Dorn: We also have a darker green version, which is the S&P 500 ESG Elite Index. So the elite version is really designed to maximize the sustainability profile of the index. And it does that by incorporating close to three times the number of controversial business activity exclusions. It also includes a much higher ESG scoring threshold so that we can really focus more on those ESG leaders within their respective industry groups. And by incorporating these more stricter sustainability criteria, it ultimately provides us a more significant increase in the ESG performance. But it does so by also taking on almost three times the tracking error that we see relative to the "lighter green version".

Maggie Dorn: So now all of that being said, if you look at the historical tenure annualized performance of that S&P 500 ESG Elite Index, it has actually outperformed both the S&P 500 as well as the lighter green version of that S&P 500 ESG Index. But even in seeing that kind of evidence about performance, I think it's important to emphasize, specifically for the purpose of this conversation, that for many of these strategies or many of these index strategies, these tracking error trade-offs still very much exist. So understanding the investment objectives and in priorities of the endpoint investor is really the most critical level of importance.

Jenna Dagenhart: I feel like I need a paint swatch after that. No, Cheryl, looking at active versus passive, what are some of the key considerations when deciding between active or passive ESG strategy?

Cheryl Smith: Okay, so, Maggie and I are on opposite sides of the spectrum. We are an active manager. We've always been an active manager. But I'd like to say that, first I couldn't agree more that the critical element is to know what it is that the end client's objective is. Having low tracking error is great when the index is up 20%. It's not so great when the index is down 15%. So as active managers, we're trying to preserve value across a variety of things. And for us, we think that the ESG value really shines in active management, to use Maggie's example of her elite green, where it's higher cutoff on the rating as well as more exclusions. One of the things that we do as active managers with our strategy of engagement is we're trying to lift companies up that ranking score.

Cheryl Smith: So we are engaging with companies. We're asking them to change their behavior. We're asking them to do that reporting that all of these indices, that all of this information is based on, reporting on greenhouse gases, reporting on employee composition, reporting on a variety of diversity metrics, which didn't exist years ago. So part of it is we think that an active strategy for a end client who is very interested in the impact of what they're doing, an active strategy is what is moving companies to behave differently, what is moving companies to address environmental issues, to look at those employment issues, look at their strategy for how are they sourcing goods from overseas and what are the working conditions there, and looking at their governance.

Cheryl Smith: So we think that a very important part of being an active manager is that impact that engagement with what we're doing. And we think that's more difficult to achieve in passive way, because for us, we have a carrot which is engaging with that, we also have a stick, we can do shareholder advocacy, and then we have our proxy voting, which is active on all those issues, and an ability to really bring other investors with us and engage them to get companies to change behavior. So for us, that active component is a really important part of what it is that we're trying to achieve for investors.

Jenna Dagenhart: Brett, I see you nodding your head. Anything you'd like to add?

Brett Wayman: Yeah. I agree with both what Maggie and Cheryl just said. I think one of the things that is left out of the conversation around tracking error is that it can be a really useful first step for getting some of the newer investors into ESG. If the concern is around performance and the potential for under performance, due to this legacy of SRI back in the eighties and nineties, everyone's freaked out about that still. But if you can point to a strategy that says, "We're going to perform along with the benchmark, but we're going to do it with low tracking error. We're going to give you that exposure, better ESG companies, but with lower tracking error," sometimes that's a way to get that novice investor engaged in their first ESG portfolio. But I also think that active ESG is really where you're going to have the most impact in terms of long term opportunity.

Jenna Dagenhart: And factors are in increasingly being combined with ESG. Maggie, what are some of the index combinations now available and what are the potential benefits of combining ESG and factors?

Maggie Dorn: Yeah, so I think it's a very exciting development in the world of indexing as it combines two very growing areas of both innovation and adoption, which is of course ESG and factors. But I think even more importantly, it also really signals yet another shift in demand, right? As investors are really looking to build out their ESG indexing toolkit and look beyond just traditional market cap, weighted strategies, and look really deeper into the application of ESG across an entire diversified portfolio or solution set. And one of the more exciting areas of development at S&P was the recent launch of an ESG version of our widely recognized and tracked S&P 500 Equal Weight Index.

Maggie Dorn: And why this launch was particularly relevant is that if you look historically at some of our factor indices, let's say like the low volatility or equal weight, by accessing these factor exposures, subsequently there have been unintended negative impacts on the sustainability profile of the index as well. So as a result of screening for these certain factor indices, what that has ultimately led to is that it's not always been a desirable or not necessarily a suitable investment strategy for a sustainability minded investor. But with the launch of the ESG versions of the S&P 500 Equal Weight Index, investors now can really access the benefits of this equal weight structure, like greater tilts to small cap companies and value as well as overall reduction in concentration risk, but do so with these meaningful and measurable improvements in ESG scores and with a lower overall carbon footprint as well.

Jenna Dagenhart: And we discussed earlier just how much growth we're seeing in the ESG space. But with that, there also comes some concerns about whether all these assets are genuine, whether they're having the impact that they say they are. There have been a lot of headlines floating around about greenwashing lately. Brett, would you say greenwashing is real? And what are the concerns?

Brett Wayman: It's a good question. Yeah, lots of talk about greenwashing lately. Yes, sure, it's real. It exists in our industry just like it exists in any industry. I take a more optimistic viewpoint of this. The way that I think about greenwashing is, greenwashing is just the beginning stage of real integration. Bigger companies are usually the ones that are being accused of greenwashing. And for those of us who have worked for big companies, they're slow to change. Now, even if they were to say tomorrow, yes, ESG is the most important investment methodology or thing that we can be looking at when we build portfolios, it's still going to take them some time to get that throughout their entire workforce to start integrating it to every portfolio. And so I think we should be helping these firms get better with their practices, not necessarily criticizing them for trying.

Brett Wayman: Now that doesn't mean that there aren't some firms that are using it as a marketing ploy that certainly exists. Again, just it does in the industry. But I think for the most part, these firms really are starting to understand that ESG is a material investment methodology, and that they're trying to figure out the best way to start reflecting that in their portfolio. So that's why you're seeing a lot of rebranding. You're seeing a lot of these legacy investment strategies that have 10, 15, 20 year track records start using ESG and their marketing materials, and sometimes even putting it into the product name. And I know it looks disingenuous. You've run the strategy for 20 years and all of a sudden now you've renamed it. But if those portfolio managers, and if the executives of those companies start to recognize the value that ESG brings, wouldn't we want those portfolios to start using ESG more fundamentally throughout?

Brett Wayman: All of that said, I don't think that we should let altruism get in the way of our fiduciary responsibilities. So, giving them a little bit of grace is okay as they build up their methodologies. But if they really can't integrate it over the near term, we definitely should be investing in the strategies that have been doing this and that do integrate best practices when it comes to ESG. But when it comes to greenwashing, I mean, I think the industry in general just talking about greenwashing means we're setting a bar. And like they say, all press is good press. I mean, that's how I feel about greenwashing. The fact that we're talking about this and it's so prevalent means that it's on the minds of investors and advisors. Now everybody's held to a standard that is above greenwashing.

Jenna Dagenhart: Yeah, those are great points. And honing in on impact, Cheryl, many advisors and their clients are interested in impact. Like the greenwashing, we've seen with ESG. It seems like impact is a term that gets thrown around quite a bit as well without a clear definition of what impact actually looks like. How do you all think about the impact generated by the different approaches to sustainable investing?

Cheryl Smith: Well, first I want to say I love Brett's conception and framing of the greenwashing as, okay, we're moving to a higher standard and everybody's going to be there. We've always had a saying that there is no such thing as a perfect company. Every company is made of human beings, no human being is perfect, and they all make mistakes. And part of what we've worked on on our impact work is to work with companies to say, "We think you're doing a great job in this area. We would like to see you do a better job in this area as well, continually upping that bar." So I think that that's a very positive approach. And the addition of ESG names to strategies that have long been sustainable strategies is also partly a change in nomenclature. So we added ESG to our strategy names.

Cheryl Smith: We've been doing sustainable investing for the 35 years, but when it was being searched through a database, it didn't come up. So there's also, as the labeling changes, you also have to change your label to be searchable, if you will. But on that impact component, I think it's really important to notice that every decision has an impact, but if you're making the same decision that is a normal standard mainstream decision, that impact isn't necessarily recognized. But what impact means is that there's an idea that came over from the private equity space of intentionality, that you're trying to have an impact. And so, when we think of impact, that's really what we're looking for.

Cheryl Smith: So, in the public equity market, the decision to buy, or sell, or exclude, or include something generally doesn't send a very strong signal unless you're doing it in a very concerted way, like fossil fuel divestment or South Africa divestment. When you have a large concerted group of investors all acting in the same way, then it can have a major impact. But for us, again, we feel that engagement is where the impact comes from. The engagement comes from giving the investors the voice to express to management that they actually care what the use of their capital is, they actually care what's happening for employee management, they actually care about what the company is doing for the environment. And having that expressed to management and doing it consistently and regularly and repeatedly, it's sort of water wearing away the stone over time. But it does have an effect, in going back to Brett's example of the very large companies.

Cheryl Smith: If you think of the impact of a company that's over a hundred billion in my market cap changing its behavior on something, that's going to have an effect on other companies in the industry. And it's going to have more effect than that really cool solar company that's just launched and is 2 billion in market cap. So you really have to think about who's got the levers, where are the levers, what do you do, and how do you impact it. So that shareholder engagement is a very important part of this. And the voting of the proxies to simply be saying, when a proposal comes up that is asking a company to report environmental information, that is asking a company to report diversity information, supporting that proposal and letting companies know that it's a large percentage of their shareholders that care about this is a very important part. And then from funds to publish that data. How did you vote? What did you vote on? Did you just support management or did you support these issues? Those are all components and parts of that impact.

Jenna Dagenhart: And Brett, going back to saying that you said earlier, this demand is really coming from everywhere across account sizes, regions, advisor channels, really from everywhere, but it's not coming from everyone. So what are some of the challenges to adoption?

Brett Wayman: Yeah, I think there's a few of them. So one of them in my mind is still education. It's really busting these myths that exist, myth around greenwashing, myths around necessary correlation and ESG data. Just a misunderstanding of what I think this industry is trying to represent. So the more education that we can get out there for the industry in general, for advisors, for end investors, I think is going to really help drive more adoption. Terminology is another big one. I mean, I hear advisors all the time say, "Well, I can't tell the difference between SRI, and ESG, and impact, and mission related investing." And there's just an endless list of terminologies. And if they can't get comfortable with that, they fear talking to their investors about it because they don't want their investors to have a different opinion than they have or a different definition than they have. And there's just this conflict. So I think education and terminology is a big one.

Brett Wayman: I think another is that the industry is pretty nascent still, especially on the impact side. ESG really has gained adoption over the past 10 or 15 years, but it's hard to propose a impact focus or impact forward portfolio for things like animal welfare or affordable housing in marginalized communities, because there just aren't enough products out there to fulfill this global asset allocation where every one of the allocations, every one of the sleeves has a specific thematic focus. So I think that's why we're seeing more adoption on the ESG side rather than on the pure impact side for now. And as those products start being released into the marketplace, and as we start thinking through new creative structures for taking some of these more direct thematic, maybe alternative investments and mainstreaming those, I think we're going to see more and more and more adoption just broadly across all investor types.

Brett Wayman: And then I think the third reason that we're not really seeing as much adoption as would be indicated by all the surveys, has to do with the lack of a feedback loop. These investors invest in portfolios that are ESG integrated or thematic impact focused, but they're not really getting the feedback that says, "Here is what you've accomplished with your investments." Reporting is getting better. Firms like Trillium do a great job with their reporting, but by and large, for the most part, you look at the reports from these ESG strategies and there is no indication of the ESG score of portfolio. There's no indication of things like the environmental or social metrics that would really create that storytelling that keeps the investor engaged, that really makes them feel compelled to continue investing in this way.

Brett Wayman: So as the industry matures and we're able to provide better reporting, we're able to grow the product set, and have this really robust product menu, and just educate and create really consistent education materials, I think we're going to see that hockey stick type of growth in terms of adoption.

Jenna Dagenhart: So Maggie, what's the role of data and ESG assessment? And what sets S&P Dow Jones Indices, ESG data apart from other approaches? And how are deeper data sets impacting ESG investing?

Maggie Dorn: So first and foremost, I think Cheryl has already done a great job identifying this in terms of the fact that the data in the overall ESG assessment process is incredibly critical. And then how ultimately that data translates into the inputs for the purpose of index construction is ultimately incredibly important as well, because at the end of the day, your outputs are only as good as your inputs. So in other words, if your ESG data isn't good or isn't quality, then your index methodology and in design will have many flaws as well. And that really is why ESG data has been such a significant focus, not only for S&P Dow Jones Indices or our index business, but for the greater S&P global organization as well.

Maggie Dorn: And over that the past several decades we've acquired two world renowned data providers. The first being Trucost, who are very well known for their client... excuse me, their climate and environmental reporting and data. And recently we acquired the ESG and data arm of the Swiss sustainable asset manager by the name of Robeco, formally known as SAM. And what is very unique to both of these data sets is that at their core, both of them are very much centered around this concept of engagement. So, we're using the word engagement a lot in this conversation, and so directly engaging with companies is a critical component to the entire ecosystem of ESG investing.

Maggie Dorn: And so we don't just rely on public disclosure data, but instead we go a step further to really account for a much more granular and robust set of data points. So, if you take, for example, our S&P global ESG scores, they're built on this framework of direct engagement through this annual assessment, which is again known as the corporate sustainability assessment, which ultimately delivers this unparalleled insight into corporate sustainability practices for thousands of companies worldwide. And I'll quickly pivot too, because as we speak to this conversation around engagement and really driving change, I have to refer back to the fact that we launched the Dow Jones Sustainability Index, which was really the first sustainability benchmark and index of its kind over 20 years ago.

Maggie Dorn: And since then, it has been determined to be this gold standard in terms of corporate sustainability practices. And if you look at it at its core, there very much is an element of passive engagement, meaning that companies are constantly competing to be included in this index. The point to that being, we actually released the results of the Dow Jones Sustainability Indices, the selections of the companies that were included in the indices last week. And it was quite surprising to me to see all of the media, and the press, and the LinkedIn, and the Twitter updates of these companies that had been included in these indices really showcasing and highlighting that they had been added to the Dow Jones Sustainability Indices.

Maggie Dorn: So I think it's a critical conversation when you're speaking to indexing in general, that there is this element of passive engagement, whether you're speaking to the Dow Jones Sustainability Index or you're speaking to the S&P 500 ESG Index. There's 4 trillion directly tracking the S&P 500 Index. So when you think about an ESG comparison or a more sustainable version of that, there's a lot of eyes on the companies that are going into that index. And again, I think that creates this element of passive engagement that's critical to the story as well.

Jenna Dagenhart: And Brett, how does diligence on ESG strategies differ from ESG research in portfolio construction?

Brett Wayman: Yeah, I think we're talking about a couple of different things here. I mean, ESG use in portfolio construction is the type of stuff that Cheryl's working on, building portfolios that integrate ESG. What we're really focused on is doing due diligence on those strategies themselves and trying to understand how those portfolio companies, or how those portfolio managers and asset managers are integrating ESG into their portfolio construction philosophies. One of the things that I think really comes up a lot is just the reliance on where that ESG data comes from.

Brett Wayman: There are over 200 ESG data providers out there right now. There's certainly a handful of them that are much well known or more well known and have broader scope. And then there's a lot of these ESG data aggregators. One of the core things that we want to know when we're doing due diligence on strategy is, where are they getting their ESG data? Is it from one of these big firms? Are they building up their own proprietary ESG research capabilities? At the end of the day, though, we're not making a decision on which one is better, we just want to know that they have a really comprehensive process in place for absorbing this ESG data and using it in the portfolio construction.

Jenna Dagenhart: Now, as access to ESG data scores and evaluations continues to improve, Maggie, what do sustainable investors need to know as they evaluate the growing array of ESG investment strategies?

Maggie Dorn: That's an incredibly important question. So thanks for asking that. And I think to some degree, all three of us have already alluded to the importance of how investors really take into consideration these various strategies. But again, I think what is most important for investors to consider when looking to incorporate these sustainable indices or strategies into their portfolios is, at the end of the day, there isn't a one size fits all approach, especially as it pertains to this very much expanding universe of sustainable indexing. So for investors, there are different investment objectives and values that could ultimately translate to different exposures and different applications of ESG data. And it can sometimes be difficult for investors to decipher if a certain investment strategy does in fact align with their investment objectives and values.

Maggie Dorn: Now, again, as an index provider, the benefits of using an index strategy to build more sustainable portfolios is that inherently that index vehicle utilizes a transparent rules-based selection process, and that transparency can ultimately help investors to gain a deeper understanding of what is or is not in a sustainable index. And ultimately that can help them decipher is that index or investment strategy aligned with their values and investment goals. So, I think, again, that real key consideration when evaluating these strategies is really going to be, do you have a clear understanding of the investment objective of the underlying, and does that index or investment strategy align with your values and your goals?

Jenna Dagenhart: Well, one final question on these topics here, Brett. What are best practices for ESG strategy due diligence, and how does that differ from diligence on impact investing strategies?

Brett Wayman: Yeah, it's a great question. I think there's a lot of best practices out there. I'll share what we think of as our four essentials when we look at ESG strategies. One, we want to make sure that ESG is incorporated throughout the entire firm. That it's being talked about and implemented from the CEO all the way down to the research analyst, that it is known that the firm is relying on ESG to really build more resilient portfolios. Also the accountability that goes around that, the disclosure of how those ESG factors or how those ESG processes are being implemented. So, that's the first one we think about, is at the firm level.

Brett Wayman: The second one is really at the portfolio level. When you're building an investment portfolio, we want to know that ESG is not just to check the box at the very end of the portfolio construction, it really needs to be integrated throughout. And that's on both the buy and the sell discipline. And I think that that's one of the most important parts, is we see a lot of these investment strategies where ESG is a very important component of the buy decision. But if there's a deterioration of ESG metrics and the stock or the security is still performing well, oftentimes we'll see, "Oh, that's secondary. That's not as important." But if you're integrating ESG in a best practices type of way, it really should be reflected in your sell discipline as well. As that ESG score deteriorate, that should be a trigger to sell that security.

Brett Wayman: The third thing we look at is the reporting. We talked about this being the feedback loop, but we want to know that these investment strategies, these asset managers are reporting on the ESG variables and metrics and factors within their portfolio. We want to know how is the portfolio doing, how are they disclosing this information to end investors. It can't just be a black box where they say we're doing ESG, and then there's really no indication of how that happens or what the effectiveness of it is.

Brett Wayman: And then fourth is around engagement, especially in active strategies. We want to know that these investment companies are talking to the portfolio companies, they're talking to management, they're trying to enact change. They're not just being reactive or reflective of what's going on in that industry, or sector, or with the company in specific, right? So it's at the firm level, the portfolio level around reporting and then around engagement.

Brett Wayman: Now, how does that differ from impact investing strategies? Well, impact is usually much more thematic, and so there's a whole different set of metrics that we would look at. Oftentimes it's less of a sector neutral approach. There's generally a few industries or a few sectors that are chosen. So you're looking at different things, both on a fundamental and ESG analysis side. And I don't think that there's a standard framework yet for the impact investing due diligence, especially in public markets. There very well maybe and there really is in the venture capital, and private equity side, and commercial real estate, but on the public market side for impact investing, we're still working through what those best practices look like because there's so many different nuances too. Is it a climate related impact strategy, or a gender diversity, gender lens, affordable housing, financial inclusion? They all have just such different nuances.

Jenna Dagenhart: They really do. And speaking of climate, I would be a terrible host if I did not ask about the COP 26 meetings in Glasgow that recently concluded. Cheryl, what can investors do to address climate change and how can investors differentiate between the commitments of asset managers?

Cheryl Smith: Thank you. And I'm glad to be talking about it. It's an important subject. As we look forward to this next winter, we wonder what storms are going to be coming, what fires are going to be coming next year. So, that climate change is something that, as Brett also alluded to, a lot of end clients are very concerned with this issue. So, part of another theme of this whole meeting has been the explosion of data and the explosion of tools. And one of the things that has come about since the Paris Accords, with the European Union really working to press asset managers and companies to prepare for keeping temperature below two degrees Celsius or hopefully below one and a half degrees, is that there are more tools for it. So it is now possible to get a climate assessment for an entire portfolio, and you can look and say, "Well, are you aligned? What temperature degree rise are you aligned with in your portfolio?"

Cheryl Smith: So we did this recently for Trillium across all of our portfolios, and we were very pleased to find that we were aligned with a 1.6 degree temperature rise through 2050, which is, sounds horrendously hot. But it's actually a very small number relative. And we have hopes to bring that down further. We also recently joined the net zero asset manager group, which was just brought out for COP 26 in Glasgow. And that asks managers to make a commitment for how are you going to be addressing the issue of carbon in the atmosphere? How are you going to be addressing that issue of temperature rise? There's a validating group. We committed. We didn't want to commit to making much further progress on that 1.6, because we're already almost at the 1.5.

Cheryl Smith: So what we did was we said we want to actually commit to changing the number of companies in the portfolio, not by changing the companies but by getting the companies to change, I should say, so that over 75% of the companies in our large cap portfolios are committed to science-based targets for greenhouse gas reduction and for addressing climate change. Right now less than 50 are, so that would be a 50% increase in that number. Again, it's that engagement, getting the companies to adopt a strategy, a science-based strategy is one that is measurable, it's defined, it has a time framework, and asking companies to do this. So, that will create that change. And going back to Brett's comment, it's the large companies that can make that change. If you get the larger companies to do it, it then creates the pathways for smaller companies to do it. And it does trickle down and create that effect.

Cheryl Smith: So, what investors can do is they can ask their managers, or ask their index strategies, or ask whoever they're choosing to have it, what's the climate impact of this strategy. The tools are out there to assess it. You can ask what's the temperature alignment by 2050, and what's the strategy that the manager has if it's not where you want to be to get it to there by 2050. And then also asking what specific commitment is that manager making to create that change themselves, by either changing what companies are in the portfolio or causing the companies in the portfolio to themselves change. Gets a little tongue twisty there.

Jenna Dagenhart: Yeah. A lot of different ways to bring about that change. Now, Maggie, is there anything that you would like to add about taking temperatures, or the climate, or the many shades of green?

Maggie Dorn: Yeah, so I think Cheryl just did a fantastic job of addressing the fact that I think there is a key priority here by investors to be aligning their portfolios with a 1.5 degree scenario, and ultimately getting them to net zero by 2050. And I think what is becoming increasingly more important is that we're looking and addressing climate change from a more holistic application and perspective. So we want to really be able to capture all elements of climate change and risk, including both transition risk as well as physical risks. And applying those frameworks into whether it's index construction or investment strategies as a whole, has really been made possible by some of these really significant advancements in terms of the data set. So, we are seeing these increasing requirements and alignments around a 1.5 degree scenario. The regulatory environment in Europe in particular, there's a lot of benchmark regulations coming down in terms of what you can and cannot have, or call, I should say, a Paris Aligned or a climate transition.

Maggie Dorn: So there's a lot of influences that are really centering around what the importance of these climate types of benchmark strategies really will be for investors moving forward. So it is top of mind for us, and we're constantly looking ways to integrate climate-based solutions into our lineup.

Jenna Dagenhart: And Cheryl, I see you nodding your head. So I want to circle back to you and also continue with the theme of COP 26. What's Trillium's approach to investing in energy and power companies?

Cheryl Smith: Thank you. And that is something that over a number of years we struggled with. And this is the engagement versus divestment area. And for many years, we were trying to engage with companies, although we were not investing in some of the companies that we felt were not... What's the word I want... truly engaged in trying to become lower carbon, were more engaged in trying to get more carbon out of the ground, if you will. Even though we are diversified portfolio managers across most of our strategies, we recently decided that we would not be investing in any energy and power companies that have not demonstrated a commitment to a business model designed to succeed in a low carbon economy. So what that means is in the United States, among large cap companies, there aren't any energy fossil fuel companies that we believe meet that standard.

Cheryl Smith: There are some companies in Europe which may soon be meeting that standard, but basically our approach right now is for any company that has a history of fossil fuel exposure, and that's whether they are a exploration, whether they're drilling, whether they're refining, or even whether they're a utility or a pipeline, has to demonstrate that its business model has shifted to alignment with net zero emissions. So we're looking at things like energy efficiency, renewable energy equipment, energy distribution, and trying to find other ways to get the factor exposure that an energy company would get us, but to do it through companies that are actually working on providing solutions toward a low carbon future.

Jenna Dagenhart: And given everything that we've discussed today, Brett, what are some of the opportunities for advisors? What can those advisors out there watching, feeling inspired, do following this panel?

Brett Wayman: Yeah, I think the opportunities are limitless. So it's both in terms of engaging with their client base, really trying to understand do they have clients that are interested in integrating sustainability into their portfolio, specifically using COP 26 and some of the other climate movements lately as a hook to start the discussion. It's getting educated about what the investment products are that are available to them. There are so many different options from investment in more thematic portfolios like renewable energy, to divestment, to engagement through partners like Trillium and others that are doing this on investors' behalfs. Really focusing on the reporting, we use Trucost for example, and the reporting for some of our portfolios. They have a really cool... And Cheryl was mentioning the asset mix reporting that shows the transition to a 1.5 degree or two degree energy or temperature change. Trucost provides that data.

Brett Wayman: And that's really fascinating for end investors to be able to look at to see, is my portfolio in alignment with some of these standards or goals that have been set? So it's the education, the product knowledge, engaging with your investors, and then deciding how do you want to implement that into a portfolio. It can be very general, I want to focus on ESG, it could be thematic, it could be narrow or broad focus. So you have things like I want to invest in mitigating climate change, or you have a whole range of different tools and leverage you can use to, I want to focus specifically on things like sustainable agriculture, and then deciding whether that becomes the core of your portfolio or it becomes a satellite. So working through all these different variables.

Brett Wayman: But the first thing I'd say is start small and just keep building on it. Get to know one particular avenue that you think is the most effective and the broadest representation of what your clients would be interested in. And then just keep adding to that knowledge, because it's like the old children's book, If You Give a Mouse a Cookie. If you give an investor a little bit of exposure here, they're going to just keep on wanting more and more. And that's what we need.

Cheryl Smith: I love that, If You Give a Mouse a Cookie. That's awesome. We have a concept we call portfolio activation, which we really should retitle Give a Mouse a Cookie, because the idea is that within every asset class, some asset classes are better suited towards some goals than others, but within every asset class, there is a way to move your portfolio towards greater impact. So, within fixed income portfolios, there are amazing ways to work on the energy transition with the development of green bonds and sustainability bonds when you know that that money is going specifically to designated targeted products. There's things in private equity, there's things in loans all over, but I think you're right. Once a client gets started on it and they get that feedback loop of the reporting that says, "This is what you've actually done," they are absolutely impelled to do more.

Jenna Dagenhart: There have been so many developments as we've been discussing and innovations over the past couple of years, including with ESG Indices, Maggie, what are some of the latest innovations and big picture? Moving forward question here, but what's next for ESG?

Maggie Dorn: So first and foremost, Brett, thanks for the Trucost plug. I appreciate that we have a happy customer on the line. So I appreciate hearing your perspective on that. But as far as what is next, I think in this constantly evolving world of ESG indexing or investing, and I don't mean to make this come off as a slight by any means, but I guess the real question is, what's not next, right? Where could we possibly take this? There's so many different areas that ESG could go moving forward. And I think really a lot of that comes down to the data sets themselves, right? So as these data sets continue to evolve, so too will the opportunities to address these, maybe currently I guess you could describe it as underserved areas. Whether that be something that we're speaking a lot to right now, in terms of building out a true cost data set, which is both biodiversity and this more natural capital framework, as well as other areas that would fill out the greater asset allocation mix, which would be commodities, private equity.

Maggie Dorn: And there's a lot of areas of innovation that still remain and could be, again going back to that, of critical importance. But even I think with as much growth as we've seen, and as much development at that as there has been in the space, there is still so much more that can be done and ultimately will be done as these challenges really continue to face the investors of today.

Jenna Dagenhart: Cheryl, any final thoughts you'd like to leave our viewers with?

Cheryl Smith: I think we've covered so much of interest here. Brett's comments that education for advisors is really a critical element in getting investors connected to a whole world of opportunities that are out there, whether they are passive or active. There are many different possibilities and there are education ability, education facilities out there. There are ways to navigate that alphabet soup of ESG, and SRI, and sustainability, and TCFD, and many other acronyms we haven't even thrown in here. And that it really will help with engaging those clients and really fulfilling a need that the clients have, even if they haven't yet been able to express it to those advisors.

Jenna Dagenhart: Brett, I see you nodding. I'll give you the final word here.

Brett Wayman: Yeah. I'll just echo what Cheryl said. Even if your investors haven't brought this up, I guarantee you it's on their minds. They may not know how to ask. Don't be afraid to engage. I hear a lot of advisors say, "Well, I don't want to bring up values unless my client brings it up first." And I'll tell you what, your client doesn't bring up things like dividends, they don't bring up things like asset allocation. You are the investment professional. If this is a way to create a better portfolio for them, that they feel more engaged with and reflects who they are and what they want the legacy of their capital to be, it's your responsibility to bring it up to them. And if they're not interested, that's okay. But I guarantee you'll find that most of them are interested.

Jenna Dagenhart: Well, Brett, Cheryl, Maggie, thank you all for joining us.

Maggie Dorn: [crosstalk 00:59:33] much.

Cheryl Smith: Thank you so much.

Brett Wayman: Thanks for having us.

Jenna Dagenhart: And thank you to everyone out there watching this Asset TV ESG Masterclass. I was joined by Cheryl Smith, economist and portfolio manager at Trillium Asset Management, Brett Wayman, senior director, impact investing at Envestnet, and Maggie Dorn, senior director, head of ESG Indices, North America at S&P Dow Jones Indices. I'm Jenna Dagenhart with Asset TV. (Silence).


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