MASTERCLASS: Inflation - May 2021
April 20, 2021
Jenna Dagenhart: Welcome to Asset TV. This is your ESG Masterclass. We're seeing increased interest globally in environmental, social, governance issues, yet there are still barriers to ESG investing, including adviser adoption.
Joining us to share more about their approaches to ESG, different themes and ways to help people align their investments with their values, we have Nicole Connolly, head of ESG investing and portfolio manager at Fidelity Investments, Grover Burthey, portfolio manager at PIMCO, and Cheryl Smith, economist and portfolio manager at Trillium Asset Management.
Everyone, thank you for joining us. And Grover, starting with you, what's driving this increased interest in sustainability, climate change and socially responsible investing? How are different parts of the world prioritizing ESG?
Grover Burthey: Sure. It's a great place to start, Jenna, and I think it's a few different drivers. One is just the population, the end-user, a growing recognition and awareness of many of the issues that we face, whether they be environmental, social, or governance related. I think it's to increase receptivity on behalf of public officials, on politicians and leaders to the importance of these items, to the fact that they, one, do influence their own ability to retain power and stay in office.
But two, and most importantly, that it's the right thing to do for society in the long run. And three, I think it's a grand receptivity on issuers, on borrowers, on companies to prioritize these items in their own endeavors. There's more precedent that enables them to do so, and to do so in an effective manner. And for an investor, more opportunities for us that are actionable, and in order to support this and create a positive ecosystem.
Jenna Dagenhart: How would you define ESG, Nicole? And setting the scene for us here, what's the difference between socially responsible investing and ESG?
Nicole Connolly: Yeah, Jenna, it's great to be here. So, I think of ESG as a framework with which we can evaluate how a company is working with all of its stakeholders. So, how it's treating its employees, its customers, the communities that operates and its suppliers, whether it has good governance practices, good practice that are shareholder friendly. And then, is it a good steward of its environmental resources? And by evaluating how it's working with all of its stakeholders, we can see if a company is built to last and built to be sustainable over time.
And when I think of socially responsible investing, I go back many years to the time where organizations were looking for ways to avoid investing in companies or sectors that conflicted with their values or their morals. So think, avoiding tobacco or alcohol, or guns. And that's more of an exclusionary approach to investing, which is still being employed today. And it can be a way to express your ESG views. But personally, what I'm more excited about is finding these companies that have embraced these ESG principles, so that again, they can be built to last and built to out perform over time.
Jenna Dagenhart: On your point about exclusionary screening too, it makes me think Cheryl of the founding of Trillium and why the founders started Trillium. Would you like to share more about that?
Cheryl Smith: Sure. Thank you, Jenna. And I think that Nicole's expression of this as a dichotomy between early socially responsible investing and ESG investing is a very common one. But at Trillium, we really think of it as sustainable investing as something that we have been doing this entire way through. And that the ESG investing is a way that the broader investment community that didn't start out in this space starts to think about it in the language of materiality risk, creating alpha from considering these factors.
But Trillium was founded back in 1982 by Joan Bavaria, who was a pioneer in the field. And she started it because she had a number of clients who had been coming to her from the seventies onward, talking about not wanting to have certain kinds of companies in their portfolio. They didn't want companies that produced Agent Orange. They didn't want companies that made weapons. They didn't want companies that were involved in Bhopal. All of these were issues that she felt were important. And the other members of her investment team passed them off to her, "And here Joan, you go deal with these nice young women or these nice old women who care about these things. And let the rest of us do our real work."
And Joan really realized that there was an interesting aspect of investing. She also recognized that there was an important part of looking at what it is that companies do, what their responsibility is to all of their stakeholders. And she also felt that it was really important to explore, whether one could do this and still be a fiduciary. So, she started Trillium as a way of having a company that was exclusively devoted to looking at these extra financial factors and considering corporate responsibility with a performance record that we could look at and put against any other company's performance record. It was really, there wasn't a record before that. So, she wanted to demonstrate that this was something that you could do.
And as we've evolved over time, and other firms, other industries have become more interested, we've tried to talk about it in that language of risk and risk mitigation, and exposures in areas that turn it into a more traditional financial language. But the interest of our clients and the interest of the people at Trillium is in that impact and that alignment in creating and sustaining a better world.
Jenna Dagenhart: Yeah. And that topic Grover, how has the role of ESG as an investment theme, risk mitigation tool, et cetera, evolved over the years and most recently with the coronavirus pandemic?
Grover Burthey: Sure. And Cheryl, Nicole touched on some great points and I'll try to elaborate from PIMCO's perspective. There certainly has been a desire and requests from many of our clients, many investors to have some of these exclusionary overlays and their portfolios and their strategies over time. And what's really changing now is a bit of a pivot or an evolution if you will, from what should I not do to, how can I maximize the impact of the capital that I invest? And that doesn't always necessarily mean some of the more commonly recognized priorities for ESG that are environmental related, but it's a wide range of things. So, it's just as important to emphasize social pillar and emphasize items within that such as wage equality and health and safety as access, even within the environmental. So, it's not solely items and priorities that are related to carbon, and has to do with nature. It has to do with water. It has to do with many different other items within the environment, beyond the simple carbon emissions that could be related to energy companies.
And so, we believe that that in terms of how this ecosystem and this evolution continues that each of these pillars, the E, the S, and the G will continue to broaden, will continue to bring in more parts of the economy and more parts of the marketplace. And hopefully over time, that that means that there's more issuers that are brought into this process as well.
For us at PIMCO, it stretches beyond just corporates and corporate issuers. It goes to sovereign issuers. It goes to the municipal issuers. It goes to a range of different asset classes and parts of the market. And this roles are equally important, because from this we truly have the type of influence and impact over time that these initiatives deserve, and that asset managers like PIMCO strive for. These efforts needs to encompass all parts of the marketplace and really utilize all parts of our platform and then, hopefully, bring in as many of our clients as possible.
Nicole Connolly: Yeah. When we think about COVID and the impact on ESG, I think about a couple of things. I mean, COVID has really put the emphasis on the S, front and center. And at Fidelity, we've really engage with companies about how have they kept their employees and their customers safe during this time. And then, COVID has disappointingly personally impacted disadvantaged communities, people of color. And so, we've been asking companies, what are they doing to invest in those communities, both outside of the company and within the company?
And I think that focus on social justice is another trend that might have investors thinking about, "Well, how am I invested? What are the companies I'm doing, how are they treating their employees and their customers?"
And then the second thing about COVID that's interesting is, there's always this performance hurdle that we talk about when we talk about ESG. And I think there were many people that thought that maybe ESG was this bull market phenomenon. It had never really been tested in a downturn. But when we look at how ESG funds performed, especially at the peak of the market, to the trough of the market in the throws of COVID, those ESG funds outperformed non-ESG funds by over a hundred basis points and outperformed for the entire duration of 2020. So, I think COVID has really, in some ways, accelerated the shift to the ESG funds.
Grover Burthey: Just building on Nicole's point, one item that we're focused on now is how do we reopen and what are the influence, and what are the implications for reissue related considerations for reopening? A lot of attention has been given to healthcare and protection of employees. And that's been critically important for obvious reasons. But there's a lot of unemployment in the system right now, and to the extent that there are permanent changes to the workforce and how people are trying to reestablish their personal balance sheet, their wellbeing. How do we do this in a manner that's, one, thoughtful and helpful in the long run? But two, just facilitates a clean, fair, equitable reopening for all those who've been impacted.
Cheryl Smith: Those are, I think both what Grover and Nicole are talking about are really important. And one of the other aspects that Trillium has been contacting companies on and asking about in the context of a US environment, where healthcare is associated with your employment, what do you do if you are an employer and you have to lay off or furlough a large number of your employees? We were asking them, "Well, what are you doing about the healthcare for those employees?" Because the very worst time to be without healthcare is of course, in the middle of a pandemic. And so, that was one of the questions that we went to them with.
And then we've also been combining them since the death of George Floyd and the Black Lives Matters Movement with an inquiry into how are they looking at the disparity of who gets furloughed, who doesn't get furloughed, who gets laid off and how are they trying to work those practices in?
So, I agree with both Nicole and Grover, that the COVID has really brought this to the fore. And I had to laugh, Nicole, at your comment about the ESG oriented funds doing better during all of 2020, and during the period from the peak to the trough. I was contacted three days in by somebody who said, "Well, ESG funds are down more than the other funds. It's been three days." Okay.
Nicole Connolly: Another disappointing ESG. Right? Long-term thinking.
Cheryl Smith: Right. It's like, I don't think the differences between companies on ESG are going to show up over a three-day horizon.
Nicole Connolly: Yes.
Cheryl Smith: This needs a little bit longer time to look at this.
Nicole Connolly: Yes. A couple of real life examples on Cheryl's point. We talked to Aritzia, which is a retailer of women's apparel. They're based in Canada, but they're rolling out stores in the US. And they committed to paying employees through store closures. And then they also sent care packages to healthcare workers of Aritzia, leggings and t-shirts. And you know what? Their social media engagement spiked. They went on to report record online sales. Showing that you can do good and do well.
And Williams-Sonoma, one of the six companies in the S&P that has a female CEO and female CFO, committing to paying employees through score closures. And then, doing really well this year, repaying debt, and then reinstituting the dividends. So, just back to that stakeholder capitalism idea. You can do well by everybody. And those are some good examples of companies that did that over the past year.
Jenna Dagenhart: Especially if you look at a time horizon longer than three days.
Nicole Connolly: Yes, yes.
Jenna Dagenhart: And going back to the point on risk management, Nicole, do you think it's fair to consider ESG as an extra layer of due diligence?
Nicole Connolly: Yes. I liked how Cheryl talked about it's looking at additional factors, in addition to the traditional financial analysis that we do. It is giving you a more complete picture of the company.
And Goldman did some interesting research looking at some ESG controversies. I think they looked at 25 different ESG controversies. So think, emissions, scandals, oil spills, data privacy, product safety issues. And not only did those companies underperform within the first year by about 20%, but they went on to underperform the sector by over 10% annually in the subsequent two years.
So, ESG can be a powerful extra layer of due diligence. Sometimes looking at these ESG factors, you uncover things that you wouldn't see in traditional financial analysis. So, I very much believe that it can be a risk management tool.
Cheryl Smith: And I'd like to build on that. I think that in the early decades, it was sometimes difficult to explain these concepts to people. That people think about it as, well, if you're in an exclusionary mode, you're just leaving out half your universe. And first of all, and the exclusions really don't leave out half the universe. It's a much smaller percentage of that. Anyone who's a large cap manager or US manager, or an emerging markets managers is cutting off much larger portions of the investment universe by simply their style designations. And so, I just want to make that clear to people.
But the other way I think about it, particularly from the risk management, is that focus on environmental management, focus on your human capital, focusing on the governance structure of your company is a way of avoiding large potholes on the left-hand tail of the distribution. So, if you cut off the left-hand tail of the distribution, the main, automatically rises, just because you don't have those other ends. And so, even without it ever contributing to faster revenue growth or faster social media engagement, or any of the other components that Nicole [inaudible 00:15:27], that means that the distribution rises. And so, we think that the positive effect that looking at these factors has on returns really is from that risk mitigation component in large part.
Grover Burthey: I would also add to that, that at PIMCO, we see much of these factors, particularly to the extent we're able to discuss them with management teams or with counter parties as great signals for how a company is being managed, how an enterprise is being managed. And there certainly are many of the direct implications that have been discussed and mentioned. But also, it's a great way to better understand how management is running the business. What would they prioritize? Where they believe resources need to be allocated? Are they proactive, or are they leaders or followers? And that sometimes has applications that you may not notice upfront, but over time, again, a phenomenal way to feed into a broader due diligence process and enable a comprehensive view of the risks that you're taking.
Nicole Connolly: That active engagement that Grover is talking about, is so important because I think, and I think we'll probably get to this, but one of the barriers to investing in ESG is this idea of maybe greenwashing and whether a company or a fund is truly authentically focused on ESG. And from a company perspective, engaging with our companies on why is ESG important? What are your priorities, where are the targets? Can help give conviction into what we saw in the corporate sustainability report. Or it can say maybe that was just the glossy nice looking report, but maybe there's not much going on behind the scenes. And that's why I think this active management engagement piece of what we're all doing is so important.
Cheryl Smith: I agree completely with that. If you meet with investor relations and they cannot connect you to a single other person in senior management, who knows anything about the issue, it's a pretty good clue that glossy brochure is as far as it goes.
And JP Morgan just actually put out a very interesting study on a research piece that they call The Human Capital Factor, where they're looking, not at many of the conventional measures that you might have of diversity and inclusion in a workforce, such as percentage of women or percentage of minorities at different levels of structure, but things that were more human resource kinds of questions, degree of engagement. Do you feel respected? Do you feel like your ideas are heard? Is your contribution welcome? And they found that it was actually amazingly predictive. And that's in line with some of the other academic research from Alex Edmonds, which was published in 2011 about just using a factor like the a hundred best companies to work for, having a substantial, not market priced out element on return over a period of time.
So, it's interesting to see that. And I just want to extrapolate that to one of the things that we see, is that when you take a third-party rating, one of the third-party rating systems and they rate a company and they say, "Well, these are As and these are Bs, and these are Cs." If that's all that you're using, you're really not getting any value out of that ESG element, because first of all, you're losing a lot of data by just taking the single combined element. But secondly, you're not getting, as Nicole does the understanding of the company, or as Grover said, you're not trying to figure out what makes that company tick, and you're not really getting a sense or an ability to use it.
And so, we think it's really important to engage with the companies and to have an understanding of how all those different indicators are pointing in the same direction, or maybe they're pointing at cross purposes. Maybe it's a company that's really excellent on the environment, but has a long way to go in human resources. And that's where advocacy and engagement with the company and praising them for their environmental activity, and saying, "Well, we think that you could use a little work on that human capital element." Really helps improve the performance of the company over time.
Jenna Dagenhart: Yeah. To quickly follow up on that, Cheryl, what themes have been most important over the past year for ESG managers and for Trillium's advocacy? I mean, what are some of the emerging themes that'll represent attractive investment opportunities and/or an expanded universe of securities to select from? I mean, to your prior point, there are so many options out there.
Cheryl Smith: Well, certainly, as both Grover and Nicole have said, the diversity, equity, inclusion has been a very big theme this year, which makes sense in the context of a global pandemic, which has disrupted supply chains. It's disrupted every corporation, every company, are your employees safe to come to work or not? And so, that's been a big issue. Continues on a lot of work that we had done over time. But as I said, we've took additional surveys on the diversity and inclusion, and added them to existing discussions with companies.
The other big theme that I think has come through year and will be developing even further with a change in administration, and the US rejoining the Paris Climate Accord, of course, this has also been a theme globally, is the transition to a lower carbon economy. And that includes in the United States, a lot of interest in the companies that are working on strengthening the grid. If you're going to move to a more electrically-based economy and less fossil fuel-based economy, and that electrically based economy is based on sustainable fuels, you need a much stronger grid. You don't want what happened in Texas to happen to the country as a whole. So, you need to figure out how do you do that? And then you have the makers of clean hydrogen, the makers of batteries, the maker of turbines, the makers of the grid elements, all of those become elements that are important in smoothly making that transition.
So, with the Biden administration, looking at a major infrastructure bill and with the commitment to reenter the Paris Climate Accord, we think that those are going to be major themes that we'll be looking at.
Jenna Dagenhart: Grover, how is your firm factoring in different ESG issues and using ESG scoring methodology? What's PIMCO's approach?
Grover Burthey: Sure. PIMCO's approach, it is first of all, as I alluded to earlier, is first of all to encompass all parts of the market. And so, we do extend these practices to as many asset classes as possible. And obviously, approaches have to defer to some extent, because you're dealing with different information or different levels of disclosure. But we do attempt to be as consistent as possible across the work that we do.
We don't have our ESG team in a silo. It's important to us to have the ESG analysts and our ESG resources, really empowering portfolio managers and credit research analysts, and other decision-makers and investment professionals at large, informing decisions that may or may not be for an ESG fund. That the purpose of much of this work, again, to the extent that it's helpful from an investment decision process or from a risk mitigation perspective, is applicable not only for our ESG strategies.
For our score specifically, we do our own internal scoring. We certainly do utilize certain third-party sources and third-party data providers, both in terms of their own scores or rankings, as well as just to utilize their data outright. But we have our own internal system. And that's something that we continue to expand, we continue to refine. We're very proud of where we are today. But we believe it's important to take our own view to try to utilize our footprint in the marketplace to draw comparisons and determine relative value in terms of what one company may be doing versus another. And ultimately, identifying certain leaders and laggards.
We also try to retain the flexibility, on that point, to not be too binary in terms of what we believe makes it's reinvestment perspective, but to support those who may be earlier in their ESG journey along the way, to use engagement as a mechanism to hopefully drive change. And then have that flow through in investment performance. But then naturally, there is a time where perhaps these processes and frameworks, and engagement efforts do signal something that's problematic, we also reflect that in how we score something and rank it against something else.
Jenna Dagenhart: Nicole, I know Fidelity recently launched its own ESG ratings framework. Can you tell us a little bit more about that?
Nicole Connolly: Yeah. So, our ESG ratings framework is through two different lenses. So, we developed what we call a systematic ESG rating, which is current snapshot in time, based on the material ESG factors by sector, weighting these factors, and then scoring these factors. And we came to the materiality conclusions by working with our 300 research analysts across every asset class, along with our ESG team. And we also leveraged SASB, which is the Sustainability Accounting Standards Board, which has worked for seven years to arrive at material ESG factors by sector.
So, that systematic piece gives us a sense for where a company is today. It is model based. And then we supplement that with a forward-looking ESG rating, which is done by our fundamental research analyst. And that's where the engagement comes in, that we were talking about. And we asked these companies, seven to 10 different questions based on the material ESG factors. We evaluate where they are on initiatives and targets, and progress. And we come up with a forward-looking rating.
But I thought, one thing that Cheryl said that was really important is, it is hard to boil everything down into one rating. And so, this is part of an investment mosaic on a company. It's an input into that process. We don't rely solely on these ESG ratings to make an investment decision. But really it's helping us develop a language and tools with which everybody can talk about ESG. In many ways, we were doing this research for years, but we were really calling it ESG and didn't have the data to evaluate where a company was in its ESG journey.
So, this ratings framework is rigorous. It's robust. It's part of the investment mosaic. And it just helps us all speak the same language on ESG.
Cheryl Smith: Those are great points, Nicole. And I wanted to just take a little bit of a lens backwards in terms of looking at a lot of the advocacy that Trillium and other early entrance in this field did for the first couple of decades, was getting companies to report. A lot of this data isn't things that's not required by the SCC yet, not required by the stock exchange that they're listed on yet. But data on environmental issues and data on employee practices, all of that kind of data, it's been a long process of getting them to reveal it. And there've been various initiatives. Nicole, mentioned the SASB, the Sustainability Accounting Standards Board, that's one. There's also the Global Reporting Initiative. There's also the one's on carbon and so forth, that keep trying to get at different things. And so, there's an explosion of the data in this area.
And I like to think of it as we think about the development of the financial standards over time. So, we have financial standards today. And if you did your CFA, you did your accounting, there's always like, "Oh no, there's another new interpretation. And now I have to learn pension accounting, how it's done now, or how reserves are handled." All of those kinds of things. It's been a process of continuous evolution for the past 60 years. We're going to see that in the ESG field as well. We're going to see better ways of doing it.
And as Grover mentioned earlier, when you look at an environment, a lot of people want to just boil it down to one number, "Well, what's the carbon intensity?" Well, that's not all that environment is about. It's the easiest one to measure. But just because the keys are under the lamppost, doesn't mean that's where you should be only looking. You really have to look at the other aspects. You have to look at the water. You have to look at how they're handling toxic emissions, how they're handling their process of environmental safety for the employees. All of those would be components of the environment. They just don't easily measure in a standard consistent way as carbon output per physical ton of output or per dollar of revenue, even though those are the ones we like to focus on because they're measurable and quantifiable, and easy to get.
Jenna Dagenhart: I like your emphasis on that data is not available yet, because it'll be interesting to see how that evolves over time. And building off of that, Cheryl, as you mentioned, investment and finance has become increasingly quantitative over time, yet much ESG data is not easily quantifiable as you highlighted. How does Trillium incorporate the multiple standards for ESG disclosures and use them and its investment process?
Cheryl Smith: There's a lot of similarities between how we do it and how Nicole was talking about it at Fidelity. We don't combine them into a current score and a future score, although I do like that aspect. What we look at is, we look at it on an industry by industry basis for every industry. Our team of our advocacy department, our sector analyst and the ESG specialists are looking for each industry, what's going to be the material factors and what are material from a stakeholder concern, as well as from a materiality. Then we collect data on those indicators. And then we score all the companies in the benchmark on that.
Now, a lot of companies are going to have missing data. And the further you go down the cap scale, the more missing data there is. So, you have to come up with a way of approximating that, do you want to use the mean or the mode? And it varies because some ESG data is yes, no, just binary. Some of it is tons of carbon emitted per ton of output, which is from zero up to not infinity, but a very large number. Some of it is a rating, yes, no, maybe. Some of it is one through 10. You have to find a way to combine all of that and put it together.
And we add with that, it's a confidence information scale that tells us how much of the data is being estimated. Because a company, if you're using estimates, you're going to bring everybody to the average for any missing data. So, somebody that comes up as average, but has missing data on 12 of 13 different indicators, it's not going to be a secure judgment.
We also include with that our information on the forward-looking elements, our own proprietary questions that are relevant for that industry. So, we try and deal with that multiplicity of the data by really recognizing what the quantitative limitations are. You can't just add a bunch of numbers together and average them, and think you're going to get anything. You really have to be aware of the different types of data, the different elements of the data and how they fit together. And some of it is going to just be very qualitative, yeah, sort of, maybe, no. And you have to be able to incorporate that within your scale because a lot of the data is that way.
Jenna Dagenhart: Yeah. Grover, how do you work on firm-wide integration?
Grover Burthey: Well, first of all, it comes down to making sure that we're present and that we're communicating with all of our peers. Firm-wide means a few different things. It means geography. And we have professionals across all our various global offices who are involved in these efforts in one way or another. Well, our headquarters are in Newport Beach. And the ESG team spans multiple offices. And while the ESG team is clearly fully focused on ESG, we rely on and partner with many of our colleagues in other groups to collaborate on these efforts and to continue to help us address parts of the market as the ESG evolution continues there. But it also means with regards to asset class and to the extent that there's more activity in different spaces, whether it be ESG labeled bond issuance, whether it be impact investing initiatives or opportunities, really being mindful of everything that takes place with regards to all the different asset classes, where PIMCO is a continuous participant.
But what I do personally, is first and foremost, make sure that I'm communicating well with all of our different teams, all of our investment professionals across these different spaces. Our goal is for wide integration, and we truly mean that.
Well, one of the things that we're impressing upon ourselves, we've mentioned engagement several times here. But again, that engagement stretches not only for your large, perhaps S&P 500 constituents and major debt issuers, but for counterparties across the board, there's opportunity for engagement. And to make that part of the process wherever we can, and continuing to grow our efforts that are dedicated in that regard.
For PIMCO, a very large participant in the fixed income market, we do make sure that we distinguish ESG scores and frameworks for an issuer, for an entity itself versus a specific and investible security or instruments. And sometimes there are differences there. You could have a company that's a fantastic ESG leader, but that's issuing something, for example, a sustainability linked bond, that we may not believe is ambitious enough. We may have an issuer that isn't in a sector or an industry that has perhaps less ESG congruent, but it's doing what it can to embark upon a transition for how they've managed their business and their mix of revenue, and are issuing ESG labeled bonds to facilitate that transition. And there, we do want to be supportive and encourage efforts in that regard.
And so, and in summary, I would say it's fluid. It requires a lot of effort and a lot of partnership. But for us, ultimately, what's critical is that we do look at the entire marketplace as a whole, and that we identify areas where there's a room for improvement, and we continue to maintain leadership in areas where we think we have a fantastic positioning already.
Jenna Dagenhart: Cheryl, how has Trillium differentiated from other ESG integrated investment managers?
Cheryl Smith: We think that first of all, our very long history in the field is a major asset as we've been involved in the field since the very beginning. Second, the advocacy resources that we devote are very significant relative to the size of our firm. We have a number of people working full-time on it. And we have been working again, over decades with various nonprofit organizations and other groups.
We've been very committed to field building with Trillium being a founder of USF, which is the trade organization of ESG, that coalition on environmentally responsible economies, founding part of the GRI. So, a number of different issue areas. So, we're connected in that. And the depth of the experience and work that we have that ESG and sustainability have been part of it throughout.
And then as I think, it's important that we're doing... We've truly believed that looking at ESG factors helps with the performance and helps with the risk adjusted return over time. But we're also very committed for our client of aligning the portfolios with their values as well. So, it's the impact that we're looking for. We're looking for the performance, clearly that's given. But we are also looking to change corporate behavior. We're looking to change the effect on the environment. We're looking to change the effect on communities. We're looking to have better opportunities for women to become part of a firm and to grow up through management. We're looking for an opportunity to include excluded minority communities. All of those are part of what we do. And they're part of how we design our portfolio. And we're looking for impact across every asset class that we touch.
Jenna Dagenhart: Nicole, you mentioned greenwashing earlier, what are some of the barriers to ESG investing? And we'll get to adviser adoption in just a moment, but anything else you'd like to highlight?
Nicole Connolly: We've talked about performance as a potential barrier. And maybe just to build out on that a little bit more, we did look at the performance of high ESG scoring companies over the past eight years, and did find that those companies outperformed by about 1% a year, every year, over those eight years. And we adjusted it for any sector bias. So, this isn't a function of poor performing energy companies with bad ESG ratings underperforming. We took all that influence out. And so, hopefully, as advisors start to realize, retail investors, institutional investors, that you don't have to sacrifice performance to invest with an ESG lens, in fact, it can enhance performance over time, that we should see more and more ESG funds adopted and more appetite from the financial advisor community.
Jenna Dagenhart: Cheryl, I'm thinking about ESG, how do companies that aren't pure get contrasted and included into portfolios, when they are improving their sustainability profile versus those companies that are window-dressing?
Cheryl Smith: Sure. It is something that, as we've discussed already, it takes a lot of due diligence to understand which companies are which, so which companies are doing window-dressing, which companies are the glossy brochure companies, versus which companies are the real deal. That said, as we go through each industry and we rank, and benchmark the companies in each industry, there are going to be companies that are in our view stronger on an ESG metric and companies that are lower on an ESG metric.
As we're looking at companies that are in the lower element, we are asking, are they on a path to improve those scores? Are they making a diligent effort to do it, or are they perfectly comfortable being the low cost provider, the low cost producer, if you want, who doesn't care about any of this? And so, it is an element of that intentionality of the management that we're evaluating as we go through.
And there's some research that indicates that maybe the ESG improvers have a little bit better performance than the companies... It's like if you go for the company with the highest ROE, there's only one place for them to go, it's down. If you go for the company with the very, very best ESG, they have to continually work to stay at that high level, whereas there's room to really have an impact and to create that change, if you're going with some of the companies that may score lower at the moment and are moving upward.
And I want to just say one other thing in terms of the small cap versus large cap. One thing to be careful of is that you're not basing your scores entirely on ESG reporting, because reporting is something much, much easier for the larger companies to do. For small cap companies, it can be a major function. So, you actually have to find out what they're doing and not just what they're out there telling you they're doing.
Grover Burthey: Yeah. Cheryl, made some great points there, and I just want to respond a bit. It is important to the extent that anyone has invested in an ESG strategy or an ESG fund. Well, first of all, as an asset manager, our goal is to deliver compelling risk-adjusted returns.
But second of all, it arguably is the point of this part of the market of this industry to cause change. And if you are restricting yourself only to those companies that are truly pioneering and way ahead of the curve in these regards, then you may do a disservice to the ultimate goal. It certainly companies and issuers that are ahead of the curve deserve credit for that. And as per the previous comments that we've discussed on risk mitigation and others, hopefully, they can perform well on an outright basis in their own right.
But it is important, right? That these efforts try to bring others along, try to expand the impact as much as possible and do not discriminate against companies that may be genuine in their efforts, but are just a bit earlier. That's putting certain exclusions aside. There are certain areas that do need to be excluded for a variety of reasons or minimize for a variety of reasons. But for those investment opportunities that are in the middle, I think that's where the ESG space and professionals such as Nicole, Cheryl, myself can really have the most impact, hopefully, through our firms and our efforts.
Jenna Dagenhart: Yeah. To quickly follow up on that Grover, How do you look for the less obvious ESG links? To your point, how do you find those ESG underdogs, if I can call them that and help them continue on their sincere mission, and ultimately, make it to the big leagues in terms of ESG?
Grover Burthey: Well, part of it is canvassing our portfolios as they stand. And then given our platform and our size, and we have the benefit of having many positions, of having many different vehicles and strategies. And so, really looking at where we have exposure. We track very, very closely what our ESG score distributions looks like and where our engagement efforts lie. And part of the other side of that, part of the goal of that, is that identifier, is where we perhaps I should spend more time, whether it's because the subjects at hand, the issuers are a bit behind in one degree or another, or whether it's because signal exposure is changing. And we want to make sure that we're covering our portfolios at large.
But I think for us, it's really, "Hey, let's use the size that we have and all the different investments and line items that we have to our advantage in that regard, and try to use a bottoms up approach to come through our exposure. And then identify areas that have specific relevance for our portfolios."
Nicole Connolly: Jenna, I think the small cap point is a really important one. And the small cap companies might not have all the resources to produce a nice looking corporate sustainability report. But when you get on the phone with them, they might have a whole series of initiatives that they're working on.
I'm thinking that we were talking to Taylor Morrison, which is a mid-cap, a home builder led by Sheryl Palmer. And she has made it her personal mission to increase the diversity of the Taylor Morrison board, to increase the diversity of the workforce, to make sure that their communities are constructed in an environmentally friendly way. And listened to them talk about their ESG initiatives. And it's like, there's no reason why a small-cap company can't have strong ESG initiatives and policies. And we, again, as active managers can get on the phone and uncover those initiatives in a way that a passive player or these third-party providers can't do that work. So, I think small cap is a super interesting area, both from an ESG perspective and for many other fundamental reasons as well.
Jenna Dagenhart: Those are great points. And turning to DNI now, how does Trillium quantify such elements as diversity and inclusion, materiality within a portfolio, as well as its attribution to returns? Cheryl, can you calculate an excess return on advocacy and shareholder engagement?
Cheryl Smith: I would say that we are always asked, "Please, calculate the excess return on advocacy." And we always respectfully decline and say, "We can provide you many, many measures of it, but the excess return element ties a return in time to something else happening in time." And as we've talked about, when we think many of these ESG elements play out over a much longer period of time. So, and the thing about attribution analysis is that it can be very, very sensitive to your choice of endpoints. So, we're a little skittish on that.
But we use impact reports for every one of our strategy that we produce on a regular basis, where we are not only reporting on the engagement that we've had with companies and the percentage of companies we've engaged with. We talk about the diversity of management, the diversity of boards on those. We also talk about, discuss whether companies have increased their reporting, whether they've released a full, equal employment opportunity, one report that gives a lot more insight into what's going on with the company.
I want to bring in one other point with diversity that at Trillium, we're very proud of. Backing up, this is not the proud part. Morningstar has done a study that says that the percentage of women in fund management in 2020 is unchanged from where it was in 2000. And it's a 20 year period with no increase. And that the percentage of women in active management is smaller than the percentage of women in passive management. Both of them are I think, passive is 16% and active as 11%. Those are dreadful numbers.
RBC, who has a sustainable investing division has been trying to do some work on that. They recently worked with eVestment to collect data on diversity of asset management firms. And out of, I think 267 different firms that they got information back, there were... I'm going to lose the numbers here. 19 strategies that had more than a third women.
Trillium has five strategies with more than a third women. And several of our strategies are only women. And that partly comes from being founded by Joan Bavaria. And we've carried that through over time. But we think it's an important component as you're looking for, what's happening in a fund, does it matter to the people that are managing the fund as well?
Jenna Dagenhart: Yeah. Nicole, I know Fidelity has a women's leadership fund. How are you incorporating ESG as part of the investment strategy?
Nicole Connolly: Yeah. It's an actively managed strategy. We launched it two years ago. And we launched it really for a number of reasons, but we were finding that female investors were often leaving their money in cash or letting their partner navigate the finances. And we're finding the financial services industry to be inclusive or accessible. And we wanted to bring more women into investing with a fund that might get them excited about investing.
And then we also wanted to do more to pave the way for future female leaders by investing in companies that were not only diverse at the leadership level and the board level, but we've created a whole screening process that looks at 25 different diversity and inclusion criteria. And that includes what a company is doing to make sure that women and people of color are getting paid fairly. What is the company doing to provide a flexible work environment, parental leave? We know that often, a woman might leave during parental leave or right when she gets back. So, having a good infrastructure and allowing her, and also new dads to take this time is incredibly important.
We also look at whether a company has a stated diversity goal or targets, what are they doing to build the diverse pipeline for the company? And so, we think that that piece where we're evaluating the initiatives and the philosophy to really see if there's a culture of inclusion to allow women and all underrepresented populations to thrive at the company is our secret special sauce.
And many of the funds out there look at the leadership and board characteristics, which we do as well, but I'm really excited about this work we're doing all culture and initiatives. And because we've now scored 700 companies, we know who the leaders are by sector. And so, we're able to create a diversified fund with exposure to every sector. And we're approaching our two year anniversary. I run against a traditional benchmark of the Russell 3000. Good performance so far, and excited about the years to come and the impact that we're having with this fund.
Jenna Dagenhart: Before we move on to adviser adoption, Grover, anything you'd like to add about diversity and inclusion?
Grover Burthey: I would say that one, it's an area where we're certainly, more data, more transparency and more consistency, is going to be helpful for the industry over time. It's clearly important for us [inaudible 00:49:25] see perspective. And I would argue that, if perhaps it's a little bit behind the curve, tends to other parts of what we do in ESG in terms of the information we have in our fingertips and at our disposal. It's an area where we do then as a result, have to emphasize some of our engagement efforts to try to gather more information, and then apply it in terms of many of our conclusions and frameworks. But we're advocates with regards to transparency across the board in the industry, which this is one key component in that regard.
I would also say that to the extent that we are very influential in certain positions that we have, certain investments that we have, then through those direct conversations, this is a point that we emphasize. And we emphasize it's important, whether it's in the employment base at large, whether it's in management or leadership, whether it's at board levels. And I have several examples of where through PIMCO's influence in certain investments and capital structures, we've had positive outcomes in that regard. And that will remain a priority for us on a go forward basis as well.
Jenna Dagenhart: Yeah. A lot of positive progress. But to quickly highlight something, Nicole, from a recent white paper, you found that advisors have been slow to offer ESG investment options to their clients. Why do you think this is the case given that ESG interests continues to increase?
Nicole Connolly: Yeah. So, we talked about the greenwashing. I think it's hard for an advisor to know when they look at a fund and a prospectus, and they see incorporates ESG factors, like what to make of that, and how authentic is that? So, I think the greenwashing piece is, one, I think these are tricky conversations to have. I think there's a desire to make sure that you avoid any political or cultural landmines when having these conversations.
But really, again, we're just talking about good business practices and good risk management. And so, these don't have to go into a political sphere. And I think having open-ended conversations, where you're asking your clients, especially ones that maybe are older, like, "What legacy do you want to leave? And what are your children or your grandchildren interested in from different causes, whether it's environment or social justice?" And that's a way to start having the conversation with your clients and bring more more people in the household into the conversation. And I think we'll find that then when we do that, we'll make those relationships stickier over time, which will be a win-win for everybody. And so, I think those are some of the hurdles we've found and some of the ways we're trying to address having those conversations.
Jenna Dagenhart: And I know advisor turnover is one challenge that the industry faces. Do you think that involving more members in the household such as younger generations could help with this? And as you said, it would be more of a win-win.
Nicole Connolly: Yeah. I think we've all probably heard the stories of, the males spouse passes away, and then the financial advisor perhaps loses the wife because the wife hasn't had a relationship with the advisor and is going elsewhere. So I think, again, having these conversations, pulling more people into the discussion is a way to make sure that you keep that client for the longterm and you meet the goals of everybody in the household.
Jenna Dagenhart: Yeah. Cheryl, how would you say advisors should be thinking about incorporating ESG into their client's portfolios as a core part of overall portfolio or as a slice within their asset allocation?
Cheryl Smith: I think the discussion that we've been having today really indicates that there are ways to incorporate it across the entire portfolio. We work on a concept that we call total portfolio activation, which is basically nudging your whole portfolio towards greater impact. So, starting with maybe the asset classes like equities, where there are more well-defined options.
And as Grover mentioned, in the fixed income area, there have really been a lot of changes in terms of the offerings of green bonds and sustainability bonds, social bonds. And that's available in the corporate space. It's available in the sovereign space. It's available in the municipal space. There are opportunities for cash management. A lot of people tend to think of impact as being private equity only, but I think our discussion today has really shown how much impact there can be in the world of the listed bonds and publicly traded stocks. And that's a very important part.
So, we would argue that it is very, very important to have it as a part of the whole portfolio in every way that you can. But I'd also very strongly argue, you don't want to let the perfect be the enemy of the good. As an advisor, you want to say, "Well, I can't think of an ESG offering for every single slice of your portfolio, so we're not going to offer it at all." I think that's a defeatist kind of attitude. You want to just work on a piece by piece gradual improvement of the ESG and impact component.
And Nicole's comment about involving all of the family, I think is really powerful. Most of us in this field that got into the field are in it because we started to think about the legacy for our children. We started to think about the legacy. What did we want the world to be when it finished? There's no reason to think our priority, that our clients don't have those same goals and same interests that we do. They want to improve the world because they want to leave a legacy for their children as well.
Jenna Dagenhart: And Grover, for financial advisors, how can they enlighten their clients about the growth of differentiated products and the active strategies, going off of some of those points that Nicole and Cheryl, mentioned?
Grover Burthey: Sure. One point that we try to impress is that certainly none of this is niche anymore. And I mean that with regards to the specific ESG related investment opportunities that are in the marketplace. Green bonds, for example, well eclipsed virtually in dollars of issuance last year. It's increasingly going to be represented in terms of overall origination activity. That's a trend that would be expected to continue. And so, to the extent that there's any perception, that just the investment universe for this space it's somewhat limited. And I mean, that point separately from anything related to exclusions or portfolio construction in that regard, I just mean simply the actual activity and evolution in the space.
What's happening through the capital markets, what's happening in private markets, it is sizeable already and continuing to grow at a very healthy annual rate each and every year. And so, one that creates opportunities for differentiation among active managers and ways to add value and hopefully, outperform various benchmarks. But again, to the extent there's any perception that this is a somewhat nascent marketplace or somewhat limited in certain terms of its aspirations and trends, we do try to enlighten and encourage market participants to think about all of these trends in aggregate and where the direction is going.
And the last thing I would offer is that, Asset PIMCO, similar to the points that have been made, we have a variety of different funds and strategies that focus on different objectives, whether it be income, whether it be total return, whether it be short duration or short term. And we see different ways to participate in the issue marketplace in each of those strategies. And the same is true for the industry at large, if you have a specific investment objective, you have a certain risk appetite, there are options available. Asset PIMCO, we believe that to continue to support and grow the product offering over time as well. There's a great product offering in place today. But there certainly are a variety of options depending on your investment needs.
Jenna Dagenhart: And as we wrap up this panel discussion, Cheryl, what's your outlook for the ESG investment field over, say the next five years?
Cheryl Smith: We think that it will continue to see the very rapid growth that it has seen over the past few years. The USF, the trade organization for companies doing ESG investing, calculates by a fairly expensive definition that went out a $3 professionally managed in the US, has some sort of environmental social governance or advocacy criteria attached to it.
And we think that that really reflects what Nicole has been talking about in terms of, there's a huge demand for it among the client base. People want to make the world a better place. People want to have some sense of what the companies in their portfolio are doing.
So, we think you will continue to see more growth over time. We've certainly seen over the past decade the evolution of it from niche business to a more mainstream business and the evolution of traditional large market players into it. We think we'll continue to see that because it is, as you explore the possibilities, as you learn more about it, as you talk with companies about setting a science-based target for environment or a target for diversity, it really becomes compelling. And you begin to understand how important that is and understanding what the companies are. And you want to have your whole portfolio in that way.
So, I think that the prospects for growth continue to be very strong. And I'll just add up and talking almost exclusively in the US perspective. Of course, you also have in the European Union a lot of regulation that's asking every portfolio to be declared, are they green, light green, dark green, brown, which is going to make it all the more obvious to the clients, what kind of portfolio they're in. And I think that will very strongly drive further adoption of ESG and sustainable investing.
Nicole Connolly: I liked that world that you described, Cheryl, it sounds great.
Jenna Dagenhart: It does indeed. Well, everyone, thank you so much for joining us. It's really great to have you. And hopefully, we can get to that world.
Grover Burthey: Thank you so much.
Cheryl Smith: Thank you.
Jenna Dagenhart: And thank you for watching this ESG Masterclass. I was joined by Nicole Connolly, head of ESG investing, portfolio manager at Fidelity Investments, Grover Burthey, portfolio manager at PIMCO, and Cheryl Smith, economist and portfolio manager at Trillium Asset Management. I'm Jenna Dagenhart, with Asset TV.