MASTERCLASS: Global ESG - June 2020

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  • 59 mins 24 secs
Three experts do a deep dive into ESG trends, integration techniques and adoption. They discuss different approaches to sustainable investing, ESG standards, and global initiatives to advance environmental, social and governance goals.

  • Thor Olsson- Portfolio Manager, Global Growth Team, ClearBridge Investments
  • Luke Oliver- Managing Director and Head of Index Investing, Americas, DWS Group
  • Terry Heymann- CFO and Head of ESG Initiatives, World Gold Council

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MASTERCLASS

Jenna Dagenhart: Welcome to Asset TV. This is your ESG Masterclass. We'll do a deep dive into ESG trends and integration techniques. Taking a closer look at some of the global initiatives to advance environmental, social, and governance goals. Joining us now are three expert panelists. Thor Olsson, portfolio manager on the global growth team at ClearBridge Investments. Luke Oliver, managing director and head of index investing Americas at DWS Group and Terry Heymann, CFO and ESG lead at World Gold Council. Everyone, thanks for joining us. Let's start by defining what is ESG. Terry want to kick us off?

Terry Heymann: Hi Jenna. Well, thank you very much for having me on and really looking forward to this. ESG quite simply is environmental social governance. It is the key areas that companies are looking to manage to ensure that they are contributing to sustainability for the longer term. That they are caring about a broad group of stakeholders, investors obviously, but also employees, their customers, others that come into their sphere of influence.

Terry Heymann: Put simply, it really is about having values that drive value. That understanding that the way in which you act and behave contributes to the longer-term value of the organization and I think that's something important to operating companies and investors that are making allocation decisions.

Jenna Dagenhart: And Luke, how would you explain ESG to advisors who might not be as familiar with these standards?

Luke Oliver: Right. There's two ways. I think the answer was really well put just that there. There are two sides. There's the value side. So environmental, social and governance, and a lot of people will position this as investing alongside your values and highlighting the fact that there's this shift in demographic, shift in views, shift in things happening in the world that are making people really value environmental, social governance when picking companies.

Luke Oliver: But the other side of it is just as important and maybe in the US even more important. That ESG is truly a capitalist way of approaching companies. Finding companies that are prepared for the changes in the environment, companies that are well suited to the change in social behavior and obviously governance, as companies that are well run. These are values. ESGs are a set of values, but they're also nonfinancial metrics, which really could drive financial outcomes in those companies.

Jenna Dagenhart: Yeah. Nonfinancial metrics that do drive the bottom line often. Tor, how would you describe the advisor learning curve for ESG and ESG adoption in different areas of the world.

Thor Olsson: Great. Thank you very much for the question. I would describe the ESG learning curve as flattening and ESG adoption rate as broadening out. We have two major pools of assets, the US and Europe. Your awareness of the benefits of ESG investing is still, probably more broadly appreciated in Europe as the European financial advisers more broadly promote ESG products than their us counterparts.

Thor Olsson: However, recent surveys indicate 83% of US financial advisors expect increased usage of ESG products up from 48% just four years ago. But in both markets, increased client engagement is matched with increased allocations. We see lots of room for continued growth in ESG investment.

Jenna Dagenhart: Yeah. I think that's a great point, Thor. To set the scene here, ESG has certainly risen in popularity and we're seeing that in terms of inflows. According to Morningstar, sustainable funds saw a record inflows in the first quarter of mid the market volatility. That being said, Luke, how is the COVID-19 crisis impacting ESG?

Luke Oliver: Well, it's a multifaceted change or period that we're going through, which is a couple of things. Very clearly, consumption dropped rapidly when we had the lockdown, global lockdown. We saw a reduction in usage of airlines, for example, just being a very top line, great example. And we also saw oil come off a lot for different reasons just prior to the pandemic lockdown.

Luke Oliver: But all of these things really demonstrate the fact that consumption and some behaviors that we think that the society is moving towards would be very conscious of fossil fuels, very conscious of their consumption. And not in any way to downplay it, but this was a good test scenario for what would happen when people really pull back on their use of fuels and their level of consumption.

Luke Oliver: What we saw was ESG do very well in this period, and it really highlights the environmental impact that that can happen when we change our behavior. And then also on the social side, more than ever since the pandemic, we've also had great social unrest that certain very important social causes of being really taken up with Gusto and I think that's very important and that will play into the ESG.

Luke Oliver: ESG really seems to be finding its right time. It's been around for 20 years, but this is really fine. It's in line with these [eight 00:05:35] days right now and I think that we're going to see the adoption increase as a result of that.

Jenna Dagenhart: In addition to some of those behavioral changes Luke, you would say that COVID-19, and some of the social issues that our country is talking about right now have shaped what investors are looking for in their portfolios?

Luke Oliver: Yeah but it's just the two sides of it. I think this will increase the demand and the awareness of ESG and why people will want ESG from a values perspective. But I think it's also going to play out into the performance and that will catch up another whole universe of investors who perhaps had less focus on the values, but clearly, you're interested in performance. If you can marry values with performance, I think you've got something that is going to be very meaningful and change the investment landscape.

Terry Heymann: I absolutely agree with Luke. This is about long-term value and I think that there is sometimes this perception, this historically that investors that were looking for ESG orientated, investment opportunities, ESG fund were sacrificing returns. We’re sacrificing performance. I don't think that's the case at all. We can talk about why the numbers are hard to come by quantify, but it really is a point around companies that are well managed for the long term, that factor in this broader set of societal issues.

Terry Heymann: Be it, how they engage with communities, engage with populations, engage with their employees, how they manage the environment, how they respond to climate change, which is clearly a very significant part of the overall sustainability agenda, but not all of it. And how they have the governance systems in place to make sure that they do that well over the long term are just better set up for long term performance.

Terry Heymann: I think that it's really important to be clear, this is not a tradeoff. This is about understanding the ways in which companies are positioning themselves or organizing themselves or responding to delivering value over the long term, is around a real demonstration of intent for environmental, social and governance in the here and now.

Jenna Dagenhart:In other words, you're saying Terry, that you don't have to sacrifice alpha in order to invest in ESG, if anything, it might be the opposite?

Terry Heymann: Absolutely and look, I think where the challenge at the moment is around the data. And so how do you find that data that allows you to have confidence that investing in an ESG orientated fund or on a company that is very clearly strongly committed to ESG does the two-superior performance. Part of the challenge is we don't have good data at the moment for what constitutes good ESG performance.

Terry Heymann: There's just such a wide range of factors that come into this and it's very challenging to try and narrow that down to a single metric, or even to identify the right frameworks to provide ratings on ESG, but certainly this intent, this idea around commitment to delivering value in the long term, through having values that support the longevity of the business, I think is a really sound business proposition.

Terry Heymann: I think that's been reflected in, for example, the business round table group in the US changing their definition of the purpose of an organization to serve this broader group of stakeholders. It is just increasing explicitly recognized that looking out for and being mindful of your impact to a broader group does position companies better to outperform in the long-term.

Jenna Dagenhart: Luke, anything you'd like to add there in terms of performance broadly speaking?

Luke Oliver: Yeah. We've seen it play out and I'm sure we'll get into the details of different strategies, but one of the great evolutions in ESG most recently is index tracking funds that are supposed to track in line with the regular benchmark but giving you ESG exposures. What we've seen is that gives us a fairly good way to compare the various benchmarks, which are ESG and non-ESG. And what we saw was our performance this year. Remember, these are products that aren't designed to outperform. Well don't try to outperform, they try to track in line.

Luke Oliver: But this tells this story of ESG giving you potential for moderate upside, even when you're trying to track in line the benchmark. Just to throw some numbers in, if you look in the large cap space, year to date is about a hundred basis points of outperformance using an ESG version of the benchmark. And since the trough of the selloff that we saw in March, we've seen about 250 basis of out performance.

Luke Oliver: ESG did better going into the volatility and did much better coming out of the volatility. It really speaks to the fact that we're trying to track a benchmark, but ESG is a risk mitigant giving some modest out performance. And that's coming from the fact that ESG as others have said, is actually reducing risk and potentially giving you long term value. And when there's stress can sometimes really see that value.

Jenna Dagenhart: And we'll discuss some of the different ESG styles and using ESG as a risk management tool later on in the panel discussion. But before we get there, I wonder Thor, are there any ESG misconceptions you would like to address such as potential tradeoff between alpha and ESG? Anything else you'd like to highlight there Thor?

Thor Olsson: Sure. I would highlight it's not necessarily misconceptions, but I think it's an underappreciated fact and opportunity that environmental risks rank as the highest importance for financial advisors in the US and Europe. And as growth investors, we see innovation and technologies and solutions to help address these large issues that will generate sustainable return for investors over time. There's a large unmet need in a variety of areas, particularly climate and increasingly social.

Thor Olsson: And these innovative companies are going be delivering services and solutions to achieve these much-needed solutions. As ESG investors, we see that there's a very good opportunity to generate above market returns over time.

Jenna Dagenhart: Terry, any ESG misconceptions that come to mind for you?

Terry Heymann: Look, I think one of the big questions around ESG and types of ESG investing is what does it mean? How do you engage in investing? And again, we're on a learning curve and there have been some people that have started for good reason, just having a very simple framework, which is okay. There are some sectors we just won't invest in and the divestment movement is quite powerful.

Terry Heymann: The challenge with the divestment movement is you can often focus on one particular area to the exclusion of others. Let me give you some examples looking at the transition that we're going through around energy and seeing that movement, who are the companies that are going to be able to help us move, advance, accelerate towards renewables, towards reducing carbon.

Terry Heymann: The big energy incumbents have a lot of capability in those areas, have a lot of understanding of what's needed to support moving through that transition. There are many investors that are saying, "Look, we can't invest in traditional carbon-based oil producers." And I think that, that's a very black and white view.

Terry Heymann: I think we are seeing more sophisticated approaches towards how to assess not just what a company is doing today, but also their direction going forward, what they're looking to do and the positive impact that they have. It's really important to look at both sides of the coin, the mitigating risk and mitigating potentially negative impacts, but also understanding the positive opportunities associated.

Terry Heymann: Historically, I think a lot of the ESG movement has focused on the mitigating risks side, as we've talked about before, ESG can and should also be an opportunity to drive positive impact. And we're seeing more investors that are taking an explicit impacts investment stand. To everybody that's thinking about this and trying to understand how they position themselves, it's not a one size fits all.

Terry Heymann: There are different choices that investors need to make as to what sorts of ESG filter you want to add on to your decision-making criteria. And that's quite a broad range of different activities or different filters that you can be looking to apply.

Jenna Dagenhart: To your point about energy, just because a company is an oil giant doesn't mean they're not investing in say renewable energy and renewable resources.

Terry Heymann: Absolutely. I think that's true for a lot of different industries and a lot of different sectors, is understanding potentially some of the negative impacts, but being able to question companies or be able to see from the disclosure that they put out, what they are doing to manage and address those risks. I work at the world gold council.

Terry Heymann: We are a membership association for gold mining companies. We have a very strong belief that the work that our members do is supporting sustain social development and economic contributions in the countries where they operate. Of course, like all extractive businesses, there are risks there and there are risks that need to be managed.

Terry Heymann: And the gold industry, I think, has been at the forefront in setting out what responsible mining looks like, holding themselves to account and saying, "Look, we all committed to ESG, we're committed to economic development. We're committed to the social development goals set out by the UN."

Terry Heymann: And investors should understand that and engage in a conversation about how we can drive that change as well as look, the efforts that we make in, in times of operating potential negative impacts associated with companies that are of significant scale that do have a footprint on the natural environment.

Luke Oliver: If I may, something very interesting in what you both said there is that we look to give people a similar risk and return to the underlying market and part of that is because we want people to adopt the ESG without having to take risk for it. Also, because it gives people an exposure, they're familiar with and will increase adoption. I think the interesting point here is that if you take a sector like the energy sector as used as an example, there are some firms that are stronger than others in their ESG values.

Luke Oliver: If you remove energy completely, then you end up with an exposure that looks very different to say the S&P 500. If that happens, your exposure then will almost be at the whim of the price of oil. And that may completely cloud or shadow any effects that you're having from ESG. If you actually look in the energy sector and pick the strongest names. For example, there are energy companies that supply the lubricant for wind turbines and so they are actually at the forefront of developing technologies for green energy.

Luke Oliver: Some of the largest oil companies or energy companies are focused on renewable energies because they see that's the future and they need to prepare for it. This is where hold sectors aren't necessarily bad. In fact, some of the players in those sectors, energy been a great example, are some of the leaders in developing the future technology. You don't want to completely exclude those, and it just goes to show that's where this ESG becomes very much a capitalist mechanism where you're looking for companies that are best prepared and making the right moves to give them longevity and value in the future.

Jenna Dagenhart:Yeah and to that point, no one thought that a Netflix company, for example, doing mailing DVD orders would be doing well right now. But they've innovated and innovation is key, it sounds like.

Luke Oliver: Yeah. And it's not likely that those companies will do very well with a green revolution. They're evolving with the revolution and we'll be in good position. You don't necessarily want to exclude everything that hints at being a bad ESG score. It might be a case of ranking companies and finding which companies are doing the best. And if we just stick to the value side of that rewarding companies that are making the right steps.

Luke Oliver: There's potential for that self-fulfilling prophecy of people moving more towards the ESG, move more towards rewarding companies that do well and do better. Then more companies will do well and do better and more of those companies will receive investment. And on the fixed income side.

Luke Oliver: Most of us think about it in equity terms, but if you think about it in fixed income tax, if more people are willing to lend to companies doing good, then their cost of capital comes down and makes their business more profitable, more efficient, and actually drives returns there also. It really does marry up the financial value.

Terry Heymann: Look, I think that's a really important point in times of how companies are not just communicating their financial performance but communicating the impact they're having. And both the positive impact they have and what they can do to contribute to society, and I think what we've seen through the pandemic is increased awareness and questioning of the role the businesses play and how business can contribute for good.

Terry Heymann: And I think that's really important, and I think we're going to see more interest in ESG because there has just been this questioning of, "Okay, how do businesses help us as a global society through events like COVID-19?" And there have been a ton of examples where businesses have really played a critical role.

Terry Heymann: But also in explaining how they're mitigating some of those risks and some of the most interesting ESG opportunities aren't going to be with companies that because of their footprint, all positions having significant risks and having some significant impact potential. And that is a nuance conversation, but a really important conversation and finding the right way, because you say for investors to integrate that and to think about how they're going to allocate capital in those cases, I think is at the forefront of where we are with ESG investing.

Terry Heymann: And I think it will absolutely drive more capital to those companies that can not only do the right thing, but can explain clearly to provide us a capital, what they're doing, why they're doing it, why it positions the company to succeed in the long-term.

Jenna Dagenhart: And Thor, turning to you, how you describe the global impact of the pandemic on ESG.

Thor Olsson: This is a very big question and one that I expect will be studied indeed for years to come. The impact of COVID is expansive and unfortunately still very much with us today. However, among other things, this pandemic was an economically, simultaneously a shock to the supply side and the demand side. Clearly different industries, experience difference and barriers, challenges.

Thor Olsson: However, I expect companies with strong ESG policies incorporated into their fundamental business practices will be better equipped to manage the crisis. Be it environmentally from long-term sustainable supply contracts, which can provide price and quality stability during periods of volatility or socially with strong employee commitments and stability from strong corporate values and alignment of all stakeholder’s interests.

Thor Olsson: Or from the area of governance and the benefit, which comes from diversity of perspectives and board independence. Corporate values matter and for the long-term perspective, is very much important, but clearly there are times when short term nonfinancial priorities need to be addressed for the good of all. I expect the pandemic ultimately will be another validation of the benefits of ESG investing.

Jenna Dagenhart: Yeah. Tore, a lot of these issues that you mentioned certainly bubbled to the forefront during the coronavirus pandemic. Looking on the social side, sick leave is an issue that we're talking about more.

Thor Olsson Yeah. Labor participation and taking care of employees and being an engaged member of the community. This all comes together to have a comprehensive recovery. At certain times you need to do all hands to the pump, and I think companies that are on the leading edge of incorporating ESG characteristics are also at the forefront of this response.

Jenna Dagenhart: Terry, Gold has had significant momentum during the COVID-19 crisis and before for in Safe Haven properties, liquidity, and other attributes. As investors increasingly consider it as part of their portfolio strategy, would it be considered a sustainable investment?

Terry Heymann: Yes, absolutely. I think it is. I think when you look at a commodity, it leads to a series of questions as to what we mean by sustainability of that bar of metal sitting there. A lot of the ways that we've done it, the world gold council is around how can investors have confidence that, that gold has been produced in a sustainable way? And in particular, looking at the mining side and a lot of focus quite rightly is on the mining side in the gold supply chain to understand what mining companies do to manage their [inaudible 00:23:49] and governance risks. And [inaudible 00:23:55] local communities.

Terry Heymann: It can lead to significant challenges around the ability to operate. And unlicensed operate can be threatened and that has an impact on your bottom line. COVID is a good example where the mining industry health and safety has been at the forefront for 20, 30 years. A really key priority because companies have learned if you have a healthy workforce and you protect and manage your workforce, it leads to better results.

Terry Heymann: One of the things that we've done at the World Gold Council last year, it was put out the responsible gold mining principles. This is an overarching framework for the gold mining industry that essentially defines what good practice looks like from an ESG perspective. What are the material issues related to gold mining? And I think we're going to see more and more of this sector specific type guidance that helps investors and others understand when we talk about ESG, ESG is not the same.

Terry Heymann: The materiality is not the same for different industries. Different industries quite naturally have different topics that are of particular importance and these industry specific approaches, that's very clearly set out what is meant by good ESG performance, I think are going to be increasingly available and increasingly useful, not just to assess performance if you like on a ranking or be it that's a part of this, but also to allow for an informed discussion between investors and companies or between the fund managers in times of all right, what are you actually doing to address your ESG performance for those issues that are material?

Terry Heymann: And just like financial reporting, ESG also has areas that are material and non-material. For those that are material, what are you doing to address and manage and position yourself for good performance, both on the sustainability side, environmental, social, and governance, but also for, as we talked about extensively before, linking that through into the financial performance and value over time.

Jenna Dagenhart: Yeah, that's an important question. And Thor, how do portfolio managers work with analysts at ClearBridge to conduct ESG integration?

Thor Olsson: Thanks for the question. At ClearBridge, ESG is not merely a screen or an overlay. It is how we conduct fundamental research. It defines how we think about all companies considered for investment. Portfolio managers, regularly source investment ideas and construct portfolios by integrating ESG analysis into the fundamental research performed by analysts on ClearBridge's centralized sector research platform, as well as analysts dedicated to the specific portfolios.

Thor Olsson: Our analysts and portfolio managers examine the ESG issues relevant to a company's business activities. They measure and evaluate their impact on both qualitative and quantitative basis and suggest for ways for companies to improve their ESG practices. This integrated approach results in a thorough and detailed evaluation of a company's risks and opportunities related to specific ESG issues and their relevant businesses. Some ESG issues are not relevant for all companies such as corporate governance and labor.

Thor Olsson: This applies to all companies, but other ESG issues are relevant to many companies such as environmental efficiency and supply chain responsibility. And other areas are very specific to the individual industries such as access to medicine and drug pricing for pharmaceutical companies. Or responsible lending for banks. But our fundamental integrated ESG process is what's key.

Jenna Dagenhart: It's now one size fits all as we alluded to earlier.

Thor Olsson: Yes.

Jenna Dagenhart: What are some of the most prominent ESG issues for investors and why do you think that?

Luke Oliver: The complaint we had in the past, and I've seen the industry now really respond to this. But the issue in the past was we saw people saying, "We're going to have a portfolio that is just companies that are really good on ESG scores." You end up with a portfolio and sometimes that portfolio predominantly look like a tech portfolio. Or we would have people say, "Right. We're going to just cut out everything that we think is bad ESG and you end up with as we mentioned earlier, if something like energy ripped out on a portfolio.

Luke Oliver: And then you end up with a portfolio that only has so called good ESG names. And the problem with those two approaches is neither of those portfolios look like anything other than exactly what they were. One was very light on energy, and one might be very high on the tech. The issue with that is that those portfolios, when most people are looking to allocate ended up being satellite or periphery positions that they put on and almost might be viewed as well, I have to give up some risk and returns for that, so that's just going to be like an add on to my portfolio.

Luke Oliver: The evolution that we've seen is now that people are getting these broader baskets of stocks that represent a tilt towards ESG screening out the worst names, keeping some sector neutrality. That allows people to actually bring ESG into the core of their portfolio. In fact, I think is the evolution and the fix that we've seen, that's really raised assets recently. And I'm speaking from an exchange traded fund perspective. We've seen about 13 and a half billion coming to ESG ETS this year and almost all of that is going into these broad benchmark exposure.

Luke Oliver: Exposure to that are low cost, highly diversified and track something like the non-ESG version. And I think that's been the secret sauce for the big rush to act there. And very few of those assets are going into I say for instance, a water specific ETF. Or a solar specific ETF. We really have seen this adoption more broadly and I think that's the proper way to go. And if that adoption really picks up, then those periphery positions that people add on, really can be started to become more nuanced and more focused on particular places.

Luke Oliver: What I'm getting at here is bringing ESG's core is key from that mass adoption. And then I think that there's some more nuanced, alpha generating thematic type exposures that will really target certain trends within or certain elements of the ESG and they'll be very powerful as well.

Terry Heymann: And just to add to that. I fully agree. I think ESG is absolutely becoming more mainstream. We're seeing investors look to incorporate it not as a niche little product offering, but as a core part of how they want to manage their portfolios. I think many leaders in this slightly different world. If you look at sovereign wealth funds and you think about their perspectives, I'd say many sovereign wealth funds and we speak to many of them have had for a long time, this view around how do we manage these funds over the very long generation?

Terry Heymann: And there'd been some real leaders and in the pension space and particularly in sovereign wealth funds, who've said, "Look, we can help shape the market because we want to invest for the long term. We're committed to holding this for the long-term. We are multi-generational, and we want to represent the market, but we want to represent those companies that are going to be around and deliver value in the long term."

Terry Heymann: And I think we're seeing other parts of the investment community come on board as well and it's going to be interesting to see how in a few years’ time you look at the ETF landscape as one good example. I wouldn't be surprised at all if ETF funds that have some kind of an ESG rapport or an ESG linked to them screen in one way or another dominate. Because there is just this increasing recognition that this is a way to manage the risks whilst delivering performance that's compatible to the overall market.

Jenna Dagenhart: I love all the creative tickers too for the ESG, ETFs. I know she is one of them and Thor returning to you, how do companies view ESG differently across different regions? Take corporate governance in Japan, for example.

Thor Olsson: Yes. This is in many ways, a fascinating subject for someone who has seen so much change over the last 10 plus years of ESG investing. Change in this case is another way of saying improvement. 10 years ago, incorporating ES and G factors into fundamental investments was still somewhat early days for some. At least on the E and S issues.

Thor Olsson: But who would have been against improving corporate governance? Japan when you look back over the years, historically, they had unnecessarily high levels of cash holdings, large holdings, and cross shareholders, low ROEs, executives with a high percentage of fixed income and little performance ties to share performance.

Thor Olsson: And boards with lack of diversity and few independent directors. Japan was very slow to embrace the gene. 10 years ago, environmental issues were widely supported by European and Japanese companies and investors. The US was not as far along as we would've hoped. As is the case in many situations, change implemented at the top is powerful. And the much lauded Abenomics and the implemented changes to the corporate stewardship code in Japan has taken big steps to bring legacy old Japan inc model to be more competitive with their global peers.

Thor Olsson: The resulting improvement in Japan in many cases has yielded very strong returns inequities. We've seen a significant improvement and now there's more broad awareness in all regions of E S and G contributing value to share our returns.

Luke Oliver: An anecdote to add to that. It's quite interesting, I think is we saw this rush to market of many ESG funds over the last couple of years and people started to monitor flows, monitor AUM, we've got various reports showing stats of how ESG is being adopted in its RTF rapport. And suddenly there was this observation, but the biggest ESG funds were funds that hadn't just been launched and they'd been around for years.

Luke Oliver: And it turned out that some of the biggest ESG funds were actually these Japanese ETFs that tracked the Nikkei 400, which was an index exactly as you said, that was designed. Some people call it the shame index, but the index to actually point out the companies to be included needs to have a certain level of governance among other things.

Luke Oliver: This index was used as part of Abenomics was an index that was favored. The GPIF favored that index also. We saw this big push towards this governance-based index. Just interesting anecdote that some of the biggest ESG ETFs are actually these Japanese equity ETFs. That before we were all saying ESG, we're actually quietly doing G very well or on their own.

Thor Olsson: Yeah. I like to describe that as a bit of the carrot and stick approach. Once companies had to justify why they were maintaining these high levels of cash. There was a punitive component to it and then as you highlighted creating these ETFs have rewarded companies for improving their overall profiles. They got the carrot when they were included in these very large pools, that'll have long-term commitments to invest in those companies. The carrot and stick approaches are something that Japan has done quite well.

Jenna Dagenhart: And you mentioned the shaming index, negative screening, indexing. Luke, what are some of the different approaches to ESG and styles of ESG investing?

Luke Oliver: Yeah, and I think I covered some of these a little earlier where you have exclusions where you're left with what's left when you take the bad actors out. You have inclusive where you just pick the strongest names and I think the approach that I favor is the approach that blends the two. You take out some of the universally accepted bad names, whether you're looking at back versus peer group and looking at the worst in the peer group.

Luke Oliver: Whether you're looking at something like the UN PRI report. And [inaudible 00:36:48] leaning out, but not necessarily removing all. Basically, ranking companies in their sector allows you then to keep some of those names. A, you get representation and your tracking to the benchmark stays a little lower. Which is a little less high conviction ESG because you're still willing to include some names that might express some of the negative characteristics in ESG.

Luke Oliver: But the point is you're trying to get the best in those sectors. And I really feel strongly about that because you keep them in because you still get some exposure to that sector, so you're not giving up risk return too much. And then you're picking the companies that have the best view on that sector. Like I mentioned, if you have an energy company that is also one of the leaders in green technology and green energy and renewable energy, actually, maybe that's an inclusion despite their legacy business being a negative.

Luke Oliver: Blending those two things and being able to compromise to get the risk and return while still being ESG. I think that's how we get the masses to embrace this environmental, social, and governance of investing. And seeing it for more than just values based. You don't have to agree with the values to know that it's good business to be strong in E S and G.

Jenna Dagenhart: And Terry, what would you say is the best way to invest in gold for the purpose of sustainable investing?

Terry Heymann: We're fortunate that there are a number of different ways to invest in gold and I think there are lots of good opportunities to invest from a sustainability perspective and gold as well. Obviously, there is physical bars and coins and understanding where those come from, the supply chain, we're all getting more used to questioning sourcing gold that comes out of an LBMA accredited refiner. It's the system the gold industry has in place to ensure that only a response sourced metal makes it to consumers and investors is really important. There are obviously got ETFs, huge liquidity relatively low cost.

Terry Heymann: And then there's the gold mining companies themselves. And I think it speaks a little bit to the point discussion before. Different investors are looking for different things, both in the financial performance, but also in their values and what they care for. And when investors do start to put a bit of a values orientated lens, then you start getting into these questions as to how do I want to direct my investments to be able to positively influence the sustainability agenda? And what do I care about most?

Terry Heymann: If I care about climate change, then you can have a slightly different set of companies that you'll be looking at relative to. For example, if you want to have a real focus on poverty in developing countries, and you want to engage with companies that are making a very active difference in that domain. If you want to look at water, it's a different set of companies as well. Now that's getting more sophisticated, but it goes back to your question as to what are the different ways to invest?

Terry Heymann: There is no simple one size fits all answer. It is in a combination of how much are you looking to do this? Because as we've talked extensively about, there's a belief that it fundamentally drives longer term out performance and risk-based returns. How much are you looking to do this? Because you do have particular values that you care about. Different investors will be at different places and that will influence their investing choices for all asset classes and gold as an asset class and also has those range of choices that investors can make about how they expressed that position.

Jenna Dagenhart: On different values as you mentioned. In different regions, depending on different areas that being said Thor, are European companies, you think held to a higher ESG standard than in other markets?

Thor Olsson: There's a different way of looking at this and a different way of answering your question. At ClearBridge we rank companies in terms of ESG by sector. We don't hold European companies to a higher standard per se, but they often ranked very well, especially in Nordics versus their global peers. I think European companies were early movers in the ESG space and they've benefited significantly from it.

Thor Olsson: Naturally competitive management teams competing with each other’s and developing higher and higher levels of excellence to excel over local and global peers and rivals. I think that was the natural outcome of that. But I will volunteer. I was at a conference in Copenhagen, this was in the pre COVID era.

Thor Olsson: And one of the Nordic banks expressed some concerns that the lead the Nordics had accrued in ESG investing over the years was being made up by some of the large us banks with top management focus and huge resources behind them putting that to work in ESG. European companies have benefited from their early lead, but I think this is an indication of broader recognition of the long-term value that ESG provides to investors globally.

Jenna Dagenhart: And building off, of that Thor, how do you engage with companies both in the US and outside the US?

Thor Olsson: Yes. I think that dovetails very nicely but as an active investor in public markets, we engage with US and non-US company management teams on a variety of material ESG issues to promote and improve their ESG characteristics. We engage with companies a variety of ways, including one on one meetings with senior management. And we have active participation in a variety of ESG organizations. This engagement has also benefited from our large asset base and typically long holding period.

Thor Olsson: We're a top shareholder, a top 20 shareholder in over 293 companies and have an average holding period of greater than seven years. Having that long-term perspective and that long-term commitment to engaging management. That has allowed us to generate a significant impact with companies that we invest in.

Terry Heymann: And Jenna, just building on those points and this engagement model. I think that engagement is different in different regions. There are different concerns. We've talked a little bit about climate change. A really huge systemic issue for the global economy as well as the planet. And the two are inextricably linked. I was in Australia at the end of last year and the discussions on climate change are really vibrant there because it is a country that you can see the impacts of climate change quite dramatically.

Terry Heymann: It already feels ages ago since the huge forest fires in Australia at the beginning of the year. We see examples of the impact of some of the physical changes associated with climate change in many other parts of the world. If you are in one of those locations that is already feeling hoe something like climate change is impacting your physical landscape. It's inevitable that, that will escalate and become more prevalent in what you're looking at and engaging with, with management teams on.

Terry Heymann: My hope is that the experience that we've had as, again, a global community around COVID and this pandemic also allows us as a global community to really engage meaningfully on climate change. Because there's no doubt that it is a systemic risk to the global financial system. That there's the potential for very widespread asset revaluations just because the world could look quite different.

Terry Heymann: And hopefully, if there are some silver linings to come out of COVID and the pandemic or a bit there, that they're challenging to look for, it's this realization that investors and the global financial community needs to be engaged in these big issues and these big sustainability issues. And think about what the long-term looks like because the globe can suffer as one and things can happen.

Terry Heymann: And we all are aware of the increasing concerns that are being voiced about climate change and what happens if we are as a community, as a global community, are unable to keep to the Paris accord and to keep emissions down and to not be able to meet that two degree target. Well, we've now got real life examples of what happens when the world goes into a bit of a tailspin climate change as a slow burner, literally slow burner.

Terry Heymann: But I think these are really important issues that all investment managers need to be thinking about and engaging with companies both to understand what actions they are taking to manage their emissions, but also critically to understand how the impacts of climate change might impact their ability to do business into the future. We've just seen with COVID that big shocks can come that can dramatically change the way businesses need to operate.

Jenna Dagenhart: And tour what progress? Go ahead.

Thor Olsson: Now, just add to that. I think there were so many excellent points that were just provided and as I indicated earlier, environmental related issues were one of the major motivating factors for people to invest in ESG related strategies. And climate change has been something for many people that is viewed as much of a longer-term issue. And yet one of the positives that could come out of this pandemic is millions of people saw very fast recoveries in air quality and water quality. Whether it was being able to see the Taj Mahal in India from a much greater distance than was previously capable.

Thor Olsson: Or the Venetian canals, the water clearing up. These were things that occurred in just a very short period of time. Clearly climate change is a longer-term issue, but I think those tangible benefits that people saw for themselves in a shorter period of time, I think really can underpin a longer-term commitment and broader growth in supporting these environmental policies.

Jenna Dagenhart: Yeah. Some of those aerial images and pollution pictures are pretty striking.

Thor Olsson: Very powerful images.

Jenna Dagenhart: And Terry, the UN sustainable development goals have gained significant traction. How's the mining community and gold as an asset tracking towards supporting those objectives?

Terry Heymann: I think the UN sustainable development goals are a really important framework. 17 goals really clearly set out in terms of what again, businesses need to do in partnership with governments, with other parts of society to impact change. And business, I think has a really important role to play in contributing to economic and social development. And the mining community and certainly our members, members of the World Gold Council, are absolutely committed to playing their role.

Terry Heymann: We've seen that in some of the responses to COVID, whether it be providing health and safety awareness for communities and community support, PPE, even access to significant health care facilities. That is just a small part of what the mining industry, the responsible mining industry does to support the SDG sustainable development goal agenda to address poverty. Because so many of these questions ultimately come down to how we can help address poverty.

Terry Heymann: Some of the social challenges and political issues we're seeing at the moment are rooted in poverty. Some of the discriminatory ways in which we've seen COVID play out is rooted in poverty. Businesses absolutely have the opportunity to help lift communities out of poverty. The mining industry very much so. For those communities that are around a mine site and those countries that are fortunate to have gold reserves.

Terry Heymann: There's no question that when it's done responsibly gold mining can help lift people out of poverty through the provision of jobs, education, tax revenue. It all links into this idea of the role that businesses play in advancing the development goals and the mining industry, because it is in so many places, a frontier industry can literally be at the forefront of that.

Jenna Dagenhart: And before we move away from some of these global goals. Thor, what progress are Chinese companies making tracking ESG?

Thor Olsson: Yes, this is a very interesting and relevant in particular because it's such a large market. In 2015, the Hong Kong exchange establishing initial levels of ESG criteria for companies listed there to disclose. Over time, those standards have increased as recently as 2020 but Chinese companies generally rank lower than their global peers in ESG disclosures. And I think generally you could categorize them as not broadly embracing ESG policies. However, recently president G who is keen to attract direct foreign investment via all avenues, including green funds, has expressed support for ESG practices.

Thor Olsson: Top down support in China for ESG initiatives seems critical for their long-term success. From a low base, I think there's some reason for optimism out of practicality. But again, it's still early stages for China. If I may just add to that. I've been visiting China for the last 10 years. China is the world's largest gold demand market. It's actually now the world's largest gold supplier as well.

Thor Olsson: Lots of gold mining that they face in China and there's no question that there has been very significant progress on the ESG agenda during the last decade in large part, because of concerns around the air pollution and living conditions and what that means for people but also as China looks to increasingly engage internationally and operate to international standards.

Thor Olsson: And ESG is very much part of that. In the gold sector, we've seen actually significant declines in the amount of gold being produced in China because the government has gone and shut down mines that are not operating to the required environmental standards. And I think that's a really good thing that we're seeing that engagement and there's a response from the industry to say, "All right, we understand why this is important. We want to improve. We're really committed to being part of this journey and to frankly, improving the quality of life for everybody." That is what underpins so much around this whole sustainability question.

Jenna Dagenhart: And to quickly revisit the topic of risk management. I know it's difficult to discuss ESG without mentioning that because it is a benefit there. Luke, how does indexing help eliminate idiosyncratic risk?

Luke Oliver: Sure. You can look at an active versus passive debate. That's always a hot debate. Or you can just look at the fact that a passive approach is usually very diversified approach and just by being diversified and maintaining exposure to all the sectors that a classic benchmark might have really does smooth out those returns and it gives you those diversification benefits. But as a risk management tool, it just simply put, ESG almost gives you a somewhat of a tailwind to the trends that are happening in the market.

Luke Oliver: That just support for me as an investor, I like to have confidence that the companies that I own. Not only our strong companies, but companies that are thinking about the future and thinking about the way that they're positioned, then trying to make this a better place. Clearly, if the worst-case scenario of climate change, for example comes in, none of these companies are worth anything near what we think they're worth today. We're missing the urgency and we need some urgency around ESG, and we need to really explore this.

Terry Heymann: And just on that point around climate change and potential asset price reevaluation. I think that's a really important point. And investors just should be thinking about what the risks to the investments are that they're holding given the huge impact that climate change could have in as short as five, 10 years, just given some of the physical risks we're already seeing, but also the transition risks.

Terry Heymann: The policy movements that we might see as a response from governments and how that can significantly change business models. Luke, I think you're absolutely right. It's really important to think about the longer term. Climate change really does have the potential to change the investment landscape and to make very big impacts on asset valuations. Actually, we think it's an opportunity for gold.

Terry Heymann: Gold is very well proven as a risk mitigating assets and if you think about climate risk mitigation and how you manage for that, the early initial work we've done looking at gold in that context compared very strong role. And I think investors will increasingly be thinking about how do they construct portfolios that are resilient to climate risk?

Jenna Dagenhart: Yeah. Thor, how can ESG factors serve as a form of risk management?

Thor Olsson: It's a great question. I view ESG factors as serving an additional level of quality. If you can measure something, you can improve it. If management teams can see the value of E S and G factors and what that can bring to returns over time, they will support it. They will develop it and all stakeholders will be rewarded. Dynamic world class companies embrace innovation and strive for improvement. Yes. I do ESG as improving risk and driving superior returns.

Jenna Dagenhart: And as we close out this panel, I want to end by looking forward. Terry, where do you think we go from here?

Terry Heymann: I think we go to all the investors incorporating a degree of ESG mentality into their allocation decisions. That investors will be aware that as we've discussed extensively, long-term value is underpinned by a commitment to operating responsibly and they will look for those companies that are engaged across environmental, social governance.

Terry Heymann: That they will look to understand what the material risks in that particular industry are and how companies are managing them. And they will think about incorporating risk analysis in times of the sustainability risks to the world in terms of their overall portfolio design in particular climate risk.

Jenna Dagenhart: And Luke, you mentioned earlier 13 and a half billion of inflows going into ESG ETFs so far this year. Do you think that's just the tip of the iceberg? Do you think we'll see more urgency, more interests going forward?

Luke Oliver: Yup. Yeah, absolutely. A couple of things. European institutions are buying ESG and they're doing that in large numbers. US institutions will begin to do the same, especially once we start to see the proof points that this is not just values only, but also made sense from an investment perspective also. And then we'll see retail and then what will happen, and we won't be having master calls ESG in a few years. I want to say how many years, but in a few years. Because that will just be how you invest.

Luke Oliver: You don't buy companies that aren't well positioned and aren't looking at the environment, social and governance among all the traditional methods of screening a company. This will become standard.

Jenna Dagenhart: Yeah. Thor, what's your longer-term outlook for ESG from a global perspective?

Thor Olsson: As I look around the globe, this is a wonderful time for ESG investing. We as a global community faced several immense challenges as indicated whether it's climate or social. And ESG investing in many ways is a continuing renewal adapting and improving on previous successes to develop our greatest tools of change, which are much needed.

Thor Olsson: ESG having achieved broad institutional and individual support is in a position to build on its strength and to be a continued force for change and improvement while providing superior returns to investors. As I look around the globe, I think this is a wonderful opportunity for ESG to build from strength to strength.

Jenna Dagenhart: Perhaps this'll be one of the final ESG masterclasses, as Luke mentioned, it'll be so mainstream and a few years.

Luke Oliver: In a strange way I hope so.

Jenna Dagenhart: Thank you so much everyone for your time and your insights. You're truly leaders in this space traveling around the world in the pre COVID area to work on ESG. Thank you very much.

Luke Oliver: Thank you.

Thor Olsson: Thank you Jenna.

Terry Heymann: Thank you.

Jenna Dagenhart: And thank you for watching this ESG masterclass. I was joined by Thor Olsson, portfolio manager on the global growth team at ClearBridge Investments, Luke Oliver, managing director and head of indexing investing Americas at DWS group and Terry Heymann. CFO and ESG lead at World Gold Council. And I'm Jenna Dagenhart with Asset TV.

 

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