MASTERCLASS: Liability Driven Investing - October 2019
October 7, 2019
Tamara Laine: Global ESG assets under management grew by 73% from 2012 to 2016 as more nonprofits explore aligning their investments with their mission.I'm joined by two experts in ESG investing, Jeremy Tennenbaum, senior nonprofit strategist at Vanguard and Douglas Grim, senior investment strategist at Vanguard.
Tamara Laine: Welcome gentlemen to the ESG Investing Masterclass. Thank you for joining me. As ESG investing continues to grow in popularity, the spectrum of products and strategy continues to grow with it. How do nonprofits and committees navigate this complex growing system? Jeremy, I'd like you to start. Can you start by defining what ESG investing is? And maybe more importantly, what it's not?
Jeremy Tennenbaum: ESG investing is not an asset class, it's not a stock, it's not a bond, it's not timber, it's not real estate, it's a series of three lenses that allocators use to assess companies along an environmental, social or governance frame.
Tamara Laine: And making decisions about a company, a nonprofit's portfolio is not always easy. Are there steps that they take in order to get higher, less risk high reward?
Douglas Grim: Yeah, right. Yeah, Tamara, I think the way that we've been counseling institutional investors is to try to think about this holistically and I think a lot of times they'll come in and just say, "Is ESG good or bad?" As Jeremy pointed out, it's really just terminology for a whole bunch of different potential issues. We try to take people a step back and say, "Okay, how do we think through this in a prudent way?" The answer's not the same for everybody as it turns out. As a result, it's all about process. To us, it really, the guidance we can give is really a roadmap in terms of steps which is what we think is define. What we mean by that is defined with what issues you care about and then secondly, what are my objectives for a said issue? If my issue is say, tobacco, what I do I want to do about tobacco? As an example.
Douglas Grim: The second one is we'll evaluate what the options are. Ifrelated to whatever issue or set of issues somebody has, what are the different options that I have at my disposal within my portfolio or maybe even outside my portfolio? And then deciding based on whatever the organization determines, based on their own criteria, which could be related to their mission, their charter, their investment policy statement, et cetera.
Douglas Grim: And then eventually, at some point, re-assessing thatso that they could decide based on their very specific criteria. And they should reassess at some point in time if they decided not to do something up front, should they now maybe do something? Or if they decided to do something, at some point re-visit and say, "was this a good idea? Or maybe should we do something different?"
Tamara Laine: Committees are looking for guidance so how do you utilize this roadmap that you've come up to get them to an optimal performance for their portfolio?
Jeremy Tennenbaum: I think the first that committees that are thinking about investing using ESG framework need to understand is that if you have an ESG portfolio, it will over time produce results that can differ materially from a broad market based portfolio, like the S&P 500 or the MSCI ACWI.
Jeremy Tennenbaum: First and foremost, is the committee, is the institution, comfortable with having an outcome which is very different from the other;the outcomes that other investors are going to have?It could be materially worse.
Tamara Laine: How do committees determine the right answer?
Douglas Grim: Yeah, I think going off of what Jeremy said too, is if investors are thinking about this of, some of these things might already be being done in their portfolio. For instance, if they are thinking about integrating environmental, social governance issues into their active manager's decision-making processes, some of their active managers or all of them may already be doing it. They might not be calling it ESG integration, but some of those things might be doing it there.
Douglas Grim: The other thing is, there's engagement in voting if they own public companies per se. Some of those activities might be going on there as well. But the investor, the committee,would have to check and make sure, what's actually happening in the portfolio todaybefore evaluating would things potentially have to change in the future?
Tamara Laine: You said that E-S-G are separate things. Is there anything in the governance area that you can give us a preview on?
Jeremy Tennenbaum: I think governance historically is something that most active managers, whether they're bond managers or equitymanagers or real estate managers for that matter, have spent a lot of time. Any fundamentally trained manager's going to look at howis the company run? How is the compensation of the top executives determined? Is it a staggered board or a collective board? How do I feel about the proxy votes that have taken place over the last few years? It's the questions around the social lens and the environmental lens that in practice become more difficult for nonprofits to evaluate.
Tamara Laine: Let's take a closer lookof the roadmap that you set out for success. When a committee comes to you and they're looking to integrate ESG standards into their portfolio, how do you help them define their goals and their mission? And how does that translate into what they're going to invest in?
Douglas Grim: I think it starts with sitting down with them, understanding exactly what their mission is all about and the scope of that mission. And then understanding if there are potential ESG related issues, what those specifically are. The classic case of this that comes up from time to time is, in the fossil fuel realm where somebody is concerned with climate change. There isa couple ways of dealing with them. Is the concern about how it's being explored for? Is it how it's refined? Is it how it's consumed? Or is it just looking at alternative energy companies or clean energy companies?
Douglas Grim: And being very clear about what are the different categories, even within a singular issue, can be nuanced. It's being very clear about those things. And then, taking it to say, "Okay, what is my objective with it?" So, then I can then determine whether this potential decision could affect that. And we tend to see three interactions with clients and they're not mutually exclusive, It could be more than one.
Douglas Grim: Which is one, satisfying a values preference which could be something like ethical or humanitarian or religious, something of that nature. The second is, I will do it if it generates a better financial outcome for me. It could be an objective to undertake of, I think because this maybe are not priced in the certain stocks the right way, or bonds the right way, the brand impact maybe isn't necessarily priced in the right way. That could be something that somebody could be thinking about as an objective. They'll have to look at whether thatis actually occurring or not but could potentially be an objective.
Douglas Grim: The last is, do I actually want to affect change on the issue itself? Whatever this quote unquote bad behavior is, I want less or none of that being done in the future or I want to do something that's going to actually enhance, amplify or have more of the positive things being done.
Jeremy Tennenbaum: Right and I think what Doug and I are always encountering is, people want to do the right thing. They want to feel good about how they invest but there's always a risk of fuzzy thinking. Doug just mentioned fossil fuel. I've had investors say to me, "The internal combustion engine is evil." Now we can agree or disagree about that. I said, "Okay, but if you're going to go to electric vehicle that consumes power, that's maybe produced by coal burning power plants, is that worse or better then driving around in a car that uses gasoline that's produced by fossil fuel?"
Jeremy Tennenbaum: We just find it's very helpful, particularly for nonprofits who tend to be mission related, to gently push back. What are you trying to accomplish? What is your mission? There's this additional tension that we've seen. We've seen this since the South African divestment debates of the 1970s. Do you just say, "We're going to sell all these shares and sell all these bonds because these guys are bad? Or alternatively, are we going to become activist investors and try and militate for true change?"
Jeremy Tennenbaum: There's a whole spectrum of options.
Tamara Laine: You just touched on it, but can you explain a little bit more the different strategies that are popular right now from divesting completely versus using your investment stature in order to affect change?
Douglas Grim: The couple of them that we tend to see is the issue integration one which is effectively an active manager is just adding ESG information in how they determine what the true worth of a security is. Bond, stock, public market, private market companies. And really just using that, integrating, integrating just means combining. It's not leaving aside all the traditional, fundamental type analysis or quantitative analysis they might be doing. It's adding that to it. They have to determine what's financially material and what could drive different changes but that's part of that processes. We're increasingly seeing that become more and more mainstream as an approach.
Douglas Grim: The second one, linked to what Jeremy's saying around engagement we're seeing is, there's some that own stock will engage with companies in order to try to change what they're doing day to day. That's more of an activism and there are pros and cons to that. There are others that just want to understand the long-term strategy, sustainable strategy and the risks that might come along those lines and not try to influence the data day and there are pros and cons to that. That's the second one.
Douglas Grim: The third one is the screening which is generally what most people are familiar with. That's the one that's been around for a long time. But implement it. Which is, look, I'm just taking stocks or under weighting stocks that we deem to be bad from an ESG perspective or over weighting or only owning those that perform the best under certain ESG type criteria.
Douglas Grim: The last one which is a little bit more of an itch but yet still growing is impact investing where it's almost like a dual objective where it's an investor who's trying either to earn return on capital or at least get their capital back but also, affect some sort of material change. That can be done in the private markets, you're trying to revitalize an urban community. You tear it down and you put up low, affordable housing for folks. You turn around in that community, at the same time you're providing space for those folks that they can afford.
Douglas Grim: In the public side, that's something like a green bond which is the proceeds are generally used for say, climate mitigation type earmarking and so that's something that can be done in the public markets. Still niche but that's certainly a growing one too. Those tend to be the four largest ones used.
Tamara Laine: After defining your goals, it's evaluating. What different approaches do you recommend for nonprofits and committees in order to evaluate their investment opportunities?
Jeremy Tennenbaum: Before they can even begin the evaluation process, they have to understand what their governing documents permit them to do or not do. Trust law and fiduciary law can be very strict. If you have a personal trust or if you are running an ERISA plan, either defined benefit or defined contribution that's governed by the ERISA laws, you have much more limited latitude to engage in ESG investing. Whereas if you have a private foundation and the person who set up the foundation mandates that you invest in only in ESG mandates, you can do that till the cows come home and no one will ever say boo.
Jeremy Tennenbaum: Again, if you are an organization with a very clearly defined mission, let's say you are a food pantry, something like investing in a program to overcome what they call urban food deserts is very much in your mission. If you're a community foundation with a focus on public wellness, you might have a real, your mission would say, "Sure, it's fine to fight junk food, fight for green markets and things of that nature." It all goes back to what your documents allow you to do and what your mission says you can do.
Douglas Grim: And I think too Tamara, for ESG integration for instance, if you don't use active managers then that is not part of the toolkit. Somebody will have to decide whether if they have active managers or not. And then if they do, then it's just about asking those active managers, "How do you think about ESG information when you're evaluating security, determining whether underweight or over weight a security?"
Douglas Grim: The engagement and voting would largely be based on unless you have a separate account or you can actually physically can do it on your own, you're going to be obviously very aware of what's happening. If you're hiring somebody, if they're a party through some sort of fund vehicle, then it's about understanding what are the policies and procedures that those firms have in terms of how they vote? And how they engage with companies? And thinking about it from that standpoint.
Douglas Grim: For the screening, it's just about assessing what I always call perfect versus pragmatic. There is such a wide range of different options that are available to folks. Having one that is exactly what I'm thinking about or what my issues are, may not be available and so a committee has to decide, is there something that's close enough for me and how much does it cost? Who's running it? How do I think it will perform relative to what I already have or would be funding it from?
Douglas Grim: And then impact, a lot of it's in the private space. If a nonprofit doesn't have a liquidity requirement like Jeremy's saying in terms of the investment policy statement, then that might not be an option or maybe they don't have the due diligence capability to evaluate a private fund and that might not be an option for them. If they do have those resources and capabilities, maybe that, yes then maybe that is an option for them to kind of use.
Tamara Laine: How does a nonprofit or a committee navigate whether to pick an index or an active investment portfolio?
Douglas Grim: Oh man yeah. This is million-dollar question. To us it's very similar to how we would think about the traditional active index discussion is, look at the end of the day, if it's an active manager, you're trying to, the committee's trying to understand, do they have the superior talent necessary in order to beat the market? We know that beating the market is difficult over the long term, but it is possible. The question is, can I find a manager that integrates it or thinks about these ESG considerations and has the talent to potentially beat the market? And then, what are they charging for that? Is the cost not going to overcome what they would otherwise be doing for it on the skill side and really thinking about it from that standpoint?
Douglas Grim: On the index side, there's so many different types of ways you can index. Indexing is not one monolithic strategy. You can take this green universe and capitalization weight it. You could equally weight it. You could weight it based on an ESG rating. That takes even some due diligence there to try to understand, what kind of factor exposures is it going to provide? What kind of sector deviations is it going to have? And then, how is that going to look when I bundle it with other parts of my portfolio?
Douglas Grim: That's really how that we think about it.
Tamara Laine: You both mentioned due diligence which is so important and key to this. How do committees approach due diligence? What do they need to be aware of in order to not have any negative impacts?
Jeremy Tennenbaum: Well the first and foremost, a lot of it has to do the size and sophistication of your organization. If you have an endowment that's in the billions of dollars, you probably have a decent size investment staff, you have a consultant, you probably have performed private investments, have made private investments in the past. You might be up to the task of delicensing either active managers or private liquid investments. If you're a smaller entity, you may not have a consultant or you just don't have the bandwidth of staff and the mission although it's important, you just don't have the people who can go out and devote the time, then you might be better off just using a more passive screen approach.
Douglas Grim: I think too, they have to be thinking about just like anything else they're doing Tamara, they have to be thinking about just as I pick any other investment product portfolio, the only difference here is, they may be fishing in a little bit pool because they are like different types of strategies. The process they apply to it of the strong due diligence, of looking under the hood, understanding how the strategy is constructed, who's overseeing it, what their philosophy is, the process, what I think the all-in costs are going to be, are all still critical things that they can apply just as they would other investment strategies that they select.
Tamara Laine: But nonprofits and charities have one more responsibility and that's a fiduciary responsibility also to their donor base. How do they navigate this when picking their investment options?
Jeremy Tennenbaum: Again it goes back to different aspects of fiduciary law. There's a very active debate among the fiduciary legal community. There are three traditional fiduciary duties. There's obedience, loyalty and care. Care is also called prudence. There's an argument that for certain pools, I mentioned ERISA before, or for personal trusts or for some charitable trusts that the duty of loyalty you really make it very hard for you to incorporate ESG or other factors into your investment decision.
Jeremy Tennenbaum: Whereas if you are a charity where you have a mission that's not just for one person but a mission for unnamed beneficiaries and for multiple charitable activities, the law says you have a lot more latitude to invest in a way that fits your mission. There's something called UPMIFA which stands for the Uniform Prudent Management of Institutional Funds Act which is why everybody says UPMIFA.
Jeremy Tennenbaum: UPMIFA calls out that if your donor intent is clear that you can invest in ESG and if you are an organization who has a special that the way you invest has a special relationship to the charitable purpose or to your mission then you have the green light from a legal perspective, from a fiduciary perspective, to go ahead and do that.
Tamara Laine: You mentioned with due diligence there's positive and negative impact. Can you just explain that a little bit further?
Douglas Grim: If we're talking about screening specifically, and screening strategy. The negative screening is you're removing or under weighting those companies that you feel or deem are bad and then over weighting or only owning those companies that you feel are good would be positive screened now. There's a big difference. The negative screening, there tends to bea little bit more clear in terms of business activity, say tobacco than say a positive screen.
Douglas Grim: Positive screens, tend to be very much around a holistic assessment of an ESG of a company. Now we're looking at 40 plus different criteria potentially. And the tricky part of that is, the data on all of that information, the transparency is getting better and there's been a lot of headway there which is great, but it's not perfect. The way that different firms calculate different numbers and where they source their information from varies, how they calculate it can differ. And then, well what's material? Of all these different things, what do we include in our decision and then how do we weight that? Does the E matter more than the S? Matter more than the G? There's no universal agreement on that.
Douglas Grim: There's not necessarily anything wrong with that but what it has led to is ratings between different ESG rating indices that have been very different even for individual companies. All that means at the end of the day for the end investors, it just puts a little bit more onus on the committee to understand and do the due diligence of not just the strategy in and of itself but also how the ratings are potentially determined for those that are exploring the positive screen.
Jeremy Tennenbaum: Doug mad a wonderful point in his piece that came out last year, which is that, one of the problems that nonprofits have is that of these 42 factors, they can be cross purposes to each other. We have well known coffee retailers who are cheered for paying benefits for their employees but in the past, they've been criticized for not using fair trade practices when they purchase coffee beans. You have retailers who use lots and lots of recycled material but who are criticized for not paying a living wage.
Jeremy Tennenbaum: If you're a nonprofit, what aspect of your mission, which one of those factors resonates the most deeply with your mission?
Tamara Laine: Well you bring up now our next point which is, picking the right investment. We've set our goal, we've evaluated, now it's time to pick. How do you help nonprofits and committees establish criteria in order to pick their optimal portfolio?
Jeremy Tennenbaum: Again, we chatted before a little bit about trying to help them think clearly, avoid fuzzy thinking. I think one of the interesting aspects of fiduciary law again, there have been these debates going on since the South African divestment campaigns, that was almost 50 years ago. Are doing things to feel good about yourself? That may work personally but that's contrary to fiduciary law. No ifs ands or buts. Or are you investing on behalf of your mission and are you very clear on what that mission is?
Jeremy Tennenbaum: Again, if you're a food pantry, or community foundation with a wellness mandate, it's very, a fiduciary would say, "Look you can make an investment in a supermarket in a poor part of your town to alleviate food desert problems." But if you start talking about making an investment in a micro lending opportunity in sub-Saharan Africa, that starts going very far afield from your mission.
Jeremy Tennenbaum: I think at the end of the day your mission becomes your north star and that really being clear about your mission helps you figure out the flavors of ESG that are most relevant for your organization.
Douglas Grim: And I think Tamara, when you're defining the goals of setting forth, what do I expect from this at the end of the day? Is that the first and foremost one related to Jeremy's point about understanding the overall mission of the organization. And then there's a whole lot of secondary things. Regardless of whether you're doing it just to satisfy a values preference, you're still going to care about the financial aspects of it. But maybe you're looking at one, I'm not sure if it's going to do as well as the thing that I would have to sell in order to fund it but based on what I think it's going to achieve, I'm still okay with that per se.
Douglas Grim: In some cases, based on the legal arrangement, whatnot, maybe that's okay in certain circumstances. There could be other aspects to it of how would this positively or negatively affect our brand in terms of if we did do something or if we didn't do something? How would it affect how from people that might be donating to us, for people that work here already, for people that might want to work here? There's all kinds of secondary ones but we always stress that whether the committee's deciding themselves or whether they establish maybe like a taskforce or a special sub-advice committee to make a recommendation is you got to apply criteria and you got to lay it out. These are the things that matter when we're making this decision. Cause if you can't tie it to that, then it's very hard then to look back and say, "Well what were my criteria in the first place?" When you're trying to evaluate or measure the success or whatever it is, the decision made, once you've made it.
Jeremy Tennenbaum: Right, and Doug alludedto the fact that there are multiple criteria. If you're an investment committee for a hospital foundation, on a mission basis it's probably no brainer to say, "We're never going to invest in tobacco stocks or in distillers." But tobacco stocks have been among the best performers of the exchanges over the last 30 years. Are you still willing to do this knowing that you might have much worse results from your portfolio going forward?
Jeremy Tennenbaum: The fact of the matter is, today we don't know what our portfolio results are going to be. They could be better than broad market indices, they could be worse. We just as a committee need to be comfortablethat we are okay if they are worse. No one seems to ask if it's okay if it's better.
Tamara Laine: You bring up an interesting anxiety. Probably different approaches for different nonprofits bring up different hesitancies. Someone who may be changing their holdings may have more reservations on what they're doing. How do you help them navigate that decision process when they have an established fund and they decide to make a big change?
Douglas Grim: I think when they're making a big change is really assessing, the good news is for most nonprofits there's not, they tend to not be taxable. There isn't that implication that say, the three of us would have in our own portfolios. But, one of the big things is it's not an equivalent swap. They're going to perform differently. They're constructed differently and so you have to understand what are the different sector tilts? What is the factor tilts potentially? Whether it's size, value, et cetera. And then how does that then roll up to what risks I'm thinking about taking from the whole portfolio context to it?
Douglas Grim: An addition is, if I'm going from an active, regular, traditional bottom up stock picker to a bottom up, active manager but he has an ESG screen applied, how do I think the expectations are going to change from that standpoint? And then at the end of the day, it is subjective and its no easy way to do that but it's an important part of the construct of making that determination cause they're not going to look identical. It's going to have some sort of portfolio implication for folks. It could be even more so in the short term where you're get performance that could be very different in the short term. Maybe the long term tends to be very similar but there could be these periods where patience could be a big deal and companies can a little bit nervous about sitting through things if a manager tends to underperform. Which is natural. These things occur in any good investment.
Tamara Laine: Why it is important that committees review legal and policy requirements?
Jeremy Tennenbaum: In point of fact, the regulators can come after you. You can be sued. Again, nonprofits, there are not a lot of cops on the beat but the ones that are on the beat have very heavy power. They can just tell you have to shut off your nonprofit. The nonprofits have to be very, very cognizant of the legal and governing burdens that they're operating under.
Douglas Grim: That's one of the things Tamara is that's important for them to really document everything. The extent that they can. There's sort of a happy medium of over documentation and under documentation just like it is in any investment activity but what we always stress is that you should document the process that you took. You should document the rationale for the decision you made and then you should document how I'm going to measure success, when I'm going to look at this again.
Douglas Grim: Then it's very clear, provides that institutional memory. There's going to be naturally be turnover in staff and committee members and just as other investment decisions, they're going to want to evaluate that at some point and if you do have any sort of issue and you're approached by regulators, you've got it there for them and you're well covered.
Tamara Laine: What are the fiduciary duties involved in this?
Jeremy Tennenbaum: You have three classic fiduciary duties. You have obedience, loyalty and care. Care is also sometimes called prudence. The two ones that are relevant in ESG are loyalty in care. Loyalty again, historically most fiduciary law comes from trust law which is four or 500 years old. In many trusts, personal trusts, ERISA trusts, the trustee is enjoined to act in the sole interest of the beneficiaries. Historically, the courts have held over the last 30 years that excludes most ESG sorts of investing.
Jeremy Tennenbaum: Charities on the other hand, are typically enjoined to act in the best interests of unnamed beneficiaries, their charitable mission. They have a lot more latitude. Private foundations have more latitude still. Care is what Doug's been talking about this whole time. Are we as a committee, are we being careful in documenting what we're trying to do? Are we being clear in how we're evaluating managers? Are we being clear in how we're defining our mission?
Jeremy Tennenbaum: By the way, are we doing this just because we feel good about it? Or do we have a much more consistent and persuasive rationale for our actions?
Tamara Laine: What are the factors involved with UPMIFA?
Jeremy Tennenbaum: UPMIFA calls out two sets of factors. There are in total about 15 or 16. There are three that are relevant. The very first factor it calls out is donor intent. If Doug sets up a private foundation and says, "This foundation must invest using ESG principles, no ifs, ands or buts." That's what it has to do.
Jeremy Tennenbaum: The second one is the strategy appropriate for the organization or the charity? Appropriate is a kind of a legal weasel word. It can mean a lot of different things but basically if it's hugely expensive, if it's very costly with very uncertain returns, and you could in theory go out to the casino and put all your money on 23, that would not be considered an appropriate investment strategy.
Jeremy Tennenbaum: And lastly, do the assets that you're investing in have a special relationship to the charitable purpose of your entity? That was put in in the early 2000s. That is probably the single sentence that gives the most coverage to nonprofits that want to use ESG. If they know what their mission is and they can say, "Look, our mission is to promote health in our community, we're not going to invest in unhealthy, in companies that make unhealthy products."
Tamara Laine: When it comes to the IRS, what is it important for private foundations to be wary of?
Jeremy Tennenbaum: Oh gosh Doug, they're going to get me talking about the Jeopardizing Investments Rule. There's section 49.44 of the internal revenue code is called the Jeopardizing Investments Rule and when the modern foundation legal regime came into effect in 1969, the IRS was concerned that private foundations we're doing the equivalent of going to the casino and putting all the money on 23 on the roulette wheel.
Jeremy Tennenbaum: The IRS said that you cannot make investments that jeopardize the potential existence of the foundation. It's been a little tricky because the IRS has never said, well what percentage of the assets would be considered to invoke, jeopardize the investment. But in general, they do look at all the assets and all the investments that a foundation makes to send them a letter ruling saying, "No, this is out of bounds."
Jeremy Tennenbaum: Most foundations keep very liquid, very risky investments down to smaller percentage so as not to trip that Jeopardizing Investment Rule.
Tamara Laine: Doug, understanding governing documents is very important in this process. What are the key things that committees and nonprofits need to be looking out for?
Douglas Grim: I think at the end of the day it's making sure that they can adequately disclose that they went through a per diem process from beginning to end. Understanding how they're going to communicate that decisions to the stakeholders that might have an interest or care or might have even brought up the issue in the first place. And then having a go forward kind of policy for how we're going to address issues like this in the future. And then of course evaluating what that decision has led to and whether any future decisions would then need to be made. And what's the criteria in order to do that?
Tamara Laine: Do the bylaws play into this?
Jeremy Tennenbaum: Absolutely. Again, most bylaws tend to revolve around committee structure but some for example, the Rockefeller brothers fund which does a lot of ESG investing, they amended their bylaws to state that the investments of the fund should really try and be for the betterment of mankind.
Tamara Laine: Is there a one size fits all strategy for nonprofits or are they different or unique?
Douglas Grim: No, they're very different. I think a lot of it goes to some of the concepts we've been talking about of what the exact mission of the organization is. What kind of resources do they have? How much time and devotion can they give this sort of topic? What their charter and current investment policy statement is. For example, if they don't use private investments today and they're looking at impact investment that's in the private markets, can they change it? Do they have the people that can, necessarily do it? Can they hire a consultant that could, potentially do it? Are they willing to pay those sorts of costs?
Tamara Laine: Does that mean they're going to be governed differently? Are they going to have different rules, different bylaws?
Jeremy Tennenbaum: They might. I think scale probably plays a bigger role. The Bill and Linda Gates Foundation, they have tens of billions of dollars invested. Hugely sophisticated committee members, hugely sophisticated staff members. They can take virtually any approach they want in terms of investing. They have in fact. Famously they seeded a company a few years ago that the IRS and Treasury issued standards about program related investments and they seeded a company whose mission was to create vaccines for I think river blindness in Africa.
Jeremy Tennenbaum: They created their own company. That's pretty cool. Whereas if I'm a food pantry with a $5 million endowment, the latitude I have, the staff I have available, the size and sophistication of my investment committee might be very different. I might be much better advised just to invest in a series of passive products using either negative screens or positive screens.
Tamara Laine: You talked about different scales but are there different costs to ESG investing?
Douglas Grim: Yeah, absolutely. Depending on different approaches, there's likely going to be some cost differences and people just have to assess where they importantly, where they're coming from and then where they're potentially going to. Because it's really about a relative train. Are there any incremental cost differences? If they're funding it from something that has a lower expense ratio going into something that has a higher expense ratio, there's going to be a cost potentially to that.
Douglas Grim: They can decide whether if it's an active manager, whether the active manager's skill is going to maybe make up for that. Or there's something else in the portfolio construction that might do that. If it's in private markets, then if they weren't in private markets before then it's there might be additional costs of hiring a consultant or staff that they need to have. That's going to take time to do that versus what they were otherwise doing with their time which might require some additional resources.
Jeremy Tennenbaum: Right. I think Doug hit on it. There are two cost buckets. There the actual cost of the investment itself and there's the cost of the management time and due diligence, the consultant time in due diligence. I was at a foundation and we did some program related investments. We didn't have the staff that was onboard, so we had to hire a consultant to perform that investment. It was not a huge cost, but it was definitely a cost.
Tamara Laine: The final step of your roadmap is re-assessing.
Douglas Grim: I think they have to start with going back to what the criteria that they established, hopefully the wrote it down. And then starting with what was my goal in the first place? If it was to affect material change on an issue or to minimize bad things that were occurring or maximize good things that were occurring, what changed there? And what did what they ended up doing directly relate to that change?
Douglas Grim: And then what were the other potential either secondary effects that have had? How did it affect the legal? Was the cost about what they expected? The explicit and the implicit costs, what they expected? Have there been any changes in what's available? The strategy suite might be materially different two years from today. We've seen way more products than we saw a few years ago in the ESG screen space. We're going to see I'm sure, a future evolution in that as well. There might be different product options available. They have to kind of go back and assess what's my landscape look now? And are we comfortable maybe with a switch? Or do we feel like we want to stay in the same place?
Jeremy Tennenbaum: I would just reiterate what we said at the outset. The financial results that you will get using ESG screens will be materially different from results you'll get if you don't use ESG screens. Sometimes they may be better. Sometimes they may be worse. Before you do anything, you have to assess your committee and your institution's willingness to accept periods of perhaps very extended under performance. Because if you say, "Well, we feel better about our mission because we didn't invest in any tobacco stocks, but we lagged the S&P 500 by a significant amount." At the end of the day the committee says, "Was that really worth it?" That's what I think we all talk about when we think about reassessment.
Douglas Grim: What we don't want is for people to say, "Look," two years or three years hence and say, "just because something did better or worse over that period," which we would call short, "is not like this made sense of this didn't." It's much broader than that. Just like we were looking at regular active managing strategy, you have to look over longer periods of time, but you can do interim assessments to understand what's going on under the hood, but you shouldn't judge something solely based on a one or two or three-year track record. Based on when you've owned it or just in the past three years.
Tamara Laine: What key indicators would you set up in order to reevaluate? There would be performance, what other indicators would you highlight?
Douglas Grim: If somebody's interested in say material change in how somebody's thinking about general equity or something of that nature then it's like, what are the initiatives that we've done that have made a difference in that area? Whether it's education, whether it's research in that area that has helped the companies, the importance of gender diversity or other types of diversity at companies. And how have the investments that they made translated specifically to that? That's one example.
Jeremy Tennenbaum: For example, Barkley's has the women in leadership index. It's a nice tool to assess how much progress the industry has made but then I would put it back on the organization. If whatever cause that you're pursuing is that important to you, you should not just be confining it to your investment portfolio. You need to take pen to paper, I'm sorry, I'm dating myself. Fingers to keyboard and write letters. Say to companies, "We don't like what you're doing." Or on the contrary, "We do like what you're doing."
Jeremy Tennenbaum: It's not just how you're investing; it's how you're behaving and what you're doing with the rest of your organization's time and attention.
Tamara Laine: What advice do you have for nonprofits and committees who decided not to change their strategy at the moment but still need to reassess?
Douglas Grim: I think it's first of all the documentation. Making sure that they documented the approach they went to. And then communicating the rationale behind it to folks. And so that if they are asked about it in the future, that they can go right back to that. It's clear to everyone what's going on in that standpoint. And then, you're thinking about based on the criteria that they established up front of is there anything under the sun that could change our decision on this? And then it's really looking for things along those lines of, okay, if certain conditions or certain things become available or there's changes in industries, would we then be interested and thinking about this a little bit more closely for it? And then establishing any future protocol if there's an interest in doing something again. Make sure people know what, how would we address this at some point?
Jeremy Tennenbaum: You see it in a number of universities, well regarded universities, that have sort of said, "Look, we're not going to change how we're going to invest. However, we may offer an ESG sleeve for alumni contributions." A lot of them have engaged students to say, "Fine, we're happy if you want to help the university change our profile, so we can use more ways to energy on campus. Can we power ourselves in a greener manner? Can we, can the university reduce water consumption? Can the university reduce the use of production of waste food?"
Jeremy Tennenbaum: And then there's to Doug's point from before, you're generally sort of engaging your stakeholders saying, "Okay, it's not just how we're investing, it's all these other activities in terms of how we're living our lives."
Tamara Laine: Well this roadmap is clearly a map to success. I'd like to reevaluate what we've talked about ourselves. What are the key points that committees and nonprofits should take away from what you've said today?
Jeremy Tennenbaum: Well, I think this is not particularly sexy but as Doug was saying, "Process, process, process." I think the second thing is, you have to be really clear, A, what the law allows you to do with your different pools and B, I think this is a wonderful opportunity for organizations to really sharpen their notion of what their mission is. Not only is what is our mission? What's relevant to our mission? What's outside the scope of our mission?
Tamara Laine: What do you tell someone who might be overwhelmed when approaching this?
Douglas Grim: Don't get bogged down on the terminology. It's certainly important to take your time. To ask deep questions about understanding because different firms will use different terms and they mean the same thing and that can be really confusing to folks. It's about, if you see terminology out there, ask whoever you're working, "When you say that, what do you mean by that?" To making sure that you're getting to the right place in terms of your understanding.
Douglas Grim: And then, really just education just in general about what the different options are. In some cases, you're potentially working with peers, potentially getting other folks involved, talking to consultants about different approaches and different ways of dealing with it in order to understand so that they can make the most well-informed decision that they can.
Jeremy Tennenbaum: I think I don't know what Doug says, I say to folks, "It's okay not to do anything." It's okay to invest in a way that's consistent with how you've historically invested as long as you're using the proceeds from that investment to pursue your mission. I think it's also fascinating to watch our industry, the investment management industry. People who never thought they'd who would reject the label of ESG all together, the level of the seas are rising so fundamental analysts are sort of saying, "Oh my gosh, if I'm looking at a real estate investment trust and it has a lot of properties in coastal cities, I have to consider a whole new set of risk factors that I never had to think about before."
Jeremy Tennenbaum: Companies are thinking about diversity in different ways. Companies are thinking about their use of energy in different ways and I think not only the companies themselves but the analysts and the portfolio managers who are investing in those companies are also thinking. What we're just witnessing is a change in how people are assessing their own companies and the companies in which they're investing.
Tamara Laine: Last word before we wrap up, what is something, a next step that a committee or a nonprofit can do in order to start creating their ESG investing strategy?
Douglas Grim: Yeah, look, I think, something I say, if the committee has not been asked this question already, there's a decent chance that they're going to be asked about it at some point in the future. I would say, for those that have not gotten the question before, it's starting to think about, okay if we do get this question, how would we approach this? And then for those that have gotten the question, then it's more about, look, take your time. Get educated on it. Make sure that you have a prudent process from beginning to end. Be very specific on what your goals and objectives for it would be. Establish that criteria and evaluate all the aspects you had related to your specific organization.
Tamara Laine: Who should they talk to?
Jeremy Tennenbaum: I think first and foremost; the board should talk amongst itself. If you're a charitable organization, this is a wonderful opportunity to have a conversation the board should be having periodically anyway, what is our mission? Are we clear about our mission? What's central to our mission and what is a nice to have that might be beyond the framework of our mission? And what are we doing to really advance our mission?
Tamara Laine: Thank you so much gentlemen. This has been a very insightful Masterclass.
Douglas Grim: Thank you, appreciate it.
Tamara Laine: And thank you for watching. Our experts today were Jeremy Tennenbaum, senior nonprofit strategist at Vanguard and Douglas Grim, senior investment strategist at Vanguard. From our studios in New York, I'm Tamara Laine. This has been Asset TV's ESG masterclass.
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