MFS: Navigating the Next Investment Dimension – Responsibility

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  • 58 mins 58 secs
Investing is no longer simply about risk and return. A third dimension, responsibility, is becoming just as important. Robert Eccles, a leading authority on corporate purpose and the integration of ESG, and MFS President Carol Geremia discuss.
Channel: MFS Investment Management

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Carol Geremia:

Great investing is understanding the rate of change. So if you can understand that change as it relates to what's happening with the environment and how companies are taking that on, there's the opportunity for good investing and creating value. This company was built for change, to understand change, and part of that is what I would have said a long time ago is we wouldn't have called it sustainability, we call it long term active management. Today, we think that's synonymous with sustainability, it's one in the same. To be a good long term investor, you have to care about the environment, you have to care about all the social implications that are happening around the world, because if you're going to own and commit capital to a company for a longer period of time, you've got to make sure they're managing the business well.

Carol Geremia:

The good news about active management is we don't have to own every company. Unlike passive, we get to actually select and choose those businesses that we think are worth owning. In becoming a responsible owner, a lot of what's involved is engagement. So you are working with management, you are working with the boards, you are working to understand that company intensely well so that you can see and it can be proved to you, to have conviction, that, that company is not only going to grow, and develop, and innovate, and change, but that management is doing the right thing. And when they're not, you engage with them to either push back against strategy, or push back against executive pay, or push back on diversity of board. You can do that in an informal or formal way, but then you can also take it to proxy voting. When those shareholder votes come up to really make a stance you can vote for or against a company on issues you think they need to do better on.

Carol Geremia:

I don't believe that the term ESG, environmental, social, and governance will exist in three and five years in the investment community. And the reason it won't is because actually people will realize that this is true long term active management, this is what our clients and our investors pay us to do, is to ensure that we factor in all of these important financial and non-financial issues about the companies we own. And if we're not doing that, then really we're not doing our job.

Vish Hindocha:

Hello, and welcome to our series today on Navigating the Next Investment Dimension, One of Responsibility. Our goal over the next hour or so is to discuss and unpack some of the key topics in this very, very dynamic space. And to do that, I've got two exceptional speakers that I'm very excited to introduce you to. First let me introduce Bob Eccles, he's a visiting professor at Saïd Business School, he's also advisor to various companies. As you'll find out, he's a prolific writer and thinker in this space, and actually, as a side note for me personally and professionally, has been an incredible source of inspiration. So Bob, I'm very, very excited to have you here. Thank you for coming.

Vish Hindocha:

And many of you will know Carol Geremia really well, she needs very little introduction in her role as president of MFS. Carol has been the instigator in chief for well over a decade now on driving our business forward on sustainability, and talks regularly about interconnected topics such as long termism, purpose, alignment, and culture, all of which I'm sure we'll touch on today.

Vish Hindocha:

And finally, let me thank you in the audience for spending the time with us and for the many questions that you've submitted in advance. If that's anything to go by, we're going to have an incredibly rich and diverse conversation, so thank you for that. And please do submit your questions as we move through the dialogue and conversation and we'll do our best to address these live or respond to them after the session. So Carol, Bob, let me call you up on stage. And first address, Bob, maybe could you just set the stage for us with some of the key topics that you're thinking about right now.

Bob Eccles:

So Vish, nice to be here. And when we did the little pre-planning you said the things that keep me up at night, so I'd like to phrase it that way instead.

Vish Hindocha:

Sure.

Bob Eccles:

And I'm going to start with last night, because it's very much on my mind. What's kept me up last night was two episodes of the Scandinavian TV detective series called, Before We Die, and so it was very troubling, lots of bad relationships. So that kept me up last night. But I know that's not what you care about, here's what keeps me up in general.

Bob Eccles:

Four things, I'll be brief on each one. The first is ideology, and I think is particularly a problem in the United States. Second is greenwashing, and I think they're related to each other. Third is the need for transition financing. And the fourth is getting to some consensus and harmonization on metrics for sustainability reporting, and I know that's not a topic that we're going to get into here.

Bob Eccles:

On the ideological front, I mean, I think that was illustrated by what happened with the Department of Labor when it was proposing changes to ERISA, that blows back and forth according to whether a Republican or Democrat as President. Over 5,000 letters were submitted in opposition, the Department of Labor, not surprisingly, went ahead and did what they wanted. And once you've got is this confounding, and I don't know if it's purposeful or it's just out of ignorance, that somehow sustainable investing is related to giving up returns, which is not true, it contributes to returns, it's a transfer payment, it's philanthropy. And so I think we just need to accept that there's still, at least in the United States, it's less so in Europe, this ideological dimension. And that in turn affects, and we probably won't get into this either, fiduciary duty and being clear on fiduciary duty for both board directors and for fund trustees.

Bob Eccles:

Greenwashing, everybody's familiar with that. I think that greenwashing lends credence to the people that say that there's something wrong with so called ESG investing, but I agree with Carol, I think we should have that term go away. And so I think that's something that needs to be addressed. I had a very interesting call with some people at the FCA this morning about it, they've done some good work there.

Bob Eccles:

Third, and we'll get into this in discussion, things like exclusion and divestment. I think we need to think about transition financing. So I'm all for investing in solutions and companies that make the world a better place, whether it's environmental or social dimensions, but it's lot of big companies out there producing a lot of negative externalities that need to change their business models and I think the investment community needs to support them. You just can't throw all of your money into article eight or article nine funds using the SFDR language.

Bob Eccles:

And then finally, we need to get some metrics harmonization between what the SEC is doing, the International Sustainability Standards Board being set up by the IFRS Foundation and the work that's going on in the EU, because for investors to really integrate as Carol was talking about, sustainability performance and their investment decisions they need better data. So let me stop there.

Vish Hindocha:

Great. Thank you, Bob. And we'll certainly touch on every single one I think of those issues as we move through this, it's almost impossible not to. But Carol, let me turn to you. Just again, set the stage from your perspective. What is it that's keeping you up at night these days?

Carol Geremia:

Yes, thanks, Vish. And I'm so glad to be here and echo your comments about Bob, not only as you've been inspirational, his objectivity to this topic has helped me so much over the years, so really glad to be here. What I would say keeps me up at night, fortunately not that much, but in reality though around this issue actually quite a bit, and I liked how Bob articulated a number of things that I would echo concern me. I think the one that is, it's not number one and I wouldn't put this as priority, but it is probably the area that we're feeling the most pressure, and that is on measuring this thing, figuring out how to get it right.

Carol Geremia:

And so there's tremendous pressure on our clients, on ourselves, on public companies to figure this out and get it right. And what I fear is that we will default to the micro measurement world that we are, you can't manage what you can't measure, and there's so much truth to that. But what happens is we build these false sense of comfort that the more we measure, the better we're going to get at this thing. And what that ultimately does is breed short termism. So my soapbox on extending time horizons is still very loud and clear as it relates to sustainability and ESG.

Carol Geremia:

The second issue though that probably truly keeps me up at night is the commercialization of this topic in the industry. We can't get this wrong, this cannot be packaged in a product. It is far too complex as it relates to really the systemic risks that we're talking about, especially climate change and social inequality, and I know we're going to get into that but the idea that a label can be slapped on it and called organic, and sold to the public, I think it's wrong, and I think that conversation has to change. The good news is I think it is.

Carol Geremia:

And then maybe to Bob's point, I think on fiduciary responsibility we might not get into the gory details of the duties there. But I'll steal a quote from T.S. Eliot, but I'll paraphrase it a bit as a fiduciary and I'll put it as, a fiduciary's greatest mistake is to do good for the wrong reasons. And I'll add, to do good also by not knowing what we're doing. And I think that's what we have to get at, hopefully, and I think that's happening real time around the industry. But it is great to have these conversations around those real issues.

Vish Hindocha:

Definitely. Thank you, Carol. So much there to feast on. I might actually begin with the ideological front, Bob, and as you and Carol both talk about. And one observation that I have in my capacity talking to lots of clients across North America is this idea that certainly in the US more than anywhere else in the world, ESG has become a political football or it's been politicized to a large extent. We actually had a question from one of the audience members today on any ideas or best practices on how to speak to clients about this whole space and how to simplify what's very complex? Some people can be very hard and paralyzing because it's been politicized, to make that easier for clients. So any thoughts on that? And Bob I might come to you first and Carol certainly would value your perspective again because I know you're in the thick of many of these conversations with our clients.

Bob Eccles:

So I guess two things on this, Vish. Number one, I think you just have to call it out. I mean, let's not pretend that this isn't an ideological issue, it's become politicized just like vaccines have become politicized in this country. I mean, it's nuts, right? I've written about this, I've written about one of our dear commissioners, feel free to share that. So I just think address that and say, look, there is this ideological component it's being politicized for whatever reasons. And then secondly, say there's a huge amount of research. I mean, I did some maybe 10 years ago, George Sarofim in Harvard Business School you'll want to see London Business School one of their first studies shows a positive relationship between sustainability performance and financial performance. George has done a lot more research since then, asset owners, asset managers have published research, other academics have published research.

Bob Eccles:

So all of these big investment firms that are going towards sustainable investing, doing ESG integration, I think emphasizing that term is important. They're not doing this for the wrong T.S. Eliot reasons, as Carol talked about, I mean, they've got a fiduciary responsibility to generate returns, there's a growing body of empirical evidence that these really are important to returns, particularly from a long term view. And I think people that are struggling with this need to call it out on the politicization and say, by the way, there's a bunch of research, as I said, 5,000 submissions went into the Department of Labor, you can go and look those up, and they were basically ignored for political reasons. So it's just like with climate change, right? The science is on our side whether these other folks want to agree with it or not, drives me nuts.

Carol Geremia:

Yes, and maybe what I would add to that, Vish, is we can't politicize this. I mean, at the end of the day when you think of what's happening, the opportunity is for us to see the massive shift that's taking place in the public markets, for that matter for the entire economy. And the shift that we're seeing from shareholder focused, maybe profits focused to this stakeholder focused environment of shareholder, of society, of consumers, of employees, this is the right shift for it to happen. I think when we politicize things, it's because it's an easier route than having to deal with the complexity of what we're dealing with here.

Carol Geremia:

This is hard, this is complex, and that's why it'd be a heck of a lot easier to package in a product and be able to just show a client, here we've got a product. But the reality is if we're really going to get at the risks of climate change and social inequality, it impacts every single business on the planet. And there's not a perfect ESG company on the planet. And so as we pull apart the onion on all of this, we've got to get at the complexities that we're dealing with at the macro level and the micro level. And again, certainly as it relates to what we do at MFS, that's our job, we have to be doing that.

Vish Hindocha:

Yes, great. Thank you, Carol. I've got to say, again, I agree with you. And actually the most constructive conversations I think I've had is when you just break it down in very simple investment terms, which I think is what you're both saying. This doesn't have to be an issue about morality, or ethics, or politics, it can be about investment issues, consumers are changing their behaviors, regulators are changing what they will legislate for, companies are forced to adapt, and the capital market has to price future risk and return, and around and around we go.

Vish Hindocha:

So this is just like any other investment issue that we've had to contend with through history. And maybe that's a perfect segue as you talk about micro and macro, and each of you have touched on this, that there's a subtle difference, I think, between the way you articulate system level risks and what we might call idiosyncratic or more micro or bottom up levels of risks. So Bob, I know that you've written about this previously, could you just articulate for us how you think about sustainability in those dimensions in terms of system level issues as well as more niche or idiosyncratic issues?

Bob Eccles:

Sure, I'd be happy to. I mean, it's interesting, I've probably talked to 170 or 180 asset owners and asset managers over the past couple years for various research projects, most recently, for a big research project in private equity, so when I'm saying it's going to apply to both the public and the private markets. And when you ask people, what keeps you up at night question from an investor perspective, they all say climate change, right? I mean, it's not a surprise. But the way they articulate it is interesting, it's like, this is a system level problem.

Bob Eccles:

If the world is a worse place, because of climate change, particularly if I'm a very long term investor and I've got liabilities that go out 50 to 100 years, like a big state pension fund, or I've got just a huge number of assets if I'm a big active manager, passive manager, I can't diversify away from system level risk at the overall level. So I'm trying to get a decent beta, right, it's like, I'm not a little fund, activist fund pursuing alpha, and with climate change, a destabilized world from an environmental point of view, I'm not going to be able to do so.

Bob Eccles:

Then it's interesting about four or five years ago I started hearing about and this came up a lot in a study I did with the World Bank, people started talking about income inequality, it's a little surprising to me. Okay, what's that all about? It was like, okay, look, the gap between those who have and those who have not has been growing, the wealth has been unevenly distributed. It's leading to political polarization, we can see in this country and other countries, it's leading to a breakdown on the multilateral order, people are saying, look, this income inequality thing is going to bite us harder and faster potentially, and it's clearly related to climate change. And so investors are less clear about how to get their arms around it, what are the stewardship activities, what are the investment theses that you want to have around that.

Bob Eccles:

And then closely related is diversity, equity and inclusion, which you hear about all the time. And then I think, coming up fast particularly when you have conversations with people in the EU and you're talking about the EU taxonomy and the CSRD and double materiality, we won't get into the weeds on that, is biodiversity and ecosystem services, people are having concerns about that. And clearly, climate change biodiversity and ecosystem services are related to each other. And so what you see is a very clear trend, and this reflects investment decisions, this reflects the information they want to get from companies, it reflects the interest in the TCFD climate change, income inequality, DENI, and coming up the curve fast, biodiversity and ecosystem services.

Vish Hindocha:

Great, thank you. And Carol, again, Bob's mentioned the word integration before in the video leading up to this, you talked about how sustainability is a fundamental component part of good long term investment management. Could you talk a little bit about how you think about some of those issues, both system wide and idiosyncratic and how we approach those today for the audience?

Carol Geremia:

Yes, absolutely. And I think this is where we all owe it to the end investors to help them understand what we're talking about as it relates to risks. In the old days it's been two dimensional in terms of how we measure what we do on behalf of investors, it's been return and risk. The future, today, now and in the future, it's going to be return, risk and responsibility. And so breaking down understanding what that responsibility element is, is both opportunity and risk and being very clear about it. And I think Bob laid it out nicely that realizing that first and foremost climate change is becoming that systematic risk very closely equal to that is social inequality, and that those risks can no longer be separated with company performance, you can't, and especially if you're committing capital for longer periods of time. And that's why I tie the longer term horizons into this whole conversation because I don't think actually you get at any of it with the idea that you're a short investor and you're just trading on price discovery versus actually being a responsible owner.

Carol Geremia:

These are systemic risks that are embedded in every business today. And as investors, we have to uncover that through the research we do, through the integrated process of every angle that we look at, whether it's an equity analysts or a credit analysts, both talking through the capital structures, but how these factors today of E, S and G, as importantly as the financial factors that we've looked at for many years, bring that story together in terms of making a security selection. And I think that's party the more difficult conversation to help investors understand that and see that, it's a mindset shift in so many ways.

Carol Geremia:

And what's easier is people going back to the old days of socially responsible product that says, okay, I'm going to exclude tobacco, alcohol, gaming, and today, I guess you could throw in tech and pharma, all the other bad things that have happened into these exclusion products and think that, that's actually how you're managing this more responsible risks that are out there. And yet, that's a completely different, really, conversation. And so I think it's really important that we help people understand that they are different conversations and we've got now systematic risks that have to be considered across every single business in order to also identify the opportunity and the risks that are specific to that company.

Bob Eccles:

Vish, if I could just say, Carol has just given me a great idea. I'm not an investment professional but I now have a great idea. If you want to create the perfect sustainable or green product based on exclusion, don't have any stocks in the portfolio, exactly like none, because every company produces negative externalities. So if you really want to do sustainability based on exclusion, it's real simple, there's no stocks.

Carol Geremia:

Right.

Vish Hindocha:

That would certainly make life a lot easier for absolutely nobody. I definitely want to get to exclusion and engagement. But each of you have touched now on, Bob, you talked about stewardship, Carol, you talked about active ownership as a component part of a investment process. So why don't we move to that. And I think, Bob, when you opened you talked about transition finance, which also touches on what Carol's getting at here, I think, which is, what is the role of the capital market to engage with companies as we move through the transitions that we need? Not least on climate, but as you mentioned on biodiversity, social inequality and the list goes on.

Vish Hindocha:

One piece that I found influential, Bob, is one that you wrote with your colleagues from the Said business school actually on the four strategies for effective engagement. Maybe you could just lay out for the audience that there's more to life than being an activist owner or a passive owner, but actually there are at least four different ways that you could think about categorizing effective engagement strategy.

Bob Eccles:

Sure, I'd be happy to do so. And let me just lay a marker in the ground and say, I don't think exclusion is going to solve the problems, and we could come to that later. So this is a research project based on interviews with both investors and companies that I do with my colleague Judith Stroller who's a senior researcher at Oxford, and a woman named Stephanie Murray who got her DPhil from Oxford. And it was very interesting, when we put it all together, and again, this was getting the views of both companies and investors, we really came up with four. And the first two were more top down, the second two more bottom up. The first two more appropriate for passives, the other two more for actives, although all of these strategies can be used.

Bob Eccles:

The first is conservatism and that's basically pretty basic stuff where you've got some simple guidelines around how you're going to approach your doxies and proxy some expectations about what you want the chairman and CEO be in the same role or not, and just apply those. It's a fairly light touch and you apply those on a broad basis across every company in your portfolio.

Bob Eccles:

The second more top down passive approach we call opportunism where an investor is typically tied to a theme and it could be the theme is around income inequality this year or it could be climate change and maybe it has to do with reporting according to the TCFD or whatever, where again, it's something that's meant to apply across every company in the portfolio. And again, it's a fairly light touch and you're not going to be spending a lot of time engaging with the companies.

Bob Eccles:

And then the more bottom up approaches we called constructivism and activism. Constructivism I think hasn't gotten enough recognition. Constructivism is a much more deep engagement, the things that active managers do that Carol was talking about where you know the company well, you know what the issues are, you know what the material issues are, you know where they're doing well, you know what they need to do better, you've known the company for a long time, your portfolio managers understand the company, they understand sustainability, and so you're working with the company in a joint effort over time really to make sure that it's in a position to continue to create appropriate returns, risk adjusted responsible returns, as Carol said, down the road.

Bob Eccles:

And then the last one is activism, and it's taken on some interesting dimensions. And there's the class of activism that we think about with the hedge funds. But what you're starting to see, and maybe we can get into this more later with what Engine No. 1 did with Exxon Mobil, calling this activist stewardship where it's much more focused on really one company or maybe a couple of companies in a sector, really targeting, it's like the navy seals that are going in there and they need the support of the others where you have a very specific objective. And really, activism and activist stewardship happens when constructivism fails, and typically constructivism fails not because of the investor, but because the people running the company are a bunch of blockheads and the board is a bunch of block heads, and they don't want to engage, and so the investors have no choice but then to go in and smack them around as hard as they can. So those are the four strategies.

Vish Hindocha:

Thank you, Bob. I'm so glad you said that constructivism doesn't probably get the airtime that it may deserve or certainly historically has not. Carol, from my vantage point, I would probably put most of MFS' engagements in the constructivist camp, I think we will probably touch on each of those four. But I wondered if you would, A, agree with that, and B, ask you just to expand on, how do we take the constructivist approach? Maybe using an example of where that approach has been effective for us and instigating change, both in terms of realizing and unlocking financial value, but also changing the real economy, which is ultimately what sustainability is all about.

Carol Geremia:

Yes, absolutely. And in Bob's paper, what I like about how he describes the four is the two conservatism and opportunism, sorry, is top down versus the bottom up of constructivism and activism. I think activism historically has focused still on the short term, but that's changing as well, because I think it's realizing it's affecting long term change as well. But there's no question MFS sits squarely in constructivism. Sorry, I don't know why I can't pronounce these things.

Carol Geremia:

Our focus is squarely there and has been because, again, as when we think of stewardship, when we think of engagement, historically people have thought about it as proxy voting, but it is so much broader than that. It is the informal conversations that you're having with management, it's the formal conversations you're having with the board, it's the collective conversations and engagement that you're doing with other constituents. And it's all put together in the idea that you're partnering as a long term owner, as a responsible owner that is deeply knowledgeable about the business and what you expect from that business over time in terms of improving itself.

Carol Geremia:

So whether that is having a deep conversation around executive pay. When you look at not only how we vote on executive pay, or diversity of board, or board independence, you'll see how engaged we actually are. But it's not just through a proxy vote, many times these conversations have been had long before we're actually placing a vote. And I'll use one example of a large engineering company where we did some collective engagement and just the difference of, I think, an active manager that does bottom up research. We knew the company so well, so when we engage, we actually know what's material, we know what we want to engage on because we're focused on the things that are actually going to affect the performance of the company.

Carol Geremia:

Without understanding the business, well, it's pretty hard to do. But when we've gotten behind some of the collective engagement more recently with ESG, what we've done with companies is realized in these conversations that a lot of people will have idealistic views of what the company should do from an ESG perspective, and the measurement disclosure, and the plan they should have, but many times they do it from an idealistic perspective because they don't understand the business. And our role has been to really actually bring to the company these issues of ESG but also understanding the company's performance and how they're linked, and actually how much of it a journey it will be or how much transition and transformation it's going to take. Our ability has been able to transform some of the engagement dialogues we're having with many of, again, these large engineering company was cited, that we were really able to transform that engagement conversation.

Carol Geremia:

And let me say, this is a journey for us as well, because when you think about engagement today versus five years ago, it's night and day. There's so much more dialogue around these things today that didn't necessarily happen in the past. So I think that's the excitement and the opportunity of continuing to get at improving the businesses we own.

Bob Eccles:

[crosstalk 00:30:51] Vish, could I just put a little emphasis on what Carol said? So I know who this company is but I follow the compliance rules, I'm not going to name names. I'll tell you what drives companies crazy, because we talk to companies as well, they hate it when people come in with little checklists, it's like, you don't even understand what our business is in. They hate it when people come in and say, well your MSCI ratings is nos so good, your analytics ratings is not so good, could you get it up a little bit? Drives them nuts. What they want is the exact situation that Carol was talking about, if you're going to take my time, do your homework, understand the company, understand our strategy. If you've got criticisms, now I can't pronounce criticisms either, you've got some criticisms, come in with constructive criticisms. Doing engagement at this really high level or going in and asking simplistic questions around ESG ratings, man, that just doesn't fly from a company point of view and it's not going to work.

Carol Geremia:

It's not enough. Vish, since Bob prompted, I would love to use one other example of a large automaker that had a lot of car emissions problems and issues, you can only imagine who it might be. But in time, what they've done is made huge, enormous steps to improving their ESG models, their business and sustainability in general and taking it on. And we knew that in a lot of engagements, we were certainly having these deep conversation about what they're doing, and we own the bonds, not the stock.

Carol Geremia:

And what was fascinating though is they were very frustrated with their MSCI score, their third party rating, which was still CCC, and that's what we kept talking to them about, why is your rating still CCC? And they were frustrated by that. And we could see because of the changes that they were making that we didn't blame them per se for being frustrated. So we actually picked up the phone call to talk to MSCI and say, why are you scoring them at this lower level when they've made such progress? And what we got in all honesty was an outdated update of what was going on at this organization. And whether it was coincidence or not, and I'm not even suggesting it was anything more, the next day the rating did change.

Carol Geremia:

And it's not so much that we're doing this perfectly, it's just the level of what it takes to be early on some of this information to understand really what's going on, but then not to just sit around and wait for a third party rating to actually give you clarity on whether they are transforming their business at the rate and the speed that they need to. And again, people don't pay us to be late. So again, certainly, we don't depend on third party ratings, but they are indicators that allow us to better engage with companies and try and bring that together.

Vish Hindocha:

Yes, thank you, Carol, appreciate all of those examples. And I think actually this discussion is super interesting for us to have at a theoretical level but comes to life when we talk about examples. Bob, you flirted with mentioning Exxon Mobil and Engine No. 1. Maybe just give us some background on what happened there. I think a lot of the audience will be very familiar with that action, but maybe just a brief bit of background. And again, this context around how engagement was an effective mechanism to deal with business transformation, and again, the impact on the real world economy that sustainable investors are interested in.

Bob Eccles:

I'd be happy to. And I've written some pieces on Forbes, I've got a little column on on Exxon Mobil, which you can share with people if you want to. When I wrote the first one I think the title was, Exxon Mobil's Investor Tour, Magical Mystery Tour is Waiting to Take You Away. And my wife read it and she said, "Darling, there goes our Christmas card from Darren woods." And so I'm not wait for that this year.

Bob Eccles:

When you look at what happened, it's very interesting, it's much deeper than the way it's being portrayed in the press. I knew that this was in the works before they went public because I know the Engine No. 1 people, I know the CalSTRS people. And what they did was actually brilliant, it wasn't just this tiny little hedge fund took down Exxon Mobil, there was a lot of groundwork that was laid over the years, they had support from very large investors. But what they did was they made a really excellent analysis that it was a business case. So it wasn't a sustainability case, yes there are sustainability problems with Exxon Mobil, no surprise.

Bob Eccles:

Their case, when you look at the materials they put together, it was a financial argument. Their performance had been crap for 10 years, S&P had downgraded their debt twice, their stock price was between a third and a half as to what it was like trading at the highs, they were lagging on all their peers. And so what Engine No. 1 said was, "Look, this is a company that is failing financially, it's also making the world a worse place, the directors don't have the expertise that they need to oversee management in terms of strategy and capital allocation, Darren is both the chairman and CEO." And so the world was changing, Exxon Mobil wasn't changing.

Bob Eccles:

So Engine No. 1 takes this tiny stake, $20, $30, $40 million, whatever it was, then they mobilized the rest of the investment community, but they were really the lead ponies on this. They were able to place three out of four people, and I think they've gotten all four of Glass Lewis and IS would have manned up on this, but that's a whole nother thing. They were able to place three people on the board of directors of Exxon Mobil. And when they started people thought, well, probably it's not going to happen, but anything to shake up Exxon Mobil is going to be a good thing. No, they got three people on the board, and I can tell you, this is a game changer. I have friends that do consulting for companies in the oil and gas industry, other high emitting industries, these companies have all come to them and they've said, oh, my God, if this can happen to Exxon Mobil, this could happen to us.

Bob Eccles:

And so I think it was good what they did with Exxon Mobil. I think it also sends a strong signal that as the investment community becomes more active and as the constructivist get more support from the activists and you have this whole ecosystem going on, I wouldn't be surprised to see more of this happening. And as Carol said before, traditionally, the activist hedge funds have been financial returns more short term oriented, big debate about what it means for the long term. As the activist hedge funds that have these technologies, they know how to run proxy contests, they know how to get people on boards, as they start to expand their aperture around ESG and sustainability topics because there's a relationship to financial performance, hedge Funds aren't going out there to be like Mr. and Mrs. Green, right, they need to make money for who their clients are, and that's what Engine No. 1 is doing. And I think there's a lot of lessons that can be learned.

Bob Eccles:

And with a colleague at Berkeley, we're writing a case study on that, that'll go into the public domain for free and we hope it's going to be useful to folks like you at MFS and really anybody that's interested in how stewardship and active engagement can both improve returns along with making the world a better place.

Vish Hindocha:

Thank you, Bob, that's really interesting-

Carol Geremia:

Yes, you wouldn't have seen that. Sorry Vish, I was just going to say, I just think that whole story is just such, to Bob's point, a shot across the bow, you would not have seen that happen five years ago, just wouldn't have seen that.

Vish Hindocha:

No, indeed. And we probably don't have time to talk about it today. But you think about the action at Shell where the courts certainly in Europe are taking action, again, unprecedented to a large extent. And Bob, I like what you're talking about in terms of the ripple effect that, that can have on other companies and is, again, incredibly powerful through through the industry. So the paper you're writing sounds interesting and I look forward to reading it. One paper you shared with us and me earlier this year was from the Stockholm School of Economics who did a literature review essentially on what are the effective strategies on engaging on environmental and social risks. It's only 11 pages long, I'd encourage people to take a look at it.

Vish Hindocha:

But one thing that I thought was really interesting in there is they talk about legitimacy, which I think is a nice way to capture so much of what each of you have spoken about today. So it's not just about the size of the stake that you have in the company, it's about the approach that you take, can you speak the language of the management company? Right, Carol, to the examples that you were talking about. If we can talk in terms of free cash flow generation and encouraging good stakeholder management, we're much more likely to get that change.

Vish Hindocha:

It's also about long termism, it's about, can you get broader support for your actions, Bob, to the point on Engine No. 1? And that paper was written, I think, before Engine No. 1 even became the issue that it's become today. So I think about that a lot. I also think about this as a segue into exclusions, the only people that didn't have a vote are the people that excluded the big energy companies, right, on Engine No. 1 and having that impact on the real economy. Now, Bob, you talked about-

Bob Eccles:

And I know investors who said, "If the people that had excluded, hadn't excluded and if they held the shares, they would have gotten all four people on the board." Let me just make a quick comment on Shell, because Shell is actually a company managing energy transition much better than Exxon Mobil. That lawsuit, to get into the weeds a little bit, was tort law in the Netherlands, and I've written about that. And the piece starts by saying, after baseball litigation as America's national pastime, we should watch this space because, basically, this was the law saying, we represent the interests of society, Shell has to move much more quickly, we don't care what the financial consequences are, this is what they have to do.

Bob Eccles:

Now, it's going to be appealed but, look, we're better at litigation than anybody else in the world just to pat ourselves on the back a little bit, this potential for how Tort law can move into this domain around climate change and potentially other issues, that's obviously important to companies, it's obviously important to investors because the Tort law isn't going to be concerned about the returns. And so I would say, there's a big incentive for investors to make it clear to companies, just like what happened to Exxon Mobil, the same thing can happen to them with Shell, they need to get their act together and you are their friend in helping them do so.

Vish Hindocha:

Ideally in a constructive dialogue. Bob, when you opened, and I think each of you have touched on this exclusions versus engagement debate. Maybe, Bob, I'll ask you first, just to weigh in on your thoughts. I think you gave us the spoiler right at the beginning of saying that you don't think exclusions is going to help us solve this problem and yet, again, in my seat, we talked to clients all the time every day about the idea of excluding whether it's a particular sin industry or a series of stocks or a particular thematic issue. So in your mind, where is that confusion coming in? And what's better way to think about this idea of the impact, the exclusions versus engagement can have?

Bob Eccles:

So I think where the confusion is coming from is mixing up value based reasons with values based reasons. And I'll give you an example, it's a tobacco company, big shock, they're a client of mine, it's Philip Morris International. I know this cigarette industry pretty well by now, I can tell you, I know the business model, it's easy to exclude tobacco stocks, no tracking error, it's a small industry, billion people smoke cigarettes, it's constant for the next five years according to who excise taxes the government soak up don't spend them on tobacco control programs. Only way you're going to solve the cigarette smoking problem is by engaging with the tobacco companies and getting them to fundamentally change their business model to basically get out of the cigarette business.

Bob Eccles:

Now, I'm not going to get down into the weeds on that, I think, where you get a confounding is if people think, okay, we think the sector is going to tank and people keep predicting its demise and it hasn't happened. You think it's a bad stock to own from return point of view? Okay, that's a fair decision. Excluding it, thinking that, that's somehow going to solve the problem of a billion people smoking cigarettes, don't kid yourself, it's not. You may feel good, but it's not.

Bob Eccles:

If you want to exclude for values based reasons because it's morally reprehensible to you, you don't want to be making money off of a product that kills people, that's obviously perfectly fine. People have their own values and it's their money, and they can invest in whatever way they want to and they can exclude whatever they went to. And for some people it's tobacco, for some people it's oil and gas, it could be pornography, could be alcohol, whatever it is, tends to be a slippery slope.

Bob Eccles:

So I would say, the people that are using exclusion strategies, particularly to create these for ESG products that are loaded up with fangs, that as Carol indicated, they've got their own issues and say, oh, it's a green portfolio, there's not tobacco stocks, there's no thermal coal, there's no oil and gas, and then there's all this other stuff, it's like, give me a break. People that are using exclusion in their investment strategies and in constructing products just need to be very clear in their own mind, is it a value reason? Is it a values' based reason? And just explain that to the people that you're managing the money for?

Vish Hindocha:

Yes, thanks, Bob. And Carol, you and I actually have spent some time with the PMI group and I, again, love your perspective, again, as an investor thinking about this idea of big tobacco that's been on the exclusionary list of some investors for close to 20 years now, maybe just give your perspective how you think about that and some of the more recent interactions that we've had with that border PMI?

Carol Geremia:

Yes, sure. I mean this is where I think it gets tricky and I think this is where all the confusion lies in understanding what we were talking about before is the big systemic risk of climate change and how much you can't separate that with any business today or social inequality. And then you've got, as Bob points out, the value based exclusionary type products. And I quote you often Vish, and that is that exclusion to us is an abdication of our responsibility of being an investor and what we're supposed to be doing. Just excluding a particular industry or company because we think we're going to impose our values or our judgment on what an investor thinks is a bad company or a good company, in terms of what they make and how they do it, we don't believe as fiduciary that's our job, our job is to generate long term results, financial returns, responsibly though.

Carol Geremia:

And that is where, again, we pull forward in order for us to do that. It's based on our research, it's based on the engagement we do, it's based on the conviction we have in our ability to commit capital over long periods of time, it's all part of that that process. But getting back to, again, what Bob said is just this idea that you can exclude industries and businesses to have some value judgment, really, when you think of pension plans and investors all over the world, we're supposed to source opportunities. And so it's very, very important that we're clear in terms of what our approach is and how it is integrated versus packaged in a product.

Carol Geremia:

And I guess it's also our job as we think about improving companies over time, the transition idea of companies like PMI are completely disrupting and changing their business model for the future. To come out and say that they're going to make a smoke free future is something as any investor you want to know more about and you want to understand that disruption that they're creating within their organization. And again, as a long term investor, it's our job to figure that out.

Carol Geremia:

I will add one last piece to this. And it is fascinating, not only that they get strong ESG scores as a company in terms of how they're operating, but even listening to them about what they're thinking about with their supply chains, I mean, that's a whole nother webinar. But I think it's a fascinating example of really not taking the easy decision to say, well, exclude it because that's the way we can package it in a product. But we do today manage $90 billion of assets for clients that have asked us to exclude based on their philosophy, on their values and on their beliefs, and that obviously is something we do separately.

Bob Eccles:

Vish, if I could just suggest an interesting little homework assignment for the group. I don't track it all that closely, but the last time I looked at PMI's market cap it was in the top 100 in the S&P 500. It was above BlackRock, Goldman Sachs, Citi, Boeing, there's only two airline companies in the world. So this notion that a company that's got about $160 billion in market cap, that's got a product that's supported by excise taxes from government, that exclusion is going to make it go away, it's going to solve this problem of a billion people smoking cigarettes, it's just naive.

Bob Eccles:

If you want to exclude for values reasons, great. But be clear, again, you think the stock is going to tank, you don't want to own a product that kills people or you want to own the product, but then you've got an obligation to engage. And the ironic thing with PMI, the frustration they have is that, you guys are an exception, it's either people don't own the stock, so there's no engagement by definition. Then there's a lot of people that own these stocks, it's like, the dividends are great and the cash flow is certain, it's like, I don't care if you're making cigarettes.

Bob Eccles:

What you need is everybody that owns a stock in any industry that's got controversies, these investors need to be responsible from a fiduciary point of view as well as a socially responsible investing point of view, be pushing these companies, it could be a food company, it can be an egg company, it could be an oil and gas company, a tobacco company, whatever it is you've got to engage with them on these issues for your own interest and their own interest.

Vish Hindocha:

Yes, absolutely. Thank you, Bob. Thank you, Carol. And I mean, so much we could talk about there. On this idea of abdication, Bob, you mentioned right at the beginning of the call that whilst there's a wide spectrum of views and beliefs in North America, Europe is a little bit more unified. Large European asset owners, particularly in institutions, have moved down as we know this path of exclusions, and we've had the great privilege of working with many of them. And Carol and I have sat in front of them and explained that we think that exclusions are an abdication of their responsibility as well as ours, we don't understand how that's an exercise of fiduciary responsibility.

Vish Hindocha:

And it is really interesting for a few reasons, one, it robs them of a long term owner that is committed and interested in these issues. Think about the public market, if we sell or exclude something, somebody has to buy that, there's almost zero impact on a company, particularly a company as large and cash flow rich as PMI. And it's interesting that when we sat down with the board at PMI, there were two things that stood out to me that I really took away or at least two things. One, the CEO talked about how in terms of embracing sustainability to make a cultural component of what they do, which I thought was fascinating, which I'll come back to in a second.

Vish Hindocha:

But also the exasperation of the capital markets to not allow them to transform their business model to move away from tobacco products, was also extremely counter intuitive to everybody in the room, right? If the ESG minded investor doesn't want tobacco in the future, then helping PMI disrupt its own business model, to steal from Carol's phrase, is surely the most effective means of doing that. So again, the law of unintended consequences is alive and well. Sorry, Carol.

Carol Geremia:

Well, I was going to say, Vish, and take that same example, right, to then the fossil fuel companies just to exclude and not engage to help them transform or really hold them accountable to transform in a very active engaged way is what I love the quote from the former CIO of the future fund in Australia, he said, "what are we trying to do? Decarbonize our portfolios or decarbonize the economy. And if we're not doing the latter, we're going to have some pretty big issues that we're not dealing with."

Vish Hindocha:

Yes, absolutely. And just recognizing the time, and we could probably spend all day on this one topic, but we did have quite a few questions on implementation and the role of both active and passive managers. Carol, I'm going to come to you here and ask you just to talk from your perspective on the role that active managers have to play in this space. And then Bob I'm going to come to you afterwards just to ask about your views on where the passive industry might be and the role of both active and passive if that works. So Carol, maybe just outline your perspective on the role of active management in this space?

Carol Geremia:

Yes, absolutely. I mean, I will say, as everyone knows, I'm biased in this conversation but at the same time I think it's really important that MFS does a lot of self reflection in all of it as we think about how to align ourselves from an investment perspective, from a corporate perspective, our corporate behaviors and how we show up in the marketplace on all of these issues. And that's why what I said earlier is what keeps me up at night is this idea that people are trying to commercialize this.

Carol Geremia:

I don't see how any of this gets done passively. And I don't mean not in passive product. I think, whether you're an institutional investor and an asset owner or you're an asset manager, we're all going to have to do this actively. Asset allocation decisions are going to need to be made actively around this issue. Asset managers are going to have to make security selection decisions actively around these issues. Engagement needs to be active, real, authentic, long term. But that is ultimately what clients pay us to do. And I think it does get confused, as we like to say, we don't simply just buy shares of companies, we own them with other people's money, and it's our obligation and responsibility as an active manager to be that responsible owner on behalf of our clients.

Carol Geremia:

It's interesting though, I also think, and this gets a little more macro is the role of active management in the public markets. And I think with this movement towards sustainability and understanding ESG factors embedded in companies or the analysis that we do, is that we are redefining what long term active management really is, and that is this engagement of ownership and what that looks like. And I think that we've got to be more and more clear about how we translate that to our clients and how we measure it to our clients, but I also think as the public market transforms between active and passive, and they are two very important roles that they play, that active managers' responsibility on this issue is front and center.

Carol Geremia:

And I will use one last story here. We were sitting with one of our large clients for a very long time, one of the largest asset owners in the world, very focused on sustainability and ESG, and we were doing a client meeting with them pre-COVID and they said, "We have to care about active management." And we smiled and said, "Great, but why? Why do you say that?" And the response was, "Because we're the largest owner of passive product." So your level of research, and understanding, and engagement in these companies is what has to happen to ensure that the public markets are working the way they need to. And if you're not doing that, we're going to have a problem with our passive products too. So it was right then and there, it's a good wake up call, and again, it's not to say we're not on a journey, but it is an obligation.

Vish Hindocha:

Thanks, Carol. I mean, I like to think that I think it's generally accepted that as managers do price discovery in the markets, that's one of the functions that we fulfill, I like to talk about, we actually do materiality discovery too, that, that's actually maybe another reason to your point that we get paid a premium to do what we do and the value that we bring to the ecosystem is understanding sustainability materiality at a bottom up level.

Vish Hindocha:

Bob, just in the interest of time, I might pivot actually and ask you, Carol talks about the commercialization of ESG, one of your four up front was talking about greenwashing, we've certainly had some questions from the audience come in on this idea of greenwashing. Again, you wrote a really interesting piece recently on the seven principles, which again, I'd encourage people to look at and read. But maybe just a quick view from you on how you think about the current state of greenwashing in the industry and how do we cut through some of the noise to see if people are really doing what they say that they are doing?

Bob Eccles:

So look, happy to. I mean, with the exception with the EU and SFDR, and article eight and article nine, let's put it aside, there's really no solid regulation, the FCA is an exception, I'll get to that. But there's no taxonomy for what's a green product even by whether it's regulation or whether by common industry practice. And so the piece that you referred to is basically coming out of interviews with Desiree Fixler who was thrown under the bus by DWS for basically being a whistleblower on what they were doing. But we stepped back from that and said, what are principles of ESG investing? And given that there's no codified definition, the simple answer is just be clear as to what an ESG product means to you. Is it based on exclusions by sectors, by people that are in the bottom quartile, by some rating? Be clear about what data you're using, where the portfolio manager is using the data, it's not just available to them. How is that being integrated? Are there non-financial metrics that you're trying to accomplish with this fund in addition to the financial returns?

Bob Eccles:

When you read the seven principles, they're all pretty basic stuff. And I think if DWS would have been following them, they wouldn't be being investigated by BaFin, and the SEC, and the Department of Justice right now. The FCA has come out with some guidance, and I'm happy to share it with you, that I think is really quite good. They've got three principles for what fund managers should follow when they're selling green products, sustainable products, impact products.

Bob Eccles:

But I just want to go back to something that Carol said at the very beginning. I mean, I would like to see the point where maybe there's some niche products and things and maybe more in the private markets, but really the name of the game is ESG integration, right? We need to be taking this into account in all investment decisions so it's not like there's green products and there's other products because that's a false dichotomy. Sustainability is core to financial returns, particularly from a long term perspective. And so the sooner we'll probably have to go through this interim period of a little bit more clarity and labeling of green products, the sooner we can get to just ESG investing, get away from exclusion, think about transition financing at a system level, that's what's going to produce the necessary beta and that's what's going to make the world a better place.

Vish Hindocha:

Thank you so much, Bob. Carol, given that we're up on time, I might ask you, what is the one thing that you would love audience members to walk away with from the conversation today? So Bob, I'm going to take that as your responses to deeply consider ESG integration as a way to best influence both alpha and beta. But Carol, reflecting we've had a wide ranging conversation beginning with what keeps you up at night to the different forms of stewardship, exclusion, engagement, greenwashing, talks about reporting confusion, the metrics and the pressure that asset owners, asset managers face on getting this right. What is the one thing that you would have people walk away with today?

Carol Geremia:

I think this is one of the greatest opportunities that's taking place in the investment world and collectively we have to get it right. And so what I would say is expect us to do this on your behalf, expect us to engage with companies as responsible owners and that we are marrying that up closely with financial returns and financial performance to get better long term outcomes. But as much as you expect us to engage with the public companies we are owning on your behalf, please, please feel free and do engage us to help you get the information that you need, to help you empower you with the story of doing this right.

Carol Geremia:

And again, it is a journey, we're all learning from it, we're all building upon it, and I think the more we're in conversations with you to understand the pressure you're under and the requirements that you have to meet, the better off we are able to serve you and make sure we are allocating your capital the way you believe we should and responsibly. So that engagement piece goes through the whole chain because we all are fiduciaries and that will make us all better investors.

Vish Hindocha:

Great. Thank you so much, Carol. Couldn't agree more. And so with that, I'd like to thank you both for what's been an incredibly enlightening conversation. And thank the audience for joining. As Carol said, just to echo her comment, we really do value your feedback so that we can not only plan future sessions that are relevant to your needs and the issues that you're facing, as Carol mentioned, but also so that we know how best to partner up with you as you tackle this complex, dynamic and very nuanced space. Please do take a brief moment to fill out the survey that's going to appear in the chat window when we sign off today. But thank you very much for your time, your energy and your participation. It's been great to see all the questions and we look forward to a session in the near future.

 

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