Brian Mackey: Hi everyone. This is Brian Mackey, and I’m the deputy director of research at Adviser Investments. Welcome to another episode of The Adviser You Can Talk To Podcast. Today’s topic goes by a number of different names, such as socially responsible investing, ESG or impact investing; but the overall theme is doing well while doing good—earning a financial return from your money while investing only with the companies who are perceived as making the world a better place. This is a particularly timely conversation at Adviser Investments because we recently launched two new strategies at our firm: an ESG Asset Allocation strategy and a Dividend Income ESG portfolio.
Brian Mackey: I’m excited to be here with Kate Austin and Liz Laprade, who are both members of our investment team. Kate focuses on researching individual stocks while Liz analyzes exchange traded funds, or ETFs, as well as mutual funds. Both Kate and Liz have spent some time researching the ESG space, so I think we’re in for a great discussion. Liz, let’s start with you. I know you’ve done some great research into this space, so maybe you can lay a foundation for the listeners. What is ESG?
Liz Laprade: Thanks, Brian. The first thing I would say is that socially responsible investing has actually been around for a while, better known as SRI. That really began as what we would call a negative screen. Basically, you’re taking an index and then you’re excluding the companies that you believe maybe aren’t doing good for the environment or for their industry or what have you. An example would be tobacco: You might exclude a company like Philip Morris from the index. Now ESG, I would say, takes socially responsible investing one step further. ESG stands for environmental, social and governance. Environmental—you’re thinking about things like energy consumption, pollution; social—you’re thinking about things like human rights and labor laws; governance—you’re looking at who’s leading the company and how.
Liz Laprade: The way I see ESG is really as an additional tool for financial analysts where managers weigh a company’s ESG score as part of their investment decision-making process. ESG can be even more nuanced than SRI. Say a company can score highly in one area, say on environmental, and maybe just okay or even poorly on another, say governance. It’s really up to the investor to determine what scores or pillars are most important to them. I would say the final point I would like to make about it, and potentially the most important, is that ESG—what that means to me or you or anyone else—could be very different. What’s important to me and what companies I think are doing good could be totally different than you, Brian, or you, Kate. I think it’s really important to recognize that there is no one definition, that it can mean a lot of different things to a lot of different people.
Brian Mackey: I think this is a great way to segue into the indexes out there that define ESG for us. Like you mentioned, everyone has a different definition of what’s good or bad.
Liz Laprade: Right.
Brian Mackey: But there are these index providers, MSCI and FTSE, that have their own process to define ESG. Kate, I know you’ve done some work on what steps are involved there, so maybe you can help us describe what makes a stock ESG compatible.
Kate Austin: Like you said, the FTSE and the MSCI ESG indexes score each company on each pillar: The environmental pillar, the social pillar and the governance pillar. Each company will get a score for each pillar, and then they’ll also get an overall score. Typically, what we see is that companies that score low on ESG are tobacco companies, gambling companies, guns or defense companies, alcohol companies or energy companies. Like Liz said, it can be very client-specific. Depending on which lens you’re looking through, you might care about the E versus the S or the G.
Brian Mackey: Yeah, that makes a lot of sense. I know we’re talking sort of high level what ESG means, but maybe you can provide a couple examples of an individual stock that you thought was pretty interesting. Liz, maybe we’ll start with you.
Liz Laprade: Right. I would say keeping on this theme of uncertainty as far as what ESG means to different people, I think a really great example of this paradox is a company like Tesla. You’ll see Tesla held in some ESG funds. On the one hand that makes sense: They’re this steward of a future solar electric economy, but then on the other hand you have a potential governance concern regarding the leadership of the company. There’s a lot of controversy out there right now surrounding the way Elon Musk is running the business.
Liz Laprade: I think a bigger concern for investors on the governance side is his board of directors. Evaluating the board of directors at a company is a huge piece of what a company gets scored on from a governance perspective, and part of that is conflicts of interest. A lot of people have concern about the fact that Elon Musk’s board of directors, most of his board of directors, are friends. That could provide a big conflict of interest. Balance of power may not be there. I think Tesla is a really great example of this paradox where it could score really highly on the environmental and an investor is like, “Great, I want to own it for that and not care as much about the G,” and then you have other investors that say, “I care too much about the way this guy is running the company. Disregard the E and I don’t want to own it.”
Brian Mackey: Elon Musk is a lot like Tom Brady it seems like: He’s either the greatest of all time or he’s a fraud and a cheater. It depends on who you talk to.
Liz Laprade: That’s a good point. Kate, I know you’ve done a lot of individual research, so any names that popped up in your screens?
Kate Austin: One that I found a little bit interesting was Tyson Foods. They’re a large supplier of chicken, beef and pork. For a long time, they were really well known for using blanket antibiotics on a lot of their animals, using genetically modified feed and keeping the animals in small, cramped spaces. Recently, however, they’ve been making inroads to lessen their overall antibiotic usage and increase the standards for animal care. I think this shows another interesting avenue for ESG in which consumer preferences and changes are actually having an effect on how a business can operate and their business model. We’re seeing ESG strategies being included in overall company strategies.
Brian Mackey: Yeah, that’s great. I know the C.E.O. of BlackRock recently has come out and said that he’s really pushing harder on companies to improve the way they handle corporation due diligence and governance, and just making sure that they’re having a positive impact on the overall society, which is great. ESG is having an impact on these companies.
Kate Austin: Right. I think, to that point, there has been huge increase in demand for strategies like this. If individual and institutional investors are finding these ESG scores important, then companies need investment so they need to make sure that they’re scoring well on these pillars. I think there’s been a huge push for it.
Brian Mackey: Think about it: If you’re the C.E.O. of Tyson and you’re noticing that investors are shifting assets into ESG strategies, you want to make sure that your company qualifies so that you don’t get ignored by a big part of the market, or a growing part of the market.
Kate Austin: Exactly. Right, exactly. Overall, it’s a good thing.
Brian Mackey: Yeah. This is a good topic to start pivoting over to performance. We’re investors here. This is an investment podcast. What’s the impact, Liz, on the performance of these strategies? Should investors expect to outperform, underperform? What should we expect?
Liz Laprade: That’s the question of the podcast, and the short answer is that we don’t know what to expect. The idea behind socially responsible investing, or ESG, is really that if you buy a company that scores well on the E, the S and the G, then these companies are more likely to produce positive returns in the long run. While there is some evidence that this approach works, there is more evidence that it doesn’t. Although to be fair, tech is historically is a big part of SRI investing. Tech, the nature of the sector itself, can be a little volatile. Some of the years of under- and over-performance could be attributed to heavier tech overweights in the indexes.
Liz Laprade: But what I think most important is that the years of underperformance might be okay to some people because at the end of the day they care more about the companies doing good for the world or the community or the environment before they care about performance. High level, you can expect equity-like returns from a pure stock ESG mutual fund or ETF, but what we would really want to focus on is that your social and financial goals are being met before you think about performance.
Brian Mackey: Yeah, that’s a good point. Maybe this is a good time to pivot to talk about the specific strategies that we just launched.
Liz Laprade: Definitely.
Brian Mackey: I know the Asset Allocation ESG portfolio is something that I’ve been involved in building. I’m really excited about it. I’ll just take a step back just to provide a little background about our company and how we came to create these strategies. For years and years we’ve invested with active managers out there, and we’ve always told clients who have called in and said, “I want to avoid a tobacco company or a gun manufacturer,” we’ve always told them just focus on earning the best return and then use some of that wealth that you’ve accumulated over the years and donate to a charity of your choice. What we found is that there are a number of investors that really feel strongly about avoiding these companies. They don’t want to be involved in helping gun manufacturers or tobacco companies succeed, and they’ve gone out and tried to do it on their own.
Brian Mackey: What we feel really strongly about is that we’ve got a great process for picking active managers. How do we provide that same process in the ESG space? The reality is there’s not a lot of great active ESG funds out there just yet. Hopefully, there will be down the road, but what we’ve decided to do is essentially take the knowledge of our active managers that we’ve accumulated over the years and apply that to the ESG space. One example is if our active managers are finding opportunities in say small-caps or mid-caps and they start adding to that space, we can then go in and look at ESG funds that focus on small- and mid-caps and add to that allocation in our portfolio. That’s a way where we’re taking the knowledge of our active managers and applying that to the ESG space. We’ve called that Active Acumen™, where we’re leveraging that experience. Really, the overall goal is just to provide that same exposure to stocks and bonds and foreign stocks and small-caps that you’re getting in a normal portfolio, but we’re screening out those non-ESG names. We’re applying that ESG filter.
Brian Mackey: That’s the bumper-sticker version of the Asset Allocation portfolios, but Kate maybe you can talk about the Dividend Income ESG portfolio. I know you’re really excited about it.
Kate Austin: Yeah, I am. We took our Dividend Income strategy that focuses on finding high-quality domestic large-cap stocks with a history of not only paying but also increasing their dividend, and then we used the ESG filter to make sure that only the companies that meet the ESG standard set by MSCI and FTSE are included. Dividend Income has our best ideas in the overall space, and our ESG portfolio has our best ideas in the ESG space. The two strategies do look very similar. There is about an 80% overlap. What we’re really doing is just using our Dividend Income strategy just with a little bit more of an ESG overlay.
Brian Mackey: Great. Well, I think the number that really jumps out at me there is that 80% overlap, which tells me that you’re already investing the non-ESG portfolio in these high-quality companies that score really well.
Kate Austin: Exactly.
Brian Mackey: Great. Well thank you, Liz and Kate. This has been Brian Mackey, Kate Austin and Liz Laprade and we would like to thank you for listening to another The Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show. You can also check us out at AdviserInvestments.com/podcasts. We love getting feedback from listeners, so if you have any questions or comments please email us at info@AdviserInvestments.com. Thank you.