Explore the Thinking behind our investment approach

As the summer heats up, we are taking a virtual trip around the world to introduce you to select managers in our SMART Investing Solutions suite. One goal of our diligence process is to find managers who make a positive impact through active shareholder engagement, alongside security selection. Green Century, a manager in our Fossil-Fuel Free managed mutual fund model, hosts an award-winning, in-house shareholder advocacy program. The firm engages over one hundred companies every year, pressing them to improve their environmental policies and practices on a wide variety of issues, from protecting tropical forests to reducing their climate impact. Among the firm’s noteworthy advocacy achievements is its campaign to prevent plastic pollution. Eleven million metric tons of plastic end up in the ocean each year1, which negatively impacts the environment in myriad ways, from harming wildlife to threatening human health. Green Century tackles this problem at the source by urging portfolio companies to reduce their use of plastic packaging In just the last year, Green Century secured plastic reduction commitments from five major corporations, including Coca-Cola and Mattel: Coca-Cola, named the “largest plastic polluter on the planet for the third year in a row,” agreed to reduce new plastic use by three million metric tons by 2025.1 Mattel “was extremely receptive” to engagement and will begin disclosing metrics illustrating their plastic footprint.1 To learn more, check out this video with Annalisa Tarizzo of Green Century: Convincing Coca-Cola and Mattel to reduce their plastic use.

When the term “ESG” was coined back in 2004[1], the goal was to focus “on issues which have or could have a material impact on investment value” over “longer time-horizons (10 years and beyond) and intangible aspects impacting company value.”1 In contrast, SRI (Socially Responsible Investing), was mostly synonymous with values-driven exclusionary investing styles. In the years that followed, the distinction between values and value has often been upheld, but in practice, the boundaries are more ambiguous, especially as data has grown in depth and breadth, and as these investing styles have become more popular. We see ESG as the underlying dataset that can be leveraged to make a wide range of investment decisions, depending on the investment philosophy or focus of a portfolio manager or asset owner. For example, ESG data can be used to create an S&P 500 index-tracking strategy that has, say, a lower carbon footprint and/or better board diversity than the underlying benchmark. Or ESG data could be used to construct a thematic strategy focused on water investing that makes active bets on which companies are creating the best or most scalable technological solutions to water constraints. Or, it could be used, as with SRI-styles, to remove an entire sector or group of companies based on a personal preference, which might be religious, political, or otherwise determined. Over the years, despite frequent calls to define terms, sustainable investing definitions arguably have become murkier. Many platforms that provide custom indexing and other personalized portfolio construction use “ESG” and “values” interchangeably, which can confuse both advisors and investors. Widely held societal values are important. They are part of a company’s operating context and can become financially material. Climate change and social justice are two topics that have gained increasing prominence in recent years, but other values-based topics may be more niche and less likely to impact company financials and valuations. ESG is now part of the mainstream and product options are growing by the day. Some are truly authentic, created by firms that have an ethos aligned to their marketing messaging. Others are, put simply, a cynical asset gathering tool. It’s therefore important for an investor to know what they are really getting when they put their money into an “ESG strategy.” Some tools and strategies take a more passive investment approach but allow investors the flexibility to exclude and include certain companies based on controversy data, industry-level data, or other variables. The underlying data enabling these decisions may be highly sophisticated or more superficial. Understanding what data is used, how it is collected, and whether it’s forward or backward-looking, is therefore key to advisor-investor research. As many ESG topics are complex and often interlaced with other topics, deeper analyses may be needed to make optimal long-term investment decisions. Take fossil-fuel divestment, for example: some investors believe it’s imperative to exclude the entire oil and gas sector, as well as other companies that are high emitters, such as cement and aluminum companies. However, some managers believe that a select group of these companies have the ambition (or potential) and the balance sheets, to be a significant part of the low carbon transition. Conversely, some consumer goods companies perform very well on social issues and may therefore be included in a portfolio of companies that also have high “S” scores. But, when considering plastic, water usage, and questionable nutritional content, an entity’s impact on the world may look much less positive. Given the breadth and depth of data available, it’s incredibly challenging for any individual to be able to sufficiently consume and synthesize the entire picture and then make an investment decision. Our investment philosophy, which is centered on climate change, amongst other ESG topics, looks at climate risk from a physical and transition perspective and incorporates adaptation opportunities as well as climate mitigation. The inherent uncertainties, trade-offs, and challenges within this space necessitate working with active managers who understand the ever-evolving climate datasets available and have teams of people continually updating their analyses. Our ESG process, therefore, is mostly diligence of the managers themselves to help ensure that their stated philosophy aligns with their actual portfolio decisions. However, what’s exciting for advisors and investors who work with us is that we’ve made it possible to marry the sophisticated work undertaken by our active managers and allow individuals to reflect their personal values and preferences. Our Unified Managed Account (UMA) models are powered by Natixis, which integrates a range of MSCI data points, allowing an individual to also determine whether they want to exclude certain companies from the overall portfolio.

So much financial advice is predicated on caring for your future self. Your present self must resist temptations today to protect tomorrow. But it’s hard. Granted, some of us are naturally wired for saving and discipline; however, others find it almost impossible to forego instant gratification. The long-term can be easy to ignore. Climate change poses similar, and bigger, psychological challenges. As climate scientist, Katherine Hayhoe, stated in a PBS interview, “It turns out, in the U.S., almost three-quarters of the people would say, oh, yes, climate change is real, it will affect future generations, it will affect plants and animals, it will affect people who live in countries far away. But when you say, do you think it will affect you, the number drops precipitously to just over 40 percent. That gap is our biggest problem, not the gap of people who say it isn’t real, the gap of those of us who say [it] is real, but we don’t think it matters.”[1] In his solstice update, Spencer Glendon refers to those who believe in climate change but don’t act because it’s a “someone else” problem. He goes on to state, “Collectively, we are inconceivably powerful while individually, we feel atomistic. We often don’t know whom to turn to when we are lost or frustrated or when something doesn’t work, and when people turn to us, we can confidently tell them that they are actually looking for someone else.”[2] But we are the people we’re looking for. There is nobody else. Katherine Hayhoe goes on to say that, “We have to prepare for the changes that are coming” across infrastructure, food, water, security, and other critical systems. Adaptation is part of our future irrespective of whether we can speed up mitigation via a swift low-carbon transition. She also encourages that “Every single one of us can make a difference.” So, how do we make a difference? Spencer says, “Stop doing things you know are wrong… Start by figuring out what you’re doing that is pretty obviously wrong.” But what is “obviously wrong” from a climate perspective? Is it eating food in restaurants that was flown halfway across the world? What about going on vacation via long haul flights? What about buying a brand-new pair of jeans or anything else that uses an enormous amount of water in manufacturing? And what are the trade-offs and second order effects from climate solutions? On that point, we previously wrote about some of the potential land-use trade-offs that may occur from shifting the U.S. energy mix to achieve net zero. At the very time we need to think deeply and openly discuss these big questions, we’re being continually distracted by the Internet, including ever more sophisticated digital marketing that taps into desires we didn’t even know we had. Our political climate, domestically and internationally, is fraught with mistrust and divisiveness which is hardly conducive to fostering collective ambition. We’re connected and simultaneously disconnected from the planet, from each other, and even from ourselves. These are challenging times with seemingly insurmountable obstacles, but there is always possibility. As Jeff has articulated before, “[we] have a tough road ahead, but we believe there are amazing feats along the way. Human potential is always in abundance.”[3]

Everyone and every organization can contribute something to the fight against climate change. That’s the message from Salesforce’s VP of Sustainability, Patrick Flynn. With a solid foundation in corporate philanthropy, Salesforce has recently supercharged its impact potential by leveraging its core products and services to support the transition to a low-carbon economy. Inadequate or inaccurate GHG emissions data are a key impediment to understanding the opportunities for reducing GHG footprints at the micro and macro levels. With its global ecosystem of customers and suppliers, and data modules, Salesforce has enhanced its platform to support emissions accounting at scale. By providing new tools, Salesforce is facilitating the capture of emissions data up and down the value chain, which, in turn, helps customers influence suppliers to take steps to make reductions. Click here to watch Jeff’s conversation with Patrick Flynn and to learn more about Salesforce’s climate policies and software innovations.

When it comes to the capital markets, the U.S. markets are the world’s largest and “among the deepest, most liquid and most efficient.”[1] Healthy, transparent markets are critical to ensure that capital flows to support innovation and job creation, which drive a robust economy and underpin individual wealth creation. However, the U.S. has been slow, diplomatically speaking, to create the conditions to ensure that the markets orient capital towards the most important environmental and social challenges of our time. In contrast, the E.U. is moving at a much faster speed. In a recent episode of TheIMPACT TV, Michelle Friedman, Executive Director (ESG/SRI strategist) of MSCI, refers to the E.U.’s Sustainable Finance Disclosure Regulation (SFDR) as the “most ambitious plan we’ve seen in terms of ESG regulation.”[2] SFDR is intended to shift capital towards sustainable opportunities, while mitigating greenwashing at the product and entity levels. According to SFDR, the volume of transparent sustainability data funds will increase, thereby influencing funds and fund families beyond the E.U.’s jurisdiction, while fund families will likely not want to create two levels of disclosure based on geography. We may even see multinationals broadly disclosing according to E.U. guidelines to avoid the onerousness of operating at multiple standards. In addition, financial advisors in the E.U. will be required to ask their clients about their specific sustainability interests as part of determining suitability for investments. While the SEC and other U.S. regulators are getting better educated on ESG, many advisors remain behind the curve on offering sustainable investing to their clients, despite growing client interest.[3] In fact, research institution Cerulli found that advisors “limit ESG investing to their high-net-worth clients…with more than $5 million in investable assets, leaving out the 56% of households with investable assets between $100,000 and $250,000 who said they would rather invest in companies that have a positive social or economic impact.”[3] In the E.U., on the other hand, “ESG really seems to be on track for becoming business as usual” according to Friedman.[2] The G7 Supports TCFD The Task Force on Climate-related Financial Disclosures (TCFD), which only released its recommendations in 2017, has fast gained support from financial services firms and governments. At last week’s G7 meetings in the U.K., finance ministers stated their support for mandatory climate disclosures, using the TCFD framework. This is another signal, ahead of COP26 in November, that climate risk is moving up the geopolitical agenda. Whether disclosure leads to far-reaching changes commensurate with the problem remains a big question, however a globally aligned understanding of the issues should support better international and domestic policy and drive more capital towards solutions and adaptation.

As we reported back in April, climate would be a significant theme in this year’s proxy season. Since then, Exxon now has three new board members nominated by activist hedge fund, Engine No.1 (initially, two board seats were announced but a third is anticipated). BlackRock, historically criticized for a lack of alignment between its outward ESG marketing messages and its proxy votes, supported three of the Engine No.1 nominees, and Vanguard voted for two. In fact, “many of Exxon’s top institutional investors voted in favor of Engine No. 1’s candidates, while retail shareholders tended to favor the company’s nominees.”[1] Proxy advisor, ISS, had recommended that shareholders elect three of the nominees stating that Engine No.1 “made a compelling case that additional board change is needed to provide shareholders with sufficient confidence in the sustainability of (Exxon’s) business.”[2] The proxy fight has cost Exxon and Engine No.1 $35 million and $30 million, respectively, making it one of the most expensive ever. While Exxon is a huge multinational corporation, Engine No.1 is a only six months old and has just $250 million in assets with a holding of just 0.02% in Exxon. Engine No.1’s May presentation regarding its campaign stated that “a lack of successful and transformative energy experience on the Board has left ExxonMobil unprepared and threatens continued long-term value destruction.”[3] It also accused Exxon of refusing to reassess its strategy in light of decarbonization pressures and instead avoiding the subject or dismissing its importance. The economic thesis underpinning the campaign is what helped Engine No.1 achieve this victory. The hedge fund highlighted Exxon’s financial underperformance and made a bet “on a confluence of events, including longstanding investor dissatisfaction with Exxon’s corporate governance and a growing appreciation on Wall Street for G.”[4] Clearly, this is a big development, but it remains to be seen what will unfold at Exxon as a result. However, as Charlie Penner of Engine No.1 stated, “If you can get Exxon to change, everybody else in the industry has to listen…There probably could have been easier targets…. But it’s about getting the most impact…”[5]