Explore the Thinking behind our investment approach

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]

The month of May brought us another climate-related executive order, stating it is the administration’s policy “to advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk…including both physical and transition risks.”[1] This latest order specifically directs financial market regulators to assess climate risks, including how they impact the financial stability of the government and the financial system in the United States. Treasury Secretary Janet Yellen, who leads the Financial Stability Oversight Council (FSOC), will convene other agencies, including the SEC, to deliver a report by November. Public and private company disclosures could be impacted by any changes. Climate disclosures and related regulation have been increasing around the world and are seen as critical to improving capital allocation decisions. S&P recently reported that “data shows that the five largest U.S. public banks reduced their exposure to energy and utilities in 2020 compared to 2019. With this latest executive order putting increased emphasis on the financial risks of climate change, we expect this trend away from financing fossil fuels to continue.”[2] So far, so good. However, the New York Times reported that, counter to the pledges, orders, and other talk, this “administration has quietly taken actions this month that will guarantee the drilling and burning of oil and gas for decades to come.”[3] Politics, notably trying to secure support for the infrastructure bill, is unsurprisingly in the mix. A lawyer quoted in the article called the administration’s actions, “carbon bombs.” A low carbon transition is hardly an easy project. And, as we asked earlier this month, until a carbon price is in place, how effective can theses orders really be? ESG at the DOL Another part of the executive order explicitly asks the Department of Labor (DOL) to “suspend, revise, or rescind” the Trump administration rule that constrained ESG under ERISA. One of the options is the proposed bill, The Financial Factors in Selecting Retirement Plan Investment Act, which has been endorsed by Morningstar, US SIF, State Street Global Advisors, and the CFA Institute, among others. Jon Hale of Morningstar explains how the bill would amend ERISA in this recent article. Given the potential valuation impacts of increased climate-related disclosures, the opportunity for individuals to use ESG and climate-aware products in their retirement savings is a welcome development.

Advisors may believe that their clients prefer that they manage investments in-house, but recent research from Adhesion Wealth states that only 17% of clients feel this way. In fact, more than half of the clients “had no preferences ‘as long as my investments are secure and performance is satisfactory’.”[1] So, why outsource, and especially why outsource ESG options? Costs and Efficiency We’re stating the obvious here, but it’s worth reiterating. As fees compress while competition increases, advisory firms are under pressure to provide value-added services without compromising the overall cost base. Investment management, including time input, costs for technology, staying on top of market trends, and attracting and retaining top talent, is expensive, and can divert valuable resources from other services. ESG integration, for reasons further described below, is even more expensive. Outsourcing, on the other hand, can be very cost effective and less time consuming. Alongside the handling of the investments themselves, advisors may also gain access to value-added research, education, and thought leadership that would be challenging to produce in-house. Providing Clients with Choice and Quality The ongoing digitization of the advisory business has led to numerous marketplaces where advisors can find investment choices for their clients. For advisory firms that don’t specialize in ESG integration, but are serving clients with individual values, preferences and sourcing investments externally can help an advisor meet the needs of their client in a scalable way. The flipside is ending up with a multitude of bespoke investments that are increasingly challenging to manage unless you have sophisticated technology and operational support. Our growing suite of SMART Investing Solutions are available through multiple custodians, with some models also available on Envestnet and other retirement platforms. Our SMART Unified Managed Accounts (UMAs) are also customizable, enabling individual clients to exclude companies or entire industries and sectors. Rebalancing is taken care of, and our custom solutions are supported by powerful overlay management technology provided by our partner, Natixis. This also includes tax management functionality that can be very valuable for higher net worth clients. Maintaining a Market Leadership Position Unsurprisingly, this is the most important one from our perspective. The rate of change in the sustainable investing space is incredible, including the global growth of assets invested according to ESG principles, the rapid expansion of data providers, indexes, and other tools, as well as the expanding and deepening of topics and themes under scrutiny. In short, ESG requires dedication. Yes, it’s possible to make ESG models out of passive ETFs, but we believe that ESG necessitates rigorous active management. As such, manager diligence is more complicated than it is for traditional investment strategies. To effectively understand a manager’s sustainability philosophy, portfolio construction, and management, it’s imperative to also understand the underlying issues and data sets. Otherwise, you run the risk of providing greenwashed investments to your clients. Over the last several years, we have invested heavily in our in-house ESG capabilities and investment platform. We’ve tested and acquired data sets, nurtured relationships with managers large and small, built out our team, including the recent hire of Jessica Skolnick, CFA, as our Director of Investments, and developed a robust research and product development approach. It’s a significant undertaking and there’s no room for complacency. We’re committed for the long haul.

During our most recent RIA Channel ESG Playbook, David Callaway agreed with Jeff Gitterman that financial assets face repricing as climate change becomes better understood by the markets. The asset management industry is already adapting by creating new investment products that reduce risks and provide exposure to solutions. Ever-improving data sets and metrics will help advisors and investors determine the utility of certain products over others, further refining the outcomes. As advisors begin to engage more with these new products and tools, they will play an increasingly larger role in helping to educate and position their clients with respect to the retirement implications of climate change. Once the “average portfolio” incorporates climate change, repricing really takes hold. If you’ve yet to consider how climate change will impact your portfolios, please book a call with us to talk about our SMART Climate UMA models and how we’re thinking about climate change more broadly. Responsible Water Investing We regularly talk about water as it is a key theme in our SMART Investing Solutions. During last week’s event we heard from Alexandra Russo, Global Thematic Equity Product Specialist for the Virtus AllianzGI Water Fund, which is one of the holdings in our SMART Managed Mutual Fund Models. Water scarcity is inextricably linked to climate change and is exacerbated by a growing global population with rising living standards. Higher protein diets, electrification, and clothing production, among many other products and services, all rely on water as a key input. Source: AllianzGI; Water Footprint Network (2008); Ecolab, Closing Keynote Presentation from the Financial Times Water Summit from Doug Baker, CEO of Ecolab (October 2015) Another key challenge relates to the proliferation of contaminants. This is a significant domestic issue, in addition to being a global problem. Chemicals enter drinking water supplies from agricultural fertilizers, as well as other sources such as chemicals used to melt snow or put out fires. The probability of exposure to dangerous chemicals, which can lead to serious disease and birth defects, is heightened by an aging infrastructure. In the U.S., core municipal water infrastructure can be over a century old in some areas, unable to meet the needs of larger populations and potentially containing a myriad of new pollutants. Municipalities with insufficient funding to replace pipes and water treatment facilities may turn to private capital to upgrade the systems, providing opportunities for investors. Alexandra sees the water theme as a way to generate “environmental and social alpha” given its link to a multitude of other fundamental aspects of human wellbeing. The increasing attention on water infrastructure in the U.S. from the Biden administration, as well as in other jurisdictions such as the E.U., will likely result in water investing becoming even more topical over the next decade. Other factors that may stimulate this investment theme include increasing soft commodity prices, which provide funds for farmers to invest in water efficiency, as well the growing focus on the impact of climate change on the hydrological cycle.