ESG - Profitably Invest Your Values (Episode 42)

It? You know, it really is, you know, ESG is often used at least today interchangeably with a lot of other terms like sustainability or responsible investing or even impact investing. And I'm sure there's a plethora of other terms that are used and there is a, you know, certainly a unifying relationship, but that connects him. But in the sense that they're all trying to drive some sort of a positive impact relative to a specific objective. Um, but there are some real differences in those objectives and then the ultimate results that the investor experiences from a performance perspective. So when I talk about this, what I tell people is that, you know, regardless of the term being used again, I think what's really important here is that, you know, it's important to understand there's kind of two different groups here. The ESG investor, which is more of a, I would say a recent term here is really seeking to enhance their long-term risk adjusted returns.

Like almost every investor that's investing in the marketplace. However, they also understand that social issues, climate change and corporate governance, aren't just policy issues that they see those as economic issues. And they believe that ignoring those actually jeopardizes their ability to generate long-term returns and it creates risk. So they actually believe that if you incorporate the ESG factors and we can go into detail of what the ESG factors are into their investment process, that they're actually improving their financial outcome. Now, on the other hand, you have a group of investors that are more impact investors, or I, you might hear a term called, you know, mission oriented investors. These investors are investing with the explicit intent of generating strong, measurable, positive impact on a very specific social, environmental organizational mission, or as you were sort of alluding sort of a faith or religious cause. So they're seeking a financial return, but they also understand that the financial return is either an equivalent or a secondary objective to what they're trying to achieve by making that investment.

Yeah, it's a great point. Right? So at a high level, there's the EDS and the G and they actually stand for something the E stands for environmental. The S stands for social and the G stands for governance and explicitly corporate governance. And what investors are saying when they're looking at that. And again, there are lots of measures of these particular factors is, you know, with the E for example, they're looking at things like climate change and carbon emissions, air and water pollution, uh, biodiversity, energy efficiency, waste management, you know, water issues and scarcity on the S they're looking at things, they're looking at companies, right? And they're saying, what are their policies around data protection and privacy? What are their policies around gender and other elements of diversification in the workforce? What is their employee engagement? What is their community impact? What is their positions on human rights?

Do they think about labor standards if they're operating in a global capacity? So in and on the G you're looking at things, what people are looking at are really corporate governance processes that are really focused on, you know, very efficient and appropriate oversights of capital allocation. So they're looking at things like the board composition, you know, and the audit committee, you know, are these true? Are there independent non-conflicted members in those companies or on those boards? So are those boards focused on long-term sustainable outcomes or just short-term results? Is there a history of bribery or corruption? How are executives compensated? You know, how do those companies participate in lobbying or political contributions? Do they have whistleblower policies? So what investors are saying with these E these S and these G and they're saying is, listen, the financial stuff, and the financial statements are really important, but also understanding these three things also can tell us and be a predictor of how a company will perform in the future.

That's a, a great question. So, you know, it really, one of the things we work a lot with at asset mark with financial advisors and, you know, our role at asset mark is to help financial advisors, help their clients achieve their goals. There are some clients that, you know, if it's exclusionary, as you were sort of alluding in the example with the fossil fuels example, that can take that approach and they can just take a strategy and just say, take out the fossil fuels. That's, you know, historically that was the way we sort of approached solving the problem for that particular investor is we would just take that out and let the weight of the portfolio settle with the removal of that. What we saw early when, when we did that, is that actually that did have some potential negative implications for the investor that were somewhat

Of course, and you know, it's a little bit sort of a naive way of approaching what the client is asking for, at least in the capacity where there's an advisor involved. Another way to have that conversation with the client is to say, listen, you know, why are you trying to avoid fossil fuels? Okay, well, what if we invest in companies that are, you know, making efforts and in, and you know, maybe there's still a footprint, but they're actually making positive efforts to do that. And what if we incorporate that in the evaluation criteria and then build and optimize a portfolio around that? What we see is that tends to be a much more effective long-term way of, um, delivering positive output relative to that particular client's ultimate objective and having a less hindrance on their performance implications for the actual investor.

It does, it requires a lot of education and honestly, the industry is still evolving. One of the things, you know, that's really clear is, and if we're honest, here, there is not a single uniform definition to ESG. And you know, that has opened the path here, right? To something that you're hearing more and more about, which is, you know, greenwashing and that is companies marketing themselves, right. In a certain capacity. I mean, and spending a lot of effort around their marketing budget to, you know, emphasize how environmentally friendly or socially conscious they are, uh, rather than investing in actually understanding how their practices are having what impact they're having on the environment or ensuring that they have standards that are consistent with whatever they're promoting. And so, you know, we definitely see that and you know, it's something that we're seeing quite a bit of.

And well, I wouldn't say quite a bit of, I think we are seeing, and I think that comes back to the fact that there aren't necessarily these consistent standards and the industry is. So I think it's what to answer. Your question is we're, if we're really honest with ourself, there's actually a lot of work, even at the industry level to really unify around some sort of consistent standards so that when we're talking to the public, we're actually talking in a way that's uniformed cuz today I think a lot of people do have positive intent. They're not intending to be on that sort of green washing spectrum. That's not their intent, but what happens is they're kind of creating their own set of rules and their own set of measurements in their own set of guidelines. And that what that's doing is that creates confusion in the marketplace.

It really can. And it's is a great question. You know, there's probably three things I, that come to mind the first is honestly avoid the fluffy messaging. Look for messaging that explains or measures the positive impact. You know, rather than just saying we're socially conscious or X, Y, and Z, whatever that message may be, look for messaging that that says how they're doing it. And it actually measures how they're doing it. Look for companies also where the parent brand and the company are aligned with the ESG objective. For example, if a firm suddenly comes out with an ESG investment strategy and ESG has never been core to their identity, or they don't even publish an annual ESG report at the corporate level, well, I think some additional scrutiny should be warranted there. And finally, when you see firms that are just that solely have a proprietary process for measuring ESG considerations, again, that should be a sign to say, I should understand that a little bit more. What does that mean? There's nothing wrong with firms that have invested tons of money in developing deep proprietary frameworks around ESG. That's great, but it, there should be some awareness or connection with some of the evolving industry standards such as the United nations SDGs and the accounting standards from the SASB.

You know, it is, and it's not just an issue for, you know, emerging markets. It's actually, you know, increasingly we operate in a very globalized world. So you have us domiciled companies or European domiciled companies that of course have operations or large parts of their revenues that are generated in, in emerging markets. So it has become more complicated. So we kind of already acknowledge that we're still evolving our standards here in the United States and the European union. And I mentioned a few sort of emerging evolving industry standards that as the United nations SDGs and the accounting standards from the SAS B as sort of some of the best practices, but clearly those practices, those levels of adoptions and uniformity around the reporting relative to those standards do vary globally. But I think my point is really, you know, it's not just an emerging market issue.

It's an issue for many large American companies, which have operations and, you know, a variety of their revenues. Again, being driven globally, it's becoming harder and harder for them to sort of measure their impacts. And, you know, Tesla's like great example of that. Of course there was some recent, you know, media with Elon Musk around, you know, Tesla's sort of losing its rating ESG rating with S and P and of course, and, uh, did not make Tesla and Elon Musk very happy. You know, they are an EV company and certainly, you know, furthering the cause around, you know, moving us to a carbon neutral world. But, you know, ESG is a broader, has broader standards and, and there have been some issues there around poor working conditions, for example, in some factories that were not here based here in the United States, as well as some safety issues in some of their driver assistant systems. And so, you know, the collection of those issues when measured in, in a collective way, resulted in Tesla losing their ESG rating. So it does sort of speak to the complexity of these ESG ratings and how do you evaluate a firm and whether they're doing good or bad,

Yes, those are the United nations sustainable development goals.

Yeah, there is a, we touched on it a few minutes ago and one of your other questions there is this myth that to be an ESG investor, you need to sacrifice, returns that to somehow to do good. You have to sacrifice returns mm-hmm . And what I would say to that is the data does not really necessarily show that, you know, for example, there is now what we're at a period where we have a lot of data. We have more than 20 years of data, um, measured by indexes that are socially aligned. Uh, the MSC KLD 400 social index is one of those. I think it has 22 years of live performance data. And when we look at the data, what we actually see is that it provides comparable if not slightly enhanced return over that 22 year period. So the data just does not support that if, uh, approaching ESG from a comprehensive perspective and a inclusive perspective where we're incorporating that ESG consideration with financial success factors of companies, you know, that we're not just doing this in isolation, that we're looking at the two together, when we do that, it is possible to achieve, you know, similar levels of return and therefore the investor, you know, hit their financial goals as needed.

Now, again, you do have a subset of investors where if you're on endowments that are more institutional geared, where they have very specific causes and the impact on that cause is the most important thing to them. And the return is a secondary objective. Certainly in those instances, we do see differential performance, but again, for the average investor, that's just looking to have a positive impact across a, a broad ESG framework. We don't necessarily believe that you have to sacrifice returns.

Yeah. And again, it goes back to what we were just saying, right? It's if you are looking at these ESG frameworks are really saying financial data, the decision that we use, you know, is a company profitable is the company's valuation. Reasonable. Those measures are still really, really important data, but we wanna supplement that data with these ESG factors when the strategy takes those two things into consideration. We see again, the performance is not necessarily as impacted and what's happening is you may underweight and overweight. Some companies, you may exclude a few companies, but in aggregate, the portfolio has similar risk and, uh, return characteristics relative to a broad based index. For example, like the S and P 500 or DW Jones. Now, again, if you go down the path of, I want to solely end world poverty, that is a very specific objective. And that significantly narrows the list of companies that you're going to invest in that are dedicated to that specific cause clearly in that situation where you have a very impact oriented objective, your performance is gonna be different, but for these broad based ESG, um, objectives, as you said, they're generally weighting, you know, strategies that are in the baseline indexes that we see on TV EV every day,

Yeah. That's the hardest point here, right? You know, the first thing is just ask yourself and make sure you understand your motivation and your expectations. We throw all this into big bucket and we call it all these different things. And we say, it's all the same, but there's two again, different investor profiles here. If you've still got financial goals, you know, you've gotta retire. Your kids are going to college. You are gonna buy a house in the next five years, but you also wanna do some good along the way, know, understand that if you're trying to have very explicit impact on a specific clause, understand that, you know, again, for most people, it's probably the first example I said. So in that case, look for those broad based ESG strategies and understand, again, your financial goal in your wealth, you know, start considering if you need a financial advisor, of course. And that's always an important thing to start asking yourself if you're starting to get more complex and doing that. And then again, avoid those strategies that those three rules that I kind of mentioned earlier that can kind of lean yourself to greenwashing. It's not just that you're trying to avoid greenwashing. You're actually trying to avoid strategies that actually could deliver, you know, performance and characteristics that aren't that important. So avoid those three things. And I think you'll land in a pretty good spot,

Asset mark.com just reach out through asset. mark.com has a lot, a wealth of information on asset mark.com. Of course we work and we help financial advisors every day, you know, drive powerful outcomes for their clients, whether that's ESG or related to other financial goals. So are not working with the financial advisor. Of course, reach out through asset mark.com and we'll do everything that we can to connect you with a local advisor in your area.

Sure. Thank you so much. I really appreciate the time. Nice speaking with you.