The COVID-19 pandemic seems to be marking a major change in thinking and perceptions across health, justice, as well as, in government, corporate, and personal responsibility. All of a sudden the concept of “social responsibility” is less conceptual or academic and is now more visceral and relevant to daily life, business, and employment realities. Every day in the news, in personal discussions, and in our attempts to deal with this massive disruption in our lives, we can now clearly see interconnections and consequences.
In the area of investing, there is no more pronounced momentum change than in the attention and movement towards social investing. Morningstar reported that in Q12020 global sustainable funds saw inflows of $45.6 billion versus the broader fund universe having an outflow of $384.7 billion.
Further facts reported by Bob Smith of Sage Advisory indicate that this impressive growth in investor demand in ESG may be found in the ETF and fixed income markets as well, not just mutual fund flows. The inflow of assets into ESG ETFs, primarily in equities, has picked up steam in the past 12 months to an assets under management (AUM) base of $25.2 billion as of April 30, 2020 from $5 billion just 18 months ago. Investor flows into fixed income ESG investment vehicles also picked up in reaction to the violent volatility exhibited across the credit spectrum and from investor preferences for values-based investing that offers competitive performance with favorable downside protection.
Looks like some form of an inflection point has been developing.
To get a better understanding of what is happening in this new evolving environment, the Institute for Innovation Development decided to reach out to a cross-section of socially responsive asset managers – from ESG to impact to focused thematic strategies – and get their real world, in-the-trenches perspective and thought leadership. We would like to thank Ultimus Fund Solutions – one of the largest independent fund administrators - who provided introductions to some of their socially responsive asset manager clients and that has created fund vehicles for all of them to enable more access for investors to socially driven investment options.
Let me introduce you to our panel and then we will jump into getting a true lay of the land from the following experts in this field:
Erika Karp, Founder & CEO, Cornerstone Capital Group – a New York City-based registered investment advisory firm whose mission is to serve clients who wish to align their investments with their impact priorities without sacrificing financial returns.
Robert Uek and Bill Page, co-managers of the Essex Environmental Opportunities Fund– Essex is a Boston-based investment manager that operates at the nexus of environment and finance investing in companies that enable greater natural resource and energy efficiency.
Matthew Blume, Director of ESG Research & Shareholder Activism, Appleseed Capital – the institutional impact investing group of Pekin Hardy Strauss Inc., a Chicago-based independent firm providing funds and separate account strategies for investors that support their values through impact and ESG investing.
Robert G. Smith, President & Chief Investment Officer , Sage Advisory Services – an Austin-based advisory firm that offers fixed income and equity ESG investment solutions that embody a commitment to sustainability and responsible investing.
Zin Bekkali, CEO, Silk Invest – a London-based advisory firm that invests in listed equities across Global Frontier Markets – predominantly in Africa, the Middle East, Frontier Asia and Latin America - with a strong focus on impact investing and has been a signatory to the UN Principles of Responsible Investing since 2011.
Venk Reddy – Founder & Chief Investment Officer, Zeo Capital Advisors - a minority and woman owned, San Francisco-based fixed income investment manager focused on short-term corporate debt and ESG high yield. ]
Hortz: What has been driving such substantial inflows into sustainable funds?
Sage: Ultimately, the acceleration of inflows into ESG investment funds was and continues to be due to three factors: first, the continued trend toward values-based investing, which has been spurred further by the Covid-19 and oil crises this year. Second, the breadth of investment options has reached critical mass – the average investor now can access a much wider and growing range of ESG-focused investment choices in the public funds market. Lastly, investors now have enough of a sample size to judge how ESG-oriented strategies perform in both euphoric bull markets and deep bear markets.
Appleseed: ESG does seem to be getting special attention. I believe many investors are seeing the value in allocating capital to more structurally sustainable industries (avoiding fossil fuels) and to management teams that are focused on creating broader value over the long-term. The pandemic laid bare some really poor, near-sighted, self-serving decision making on the part of management teams (for example, sacrificing the balance sheet for buybacks, etc.). I think investors saw this and are making conscious decisions to avoid companies with that kind of management.
Cornerstone: Inflows to sustainable investment strategies are likely a reflection of the flight to quality we often see in times of great uncertainty. We would argue that the systematic analysis of material environmental, social and governance (ESG) factors represents an enhanced analytical lens for investment research. The predictive insight that can be gained represents an edge in the investment process. Further, this analysis of corporate governance allows us to have a “proxy” for quality. It also gives us a proxy for innovation, productivity, and resilience.
Essex: We think that this broadening interest in ESG is due to a number of factors, with the most important being performance and establishment of track records. Growing awareness of issues such as income inequality, global health, and climate change, particularly among younger generations that are reaching the earning and saving stage of their lives, has driven increased interest in the sustainability, ESG and clean energy funds.
Hortz: Can you explain for us how a multiple bottom line approach to running a company and its resources can help determine the future prospects and value of a company?
Appleseed: I think this approach helps to de-risk a company. There is always uncertainty with any business, but knowing that management is listening to shareholders, prudently managing the firm’s balance sheet, and thinking about the broader effects of their business on society should give investors more confidence in the long-term success of a company. This should lead to a lower cost of capital when valuing a company.
Silk: Social impact and ESG policies are critical for achieving long term sustainability and almost always are a positive for companies’ cash flows. In some cases, companies may on the short term need to sacrifice some profits but long term it always adds to the company’s profits as they build better relationships with all stakeholders including customers and employees. Companies with strong sustainable models will be recognized by clients and companies with better HR policies should be able to get better and more motivated employees. So essentially the multiple bottom lines eventually converge to one.
Essex: It is important to have a framework to measure both the social impact as well as the financial impact of a company. Our thesis is that those companies that can provide solutions to our environmental challenges will grow faster and generate above average returns over time while improving our environment, reducing business risk for corporations, and generating greater customer satisfaction. Doing the right thing is better for returns.
Cornerstone: If investors take the approach that there is value in multiple forms of capital – financial, human, natural – they can embrace the concepts of truly maximizing profitability over the long-term. The stewardship of all the capitals will allow for shareholders, employees, and customers to participate in a “triple bottom line” and then some!
Zeo: We would argue that ESG investing does not need to be viewed as having multiple bottom lines. This implies that the efforts to behave responsibly are somehow not aligned with the financial bottom line of a company. Sustainable corporate behavior is not a choice between financial and non-financial bottom lines; the real dichotomy is between short- and long-term horizons. A management team prioritizing only short-term profits is doing nothing for a company’s future prospects and value; short-term profits are rarely so repeatable as to dictate value without taking into consideration longer-term risk factors. The key for investors is to focus on those ESG factors which are material to a company’s underlying performance and consider the long-term liabilities and short-term uncertainty that is created if that company does not behave in a responsible way. Then, we believe investors will see that there is still just one bottom line – it’s just a matter of whether one cares about that bottom line for one or two quarters or over a longer timeframe.
Hortz: What are some of the best ways you see that companies have been managing the balance between shareholders and extended stakeholders? Can you give us a few examples?
Appleseed: For years, it seemed like management teams saw sustainability issues as an annoyance and a threat to profitability. They felt that engaging on these issues would be detrimental to their shareholders and were combative as a result. However, there has been a notable shift in the conversation more recently. In years past, it was common for us to need to file a shareholder resolution and receive a significant vote in our favor from shareholders to push a company to come to the table on sustainability issues. However, companies today seem far more willing to talk about and actively address these issues without a shareholder vote. I think they are coming to the realization that addressing sustainability issues is actually in the best interests of all stakeholders, including shareholders and management themselves.
By way of example, last year we engaged with Air Lease, a major aircraft lessor. Air Lease has the youngest, most fuel efficient, and cleanest aircraft fleet of any major lessor in the market. We asked Air Lease to significantly enhance its disclosures around the various environmental metrics related to its fleet. Instead of brushing us off and forcing the issue to go to a vote, the company realized that such disclosures were good for all stakeholders and willingly overhauled its disclosures on environmental issues without ever taking the proposal to a vote.
Cornerstone: The most critical element for balance here, is an understanding that in the long-term, stewarding on behalf of all stakeholders (investors, employees, customers) is a self-reinforcing effort. Again, that is in the long-term. There are always near-term tradeoffs as capital is deployed but being transparent around those decisions will allow for progress. As an example, let’s say that Cisco decides to build a $2M education technology center in China. Some would argue that the investment makes no sense. Cisco would argue that they are opening a market and building the workforce of the future. Let’s say that Intel decides to spend $1B studying their supply chain down to the minerals mined. Some might say that that is not their problem, lntel would say that they are avoiding a huge risk factor.
Silk: Our focus is on Frontier Markets where companies have a natural focus on achieving larger economic and social impact including import substitution and innovation. Good examples include companies like Safaricom which has pioneered the telecom industry in Kenya and developed a unique payments platform called M-Pesa. Through its business and services, it has been able to transform the Kenyan economy and positively impacted Kenyan society. Companies in Frontier Markets have not always been effective in articulating their ESG/SRI strategies but are increasingly adapting and improving. Many firms have started to give special attention to social topics including community engagement and gender equality.
Zeo: The companies we have seen that best balance shareholders and other stakeholders are those for which the mandate to do so has come from their Boards. Ultimately, a CEO is hired and given a mandate by the Board, so until the CEO is incentivized or at least doesn’t feel disincentivized to prioritize stakeholders other than shareholders, we can’t have the confidence that such a balance will persist as part of the company culture.
Within our investment universe, one company that has done a great job of prioritizing employees and its local community in addition to shareholders is Caleres, a shoe manufacturer dating back to the 1800s. They have a long history of community engagement, for example, that dates back to a trust fund established by their founder in 1921. Another standout in this area is Clean Harbors, a hazardous waste disposal company, where their efforts around employee safety earned the company national recognition as a leader by the Occupational Safety and Health Administration.
Essex: With the Essex Environmental Opportunities Fund, we focus on companies that are providing solutions to the substantial environmental challenges that the world faces. Over the past few years, more forward-thinking companies have started to address these environmental risks in many meaningful ways such as purchasing power from renewable sources, building offices and warehouses with more efficient insulation and HVAC systems, and outfitting factories with automation that is safer and saves time and money. These trends are creating opportunities for the companies providing solutions such as distributed solar generation, factory automation, and electric and hydrogen vehicles. The result of this improved corporate behavior is reduced business risk, a safer workplace and a cleaner environment.
Sage: It is also worth noting how the crisis has served to help introduce new and creative forms of public finance to help address some of the global social challenges aggravated by the spread of the virus. Social bonds are “use of proceeds” bonds that raise funds for new and existing projects that directly aim to address or mitigate a specific social issue and/or seek to achieve positive social outcomes. As the pandemic is causing far-reaching economic disruption in emerging markets and developing countries, the social bond market is one avenue through which the public and private sectors can now access the critical capital required to meet healthcare needs, restore economic stability and preserve jobs. In the first half of this year global social bond new issuance supply reached an impressive $38 billion compared with $16 billion for the full year 2019.
Hortz: Any other thoughts or advice you would like to share with advisors on social investing?
Appleseed: Do your homework and understand management’s incentives. Poorly structured incentive systems can push management teams to act counter to the long-term interests of the firm. The pandemic showed us that many management teams have spent the past several years gutting their companies’ balance sheets for short-term stock gains to their own benefit, and this caused serious issues when the pandemic brought the economy to a standstill.
Also, be prepared for volatility. The vicious speed of the crash in March caught nearly everyone off-guard. Passive investing has created an incredibly fragile market structure that is highly prone to volatility at levels we have not seen historically. Your portfolio should be structured to manage volatility going forward because this is not a temporary issue.
Essex: The improved corporate/social balance actions that we have seen and the acceleration in clean technology and environmental investment trends are positive developments that will benefit all stakeholders with improved financial and social returns for many decades. There are rays of sunshine to emerge from this crisis and we need to ensure that these positive qualities are perpetuated.
Silk: The key missing point is that so far, many advisors are only focusing within their local radius and do not give sufficient attention to developing nations. Investments in Emerging and Frontier Markets have the highest impact multiplier when looking at how capital can be a catalyst for change and the achievement of Sustainable Development Goals. Unfortunately, investors have never been this underweight. True ESG and impact investments need to include the rest of the world and facilitate convergence at a global level.
Cornerstone: “Social Investing” is just investing! It is done in a more methodical and transparent way, and it allows for the alignment of one’s values and assets.
Sage: The past three years in markets have alternated between a low volatility rally in 2017, a sharp drawdown in the fourth quarter of 2018, one of the best years for equity markets in 2019, and the fastest bear market in history in the first quarter of 2020 during the Covid-19 crisis. It truly has been an interesting “laboratory environment” for an investment strategy, and thus far ESG has shown robustness across all market environments.
Zeo: It’s important for investors to remember that ESG investing is an exercise in risk management. While we agree that a portfolio which aims to manage risk is likely to outperform traditional benchmarks over time, few investors believe that choosing a more responsible company over another will result in outperformance in the next few months. The advantage comes further down the road typically. But what we have learned from recent events is that anything can happen at any time, and indifference can be costly.
While many ESG managers did outperform traditional benchmarks in the last few months, we must not forget that there is more to good performance than outperformance. For those advisors whose primary goal is benchmark outperformance in short timeframes, ESG portfolios may not be for them. But for those advisors whose client portfolios are goal-based, sometimes mitigating risk is as important as seeking return. Now is the time to choose sustainability over indifference.
Thank you all for your participation in contributing your thought leadership and perspectives and for the readers, who are welcome to comment below, in being part of this dialogue. – Bill Hortz, IID
The Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation and unique community engagement strategies. The institute was launched with the support and foresight of our founding sponsors - Pershing, Voya Financial, Ultimus Fund Solutions, Fidelity, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines). For more information click here.