[ Disruption breeds consequences and changes. In our last interview with socially responsive asset managers, we looked at how COVID-19 has acted as an inflection point for social investing and moving it well beyond its already existing upward trendline. This inflection point has been powering a major change in thinking and actions across health, justice, as well as, in government, corporate, and personal responsibility mainly due to the visceral impacts and universally relevant effects 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.
To dig a little deeper and get a better understanding of what is happening in this new evolving environment, the Institute for Innovation Development decided to reach out again 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 re-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, Pekin Hardy Strauss Wealth Management, managers of the Appleseed Fund – a Chicago-based independent firm providing funds and separate account strategies for investors that support their values through impact and ESG 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 type of corporate actions do you see as a new bar of corporate responsibility behavior?
Cornerstone: The newest bar for corporate responsibility is about transparency and consistency. The disclosure of material ESG factors by companies is a critical way to give investors insight into the extent to which a company is conscious of the environmental, social risks and opportunities it faces. This is a critical indicator of the overall Governance of the company. Beyond disclosure, companies must be consistent in words and deeds (e.g. If a company states that it embraces diversity, it must truly drive women and people of color into positions of authority. And if a company truly wants to support a fossil fuel free energy transformation, it wouldn’t say that it will reduce carbon emissions but have no targets to do so, while lobbying to lower standards.)
Essex: There is room for much improvement in corporate responsibility. Historically, the bar has been set pretty low as the corporate world has placed profitability and stock returns above all other concerns. We need to expect more from companies and the message is finally being heard in the corporate boardrooms.
The fragility of human life and our society has been starkly unveiled over the past months. If we want to maintain capitalism, then we need to realize that there needs to be a better measurement of success than we have traditionally used. We need longer investment horizons and a recognition that good corporate behavior (which includes environmental stewardship, better treatment of employees, etc.) leads to superior investment returns over time.
PekinHardyStrauss: A couple things that immediately come to mind are a stronger focus on board and executive diversity and new incentive structures for management teams that better align management’s incentives with shareholders and other stakeholders.
Silk: Diversity has become increasingly important and should receive more attention going forward. Investment Managers themselves should encourage and pressure portfolio companies to become more diverse at board, management and at the broader employee level. Some progress is being made but unfortunately many investment managers are themselves not very diverse and are not a true representation of the values that they sometimes advocate. Changes may need to start at their level first.
Zeo: In our view, it is much more effective, especially in the debt market, to focus our capital on rewarding companies who are making progress along a spectrum of awareness to action – As long as a company is being intentional and making deliberate decisions to prioritize key ESG factors, even if they are early in their sustainability efforts, we want to use our capital to incentivize them to make progress along that spectrum. So we aren’t as focused on the “next frontier” of corporate actions or a new bar as we are on getting companies to get the fundamentals right in a deep and sincere way across all areas of sustainability that are in focus, old and new. COVID-19 and the recent and long-overdue national focus on equity and inclusion have provided opportunities to engage with companies who may now be linking ESG factors to their company’s financial performance in a way that they may not have before.
Hortz: How does this increased scrutiny on corporate behavior impact employee engagement and morale?
Essex: We think that the increased scrutiny on corporate behavior and its impact on employee engagement and morale is like a flywheel. Once the process gains momentum, there is continued improvement and stability. Employees are more positively engaged and have improved morale in those organizations that have better corporate behavior, which leads to better returns.
PekinHardyStrauss: I think the long-term effects are positive because management teams are going to be held to progressively higher standards going forward. Employees, investors, and other stakeholders are less likely to just let management teams run amok like they have done historically. I think this leads to more of a sense of purpose and ownership for employees when they know they are being led by people they can believe in and trust.
Silk: This should be a natural positive where companies achieve a better representation of the society in which they operate.
Cornerstone: In order to attract and retain talent in the world of the future, companies must absolutely show that there is a corporate “Purpose” that aligns with their employees. In this world, where we have tremendous transparency from social media and big data, authenticity by leadership is essential. An organization that does not have a culture of innovation and trust simply cannot thrive.
Hortz: How do you see ESG and impact investing potentially affecting portfolio performance?
PekinHardyStrauss: What most jumps out at me is the intense scrutiny many ESG strategies apply regarding corporate governance. Businesses which are led by management teams and boards with a focus on long-term sustainability and whose incentives are aligned with other stakeholders, tend to outperform over time and should fare better in downturns and times of pressure. ESG strategies that focus on identifying such companies ultimately benefit.
Many ESG and impact investing strategies also have a tendency to identify and align their corporate investments with positive and environmental trends before more traditional strategies, which can lead to outperformance over time. And of course, avoiding major legal, regulatory, and reputational controversies by eliminating certain companies and industries from their investment universe can contribute positively to the performance of ESG strategies.
Cornerstone: Given that sustainable investment strategies are often focused on addressing the world’s greatest challenges, they are often long term in nature aa they are building innovation into their strategies. When markets correct, and there may be indiscriminate selling, we often see that high quality strategies which incorporate future innovation can sell off and then rebound more strongly as growth accelerates. Historical empirical evidence (e.g., Morningstar) shows that ESG integrated funds, across asset classes, perform as good or even better than their traditional benchmarks.
Essex: We think that over the past year we have seen a broadening of interest in ESG and sustainability funds (and away from broader equity funds). We think that it is due to a number of factors, with the most important being performance and the continuing establishment of strong 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.
Silk: The current crisis has proven that ESG driven investments are becoming the norm. The strong inflows are partially related to the increased awareness of investors to the subject but also to the fundamental bias of ESG funds to more sustainable business models. These companies have weathered the current crisis better than others. The growth in ESG and the strong performance so far in 2020 is a good start but more needs to happen to have a real impact.
Zeo: Every strategy is different, and I would caution anyone to read too much into recent relative performance in such a short timeframe. ESG factors are longer-term risk management metrics, not short-term performance metrics. We invest in businesses who prioritize sustainability because we see them managing risks before those risks turn into liabilities down the road
Hortz: Does this newer broader corporate mindset help “future-proof” our investments as some claim?
PekinHardyStrauss: It’s hard to know what the long-term effects will ultimately be, but I think we will see more management teams that view themselves as stewards of their businesses, rather than seeing the business as a way to extract wealth. I just don’t see investors continuing to put up with short-term thinking and financial engineering at the expense of the long-term health of a company. This should lead to greater long-term value creation and lower risk in investments.
Cornerstone: “Future-proof” is a strong statement and also has a connotation of risk only. It’s critical that we understand that both opportunity and risk are reflected in corporate sustainability. We can define corporate sustainability as “the relentless pursuit of material progress towards a more regenerative and inclusive global economy.” That mindset, albeit very long term and macro, would make for better positioning in the “next economy.”
Essex: If we have learned anything over the past couple of decades, it is that there is no such thing as a “future-proof” investment. However, we think the increased corporate awareness and the improved corporate mindset when it comes to environmental and social issues is a new minimum that is required of successful corporations. We can no longer afford to focus only on short term financial metrics as a measure of success. The social and environmental issues that we face are very long tailed and will require continual focus and improvement. Companies that aren’t able to recognize these issues or provide solutions to these issues will not succeed in the long run.
Zeo: That is our thesis. Every company has risk factors that impact its underlying fundamentals. Traditionally, those risk factors have not included ESG factors, but we very much believe that a business who does not behave in a long-term sustainable way is introducing risks which may impair the company in the future. But I would hesitate to call it “future proofing.” The work of ESG investors is no less constant than that of the value investor, continuously reaffirming the investment thesis and evaluating a management team’s performance. For ESG investing, we see explicit mandates from firm management and Boards and we must stay hyperaware because companies can shift priorities and strategies quickly.
Hortz: What do you see as the longer-term implications of this current crisis on ESG investing and financial services?
PekinHardyStrauss: From an investment standpoint, I think the most important long-term change will be a stronger focus on good business stewardship and the sustainability of business models. The pandemic exposed a lot of weaknesses, but it also highlighted a number of opportunities for businesses to become more resilient (better balance sheet management, more elastic supply chains, etc.) and purpose driven. I believe investors are going to become more attuned to these qualities as they search out new investment opportunities going forward.
On a strictly concrete sense, I think the financial services industry is also going to become a better place to work as a result of the pandemic. While historically the industry has largely resisted the remote working model, the pandemic forced the industry to crash-test it, and it worked. Firms are realizing that they can utilize this model with no adverse effects to their businesses, which should lead to downsizing of real estate footprints and giving employees more flexibility with work/life balance.
Cornerstone: The current crises has been the ultimate test of resiliency as tremendous inequities that have existed are being laid bare. The ability of corporate managements to handle employee, client and shareholder actions and communications reflects their priorities and competencies - and the ethic of companies will come through.
Essex: We have been calling the COVID-19 pandemic the great accelerator. This crisis is not necessarily causing any unique changes to business practices rather it is accelerating trends that had already been in place prior to the pandemic. COVID 19 has revealed a need to build more resiliency and stability throughout our economy which is leading to greater demand for distributed power generation, back-up power solutions, a focus on building out a smarter electric grid and more efficient transportation solutions to name just a few environmental and social solutions. The pandemic is reinforcing and accelerating many of the environmental and clean technology trends that we have been investing across.
Silk: The current crisis is pushing investors and companies to examine their normal practices. It is too early to state where the industry will land as the current market volatility down and up may disguise the true impact of the crisis. Maybe wishful thinking but hope the crisis will lead to more engagement and more focus on all stakeholders. Many companies are run tactically with CEO and shareholder first.
Zeo: I think the bigger issue ESG investors face is that the language of change has been limited to a lens of social or mission-driven catalysts in the first place. That is, we talk about changes in corporate behavior as motivated by factors that are not necessarily tied to profits; from this, the traditional investor concludes that profits and change are a mutually exclusive trade-off. We know that to be false.
ESG factors drive financial outcomes as well, and I encourage all ESG investors to start speaking in these terms. This is how responsible investing will take hold in traditional portfolios. This does require investors to take a long-term view rather than focus on short-term relative performance vs. traditional benchmarks, so not everyone will come along. But if the financial costs of, for example, environmental liabilities or a lack of perspective are more broadly understood, self-interest alone will naturally point both ESG and traditional investors toward ESG strategies - not just because these priorities are right, but because they are financially beneficial to Boards, CEOs and shareholders.
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).