MASTERCLASS: ESG - December 2020

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  • 01 hr 06 mins 28 secs
ESG investing continues to grow as more people look to align their investments with their environmental, social and governance values. Three experts discuss the evolution of ESG, their approaches to ESG, tailoring ESG investments to client needs, and more.

  • Julie Moret, Global Head of ESG, Franklin Templeton Investments
  • Brie Williams, Head of Practice Management, State Street Global Advisors
  • Sarah Bratton Hughes, Head of Sustainability, North America, Schroders





Jenna Dagenhart: Hello. You're watching Asset TV's ESG Masterclass. Joining us to talk about the importance of environmental, social governance factors and their outlooks, we have Sarah Bratton Hughes, Head of Sustainability, North America, at Schroders, Julie Moret, Global Head of ESG at Franklin Templeton Investments and Brie Williams, Head of Practice Management and Global SPDR Business at State Street Global Advisors. Everyone, thank you for joining us. And setting the scene here, Brie, given this unprecedented year, where is ESG investing today and what's changed?

Brie Williams: Definitely been an interesting year to say the least. And when we look at ESG investing, a lot has changed. If we look at the recent past where we were the last decade, was really an opportunity for us to lay the groundwork. ESG needed a lot of education, we also had, of course, government regulation laying a roadmap ahead of us. When we look ahead, the next decade, the 2020s, really this is an opportunity to renew commitment and actually put ESG into action.

Brie Williams: There are three trends we see as really driving that continued growth in ESG. If we look to what has started off is to be very turbulent, beginning to the decade 2020, put two issues at the forefront, S and G in particular. We had greater emphasis on those social and governance factors after our environmental factors for so long had been dominant in the ESG conversation, whether it was relative to considerations or the investments themselves.

Brie Williams: So when you look to the factors that are really about S and G companies contingency plan, the work environment, how they treat their customers, the community, that just helped underscore how nonfinancial ESG factors impacted long-term valuations. And that has helped enable leading the way towards a more complete application of ESG.

Brie Williams: The second driver really has to do with the investors themselves playing an influential role on shaping what's next. As we look at the industry transformation that's truly underway, we're seeing a lot of changes in the last 10 years and it's been providing an opportunity to put forward more solutions. There's a big appetite out there that we need to satisfy. We've had tremendous growth.

Brie Williams: You look at just sustainable reporting from Morningstar as an example in their US landscape report recently, they showed 564 conventional funds consider ESG factors. And that's up from 81 in 2018. So, there's been tremendous growth in the space, and that has led to more transparency, that's also improved reporting.

Brie Williams: And that helps investors across the board understand their ESG exposure and take the action that they need to not only achieve their goals, but monitor that progress, which is important to staying invested in a long-term. The last one is about the ever-changing demographics. We all know that there's a tremendous wealth transfer underway, money is in motion.

Brie Williams: And this large-scale wealth transfer between the baby boomers and their children has enabled a greater emphasis on how you redefine what that family's legacy is. But also, when we think about COVID and all the time we've been spending together, a lot of living with our values has encouraged ESG adoption. And if you think of shared values as a bridge generationally, that really helps enable move in ESG into the mainstream. And this is a change that we see reverberating and being magnified when we look at government regulation as well as across institutional investments.

Jenna Dagenhart: Building off of that, Julie, how would you see ESG investing has evolved over time?

Julie Moret: Yeah, absolutely. Sure. ESG really started out from the traditional values based socially responsible investing, so very much this predominance on exclusionary criteria and screening out investments. What we've seen continue to accelerate is the shift towards positive inclusion and more specifically the incorporation of ESG information as part of the fundamental research process, and really beginning to understand what are the vulnerabilities and what are the opportunities that these drivers of change represent to the operational resiliency of businesses.

Julie Moret: So in short, it's really been a shift away from the predominance of screening out investments to really an integration of ESG as more of a rounded out holistic understanding of evaluating companies. When you look at a lot of the industry studies out there that cite two key reasons for integration, one is risk management and two is the prospect of improved returns.

Julie Moret: Some of the underlying dynamics that Brie touched on, certainly we view as well as sustaining this growth in ESG investing, whether that is the intergenerational transfer of wealth. First and foremost, I think what we're seeing is really a reallocation of capital that incorporates wider stakeholders and beneficiaries.

Julie Moret: I think an interesting observation is going to be when we look out over the next two, three years, we're going to see increasingly a shift from the inputs to ESG integration and what those are to really measuring what are the outputs and the outcomes, the impact of the investments that we make.

Jenna Dagenhart: And Sarah, building off of that, how would you describe the ESG landscape today? And we can't talk about it without talking about COVID too. So how would you say COVID has impacted ESG?

Sarah Bratton Hughes: So Brie hit on a lot of those points in the first question where we've really seen this massive swing in the pendulum. So up until now, there's been a massive focus on the environmental issues and the impact and the risk to companies' profitability around the environmental issues and that was in... and Greta put an exclamation point on that, right?

Sarah Bratton Hughes:  You had this whole massive buildup about all these environmental issues. 2020 came and the pendulum has swung completely in the opposite direction with COVID, how companies are treating their employees during this time. Then that was doubled down on with the protest and inequality that we have here in the US. So, you've seen this massive swing in the social issues.

Sarah Bratton Hughes: But I always say the pendulum always lands back in the middle. And I think that that's really where we're heading in the next coming years. You've seen COVID as an opportunity by policy makers when they're passing these big relief and stimulus bills to use it as an opportunity to build back a greener economy.

Sarah Bratton Hughes: There's no better example of it than what is going on in the EU, and I'm sure we'll get into our politics we have here in the US, but we can save that for later, but this massive stimulus of money that is going into green finance. At the same time, we've seen not just this upcoming generational transfer of wealth, but you also have had increasing demand beyond the millennials and beyond the women for sustainable investing.

Sarah Bratton Hughes: Actually, our global investor survey this year said that more Americans, 55% of Americans felt like they were going to miss out on return if they didn't invest sustainably. So, you've seen this massive shift in mindset. And that survey was taken right when sustainability really proved itself as no longer being a bull market luxury.

Sarah Bratton Hughes: So as I think about it, I think COVID has really helped push the narrative forward, dispel a lot of those performance rumors that you've heard. And you've seen companies that treat their employees better, JUST Capital has done a number of it on the social side, where those companies that outperformed in the midst of the crisis.

Sarah Bratton Hughes: The evolution we're on from a product perspective, I really think Julie hit the nail on the head and I call it the A, Bs and Cs and Ds. I have my own D, and we'll get into that, and we hit on that impact aspect. So, avoid, that's where we were, that's the negative screening of the past. B is integration, that's where we're at really right now, that's benefiting your returns from integrating sustainability into your investment process.

Sarah Bratton Hughes: C, that's where you're seeing the market going. So, these solutions that you're really going to contribute and contribute to solving some of these world's problems. And then D, that's direct. So that's more of impact in the private markets and you're seeing an explosion of growth there as well.

Jenna Dagenhart: I'm looking across the pond. Julie, anything you'd like to add on those comments?

Julie Moret: Yeah, absolutely. So, I think to echo a number of Sarah's points, I mean, really, it's fascinating that COVID rather than dampening the interest in ESG informed investing, it's actually really accelerated a number of these preexisting themes. Number one is we'll continue to see an acceleration in climate focused investing.

Julie Moret: And particularly in Europe, that's being supported by a number of policy and regulatory reforms, which are mandating the incorporation of sustainability into capital allocation decisions. I think secondly, what COVID has really exposed is the heightened amplification of societal risks just as quite simply growing inequality.

Julie Moret: And so we've seen dislocations in market, and we've seen the real impact on the economy, and particularly certain segments of the economies where employees, consumers have been left with very little protection, whether that's leisure, entertainment, and travel. And I think it's an absolute reasonable expectation that post COVID from an investor's perspective, there's likely going to be downward pressure on free cash flows.

Julie Moret: And really the messaging that we focused on in our engagement with corporates is really to ensure that there's operational resiliency, strength of balance sheet, cash flows, and any decisions that are taken, that need to be taken really are done with a long-term view on the viability of the businesses. And I think a lot of these behaviors that we're seeing is essentially shifting towards a capitalism that takes into account wider stakeholders, employees, consumers, suppliers, as well as the shareholders.

Julie Moret:  And I think the underlying takeaway is that it actually pivots a heightened attention on engagement and how we as investors engage with corporates on these issues. Because ultimately, a wider stakeholder orientated model essentially drives towards... Sorry, I've lost my train of thought. So, a wider stakeholder orientated model really drives towards ultimately a company's social license to operate.

Sarah Bratton Hughes:  I find that super fascinating and we're sort of coining the term here of impact adjusted profits and how that's going to really come into the centerfold going forward.

Jenna Dagenhart: Brie, as discussed, ESG has really become such a popular topic, but even before 2020. Why do you think that is? And do you expect this trend to continue moving forward?

Brie Williams: So I think it's fair to say the ESG tide has been rising for decades. It's just now reached this critical inflection point. And we have investor engagement growing, we have data and analytics to track the performance and the strategies there. Those are evolving. So, as a result, you have the adoption of ESG only continuing to accelerate.

Brie Williams: As referenced earlier, we definitely see some end client segments in particular really taking the lead here and being most influential among their peers, next gen investors of course, and then our female investors as well. But across all investor segments, there's this general increased proactivity by the individual investor.

Brie Williams: And we can see that in the data from individual investors across the world, and it only underscores ESG's potential as a long-term investment when you think about the role it can play in one's investment portfolio. So just a few that I had pulled forward that I think are really spot on for looking at why ESG now, but also why this will continue to grow and it's not a fad.

Brie Williams: When you have almost 60% of next gen investors as well as female investors saying they want to make a tangible difference and an impact through their investments, they're choosing to cast a dollar vote in the change they wish to see in the world. And that's pretty impactful. We also see planned increases by investors in their allocations towards ESG.

Brie Williams: Looking at the US region, we have about a quarter of US investors saying over the next 24 months, they're likely to increase their ESG investment allocation. And when you look at that through either a generational lens or take the entire world as our lens, you can see that that is higher among our millennials, as well as gen Xers not being too far behind where they too are planning those increases in allocations to ESG over the next 24 months.

Brie Williams: I think the most important learning that has come forward, and both Julie and Sarah had touched on this, this is a no compromise approach when it comes to investor performance expectations for ESG. You have a third of investors that are in agreement that yes, it's possible, I can achieve a market return rate when I invest in companies based on their social or environmental impact.

Brie Williams: And you have over 55% of next gen investors agreeing with that statement, 35% of gen Xers and 24% of boomers. So, we are pushing past some really old myths that often can hold back ESG from hitting mainstream. And I think we're really at that inflection point now.

Jenna Dagenhart: Julie, what do you think some of the underlying drivers sustaining the growth in ESG investing are? And are people's motivations for investing in ESG also changing?

Julie Moret: Sure. So, there's four drivers that we see sustaining the growth in ESG investing. The first driver is really just the growing relevancy of sustainability challenges, whether those are climate transition impacts, both policy, risk, as well as physical risk, whether that's natural resource use and scarcity.

Julie Moret: The second, which both Brie and Sarah have touched on is really demographic shifts, which ultimately represent changing consumer behavior and changing investor preferences. There's been a multitude of studies that have shown that millennials are much more sensitized to environmental and social considerations, which is not the same thing as saying that there's a desire to trade off returns for these positive impacts.

Julie Moret: I think where the mindset is at the moment is the fact that both generating a positive return alongside a positive impact to an environmental or social consideration aren't mutually exclusive. I think the third sustained driver is really the ongoing regulation and policy.

Julie Moret: The acceleration that we're seeing, not just actually in Europe, but certain parts of Asia that are really adopting regulation in a manner that is trying to drive at a cleaner pricing signal on climate transition issues, but ultimately again, to allocate capital towards more sustainable forms of investing in economic activity.

Julie Moret: So the fourth point is really just the increasing pressure that corporates face on sustainability disclosures. We've seen most recently the big four accounting firms come out with their recommendation on 21 sustainability disclosure standards, which have been informed by SASB, the Sustainability Accounting Standards Board, as well as GRI.

Julie Moret: And most recently we've seen also the IFRS, the International Financial Reporting Standard also come up with a consultation which is trying to drive out essentially a global standardization framework around ESG disclosures. That fundamentally is a good thing for the industry. I think the one caution that we would have is the desire that all of these frameworks build on existing market established frameworks that already exist rather than a reinventing of the wheel.

Jenna Dagenhart: Sarah, I see you nodding your head. And one of Julie's points kind of reminded me of what you said about ESG not being necessarily just a bull market luxury.

Sarah Bratton Hughes: And just to really hammer down on this regulation and the massive flow of capital that we're going to be seeing into these solutions, it really is the third leg of the stool, in my opinion. So, you have the rising demand there, the consumer demand and client demand are there. We still have some work to do on the educational side of it, but the demand is definitely there.

Sarah Bratton Hughes: You have the... like I said, it's not a bull market luxury anymore. Actually, green power is some of the cheapest power we have available to us here in US. And nothing signaled it more to me than when NextEra, our largest producer of renewable power here in the US crossed over Exxon in the S&P 500 in terms of its weight.

Sarah Bratton Hughes: So you have the economics are there, the demand is there, and the third leg of the stool is the policy. And Julie is definitely an expert on the EU, but make no mistake, not only are they trying to increase disclosure, but they're also trying to increase the flow, as Julie said, away from brown industry and into green industry.

Sarah Bratton Hughes: But the real dark horse in this race, and I am the only US-based person on my sustainability team and I am shouting loud and hard right now, is the US and what we have the potential to do here to really move the needle in terms of policy that you will see from the incoming administration. We're talking about investing over 2 trillion in a very short amount of time into more sustainable infrastructure here in the US.

Sarah Bratton Hughes: And that is certainly going to be a boon to anybody that is contributing to this solution. So, I think that goes... I'm pounding the table saying that the US is going to be the needle mover here this year. We will no longer be tardy to the party. I'd say we're just fashionably late. So, I'm looking forward to seeing what we do here after long having the reputation of being a laggard in the space.

Jenna Dagenhart: Tardy to the party, I like that. And we'll talk more about your outlook there later in the program. But before we get there, Brie, looking at ESG funds themselves, how would you say that they've evolved over the years?

Brie Williams: So it's definitely an evolution. It's an evolving space, if you will. And it's still relatively small from an asset base, as well as a product offer standpoint. But the development that you're seeing is becoming much more dynamic and much more diverse. You have new products launching, you have new issuers coming on board. There's also conversion taking place of existing products over to ESG.

Brie Williams: When you look at where are the assets, most of those lie in equities where flows are favoring broad ESG strategies over thematic solutions, which is a really noteworthy shift as reflected when you look at trends in assets under management flows, new product development, as well as some closures thematically among ESG solutions. We also see the industry trending towards lower cost, lower cost solutions. You don't need to pay a premium to access an ESG product. And when we look at management fees for both ESG and non ESG versions, they're about the same.

Jenna Dagenhart: To quickly follow up on your point about lower cost Brie, the adoption of ESG ETFs is also growing, what's fueling that growth?

Brie Williams: So with the advent of ESG ETFs, all investors of any size can access ESG in a very cost-effective manner, something that really wasn't as prevalent as it is today and will be moving forward. So essentially ETFs have really helped democratize access to ESG, and that enables investors, large and small to be in a better position to realize their investment objectives.

Brie Williams: Now, specific to the growth component, this tipping point seems to have occurred last year. When you look at where net flows were into open-ended and exchange traded ESG funds, that topped over $20.6 billion. That's four times the amount such bonds had attracted in the previous year. So, you can see, even though the space is still small, there's tremendous momentum.

Brie Williams: When we look to what 2020's will be highlighting, you have the importance on that this environment has started off with this year of integrating ESG factors into investment decision making. It can enable better decision-making. So when you look to ESG ETFs and the flows, they're on record pace for a record year, and that potentially signals this long awaited pay off for both products after we've had years of hype and muted flows, as well as a bit of the proof in the pudding that ESG is here to stay.

Jenna Dagenhart: Now turning to your respective approaches to ESG, Sarah, how are you measuring ESG and what are some proprietary tools to help quantify ESG?

Sarah Bratton Hughes: So here at Schroders we have developed a large proprietary tool kit all with the aim of taking these long-term structural trends and turning them into actionable investment implications. And what do I mean by that? I work with all of our portfolio managers and analysts here in the US and not one of them speaks in carbon footprint.

Sarah Bratton Hughes: But when you can build a tool that says, what would be this impact to this company's profitability, say if carbon was taxed at a hundred dollars a ton, then you're speaking their language. So, it's turning it into how they understand things, which is data and dollars. So, our tools, we built a robust toolkit. They give us the ability to quantify both the risk as well as the sustainability opportunities within our holdings.

Sarah Bratton Hughes:  The ability to quantify is really important because if you can quantify, then you can measure. And we've talked about all the products being launched and all the conversion, and I'm sure we'll get to the concept of sort of green washing what you've seen going on in the market. And Julie hit on it early with talking about that fun level sustainability reporting and wanting to understand.

Sarah Bratton Hughes: So the ability to quantify gives us the ability to measure, and by measuring our sustainability profiles of all of our funds, it gives us the ability to manage. And you can manage two ways. One is via active ownership and engagement. So just to give a scale of our engagement program, we did over 1700 engagements across 57 countries in 2020.

Sarah Bratton HughesWe are an active owner; we are not activists. This is really about unlocking that long-term value and understanding these managements are managing these long-term threats and opportunities to their business model. And then you can manage it the other way. And this is via providing investment solutions for our clients that we have. So, it's about, I think that quantification piece is really important in both the measurement as well as the management.

Jenna Dagenhart: And Brie, what's been State Street Global Advisors role at ESG's changing landscape? I know you're responsible for the Fearless Girl Statue, which I always enjoy seeing.

Brie Williams: Sure. So ESG has long been central to our mission at State Street Global Advisors. We invest responsibly to enable economic prosperity and social progress. And we're committed to helping the world's government institutions, as well as financial advisors reach their ESG investing goals. So, we're stewards of our client's capital, and we want to help investors see what is fair for people and sustainable for the planet can help deliver a long-term performance.

Brie Williams: Well, we began managing ESG portfolios more than 35 years ago, and we know that when it comes to ESG investing, it is about putting your money where your mouth is, hence your reference to Fearless Girl. I mean, so ESG is really about action and she's a great example of asset stewardship in action. So, if we look back to when she entered the world stage, that was March 2017, that she truly puts our belief front and center.

Brie Williams: And she served as the public face for our efforts, in this case to raise awareness about the importance of gender diversity in corporate leadership. Since her launch, we've identified more than 1300 companies around the world that did not have a single woman on their board, and we made it clear that we would not hesitate to use our proxy voting power to effect change if they had failed to act on their part.

Brie Williams: It's been three years now since she debuted. But I think she's a wonderful example of how sometimes what can be a really small ask can bring about really big change. And it's incredible to consider how simple a call to action for a board to look at their diversity makeup is and how that can have such a lasting and profound effect.

Brie Williams: If you just look to the data as evidence to show that action does create change and change creates progress, and that can be sustainable, which we want it to be because it's about improving decision-making over the long-term and impacting the bottom line. When you look to the number of companies in the Russell 3000 that did not have a woman on their board, that dropped from 25% to just about 10%.

Brie Williams: If you look to the S&P 500, every company now in the S&P 500 has at least one woman on their board. That conversation has moved to the value of diversity more broadly, not just gender diversity. So, the companies are now thinking about the connection diverse thinking has to performance across the organization, not just within the corporate board room.

Brie Williams: It also has an impact in their minds now on pay parity, teams, company culture. And of course, this has become a global conversation. So, when we started this in 2017, our focus initially was in the US, the UK and Australia. But since that time, we've expanded the conversation and our diversity voting guidelines to Canada, Europe, Japan, and now Hong Kong and Singapore. So yes, progress is being made, the change is very real. But I would be remiss to say there's still a ton of work that we have to do together.

Jenna Dagenhart: And that note too. It's interesting looking at how NASDAQ is trying to advance some of these diversity goals with some of their new listing requirements that they've submitted a proposal for to the SEC.

Brie Williams: Exactly. I mean, it's been exciting and I think a little bit beyond our wildest dreams at how much this has created a sense of collaboration and accountability across not just financial services, but all industries, in recognizing the power of diversity of thought and how that can impact the bottom line, either positively or negatively, depending on how you choose to address it.

Jenna Dagenhart: And Julie, turning to you, how would you describe your approach to ESG and how do you interpret ESG data to meet client needs?

Julie Moret: Sure. So, in terms of Franklin's approach to ESG, we very much look at ESG information as pre financial indicators. What I mean by that is ultimately it's a pool of information that has financial relevancy. And so, our analysts and our portfolio managers incorporate the assessment of the risks and vulnerabilities as part of the fundamental research.

Julie Moret: On a practical level, what that actually means is the first step is we perform a risk-based assessment, which is a sector specific materiality framework. We identify at a sector level the most business relevant ESG themes, topics, what are the indicators that helps us to assess the company's performance against those issues and how well we believe management is at actually overseeing and managing and mitigating some of these risks.

Julie Moret: The next step is really how we reflect that in our valuation models or our financial forecasts. And so typically what we will do is we will either adjust the forecasted financials either through revenues or through costs, adjustments to the CapEx or OPEX of certain companies and sectors, or in the actual valuation model, we will make adjustments whether those are adjustments to the discount rate or adjustments to the weighted average cost of capital, which essentially reflect ultimately our view around the risk premia associated with the management of these issues with certain companies.

Julie Moret: What we do to help support the research, efforts around that, is we've also, like Sarah was mentioning, built a proprietary platform which is essentially ingesting, at the moment we have something like 17 different ESG data sources which are ingested into a technology platform. What we're interested in is dis-aggregating all that information into the raw inputs so that we can start to create proprietary scores and signals by blending that information with our own fundamental research. This enables us to just get deeper on the actual research around ESG.

Julie Moret: Second to that, we've also kind of built out a centralized engagement tracker which enables us to capture and quantify in a much more scalable manner and targeted manner, the types of engagement activities we're having globally on certain topics and certain issues. And so, all of this together combines to, in our organization, continue to further evolve and deepen the actual research capacity around some of these latent issues and risks.

Julie Moret: With regards to your second question on how the data is used to meet different client needs, it's interesting because often the ESG field is referenced as being a spaghetti soup. There's lots of different acronyms, they're used interchangeably. When you look at the issues and the topics under each of the ESG pillars, they're relatively consistent in the sense that under environment it's typically climate emissions, CO2 emissions, it's biodiversity issues under the earth, human capital issues.

Julie Moret: What leads to the variability is the manner in how that information is used to meet different client goals. And so for instance, we will look at this data set and for the conventional strategies we have, where using that information as really part of the fundamental research in providing an additional input or the mosaic and how we assess ultimately intrinsic value of companies, and investors who are interested in aligning their investments with their values, whether those are religious, ethical, or whichever issue.

Julie Moret: The pool of ESG information is then used to identify certain companies or sectors that go against the values that a particular investor wants to be exposed or not exposed to and it becomes much more of an exclusionary criterion. Where we continue to see more and more client, interest is the utilization of the ESG data set for thematic or impact investments.

Julie Moret: And there within thematic investments an example of that would be the allocation of capital towards certain companies or issuers who are providing solutions to some of the sustainability challenges. As I've mentioned, whether those are doing more with less, whether that's alternative energy sources or the components that go into building solutions for say better water efficiency in certain production cycles.

Julie Moret: Another example on the impact investing side is for clients who are actually wanting to allocate capital in a way where they actually want to drive positive outcomes and certain environmental or social considerations. A particular example of that would be allocation towards social housing or education, where there's a very targeted direction in how that capital is allocated to actually drive improvements in certain areas.

Julie Moret: So what we typically tend to find is that variability is an outcome of the different ways in which ESG information is used to serve different investor needs and profiles. And for us, I think it's very much about really understanding the motivations behind clients and what they want to achieve.

Jenna Dagenhart: And to really take the pulse of what investors need and what they're looking for with ESG Sarah, you did a global investor survey. Could you share some of the key takeaways with us?

Sarah Bratton Hughes: Yes. I think the most interesting one for me is this dichotomy you have between the US and Europe. And the light has been shone on diversity over here this year, given all the inequality protests that we've had. But it's actually been a longstanding divergence between I would say Americans and Europeans where Americans are more likely to think that social issues like pay gaps, like women on boards such as fair treatment of all workers are just as likely if not more likely to drive return over the long-term than addressing some of these environmental issues.

Sarah Bratton Hughes: And we actually, Schroders, we see it from a corporate perspective as well. And I always find this interesting as I have a peer over in Europe. The questions that they get asked about clients at Schroders at a PLC level is all about our commitment to environmental issues. The questions I get asked over here about Schroders, our own sustainability profile, is all about our diversity issues So we continue to see this in our global investor survey of that coming out.

Sarah Bratton Hughes:  Also, what we continued to see is this driving an increase in demand from gen X. Actually in 2019, we saw demand from gen X increase over that of the millennials. I know, surprised us too. But if you think about what was happening in 2019, it was the year of Greta. So, you had all of these children walking out of school protesting against the climate and then coming home and asking their mom, their dads, their grandmas, their grandpas, their aunts, uncles, friends, what are you doing about your environmental profile?

Sarah Bratton Hughes: And I think that gen X really took a good look at themselves and the younger generation questioning them, and that was really driving a lot of that demand. What we saw in 2020 was actually an increase in gen X. We also saw growth in the baby boomers as well, really to double down on what Brie had said earlier.

Sarah Bratton Hughes: One of the interesting things, and we've talked about it, millennials didn't say they wanted to sacrifice return by investing sustainably. There was always this narrative about you had to sacrifice return to invest sustainably. But what we found was that the millennials were actually the most likely group to invest against their values, contrary to what you've seen out there in the market. So just a couple of interesting tidbits we've seen again on this demand side.

Jenna Dagenhart: That's pretty interesting. How should financial advisors be digesting and interpreting these results, Sarah?

Sarah Bratton Hughes: Well, I think if I put myself in a financial advisor's shoes, I think ESG is actually a great opportunity to continue not only your current book of business, but also grow that book of business. If you think about it, and we haven't hit on this yet, but ESG itself is inherently longer term in nature. And if I'm a financial advisor, I want my clients to start thinking about their return profile for five years rather than this period of short-termism that we are in right now.

Sarah Bratton Hughes: But also what we've seen on this market, and I think is something that is a little bit... Also, what we've seen in this market, and we've talked about it, is the increasing amount of product that we've seen coming to market and, or conversions. And I think financial advisors really need to understand what they can expect of their sustainability product they have in markets.

Sarah Bratton Hughes: Something that we're investing heavily here at Schroders to industrialize is fund level sustainability reporting. So no longer okay for us just to tell you we're investing sustainably, it's about showing you we're investing sustainably. And it's not about our sustainability team putting out some glossy report, it's actually about looking at what is the impact that my investments are having over the long-term.

Sarah Bratton Hughes:  And I think as those impact reports, I would be surprised if we were the only firm that was investing in this. But I think over time, as you're continuing to see those come out, that's also a driver that's going to shift some of these capital because we always say it's not just about how much money you make, it's about how you make that money.

Sarah Bratton Hughes: And when you put that piece of paper in front of somebody, it really turns impact into a third dimension of risk. So, if you think about how... and we're seeing it more and more as these externalities that companies create, being passed back onto them in the form of cost. I think people are really going to wake up, that this is actually a value driver. It's not about values, it's about long-term value creation.

Jenna Dagenhart: Great points. And Brie, for clients who are adopting ESG investing, how are they approaching incorporating ESG into portfolios?

Brie Williams: Definitely. And just to underscore a point that Sarah had made about the takeaways for the advisors, I mean, they really are going to be the change agents here in helping not only provide the additional level of education that the individual investor requires to navigate this space and stay in it for the long haul, but help them realize how they don't have to have the trade-off and they can use some of the metrics that both Julie and Sarah had referenced as a way to integrate more thoughtfully how that information can enable better decision-making.

Brie Williams: So when we talk to our clients in how they're shifting their adoption of ESG investing, the change we've seen, which has been brought up in our conversation earlier, you do have that shift from being thematic, the more pure values based or SRI style of investing. And it's been transitioning more towards this incorporation of all three ESG metrics.

Brie Williams: And essentially, in that case, you have financial materiality, those ESG metrics by industry, and they're showing us how it can mitigate risk and improve long-term performance. So, with the scoring data that Julie was talking about, when you have more ESG data providers investing in developing ESG scoring solutions, the more companies will prioritize reporting and disclosure. And that's necessary for our continued success with ESG investing.

Brie Williams: With this continuing to evolve, the opportunity associated with it will change right along with it. And we're right now in a position to focus in on those financial materiality so distinctly because of the increased reporting in non-traditional areas, and that's already been in motion, but again is so central to our success moving forward. Because it's the lens they need when you're talking about things like value creation and an impact on one's investments, depending on what their motivations are, be those extrinsic and, or intrinsic.

Jenna Dagenhart: Julie, what do you think has informed the view that ESG means sacrificing performance? Why does that view even out there?

Julie Moret: Right. That's a great question. More often than not, it's the question that keeps coming up. And it's always considerably surprising when you see the growth in empirical research that shows the correlation between companies that perform sustainably and the impact that it has on actually lower cost of capital and when they're going out to the debt markets to refinance that debt.

Julie Moret: And so we believe that part of what's driving that misconception around ESG having a negative performance impact is tied into some of the early day kind of concepts around just screening. And so, a tool whereby you avoid risk by screening your investible universe, which inherently, depending on the scale of screening that you do, you effectively shrink down the ability for you to invest in certain sectors. And so ultimately, I think part of that notion has been informed by really the view that, well, if you take out chunks of the index, you narrow your ability to invest and you narrow your upside opportunity on the alpha side.

Julie Moret: And really the ESG integration approach flips that on its head somewhat and says, well, if we take a step back and we look at some of the big mega trends happening in the world, generally, whether those are just increasing amount of air pollution, water pollution, rising CO2 emissions, or whether that's aging population, growing population or the millennials, one can look at those as essentially drivers of change that actually they're economic issues.

Julie Moret: You look at the World Economic Forum's risk perception survey, and you look at the direction of travel on some of these issues, they're high probability and high risk. Looked at it through those lenses, beyond being just environmental and social considerations, they are actually economic issues that are potential drivers of change, which makes them absolutely relevant for any investor to understand from a risk and return perspective.

Julie Moret: It also enables investors to use these metrics and these different perspectives as a means of an additional tool to really differentiate between who are going to be the winners of tomorrow that are able to navigate their business and business models and also capitalize on some of the shifts that we're seeing in consumer behavior, which again, reflects in investor behavior preferences.

Sarah Bratton Hughes: I think that's super interesting, Julie, too. Because we spent a lot of this time talking about the impact of ESG on corporates. We, like both State Street and Franklin, manage a whole variety of asset classes going from plain vanilla equities into private assets. And we've talked a lot about it. And if you think about what some of those risks can mean for countries out there, for muni and you need tools and data to help you assess the sustainability of those as well.

Sarah Bratton Hughes: So my favorite tool we have here because it was developed here in our New York office is our muni dashboard. And we have over 47 different indicators across ES and G. And the environmental indicators aren't just isolated to the physical risk, we also take into account issues like air quality. It can take years off of people's lives.

Sarah Bratton Hughes: If you live in an area that has poor air quality and you're elderly, you have small children, you're probably going to move. And the social issues, it's not just the demographic things. We'll look at school districts, rising crime. And if you think about it, muni are long life investments. So, it's really important that you're looking at some of these trends.

Sarah Bratton Hughes: And everybody always asked about the governance and if we make a call on one party versus the other, no, we don't. We're looking at pension liabilities. We're looking at pension liabilities, we're looking to see if one party controls are dominant because things are more likely to get done. We're trying to avoid some of the gridlock that you can see if you have a divided government.

Sarah Bratton Hughes:  So I think we've spent a lot of time talking about corporates, but I think it's also important to understand that we're utilizing these tools across our different asset classes and it's not just, oh, you've built this great muni dashboard for this. Well, we'll take our securitized loan book and overlay it to understand, do we have any physical risk within our loan book?

Sarah Bratton Hughes: So it's about using this data, using these tools because these issues like climate change are continuing to rise up as risk. And I think we've all lifted in 2020. We've seen what a pandemic can do to our supply chains and we can see what a pandemic can do... We've all lived it in 2020, and we can see what a pandemic can do and how it can disrupt both industries and governments and the cost it can have on society globally.

Julie Moret: So just to chime in, so some of the concepts that you mentioned are really interesting because sometimes taking a step back, we do wonder we have a healthy debate within our organization where whether ESG information is in some magnitude a recognition that there are pressure points and latent risks, that through societal pressures are actually bubbling up and actually can potentially represent reputational and franchise risk.

Julie Moret: And of course, again, that's the other side of risk, which is always which companies are actually navigating and managing to those issues very well. I think it's also interesting the influence of social media and the fact that a lot of these issues are getting much more publicly and instantly dispersed, which helps shape and inform the generational thinking actually, whether it's young or old, but the instant nature in which there's a proliferation of further information that has consumers and investors better informed, has a role to play in also influencing investor behavior on some of these issues because they become much more sensitized.

Sarah Bratton Hughes:  You just brought up a great point that we saw in our investor survey. And it's really interesting because we looked at a number of different factors like; do you recycle at home? Do you drive green vehicles? And there was only one factor that all generations agreed on and had over 50% in understanding of that factor, and that was, I do not shop at companies that have had... or I try to avoid corporate companies that have a scandal.

Sarah Bratton Hughes:  And you think about how that scandal is amplified now compared to how it was five years ago, 10 years ago, never mind 15 years ago, these costs or these externalities that companies create are becoming more and more important. And I think about it because I'm going back to something you said earlier, Julie and I love the term you used. I think you said it was pre-financial when talking about some of these sustainability risks, and I'd love that rather than the term nonfinancial.

Sarah Bratton Hughes: Everybody always thought, oh, these are nonfinancial. Actually, they have the ability to materialize as financial risks really quick. And if you look at the 10-Ks of the hundred largest companies here in the US, every single one of them has an ESG risk within their 10-K. So, if it's important enough for them to put in their 10-K, it's a financial risk probably, or a pre financial risk as you put it, I love that term.

Jenna Dagenhart:, is there something you wanted to add?

Brie Williams: I just think what the global pandemic did, if there's any silver lining to it whatsoever, is it shined a light on those issues that we don't normally experience on a sustained basis and in exposed, very real vulnerabilities. So, to Julie, your point of social media, as an influencer and a connector, globally we've experienced a lot of shock events and the aftereffects within the last decade in a very real and tangible way because of digital communication.

Brie Williams: And it has changed, to point again Julie, the generational thinking and response to how do we not do that again, or what type of change can we influence in very real time? And I think that that has really put forward a lot of the motivators in a different way for the ESG investor.

Brie Williams: And I think that is an inspirational factor when we think about what's changed from ESG investing, where you can take something that's not a positive event, like the global health pandemic, and you can see where the good actually can come out of it, where companies have to shore up relations with their communities or tightened up what happened because they weren't prepared properly from a continuity planning standpoint and, or the impact from a supply chain position.

Brie Williams: That is something normally that you would not find on social media outside of the news outlet and you have every day individuals casting opinion about it, and they're talking about it. And that is helping create the change that they want to see, they expect to see when they invest a dollar and choosing which company gets it, whether that's an investment or to your point, Sarah, where they shop or don't.

Sarah Bratton Hughes: I love that Brie. That is a concept we discussed a lot here on corporate karma, right? These events, how you treat your workers in a time like this now, what you've done in terms of providing a service to society during these times. We think we'll come back and reap either... well, hopefully reap rewards if you behaved in the right way over time.

Sarah Bratton Hughes: And we've done a lot of work thinking about the silver lining of COVID, and we've been really pleased with some companies and how they have really stepped up to the plate and used COVID as an opportunity to really reset them in terms of sustainability. So, we've got a number of companies within our small cap portfolio. Smaller caps tend to have poor ESG scores. A lot of that has to do with disclosure and not having the IR resources.

Sarah Bratton Hughes: But we had one company, it was a services company that really stepped up and took the opportunity to show themselves and shine in this crisis. So historically they maybe had a poor culture with how they treated their employees. And during this time, although they did have to have some layoffs because they were in a food services industry, they ensured that their workers all kept their benefits.

Sarah Bratton Hughes: They also had a uniform services industry that they completely transformed their lines very quickly to manufacture PP and E. And actually, in the city of Chicago they held the lunch school contract there and they continued to provide lunches to the children of Chicago during the pandemic. So, for us, these are all indications that they were really committed, and they're really committed to sustainability over the long-term.

Sarah Bratton HughesAnd we feel like management's ability to pivot, management's ability to treat all stakeholders fairly are really going to be rewarded over the term. So, I would say from a corporate perspective, there have been examples of what we call saints. We also have a list that we've kept that are COVID sinners. And I would say that there's probably one name on there that constantly goes back and forth, and it's our good friend Amazon. So, it's a hotly debated topic here, is Amazon a sinner or a saint in how they prove themselves through the COVID crisis?

Jenna Dagenhart: And to all of your points, so much of a company's value is tied up in those intangibles. It's not strictly cash flows on the balance sheet. So, a scandal or a damage to our reputation can be really damaging. Julie?

Julie Moret: Yeah, I think that's a great point. What we've seen generally is the valuations of companies, particularly those companies in the fans are really increasingly driven by intangibles. And it's actually those intangibles that capture brand, reputation, R&D intellectual capital. And when you pivot back to ESG information, ESG information is essentially trying to provide insights and capture metrics and data that provides some type of valuation analysis.

Julie Moret: And so I think absolutely a strong case is that as corporates and companies' valuations more and more shift away from physical to these intangibles, it poses a question whether the valuation models that are used today essentially need to be recalibrated to include much more of these intangible pre-financial indicators.

Brie Williams: Julie, just adding on to that, that's actually an area we see clients struggle with when it comes to ESG investing. Because when you think about it, for all investors using ESG to inform better decision-making, like you were referencing, it starts with having the right data and that ability that we all need as investors to obtain clear and standardized ESG reporting is essential to continued success, as well as the acceleration of adoption continuing to be in such an upward trajectory.

Brie Williams: So there's a lot of work needed, which you both have mentioned Sarah and Julie in terms of a consistent framework for companies as well as index providers, ourselves as asset managers. But those current limitations are certainly not a reason for anyone as an investor to be sitting on the sideline. And I think all of us would agree wholeheartedly that we must not make the perfect the enemy of the good.

Jenna Dagenhart: And as we wrap up this panel discussion, I want to spend a little bit more time on your outlooks for ESG in 2021 and beyond. Julie, what do you think are the key themes that will shape the industry moving forward?

Julie Moret: There is just so much momentum within the general ESG field. If I had to narrow it down to some of the key themes, at the industry level our viewer is that number one, we'll continue to see an acceleration of regulation, particularly around increasing transparency, disclosure, reporting. Number two, we'll continue to see an acceleration in climate related themes.

Julie Moret: What will be interesting to watch and keep our eyes opened on is beyond climate transition there are some underlying themes such as water and biodiversity, which are increasingly coming up the pipe in terms of our client conversations. I think human capital issues, certainly, which has been amplified by COVID, there's a lot more research work and disclosure data required there, but that's certainly going to be a critical theme going forward.

Julie Moret: And finally, I'd say on the impact on SDG aligned side, we continue to see active interests from our investor and our client base there. And really just on the broad ESG topic, what we're seeing at the sophisticated end of the spectrum is really a pivoting towards ESG in alternative asset classes, such as private equity and hedge funds. And we think that's an area that's under explored, and particularly in a low yield environment can offer some benefits to end investors that are really looking for the intersection between alts and a more sustainable form of investing.

Jenna Dagenhart: Sarah, could you explain the concept of quality of jobs as well as the implementation process for quality jobs? What's your outlook like there?

Sarah Bratton Hughes:So this is a big theme that we're exploring here, and I think it's very timely as we saw our grocery store workers become essential workers and really thinking about the people who are in these industries that may not be making a fair wage have access to benefits, thinking about do they have a reliable schedule? Is there equal opportunity for people to advance in it? Really this concept of treating your employees as assets instead of liabilities.

Sarah Bratton Hughes:  And the numbers are actually shocking on what disengaged workers can cost an economy each year. So, Gallup has estimated that disengaged workers cost the US economy about 350 billion. And I think this concept of quality jobs, employee engagement, human capital management, especially as we come out of this COVID crisis in 2021, is going to continue to have tailwinds that go with it.

Sarah Bratton Hughes:  As we start to see maybe some of the fallout, the unintended, the fallout of these risks from COVID that hadn't actually born themselves yet, what is the long-term implication that COVID has had on mental health, working from home, the issues around cybersecurity? So, I think there's a lot of these S issues in 20, although the policy is more focused on the environmental issues, the policy that we've seen come out, I think there's going to be a continued focus on these S issues moving forward into 2021.

Jenna Dagenhart: Brie, what do you think lies ahead for ESG investing?

Brie Williams: So I think Sarah and Julie have done a great job hitting the key points. I think the one that's worth emphasizing when you look at a real key driving factor behind the surge in ESG investing to date really comes down to the demand from investors for clarity when it comes to a company stance on those S issues, the social issues. Because that has a significant consequence, especially financially on how that company will stand or fall if it fails to adapt to the way consumer behavior is adjusting.

Brie Williams: And I think we have much work ahead of us to continue this momentum and the opportunity that lies in this space, especially if we want to be able to position ourselves to achieve those long-term sustainability targets. But the fact that we have this growing focus from the investor, it's really starting to have an impact.

Brie Williams: And our origin may have begun with that morals being at the forefront here. The society evolution that's underfoot only highlighted again by the global pandemic that has started off our current decade, it's become an important metric. ESG is viewed as imperative when you start looking at a company's future and its potential as a competitive player in their industry and the role that it has, whether it's a solo stock investment you're making, or an index solution in the part that it holds there.

Brie Williams: So when I think about our current environment, it highlights the importance of integrating ESG factors into the investment decision-making and I don't think that's going to go away. That said, we have to recognize the other side of the coin. We have a very harsh light right now that is shining on how much work we have to do.

Brie Williams: When we think about taking the data and moving to consistent standards where possible and whittling down our wide ranging definitions, to take a deeper dive into the insight of what this really is about and what it really means for clients, what it really means for their portfolios and holding fast to this being about value and values without compromising the approach in how we utilize it to improve decision-making.

Jenna Dagenhart: And Sarah, looking at the next four years, is the incoming administration potentially good news for ESG? Given some of the president elect Biden's views on the environment, diversity, for example, he's appointed John Kerry as climate czar, and this marks the first time that an official dedicated to climate change will sit on the National Security Council.

Sarah Bratton Hughes: I think my pounding on the table earlier might have given you a little hint into my opinion of this, that yes, I do. And I think it's a great way to end. I do think the US really has the ability to drive sustainable investing through the next four years. We've seen policy roll backs under the current administration, we've seen the DOL ruling around sustainable investing, around fiduciary duty come out recently.

Sarah Bratton Hughes: And I think that we are in for a real transition in policy with both Biden and Harris having proven records of climate justice. And I always go back to... I didn't find it ironic that Harris signed onto and brought the Climate Equity Act to the floor just four days before she was appointed the nominee for VP. So, it's definitely on the agenda.

Sarah Bratton Hughes:  Although the climate issues get a lot of focus, a lot of the social issues that we've touched on here are also in the forefront, whether that is medical issues, whether that is our first increase in minimum wage since the Obama years and how that is going to potentially impact some of these industries that are already reeling from COVID will be something interesting.

Sarah Bratton Hughes: I always say the wild card is what happens in Georgia, and we won't know that until 2021, and I'm not going to make a political call either. So, having a closed eye on Georgia to see actually how much of these bills will really push forward. But I do think that there is more bipartisan agreement on some of these issues now in post COVID world.

Jenna Dagenhart:Well, don't worry, we won't ask you to call the election or anything. But final question here, Julie and it's kind of a loaded question. What's the ultimate end goal of ESG?

Julie Moret: Very simply, to take better informed investment decisions with ultimately the end goal is the prospect of improved risk adjusted returns for really the end investor. It's as simple as that.

Jenna Dagenhart: Well, everyone, thank you so much for joining us, and really great to have you.

Julie Moret: Thank you.

Sarah Bratton Hughes:  Great to be here.

Brie Williams:A pleasure. Thanks for having us.

Jenna Dagenhart: And thank you for watching this ESG Masterclass. I was joined by Sarah Bratton Hughes, head of sustainability, North America at Schroders, Julie Moret, global head of ESG at Franklin Templeton Investments and Brie Williams, head of practice management, global spider business at State Street Global Advisors. And I'm Jenna Dagenhart with Asset TV.