Episode 9 : 10/12/2016

Guiding the social and environmentally conscious investor

Dawn Wolfe

Director, Responsible Investing
BMO Global Asset Management


Matt Smith
Managing Director
BMO Global Asset Management

Ben D. Jones
Managing Director – Intermediary Distribution
BMO Global Asset Management

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Guiding the social and environmentally conscious investor

Socially Responsible Investing (SRI) is gaining traction in the United States and around the world, as more investors seek to align their personal beliefs regarding environmental, social and moral issues with their investment preferences. New research and data on SRI has shown that it can make long-term financial and economic sense rather than just moral sense or social impact. Our guest for this episode is Dawn Wolfe, Director of Responsible Investing at BMO Global Asset Management. She discusses what socially responsible investing means, the different facets of SRI and considerations for advisors with social and environmentally conscious clients.

In this episode:

  • What investments say about the investors
  • When to start considering SRI
  • How to evaluate financial performance of socially responsible investments
  • The changes announced by the Dept. of Labor ruling in October 2015

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Dawn Wolfe – So the US market is the fastest growing market for responsible investment dollars.  You’ll see the two fastest growing strands are areas of interest when it comes to responsible investing is with millennials and with women.  I think if you are thinking about intergenerational wealth transfer and really serving the clients coming up through the pipeline, just to give you an idea on this study among high net worth millennials that are surveyed, 93% consider the social and environmental impact of the companies they invest in to be an important part of the investment decision-making.  So this is absolutely on the growth trend and this is something that this generation of asset owners just thinks naturally should be incorporated.

Ben Jones – Welcome to Better conversations. Better outcomes, presented by BMO Global Asset Management.  I’m Ben Jones.

Matt Smith – And I’m Matt Smith.  In each episode, we’ll explore topics relevant to today’s trusted advisors, interviewing experts and investigating the world of wealth advising from every angle.  We’ll also provide actionable ideas designed to improve outcomes for advisors and their clients.

Ben Jones – To learn more, visit us at bmogam.com/betterconversations.  Thanks for joining us.

Disclosures – The views expressed here are those of the participants and not those of BMO Global Asset Management, its affiliates, or subsidiaries.

Ben Jones – Socially responsible investing is known by many names.  You can shorten it to SRI, or use another acronym, ESG.  That stands for environmental, social, and governance.  No matter what you call it, SRI is gaining traction in the United States and around the world.  More and more people see it not just as a nice-to-have option, but as a key part of their investment strategy.  New research and data on SRI has also shown that it can make long-term financial and economic sense.  Not just moral sense or social impact.  My co-host Matt Smith sat down with Dawn Wolfe, the director of responsible investing at BMO.

Matt Smith – Dawn, thanks for being on the podcast.  Let’s start with a little bit of your background and how you got into socially responsible investing in the first place.

Dawn Wolfe – Well, Matt, after my undergraduate career, I spent a few years working in primarily the non-profit sector.  After a few years of that, I really wanted to see how I can marry my passion and interest in things like environmental justice and social justice with something more traditional in the business world.  And when I went to graduate school, I came across a program that maybe some of your listeners are familiar with called Net Impact.  It’s common on a lot of business school campuses across the US.  And as it name implies, it’s really about a net positive impact the business can have on society.  And that is really when I became aware even of the field of responsible investment.  So after my graduate work, I moved to a small SRI boutique that focused really on high net worth individuals and endowments and foundations that were really driven to invest in line with their values.  And then I moved to a larger firm based out of London.  F&C Investments, where I spent a lot of time doing shareholder engagement work with US corporations.  And then to BMO GAM, where I’m really enjoying working side by side with a lot of portfolio managers on how they can integrate ESG into their investment processing.

Matt Smith – If you have 10 people what socially responsible investing means, you’re going to get 10 different answers.  So first, let’s get a baseline understanding of the different meanings and approaches to SRI.

Dawn Wolfe – There are lots of different approaches that you can take to implement a responsible investment strategy.  Obviously, depending on the ultimate goal of the client is going to lead you to the one that is best suited.  I think a responsible investment, if you go back to what is often cited as the beginning of this field, is really about avoidance.  So it’s saying we’re going to avoid certain sectors, companies, issues, areas that do not align, ultimately, with my values.  There is a lot of symbolic power to divestments, to avoidance.  But many people would say that isn’t going to go that extra step of ultimately changing the behavior of a particular corporation or issue because it would have to be on such a massive scale for divestment or avoidance to have that type of impact.  So if you kind of keep moving down the spectrum of what is responsible investment, you would come, next, to a field that’s grown probably much more rapidly in the last 10 years compared to if you go back to the avoidance and the anti-Apartheid movement, which is ESG integration.  And that’s really saying we’re going to take a broader view of risk and opportunity by looking at environmental factors, social factors.  Like I mentioned often include community impacts, labor impacts, and key corporate governance issues.  And incorporate that into our decision-making.  That’s certainly an area.  There’s also, within the world of responsible investment, you can think about thematic-type investing or impact investing.  So we’re all seeing different things like water funds or climate change.  Climate opportunity funds fit into that space.  And then there’s engagement, which I think is a really important piece of what makes up or defines responsible investment and can really be applied in any of those different approaches, whether it be avoidance, integration, or impact.  And that’s saying, as a holder of a particular security, I want to use my voice to affect change.  And, really, as I said, in any of those different areas, that’s something that can be undertaken.

Matt Smith – I mentioned in an earlier podcast a quote that I got from a book by Meir Statman, who’s a professor of finance at Santa Clara University.  And he said in his book, What Investors Really Want — that’s the title of the book.  He said that investments give people three things.  They give them utility, which is the ability to grow their assets and what they can do with the money.  There is an emotional value, how they feel about their investments.  And the third one is what their investments say about themselves, their expression with their investments.  And so I think that socially responsible investing covers that third area.  Some people want to express themselves through their investments.  Taking a step back for a second, it’s important for an advisor to clarify with their client, what is their goal.  What are they trying to accomplish with their investments.

Dawn Wolfe – Absolutely.  And Matt, like we mentioned, responsible means different things to different people.  And really, it’s what, ultimately, is drawing them to this space.  Is it because they want greater values alignment between their portfolio and either their organization or their personal beliefs.  And that often falls into the avoidance category.  Although what we’re seeing more and more is that, if that ultimately is the goal of the client, to avoid a particular area, there’s also often an interest in kind of layering on the opportunity to tilt towards or to favor different areas that are important to them.  Whether it be in the environmental realm, the social realm, or around good governance practices.  So that’s kind of two ways in understanding, ultimately, what the client wants, which path to take them down.  Within the impact space, I think that is kind of the one area where a client might prioritize the social or environmental impact of their investment over the return.  And that’s an area where clients may be more willing to look at concessionary-type investment opportunities, because the ultimate goal really is on the social impact as opposed to something like a values alignment or integration, where we would expect to see financial return kind of on par with traditional or mainstream investments.

Ben Jones – So socially responsible investing started with avoidance, where you divest a particular asset that doesn’t align with your values, principals, or beliefs.  You also have integration, which incorporates broader data when making traditional investment decisions, like environmental or economic impact.  Impact investing is the only facet of SRI that may not have a financial return that is on par with traditional investing.  The impact of a water fund, for instance, is more important than the financial return.  Finally, you have engagement, where you choose to engage with an asset you’ve invested in in order to change behaviors towards your values.

Matt Smith – SRI, or ESG investing, has many different facets.  But before we go further, I asked Dawn about why some advisors might be hesitant to look into ESG investing for their clients.  Investing well is difficult to begin with.  And adding ESG investing creates another layer of complexity, especially with the feeling that socially responsible investing might not add greater returns.  Why would it make sense to explore this investing approach in the first place?

Dawn Wolfe – Investment is hard.  It’s hard to do right and it requires a lot of skill.  I don’t think, whether you’re talking about fundamental style investing or small cap or large cap or quantitative strategies, it’s all a level of difficulty that requires a tremendous amount of skill to do well.  I don’t think this is any different, really, than any other type of strategies that you might consider.  I think, certainly, with ESG integration — so taking those environmental, social, and governance factors, and wanting to integrate it into investment analysis is adding additional rigor.  And I don’t think any of our clients would say that is a bad thing.  You’re going to take your traditional financial analysis and add the sustainability lense to that to give you a more complete investment picture, a more complete picture of total risk and opportunity as it relates to these drivers.  It’s, if anything, more rigorous.  It does require a tremendous amount of skill to do well.  I don’t think that’s a bad thing.

Matt Smith – Earlier, when Dawn was describing her background, she mentioned F&C, a UK-based asset management company that was a pioneer in ESG investing.  BMO acquired F&C a few years ago, bringing its history of more than 30 years of ESG investing experience into BMO Global Asset Management.  I asked Dawn about the ESG investing market in Europe and the United States, and where the most growth is happening.

Dawn Wolfe – Well, as you mentioned, F&C started the first socially screened mutual fund in the UK over 30 years ago.  And we do have this long history there.  So Europe remains the home to the largest tranche of responsible investment dollars in the world.  What we know from groups like the US Social Investment Forum is that the largest market in terms of growth is the US.  So while Europe still remains the largest market for socially responsible investing, the fastest growing market is the US.  So they do a bi-annual survey trying to track these dollars.  And we know — the last one was in 2014, so we’re expecting the 2016 soon.  But the best data that we have so that there’s over $6.5T in US domiciled assets that are currently engaged in responsible investment strategies.  Which is a significant number in itself, but if you look back compared to the 2012 same survey by the US SIF Foundation, that’s a 76% increase.  So while we still trail Europe by a fair amount, it’s certainly the largest growing market.

Matt Smith – Yeah, that’s interesting.  In preparing for this podcast, I also took a look at research that I could find.  I found the Callan Investment Institute conducted a survey of ESG, and they have for several years.  And in their report that was released in December of 2015, they reported that 29% of their respondents to that survey incorporate ESG factors into their investment decisions.  And that was up from 22% two years prior.  I’m talking about institutional funds, but that’s another data point to show the rapid growth in this.

Dawn Wolfe – Yeah, I think that’s exactly right.  It’s a small base.  We’re still looking at the overall picture of investment dollars in the US market.  We’re still talking about a smaller slice of the pie, but absolutely a growing piece as the Callan survey and others are demonstrating.

Matt Smith – So now we’ve gotten the lay of the land and can understand, at a macro level, what’s happening today in the world of ESG investing.  But what prevents people from starting?  Is there a point when it’s too little to be effective?  Dawn and I discussed a starting threshold: Evaluating financial performance and fiduciary responsibilities.

Dawn Wolfe – I think, like so many things in life, the hardest part about, whether it be socially responsible investing or anything, is just getting started.  And what will prevent a lot of asset owners that may have a strong passion or interest in this area from doing this is a sense that it’s overwhelming and that they would have to allocate every dollar to some specific sustainably oriented strategy.  And so I think — what I always encourage advisors to do in terms of talking to their clients is to carve out a particular piece of the asset and allocate to something whether it be avoidance or ESG integration or impact or whatever the ultimate goal is.  And then once you get started, to continue to grow and be seeking the opportunities that are out there that match this financial rigor that you’re looking for, but also the social return and social agenda that the client is interested in.  So I don’t think that there is an area that’s too small.  And I think getting started is the key.

Matt Smith – Let’s talk about how to evaluate the financial performance.  First, let’s just talk about the financial performance of funds.  What is your recommendation on how advisors should evaluate these funds, the performance of these funds going forward?  Should they be using specialized indexes for that part of the portfolio, or should they just treat them like any other part of the portfolio for that given asset class?

Dawn Wolfe – Well, certainly within ESG integration.  So that’s saying we’re going to take our traditional financial analysis; we’re going to add the sustainability analysis and it’s going to give us a more complete picture to help up make better investment decisions.  This is something that we would expect — and all of the recent and good academic data will show you — that you should expect results at least on par with traditional funds.  And in some cases where the ESG integration or sustainability lens is really skillfully applied, we’re seeing cases where you’re actually experiencing ESG alpha.  So absolutely, within the equity and fixed income space, we shouldn’t be thinking about this as concessionary.  And if you’re looking at a US large cap portfolio with a sustainability bent, you should be comparing that against the S&P 500.  I want to make sure that we’re not confusing, again, the ESG integration strategy or approach to responsible investment and sustainability with avoidance.  So, yes, tobacco companies are incredibly profitable, right?  If you’re looking at just the balance sheet of the tobacco company.  If you look at a group like CalPERS — they’re interesting because they’re reconsidering their decision to divest of tobacco industry because of the lost revenue that they’ve seen over the past years.  Are you going to step back and say, A, I disagree.  Tobacco is a product that, when used as intended, kills people, and so it’s something that does not align with my values.  You see this a lot.  For example, hospital systems that divest or avoid tobacco because of a values alignment issue.  But I think that these are groups that are also saying let’s step back and take a look at the big picture and ultimately what these deaths and disease are costing us as an economy.  And so if that’s the approach that you want to take at looking at something like tobacco where you’re not just looking at the returns on a specific security, but the ultimate cost to the economy, then it does make sense to continue to shy away from those particular industries.  But that, again, is different than ESG integration.  And we’ve also talked, for example, about engagement.  I know of many asset owners that will continue to hold tobacco companies and have been very aggressive in engaging them on, for example, their marketing to youth.  Their marketing in other countries as tobacco uptake in the US begins to decline.  So there are many ways to approach this in a “responsible or sustainable way” that isn’t just avoidance.

Matt Smith – So you mentioned several things, and I think this is a really good part of the conversation, particularly since advisors could be dealing with a client who just comes in the office and says, I’ve a family member who died of lung cancer and I do not want any of my investments supporting those companies.  So I’m telling you screen out any manufacturer of cigarettes.  The advisor might have more than one approach to that.  First of all, that might be a very difficult thing to implement.  First of all.  If you’re looking at buying mutual funds to put in the portfolio, right?

Dawn Wolfe – Right.

Matt Smith – But it’s not — avoidance isn’t the only way to attack this.  Like you said, engagement might be a more effective way to get to the same goal.  And so this is what we were talking about earlier.  Have a discussion with your client about what really is the goal here.  And are we going to be able to accomplish our goal better by avoiding these companies who, quite frankly, have access to capital globally, as much as they need.  So your avoidance might not make an impact as opposed to something like engagement, which might have a better impact.

Dawn Wolfe – That’s exactly right.  And, again, it all goes back to understanding what your client ultimately wants.  If it is — you share a personal story about a family situation, the desire to not hold or support, with their own personal capital, a tobacco company is strong enough that they’re going to say, I don’t really care that I may be giving up some performance in order to not hold these tobacco companies.  If it’s to change the way a tobacco company operates, then you want to hold and engage.  I would also point out that if you look at the data on performance, when it comes to responsible investment strategies and look specifically at screening and avoidance, what we’ve seen, what academic studies show, is that over longer time horizons, any difference that you see as a result of holding or not holding that specific company dissipates over time.  And so, again, at the end of the day, you generally end up in the same place.  It’s a good time to own oil, it’s a bad time to own oil.  So you’re going to ride that and feel that volatility more.  But over 10 plus year time horizons, the data demonstrates that that all evens out.

Matt Smith – Well, and maybe — I’m going back to the Callan study and maybe part of what we’re seeing in this statistic is that, in the Callan study, 61% of their respondents said that they felt like engagement was more effective than divestiture or screening out.  So maybe that’s what we’re uncovering there is maybe it’s better to hold the entire asset class and then go engage with these companies because now you’re a shareholder and you have a voice, and you have a chance at getting an audience.

Dawn Wolfe – That’s exactly right.  Divestment is a very blunt tool.  You’re selling off your shares and someone else is buying them.  And someone who probably doesn’t care as much as you do.  But if it is so personally opposed or against your values, then that makes perfect sense for you.  If you want to hold and engage, that can certainly be a powerful way to say I’m going to work with the organization to improve its performance in a particular area.

Matt Smith – Many of our listeners also deal with accounts that fall under ERISA.  For instance, 401(k) plans.  And fiduciaries of ERISA plans, they’re held to a higher standard.  They’re held to a standard that they have to act with the exclusive benefit of the participants and the beneficiaries.  Is it okay, then, for them to integrate these factors into their decision-making?

Dawn Wolfe – Matt, it is, and I think this is one of those outdated myths that continue to persist that ESG issues are non-financial.  So you would be breaching your fiduciary duty to incorporate them into your decision-making right?  But if we think about resource scarcity, stranded assets, human capital management, the market now recognizes that these are not immaterial or not non-financial factors.  There’s actually a growing consensus today that failure to incorporate these types of issues that I just mentioned, like resource scarcity, stranded assets, human capital management, into decision-making may, in itself, be a breach of fiduciary duty.  And you see that concept gaining a lot of traction in places like Europe, which generally start there and then we would start to see it here.  Just last October, the Department of Labor issued an amendment to its ERISA guidance that really recognizes this.  And it, of course, does not change the definition of fiduciary duty.  It remains on risk and return.  But what it says is that ESG issues — material ESG issues should be part of that risk and return analysis.

Matt Smith – When I look at the Department of Labor ruling of October 2015 about ESG, they’re basically saying, look, taking into consideration socially responsible factors in your decision-making within ERISA plans is perfectly fine.  You’re not held to a higher or lower standard for that particular factor.  There’s lots of factors that you use in choosing any investment, and that is a valid factor to consider.  They also, just for our listeners, you talked about there’s a lot of abbreviations used — the Department of Labor uses an abbreviation ETI, which stands for economically targeted investments.  And that’s just their terminology for funds that use social responsibility as one of the factors for determining their investments.

Dawn Wolfe – That’s right.  There’s a couple more things I would say on the DOL ruling.  You’re exactly right in terms of what came out in October 2015 was really received by the market and those of us in the responsible investment industry as removing this sort of chilling effect.  So it wasn’t a huge sweeping change in the definition of a fiduciary duty, but it went back to that 2008 guidance that really unduly discouraged fiduciaries from considering ETIs and ESG factors and said that we don’t need to do that anymore.  So it removes this chilling effect.  And if I could, I would just read a piece of that amendment where it says “fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny, merely because they take into consideration environmental, social, or other such factors.”  So I think that’s exactly right.  What kind of — we had put a higher hurdle or this chilling effect across the idea of ETIs and ESG, is now taken away.

Matt Smith – Great.  I’m sure that that will be a relief and of interest to the advisors listening who deal with — whether it’s 401(k) plans or they might between fiduciaries for profit-sharing or defined benefit plans.

Ben Jones – Hopefully, Dawn’s dispelled a common myth once and for all, that ESG investments are non-financial.  In fact, you heard her say that, if executed in an expert manner, ESG integrations have been shown to create an ESG alpha over time.  With the Department of Labor ruling, among many other things that Dawn shared with you, you should be feeling better prepared to explore ESG approaches with your clients.

Matt Smith – Dawn and I ended our interview by summarizing a few action steps that advisors can take to start implementing ESG strategies.

Matt Smith – We try to, in every podcast, summarize what are the actionable steps an advisor can take.  And what I heard was, first, it’s important to discuss with your client, where does this objective fit in their priority.  So whether you have a formal investment policy statement or it’s just part of the objectives that you have written down in the file for your client, you want to understand, for socially responsible investing, where is this in terms of priority?  Is it the primary priority?  Or is it a secondary?  Or are they equal?  So that’s the first thing.  Make sure you have a clear understanding and agreement with your client, where does this fit in your priorities?  Second, help them clarify their goal.  What are we trying to do?  What’s the objective?  And then that leads to the approach, whether it’s this avoidance or integration or engagement, that will help you lead to what the approach is.  And then based on that information, then you have enough to start looking at funds and evaluating which funds might be appropriate to put in their portfolios.  Did I get that right?

Dawn Wolfe – That’s exactly right, Matt.  And I think that, on that last point of going back and then looking at what the opportunities are, we’re in such an interesting and growing time right now in terms of opportunities in this space.  Because I think, 10 years ago there were a lot of pioneers in this field who absolutely wanted to do this with every dollar and in every asset class and there really were no options, for example, to do socially responsible investing and fixed income.  Today, you have many opportunities.  New product is being created to meet this market.  You certainly have to do you’re due diligence, but I think the opportunities are growing.

Ben Jones – Well, we hope the opportunities grow for you as you continue to explore these investment strategies, as well as the other practices you’ve discussed on earlier episodes.  A big thank you to Dawn Wolfe for her time and experience on this topic.

Matt Smith – For show notes and links from this episode, visit bmogam.com/betterconversations.  That’s bmogam.com/betterconversations.  This episode was produced by the Freedom Podcasting Team, as well as our BMO GAM team, Pat Bordak, Gayle Gibson, and Matt Perry.

Ben Jones – Thanks for listening to Better conversations. Better outcomes.  This podcast is presented by BMO Global Asset Management.  To learn more about what BMO can do you for you, go to bmogam.com/betterconversations.

Matt Smith – We hope you found something of value in today’s episode and if you did, we encourage you to subscribe to the show and leave us a rating and review on iTunes.  And of course the greatest compliment of all is if you tell your friends and co-workers to tune in.  Until next time, I’m Matt Smith.

Ben Jones – And I’m Ben Jones.  From all of us at BMO Global Asset Management, hoping you have a productive and wonderful week.

Disclosure – The views expressed here are those of the participants and not those of BMO Global Asset Management, its affiliates, or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, or security.  This presentation may contain forward-looking statements.  Investors are cautioned not to place undue reliance on such statements, actual results could vary.  This presentation is for general information purposes only and does not constitute investment advice and is not intended as an endorsement of any specific investment product or service.  Individual investors should consult with an investment professional about their personal situation.  Past performance is not indicative of future results.  BMO Asset Management Corp is the investment advisor to the BMO funds.  BMO Investment Distributors LLC is the distributor.  Member FINRA SIPC.  BMO Asset Management Corp and BMO Investment Distributors are affiliated companies.  Further information can be found at www.bmo.com.

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