In Episode 1 of The ESG Update, CEO of Change Finance, Andrew Rodriguez, joins the pod to discuss how millennials feel about responsible investing and the impact that a proposed rule from the Department of Labor may have on ESG funds in retirement plans. Andrew and host Dan Carreno also discuss the relationship between ESG and investment returns.

Transcript

Dan Carreno:
Welcome to the ESG update presented by change finance. I'm your host, Dan Carreno. I’m the head of business development at Change Finance. We are an ETF provider dedicated to environmental, social, and governance investing, and our mission is to help investors align their portfolios with their values without sacrificing returns. This is the first episode of the ESG update, and for this one, we're going to stay pretty close to home. My guest is the CEO and Chief Investment Officer at Change Finance, Andrew Rodriguez. 

The first thing that we're going to do is review a few current events in the world of responsible investing. Andrew was going to provide his perspective on those, and then in the second half of the show, I have asked Andrew to discuss the lingering issue in the world of sustainable investing about how ESG or SRI oriented portfolios perform relative to traditional portfolios.

Andrew, you ready to jump into the agenda? All right. So first article that we're going to cover this week comes from MoneyWeek, titled “ESG investing provides shelter in the storm.” This segues a little bit into the second half of the show, but there are some interesting stats here about, just in the short term, how ESG portfolios have performed relative to their traditional counterparts and relative to indexes. What they have found is that in the first quarter of the year, according to Morningstar, 85% of domestic ESG ETFs outperformed, and 100% of foreign developed market ESG ETFs outperformed during that period. It also says that ESG funds were the only equity funds to show positive flows during the drawdown. They attribute many of these good statistics to the fact that ESG funds, on average, tend to be overweight growth stocks, quality, and healthcare. And they tend to be underweight capital intensive industrials and energy stocks. There was also information here about Professor Chendi Zhang from the university of Exeter Business School who performed a study in the first quarter of 2020 and found that companies with high ESG ratings outperformed low ESG scoring companies by about 7.2%. I'll close with a quote from Professor Zhang, who said that ESG policies are "as valuable in creating resilience as cash." Andrew, what do you think?

Andrew Rodriguez:
That's quite the quote there at the end. Really exciting to see. It reminds me of the Bank of America report that was put out last year on ESG, where they said that they were considering ESG factors to be as material as fundamentals when considering an investment. What a wild world. When I started in this industry, in every other conversation, I was talking about whether or not the kind of investing we do would underperform. And now the biggest players in the world are pointing to the fact that it's been outperforming, which is exciting to see.

Dan Carreno:
It's been a big shift in a short period of time.  What I was thinking when reading this article is that ESG funds have posted positive inflows during a year when pretty much all other products have not been able to do that. If they continue to perform this well, how much is that trend going to accelerate as we move forward in 2020 and into 2021?

Andrew Rodriguez:
Wall Street is driven by capital. It's why we love it, why we hate it. If money is going to be made in sustainable and green investing, then everyone's going to be doing it. It'll just be investing at that point. I wouldn't be surprised to see more and more of this investing going on. In fact, we're already at one in every four dollars invested this way here in the U.S. that's professionally managed. I see that climbing.

Dan Carreno:
So we'll move on to the the next article. This is a report that came out from MSCI. It's titled “Swipe to Invest the Story Behind Millennials and ESG Investing.”

This is a very statistic heavy report, so I'll try to limit the numbers that I'm reporting here.  Just to give you a few highlights, it says that 90% of millennials want to tailor their investments with their values. The millennial generation is now 79.4 million people, and they are in line to inherit about $30 trillion in wealth.  And about 43% of affluent millennials are currently working with a financial advisor, which I think really flies in the face of the perception that younger investors are more likely to do their investing online or through robo advisors. In fact, this particular report says that only 20% of affluent millennials are using robo advisors compared to the 43% that are working with financial advisors.

Andrew Rodriguez:
That is fascinating. I'm guessing that has at least something to do with the affluence comment. I haven't gotten the impression from even my favorite robo advisors that they are yet able to provide the more sophisticated types of transactions and investments that folks would be used to. This general trend towards ESG and sustainable investing, being important to millennials, is something we've seen for years. Morgan Stanley does their own report, and it was saying that 95% of millennials are interested in investing this way. And actually 63% have already started to allocate their portfolios accordingly. So it's really interesting to watch. The 2008 recession provide millennials with their first big understanding of markets and their financial future. Many of them that I spoke to in those early days were avoiding ESG because they were so worried about returns. But now I believe people are getting to a point where they're fed up with how many things are at an edge, at an edge that's not good for any of us. So, I would imagine given what we're seeing right now, this is going to grow even more from here. Going from that 95% on up, we only got a few people left to go, but it seems like all of us in society are starting to move this direction, saying enough is enough.

Dan Carreno:
The other stat that I thought was really interesting from the report is that, on average, millennials exhibit higher inflation-adjusted income per household than previous generations, including generation X and millennials. Of course, that being because we're often looking at dual-income households compared to single-income households in the past. Just something else to consider when we think about how quickly millennials may end up accumulating wealth and how they want to invest it.

Andrew Rodriguez:
This wealth transfer is the biggest in human history. There's always some level of conversation about just how money inflates, but it's still $30 trillion moving hands right now in the U.S. And the assets invested with some sustainable screen is $12 trillion, according to USSIF and as of 2018. Here is almost three times that amount of money going into the hands of a population who is driven to invest this way. I think we're going to see things move a lot over the next decade.

Dan Carreno:
All right. Moving on to the last article here. This is from Pensions and Investments titled a “DOL Proposal, Reinforces Fiduciary Role in ESG Investing.” Disclaimer here, neither myself nor Andrew are ERISA attorneys. We are not the most qualified to discuss fiduciary roles, but I thought it was important to include this particular article because this is a developing story in the world of ESG investing and how it applies to retirement plans. This proposed rule, which is coming from Labor Secretary Eugene Scalia, is largely viewed as being somewhat hostile to ESG funds and their potential inclusion in retirement plans. But there is a quote from a senior department of labor official from the article that I wanted to share. And it says to the extent that a particular ESG factor is relevant to an investment decision, it is appropriate for an ERISA plan fiduciary to consider that factor. So the proposed rule is stating that plan sponsors need to focus on performance and financial interests first, but I believe that if we see more data come out that shows how ESG is correlated with good performance, that there is going to be a rationale for advisors to continue to recommend these types of investments for retirement plans. What do you think?

Andrew Rodriguez:
It's frustrating to see. Certainly, I'm going to have a bias towards this sort of investing, and nobody should be all that surprised. We see this even in the work we do with folks getting pension plans to divest. There is this pushback at every turn because companies will get excluded based on bad behavior, and it seems to have taken on a partisan angle. The push back is held up as if it's beneficial for the average person in one of these plans. That they just want to make sure that they're going to get the most money possible by the time they retire.

In a way, the Trump Administration did the opposite of the very beginning of the administration by removing some fiduciary rules that prevented advisors and others from selling plans that had expensive kickback fees for them. So that was taken out, and then this is put in. My worry is that it's left really broad so that people will get scared. The legal definition that they're drawing is so broad, it's hard to include one and know that you're safe. One of the pieces that were in this article, a quote, was saying that this would likely make it impossible for an ESG fund to be included as a default selection. So a new employee is going to be forced into some fund that isn't ESG on purpose. It seems like there is a goal to prove that ESG works and not to prove that not ESG works as well. So I think it's set up to support funds that aren't like this. And honestly, these haven't been performing as we've been talking about this whole podcast. I actually think this will be bad for people on aggregate.

Dan Carreno:
We'll leave it there, but suffice to say that this is going to be an evolving story. It'll be interesting to see how this goes. We'll continue to touch on this story in future episodes. I plan on having some guests on in the future that do specialize in the retirement plan space who can probably give some additional insights. So we're going to move on and transition to the second part of the podcast. We already touched on some of these themes in discussing the current events, but as I mentioned before, the reality is that there is a perception that ESG data and ESG-oriented portfolios do not perform as well as traditional investment portfolios. This has been a stubborn perception in the industry now for a long time, even though there's quite a bit of data coming out to refute it. So Andrew, how do you feel about this lingering concern, and how should investors and financial advisors think about the relationship of ESG and performance?

Andrew Rodriguez:
This has been a story the whole of my career. Although, I'll say it's been coming up less and less over the last number of years. I had a client once when I was running SMA strategies who signed on the dotted line, had moved their assets, and then said, “Hey, Andrew, all right, let's talk, honestly, what under-performance will I get. Tell me the truth.” I think that was 2014. We were telling them, no, we have no expectations of lesser returns. If anything, we expect to outperform, and so you should have that assumption. And this was a tried and true activist from the sixties, who cared deeply about the subject and even for them, it was a story. What I'd say is there's been a lot of studies done at this point about ESG investing. Some show that it outperforms. Some show that it doesn't. The best report for people to go and look at is about five years old at this point and from 2015. 

That a study was done on ESG investing across about a thousand smaller studies and found that it was material and that factors and investing along ESG factors lead to outperformance over not considering them. You would think that would have settled it on the spot, but, it's just rising now. Hopefully, we'll get this done by 2025. That'll be the end of the conversation. 

Dan Carreno:
I'm glad that you mentioned that meta-study because I've been in the financial industry long enough now to know that if you are attempting to make a case, or maybe sell a particular type of product, you can find and slice up data in any way that you like in order to support the case that you're making. There's always going to be one study here to support one side of the story, another study over here to support the contrary opinion. But in order to get a good sense of what's really going on, you have to look at the aggregate of all the studies out there.

Andrew Rodriguez:
I can't wait for the day when we all are on the same page. If you're going to make your thousand bucks with your values, or you're going to make your thousand bucks in companies that don't reflect them. I think if you're going to make the same money, either way, people are going to choose to invest with their values. We're going to see a lot more of this investment going forward. People can sleep better at night while still getting their needs met in terms of what they're investing for. Very exciting to see.

Dan Carreno:
Fantastic. I know that you also referenced earlier in the pod some data that came out from Bank of America late last year in 2019 which is also helpful data showing the degree to which ESG really helps investors avoid a risk. So if you're avoiding risk, you're also going to positively contribute to returns. I will also say that there are some resources on the website of Change Finance, which is www.change-finance.com, under the Insights tab, that can help educate and make the case around ESG and investment returns. One piece in particular is titled “The Benefits of Responsible Investing.” For the listeners that may want to read additional information, I would encourage you to please go to the website and see if you can find that particular document. So, we'll close it out there. And I want to say thank you for listening. And for those that appreciate the information, we would ask you to like the podcast, to share it with colleagues, friends, family, and we will be back soon with episode two and some more updates about what's happening in the world of responsible investing. Andrew, thank you very much.

Goodbye everybody.