George Gay has been working to effect positive change through the capital markets for 35 years. He joins the podcast this week to share his perspectives on the evolution of the SRI / ESG industry and update us on his firm, First Affirmative Financial Network.

Transcript

This transcript has been edited for clarity.

Dan Carreno, Change Finance:
Welcome to The ESG Update presented by Change Finance. I'm your host, Dan Carreno. I am the head of business development at Change Finance, and 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. Joining me on the podcast this week is the one and only, the OG of SRI, if you will, George Gay, CEO of First Affirmative Financial Network. George, Happy Holidays. How are you doing today? 

George Gay, First Affirmative:
Thank you so much, Dan. I'm doing well. It's a busy time, but exciting. We're happy to move forward and happy to be with you today. 

Dan Carreno, Change Finance:
Well, thank you for being on again, and we're going to follow our usual format here. We're going to talk about a couple of current events, a couple of articles that we've selected, and then I wanted to ask you some questions about what's going on at First Affirmative these days. But before we launched into any of that, I just wanted to back up for one second, because you have been doing this work for as long as anybody in the industry. I wanting to ask how you feel about things and how you see the industry evolving over these last couple of years? 

George Gay, First Affirmative:
Thanks Dan. I've been here at First Affirmative for 34 years. We started doing SRI in 1988. We hosted the SRI Conference for 30 years. It's one of these 32 years to become an overnight success things. I was fortunate to come into the industry and participate in a lot of things with the real pioneers of the industry. Many people who have either passed on or retired now, like Amy Domini, Peter Kinder, Joan Bavaria, people like that. And I think everyone would look at what's happened in the last couple of years and say that we’ve finally found words that resonate in the marketplace with ESG: environmental, social, and governance, as compared to SRI, which was socially responsible investing when I started and then became sustainable, responsible and impact investing. But ESG is was caught on. Unfortunately, as I’m sure we'll discuss, ESG has become less clear, less well-defined than socially responsible investing used to be. When you look at who is using ESG and what they're actually doing with it, there are big differences. We see a lot of money going to products that say they're doing ESG or say they're concerned about climate change, yet it’s hard to figure out why they own what they own. So as we go into the marketplace, we try to help people who care about issues distinguish between investment products and services that match their values and which ones don't.

Dan Carreno, Change Finance:
That's a pretty good segue into our first article, and it's coming from Pensions and Investments. It is titled “Investors Beware of ESG Fund Ratings.” The author here is making a comparison between some more traditional fund ratings that are out there, such as Morningstar's star rating system, which are largely based upon quantitative data, and ESG ratings that are coming to the fore these days. Different companies are adhering to different disclosure frameworks such as SASB or others. And not all companies are disclosing data equally. These discrepancies filter down into how funds are being rated. The author gives two examples of companies that are in very different industries that are getting extraordinarily different ratings from ESG rating companies. We should also mention that a lot of these ratings are not taking into account shareholder advocacy and proxy voting practices. So, this seems to be a little bit of a thorny issue in the ESG world over the last few years. George, how do you think about this? And do you have any advice for folks that are trying to do more ESG business and navigate some of these discrepancies? 

George Gay, First Affirmative:
I've tried to come up with a quick, pithy sentence about this, and essentially ESG is data. What ESG ratings do is they'll tell you which tobacco company is the best run or which gun company or which oil company is the best run, but it won't give you very much information as to whether you really ought to invest in tobacco companies or gun companies or oil companies. And what has happened with these ratings is that big companies have the resources and motivation to report, and small companies don't. What will happen is you might have some wonderfully run small companies that don't have the resources to fill out the 50-page questionnaire that comes in, and they'll score poorly. Early on when ESG first came out, one of the most surprising companies to us was Monsanto, which of course now is owned by Bayer. Monsanto had a very good ESG score because they took the time to fill everything out, and to some extent, they gamed the system. On the other hand, Monsanto was, despite what they did for business, a pretty well-run company, at least for a period of time before they started getting sued an awful lot. You still see that today where it's very hard for a small cap or mid cap fund to get a good sustainability rating because the companies that they own don't take the time or don't have the resources to do the reporting. And in some cases, they might have to report on things that aren't even part of their business model. Intel can make a report about how much water they use, but a small software company, they use how much water comes into their office building. It's an area where you have to understand what it is they're measuring and what the intent is. When you look at SASB versus Sustainalytics versus Morningstar, you see dispersion between ratings because they do it in a different way. The emphasis is on different things. How people use data is different. What MSCI uses their data for is primarily to sell indexes to exchange traded funds, whereas Sustainalytics uses their data to feed the Morningstar engine. Those are two very different purposes for data. You have to pay attention to all those things and have some understanding of what they measure and why they measure it to determine what the outcome is. 

Dan Carreno, Change Finance:
Do you think we're getting better on this front as folks agree on frameworks like SASB? 

George Gay, First Affirmative:
I think SASB is the place where you're most likely to gain traction on standards. Actually, there was an article that just came out last week about how ESG is going to be about accounting. So, once you get accounting standards and companies to agree, then companies are going to have to pay as much attention to this as we do. I like what SASB is doing. Here at First Affirmative, we look at several sources of data, but we feel that SASB is the one that's going to help to standardize the playing field. 

Dan Carreno, Change Finance:
I'm sorry for the listeners out there that maybe aren't familiar. I always try to make a point not to throw out acronyms without clarifying what they mean. With SASB, we're referring to the Sustainability Accounting Standards Board.  George, I appreciate your feedback on that particular article, but let's keep moving along. The other one that I wanted to get your opinion on is a new Morningstar report that just came out a couple of weeks ago titled “The Morningstar ESG Commitment Level: Our First Assessment of 100-plus Strategies and 40 Asset Managers.” Morningstar has reviewed a number of asset managers and funds and has classified them as being either an ESG Leader at the top of the pack, as being ESG Advanced, which will be the second to best rating; Basic would be the second to lowest, and then finally the bottom would be a Low rating. And it appears as though their goal here is to determine the degree to which asset managers and funds are internalizing ESG principles and living by them as opposed to greenwashing. So George, I'm sure you had a chance to read the report. I'm curious to hear your thoughts and your feedback on it. 

George Gay, First Affirmative:
Well, the first thing I want to do is compliment John Hale at Morningstar. John has been a leader in getting Morningstar to pay attention to this. I've known John for a long time. I remember him speaking at the SRI Conference 15 years ago. As Morningstar became more and more interested in sustainability, John became a larger and larger influence. Early on, our position with Morningstar was that it is wonderful to rate things, but you have to understand intent, and this report looks like their initial effort to evaluate intent. Intent includes not just how you use the ESG data to pick stocks, but how you use your proxy votes, how you use your ownership position to negotiate with companies. There are two scopes of the ESG. Some people want to use ESG to gain a few basis points of alpha and reduce a few basis points of beta, and some people that want to use ESG to make the world a better place. And there is marketing and greenwashing. I'm happy to see Morningstar begin to evaluate intent. I have to admit looking at this report and mentioning a mutual fund's name is not a recommendation for investing, but on this report, getting a low rating is American Century. I was surprised. American Century is a family of funds that we're familiar with. They're partly owned by a non-profit organization, so most of their revenues go to support cancer research. I was surprised to see them get a low score. On the other hand, the highest scores were a couple of names that we've known for a long time: Calvert and Parnassus. It's going to be interesting to see how this develops. If you're big enough, people manage to what you measure, and Morningstar is big enough that people will manage to what Morningstar is measuring. So as long as Morningstar stays committed to looking at sustainability in ESG and intent, some of these funds that are using the ESG label as a way to sell product, sooner or later, they're going to get caught. I look forward to the next generation of this process with Morningstar and to see whether John continues to be as front and center as he's been the last couple of years. Morningstar owns Sustainalytics, so they've got a fairly deep bench for research, and it's going to be important to see how they use it. 

Dan Carreno, Change Finance:
I tend to agree. I think this is a great development in the industry, and it really speaks to where we are after all the traction that ESG has had over the last few years. Now we are at a place where people are not just looking for one product that fills one particular asset class that says ESG on it. We are at a point where we can really start thinking about the intentionality behind the products. We can start getting deeper into it. It's great to see Morningstar stepping into the space and doing this work early on. It should be really valuable for investors. I've had a number of folks on the podcast lately that weren't too happy to see some funds label themselves as being environment or climate change forward. Then news comes out that this company is using all of their proxy votes to reject climate-related shareholder resolutions. Then that creates uncomfortable conversations with clients. So this can help start separating that out and help people avoid those more uncomfortable situations. 

George Gay, First Affirmative:
You have to differentiate between what people say and what they do. Proxy voting and advocacy have been things we've been active in. We vote all of our client's proxies. We have proxy voting guidelines on our website. We have a shareholder advocate on our staff who works with our clients and with our partners in the industry. We participate in 10 to 15 shareholder actions a year. It's a very important part of the process of positive corporate change. If you don't match your proxy votes and your advocacy efforts with what you say in your marketing materials, you're going to have a problem at some point.

Dan Carreno, Change Finance:
Another really good segue. Let's start getting into First Affirmative a little bit. So obviously, there's a little bit of a preview in terms of what the organization does on the shareholder advocacy front, but let's back up for a second. For a financial professional that's out there that is not familiar with First Affirmative, uh, what's the first couple of things that they should know about the firm?

George Gay, First Affirmative:
First Affirmative started doing socially responsible investing in 1988. It is our essential business. That's why people come to us. We currently support about 70 advisors around the country. We are what was called a third-party asset management provider. Advisors refer their clients to us so that we can handle the management of the investment process. They rely on our due diligence research. We managed mutual fund portfolios. We have 25 model managers that run separate account models. We are slightly below a billion dollars in assets under management, and hopefully, we’ll be back above that billion-dollar level here in 2021. As I mentioned before, we hosted the SRI Conference for 30 years. This year it, unfortunately, had to be canceled. Of course, when we go into the other thing that we aren't responsible for it anymore, but we do intend to remain in the event space in the coming years.

Dan Carreno, Change Finance:
Can you elaborate on that a little bit? In terms of what's been happening with the company in the last number of years?

George Gay, First Affirmative:
First Affirmative was an independent firm until 2016. At that point, we sold the business to a firm now called Folio Financial. And earlier this year, it was announced at Goldman Sachs entered into an agreement to acquire Folio. We thought at first that we were going to become part of Goldman Sachs, but partway through the summer, it became clear that it was not a good match that our business, even though Goldman is very aggressively pointed at sustainable investing. From an operational standpoint, it became clear that we weren't a good fit, and once they recognized that, they worked very proactively with us to find a solution. And what ended up happening was when they closed the transaction to buy Folio Financial, they spun the equity of First Affirmative out. We are now a hundred percent employee-owned company and independent again. We're a certified B Corp. We stayed that even while we were owned by Folio and we should get more points now that we're employee-owned; that was a good outcome for us to become independent again. We still have assets at Folio. Folio has some good technologies and really helped us to develop our next product cycle. But we're very, very pleased to be independent again. There is an awful lot to be said to own your own business and have control of your own destiny. You go into a bigger firm, and you hope that you're going to reap some benefits of being in a bigger firm. Sometimes you do. Certainly, we did from a product development standpoint, but in the SRI / ESG marketplace, there's a better level of confidence in us as an independent firm. We feel good about that. Goldman kept the SRI Conference. We'll see what they decide to do with it. I did carve out the ability to run smaller non-competitive events. So we'll still be out there, but I'm not interested in hosting a thousand people anymore. I'd rather have a few hundred people that I know very well and where we can do something very productive. 

Dan Carreno, Change Finance:
Take it back to its roots, right? 

George Gay, First Affirmative:
It started out as SRI in the Rockies, and the main focus needs to be on advisors who work face to face with clients and people who are working to effect change. And those are the folks that we want to maintain in the community. 

Dan Carreno, Change Finance:
Let's flush it out a little bit more for the listeners. So let's say I'm a financial advisor, and currently, I have 10% of my overall book that is starting to ask questions or is invested in ESG strategies. But the writing is on the wall, and we know that this is going to continue to grow. So what tools and resources does First Affirmative bring to bear that are going to help me as an advisor continue to grow this part of my business and help manage it more efficiently?

George Gay, First Affirmative:
When we started, SRI was more about exclusions and avoiding certain kinds of businesses and certain kinds of behaviors. The trick has always been what you do with the money that you excluded? How do you invest that? Early in our careers, we were focused on mutual funds who were the pioneers in the space, and where we had a high degree of confidence in their ability to do research and be activists in the shareholders. When we got involved in separate account model management, we were able to say we can also do some other exclusions. We can customize the account for you a little bit more. But then, still, what do you do with the money? With mutual funds, obviously, you get what you get. But with model managers, if you start overriding their portfolio management decisions, you start to skew the performance and the risk characteristics. The way I put it is you essentially start paying a model manager to not run their model. So the newest thing for us is what we call Affirmative ESG, which is the technology that we helped develop while we were owned by Folio. It has one of the most comprehensive sets of screens, both positive and negative, that I've seen in the marketplace. We have 52, and we're developing more where a client can pick and choose things that they want to support and things they want to avoid. And the algorithm builds a portfolio that has risk and reward levels very close to the target of the marketplace. A client can choose 40 of our client impact preferences and still get a portfolio that matches up very well with market risk and return characteristics. We feel like we've come a long way in solving the question of what to do with the money after you decide what you're not going to own. We feel pretty good about this. We still offer portfolios made up of mutual funds and exchange traded funds because some clients don't want to own 150 individual securities. So if they want to own 15 exchange traded funds or mutual funds, they're happy, but you can't customize the impact as well. The other thing that we have done is we feel like we've made some good strides in being able to measure impact performance so that we can tie a portfolio back to the UN Sustainable Development Goals. You can compare what we can do with what a client has and show that difference. Everybody always said, if you make security exclusions, you're going to affect performance. We've got to the point where when you make security exclusions, you don't affect performance, but you do affect impact. When you consider the Sustainable Development Goals, there are human impacts, and there are natural resource impacts. So depending on what you choose to include or exclude, you can skew your impact. That was one of the most interesting things that we discovered as we looked at accounts based on different selections in the impact preferences. That's been pretty interesting, and we think we can do a lot of things right now that a lot of firms can't.

Dan Carreno, Change Finance:
We're running out of time here. So if somebody wanted more information about First Affirmative and the services that you offer, where should they go and how can they get more info? 

George Gay, First Affirmative:
Our website is www.firstaffirmative.com. If somebody wanted to call me, I'm at (719) 478-7054, and georgegay@firstaffirmative.com is my direct email address. Thank you again. 

Dan Carreno, Change Finance:
Thank you for being on today and for sharing your story and your perspectives on what's going on in the industry. For anyone that is listening that wants to find the articles or any of the resources that we discussed during the podcast, you can go to www.change-finance.com. Our podcast library can be found under the INSIGHTS tab, and links will be provided within that transcript. And of course, if you have any questions or feedback for us here at Change Finance, you can always get in touch with us through the website. George, thank you again for being on. Happy Holidays. Thank you to those that tuned in, and we will be back soon with another episode of The ESG Update.

Disclosures, Definitions & Footnotes

1.  Alpha: a measure of the difference between a fund’s actual returns and its expected performance, given its level of risk as measured by beta. Source: Morningstar.
2.  Beta: a measure of sensitivity to market movements. Source: Morningstar.