The ESG Update Episode 24: Getting Meta on ESG and Financial Performance
Transcript
This transcript has been edited for clarity.
Dan Carreno, Change Finance:
Welcome to the ESG update presented by Change Finance. I'm Dan Carreno.
Brittany Damico, Change Finance:
And I am Brittany Damico.
Dan Carreno, Change Finance:
Brittany and I manage the business development efforts 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. We have been absent for a couple of weeks now. We actually missed an episode in our recording that we had scheduled a couple of weeks ago. Brittany, what happened there?
Brittany Damico, Change Finance:
Well, the temperature had a fierce spike up in the Pacific Northwest, and I had to evacuate my home so we weren't able to record. So we did miss a couple of weeks.
Dan Carreno, Change Finance:
Had to evacuate to air conditioning. So we're moving into a world now where we're having a lot of specific days off for employees to deal with the climate crisis. Right? We've got Brittany moving around there in the Pacific Northwest. We have other employees who have to evacuate their homes every year for fires in Northern California. So, this is the world we're living in. But, anyway, moving on. I wanted to introduce our guest this week, who is a clinical professor of business and society and the Director of the Center for Sustainable Business at NYU Stern School of Business. Tensie Whelan’s center recently published a report titled, ESG and financial performance uncovering the relationship between ESG and financial performance through meta analysis of 1000 plus studies. Tensie, thank you for joining us and how are you?
Tensie Whelan, NYU Stern:
I’m doing well. It's a pleasure to be with both of you. Thanks so much for having me.
Dan Carreno, Change Finance:
Yeah, of course. Thank you. And, we have plenty of questions for you about your work. These kinds of analyses, I believe, are really critical for the financial industry and for us working in the industry to really understand where ESG data kind of fits in the lexicon of tools out there for portfolio management. So I want to really dig into that report a little bit more, but first we were hoping to get your perspective on a somewhat provocative article here from the UK. Would that be okay?
Tensie Whelan, NYU Stern:
Absolutely.
Dan Carreno, Change Finance:
Excellent. So this article comes from a website in the UK called https://capx.co, and it is titled, How socially responsible investing could distort markets and harm the planet. I selected this article this week because we really try to make an effort not to live in an echo chamber at Change Finance. We obviously see the value in ESG data, but we believe it's always important to test our assumptions. So I thought it'd be interesting to look at this article and get the feedback of one of the leading researchers and thinkers in field. With that being said, I did have a little bit of difficulty following the logic of the article. What I got from it was that the rise of ESG is changing incentives for corporations, but it may actually be changing incentives more just to create fancier corporate social responsibility reports than actually creating incentives for companies to do anything that's really meaningful in regards to issues like climate change or social issues. The author goes on to make a point to say that shareholder action is preferable to bureaucratic regulation, but then closes out the article by saying, “The power of ESG has grown exponentially is recent years. It now sets a ‘climate change trumps the invisible hand of markets’ agenda. It has the potential to become another massive distortion moment. I’d much rather see good corporate governance than companies feeding the ravenous ESG panjandrum of conferences, courses, experts and consultants.” So, Tensie, do you believe that there is some unrecognized negative externalities that may come out of the rise of sustainable and responsible investing that individuals like us working day in and day out in the industry may be somewhat blinded by our biases and not see those?
Tensie Whelan, NYU Stern:
So I agree with some of the criticisms raised by the author in that I think when companies focus just on ESG as a corporate disclosure exercise, and actually our research that we'll talk about later, shows this that it doesn't result in performance and improvement. It's a process-based orientation, right? ‘Let me just figure out how to answer yes or no on a variety of these different questions, and then I'm done, right?’ So, and to be clear, I don't think that's the case for all companies, but some do indeed approach it that way. What I disagree with is where he goes with some of his criticisms. So as you read that quote, where he said, ‘I'd rather see good governance’, well, what ESG is, when it's done well, when it's embedded in your corporate sustainability strategy, it is good governance. It's the next wave of total quality management, right? So if you're a company that's dealing with material, environmental issues, such as climate change or material, social issues, such as diversity, or major governance issues, such as corruption, and you don't have good management systems in place where you're actually tackling both the risks and opportunities of that, you're going to create financial challenges for yourself. So for me, I didn't quite get where he was going with the end of it. Other than to, as I said, I agree with the fact that just generating information to generate information is not a good strategy for impact.
Dan Carreno, Change Finance:
Did you get the impression, which I thought kind of strange, was for the author to say that the free market is one entity over here and ESG is this other entity over here and they may be some way at odds. I look at it as ESG being completely part of the free market. They are one in the same. Did you see that? And do you have any perspective on that?
Tensie Whelan, NYU Stern:
Yeah. I didn't really follow the logic there. I believe he was objecting to regulation and bureaucracy as sort of holding back free markets, but we know that free markets without robust regulation and without a way to execute on it, which doesn't mean we love large incompetent bureaucracies, but free markets by themselves, end up with free riders, right. You end up with climate change affecting everybody and nobody taking responsibility for it and all of us suffering. Right. There’s always been an understanding that you need regulation of markets to ensure that they can operate freely in a way that doesn't encourage free riders. I think I missed the connection there in terms of this analysis. One of the challenges that we have right now is that this is so new and that the regulations are a bit clunky. The data challenges are there, it's a new space. There is overclaiming by different ESG investors where they're not clear on what their strategy is, where you don't really understand why they're choosing certain companies. So there are a lot of challenges in the space, but bottom line, what we see is that materially ESG issues need to be managed by companies. They also create real business opportunities. We've done a lot of research around consumer insights. 55% of the growth in consumer packaged goods in the last five years came from sustainability marketed products that were being sold on average at 39% premium, if that is not a business to be part of, I don't know what is. You need to sort of build this into your strategy in a way that makes sense from a business perspective.
Brittany Damico, Change Finance:
Thank you so much. Tensie, that is really incredible. I appreciate your perspective. I couldn't agree more. I would love to hear a little bit more about the report that you and your colleagues published recently, ESG and Financial Performance uncovering the relationship between ESG and financial performance through meta analysis of 1000 plus studies published between 2015 and 2020.
Tensie Whelan, NYU Stern:
Don't you love the title? We got interested in doing this work because the last time any type of meta analysis was done was 2015, and this is really rapidly changing and dynamic because it is so new. We undertook the analysis, understanding what we had learned in the last five years around the correlation between ESG and financial performance. What we did, which was unique from prior studies is we divided the reports between those focused on corporate performance and those focused on investor performance, as we found that merging the two, or mingling the two confused some of the learnings that we needed to have, what we found big picture was that 58% of the studies found that there was out-performance in terms of corporate ESG performance, related to ESG, there was only a 6% of the studies that found a negative correlation between ESG and financial performance. At the corporate level, when we looked at the investor side of things, we found that about 33% of the studies uncovered a positive alpha between investor ESG and financial performance. We found that about 26% of the studies found that ESG investing performed at the same level as conventional investing. So more than 50% either operated at par or with, or generated alpha, and about 14% found a negative correlation. We also did a deep dive into climate literature of which there were far fewer studies, and there we found similar correlations on the corporate side around 50 something percent there too, but we found actually more of an outperformance on the investment side. And one final point I would make is that what's interesting about the investor research is I think it's still relatively new. And because of that, I think there's often confusion around different investment strategies, which obscure and make difficult the data analysis. So they're not distinguishing between concessionary impact investing or ESG integration that focuses on laggards or negative screens or impact investing that is at market rates, but it's high risk because it's P/E or venture capital related. So there's just a mixed generally for almost all the studies. There's not a clearer articulation of that, which is also partially the fault of the asset managers and others offering products, because they're often not clear about what their strategy is. So I think that influences our understanding of the research too.
Dan Carreno, Change Finance:
Super interesting Tensie. Thank you. So I guess, trying to package this a little bit, what would you hope that investors and financial professionals really learn from this research and this work? What are the key takeaways?
Tensie Whelan, NYU Stern:
First of all, clearly there's a preponderance of data and studies that are showing positive correlations, and we need to be moved beyond this conversation of, is there a positive relationship too? There is a positive relationship, let's understand better, what's generating that. And one of the challenges around understanding what's generating that is that all of this research is around correlation, not causality. We really need to understand that causality and what the challenge is when you talk to the corporates and try to understand what's under the hood, what we find is they're not actually tracking the return on their sustainability investments, they're tracking their ESG and they're tracking their financials and they're not bringing the two together. For that reason, there's real challenges around their strategic direction. Cause they're not really understanding the value creation opportunities in terms of intangibles, as well as tangibles. So we've developed a methodology called ROSI (Return on Sustainability Investment), where we've been working with automotive, pharmaceuticals, apparel, agribusiness, a variety of different, international brands around really understanding where the value is being created through, ESG at a corporate level, which then obviously becomes useful to investors. So as an example, with automotive, we signed for one company that their waste reduction strategies was generating a total benefit to annual of $235 million, which they did not know because they hadn't looked at the total benefits because they're not set up to do that. So as an example, automotive companies now are recycling their paint and solvents when you recycle your paint and solvent. So you no longer buy the version stuff, you no longer have the waste disposal costs. And actually you have some leftover to sell. Nobody was pulling together, all that sort of operational efficiency data to understand the benefit. Another example is an outerwear company. What kind of value is that driving in terms of employee productivity and retention? And what we found is that there was a total benefit of about $34 million, about 5% of payroll in terms of higher retention rates and higher productivity as a result of that. So that's the kind of analysis that we need companies to begin to do, and investors should begin to demand that companies are tracking that. So then we'll be ever better able to understand where value is being created.
Dan Carreno, Change Finance:
So, where do you think we are in terms of that research? Should we, as investors expect in the next year, three years, five years, that we're going to start seeing more research and more analysis dedicated to causality, as opposed to just showing the correlation?
Tensie Whelan, NYU Stern:
I hope we will. I think one of the ways to get there is for investors to begin to demand that information. Because again, as I said, right now, they're asking for them separately. And that means that corporations are going to have to put a new systems in place to actually track this data because they're not currently set up to do so. Also we've seen that traditionally, although this is changing, the CFO has not gotten involved in the ESG data collection. And again, generally sustainability people are doing that ad hoc, filling it out of Excel spreadsheets, trying to find the data. So I think this whole question around, first and foremost, embedding sustainability and ESG into your corporate strategies, but then putting in place those metrics to track the financial returns, as well as the impact returns, investors need to be demanding it, and probably pressure on board to demand it. Boards need to be demanding it to help with their decision-making. So I think if investors begin to do that, we will be in to see far more understanding of this and more research on it with that data, and more impact on the bottom line as well as on society.
Dan Carreno, Change Finance:
Well, I guess as a final question here, do you, at this stage, believe that there is enough data that it's really influencing corporate managers at a systemic level where folks are now saying this is not just about creating the pretty CSR reports? Is it tangible to make these types of sustainable changes to the business model and result in benefits to the bottom line?
Tensie Whelan, NYU Stern:
Yeah, I've been working in this space for plus 25 years. I would say in the last five years, there's far more recognition by companies around the upsides of this, but while both managing for downside in terms of risk, but upside in terms of business opportunity. That said there is still a view, as we heard from that first article, a lot of naysayers, a lot of companies who are doing it just because they're being asked to or for CSR reasons. I don't think we have sufficient momentum yet because as we're not still in the kind of scaling up that we need. To get that scaling up, you need that real understanding that this is a business case. I can create competitive advantage. I can create more employee recruitment, I can create more innovation. I can create more operational efficiencies. I can reduce my risk. I can increase my supply chain resiliency, all of those things that, again, this good management through sustainability can do. I think beginnings of understanding, particularly as for companies who've been working on this, in this space for five or 10 years. The newcomers, I think they're still doing it just because they're being asked to report on the data. Like we heard from that first article. And they need to move beyond that and that, and that's where these cases will help us hopefully begin to help those companies understand and investors understand that this is a business imperative.
Dan Carreno, Change Finance:
My God, I have so many more questions for you. I could keep this going for so long, but we can't, we're running out of time so we have to start wrapping it up. Again, thank you for your perspectives, your comments and the research that you've done. It's really, really critical to us in the investor community. Before we wrap up, though, we do want to just take a minute to share what is interesting and inspirational in our lives personally. We’re going to do that Around the Campfire. And as usual, I guess, we'll start with you, Brittany, when you are sitting around the campfire with friends and colleagues, what are you going to be chatting about?
Brittany Damico, Change Finance:
So, one thing that I've never mentioned around this campfire is that aside from promoting conscious capitalism with you, Dan, I am also a certified yoga instructor and I've been teaching a little over nine years. I'm certified in Hatha, Vinyasa, yin and therapeutic styles. I also taught trapeze for a couple of years, which was incredibly fun. But, recently I've been hearing a lot about post-pandemic burnout and people's anxieties relating to reentering society. And I think now, more than ever, it's really important to focus on mental and physical wellbeing. For me, that means spending a lot of time in the water and digging deeper into my practice. So lately I've been exploring a way to do both. I got a paddle board about a month ago and I’ve been having way too much fun taking my practice off the mat and onto the water, which takes it to a whole new level, but it's been a really great way to enjoy the water, focus on being present, breathe in all the fresh air, build some strength, and then most importantly, find that playfulness that I think can get lost in our day to day, as we're getting back to the grind, going to work and feeling those anxieties. So, I wanted to reach out to any of our listeners who are in the Northwest area, specifically Seattle region, that if anybody's interested in joining me, I'd be happy to lead a very beginner, paddleboard, yoga. And again, just to get outside socially distant, but if anybody's interested, I'd be more than happy to facilitate something like that. If you want to reach out to me, you can contact me directly at my email and it's Brittany.damico@change-finance.com
Dan Carreno, Change Finance:
Excellent. So cool. Wish I was in that neck of the woods. Not that I can actually do yoga on a paddleboard, but I could try. Tensie, how about you?
Tensie Whelan, NYU Stern:
Well, first of all, I do I Iyengar yoga a couple times a week, cause I needed to de-stress myself. Thinking about doing a paddle is incredibly intimidating, so I'm very impressed. I have to say I'm both, sorry and I'm glad I'm not on the west coast. Cause if I was, I would have to try it and then I, yeah, I'd fall off. But anyway, in terms of an Around the Campfire kind of idea, I thought maybe I'd share that I've been lucky enough in my career and life to spend a lot of time in the field talking to people who create the stuff that we consume. So let's just talk about coffee for a minute. Coffee is the second most traded commodity in the world after oil, I mean most of us love coffee. I don't know that we think about the lives of the people who produce that coffee. In my previous role, I spent time with coffee farmers who were bringing sustainability to their coffee production. So just to give you an example, I remember meeting with a young man, a Colombian coffee farmer and he had just been sort of working with us around bringing sustainability to the farm, which meant wildlife protection, soil, quality management, reforestation, better quality coffee, and showing good livelihoods for the people who work there. He said to me, “coffee is something that people, my generation, have left, you know, it's seen as something your grandparents do. It's not very sexy or exciting”, but he said, “for me getting involved in the production of sustainable coffee, I feel like I'm contributing to the patrimony of my country. I'm providing good, important jobs for people I'm protecting these different species of birds”, these migratory birds that were living there on his farm. He said, “I'm proud to be part of this. And most importantly, I'm proud to know that people around the world care about my coffee and are buying my coffee because of what I'm doing here.” So I just wanted to share with people the inspiration of thinking about from a sustainability and people perspective where all this stuff comes from, that we rely on, that we eat, that we wear, that we, drive around in and appreciate and support those folks who are really putting their heart and soul into producing it in a way that is sustainable, that provides long-term employment and environmental stability globally.
Dan Carreno, Change Finance:
God, this is like a tough act to follow. You guys are really bringing it around the campfire this time around. I feel like mine is not nearly as interesting. Thank you, Tensie. I guess just to round it out, I just wanted to mention that I, for better or worse, I was born a lifelong skeptic and I generally don't take anything at face value. And with that in mind, I just have to mention all these news reports about this report that came out recently from the Pentagon documenting approximately 140 cases of very serious individuals, Navy pilots, seeing these objects, surrounding aircraft carriers out in the Pacific ocean and in different areas. Historically I was always the first one to say if it's a UFO sighting or, you know, somebody saw a ghost, I was the first one to naysay and say, that's not possible, but you know, with the amount of data that they're showing and the fact that all of these things are being picked up on multiple instruments, this is one of the first times in my life I feel like I really can't think of a rational response or answer to something like this. And it's a weird place to be. There is like something out there that we just have no idea what it is. I'm not sure how to think about it.So with that being said, we will wrap it up there. Tensie, thank you again so much, not just for coming on the podcast today, but for the work that you're doing, I'll say it again, totally critical to the work that investors like us are doing in the capital markets. I do want to remind anyone who is listening, if would like to find any of the articles or resources that we discussed during the podcast. You can find those on our website, www.change-finance.com underneath the podcast library. All the links will be in the podcast transcript. And of course, if you have questions or feedback for us, you can always get in touch through the website. So thank you to those that tuned in, and we will be back soon with another episode of the ESG update.
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