Canadian Sustainable Investment Forum

Kelly Gauthier, our Managing Director and Partner, spoke with Bloomberg Toronto Bureau Chief Jacqueline Thorpe at the Canadian Sustainable Investment Forum in Toronto.

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Transcript

[Jacqueline] I’d like to introduce our panelists. We have Nalini Feuilloley, who is the Director of Responsible Investment Team at BMO and Kelly Gauthier, who is Director of Impact Advisory at Rally Assets.

Let’s start with some numbers, because we are Bloomberg after all. There’s something like more than $30 trillion worth of responsible investments around the world at the moment. That’s up 34% since 2016, it’s poised to reach $40 trillion by next year. There’s ESG funds, there’s ethical funds, there’s green bonds, there’s social impact bonds, I came across a ESG ETF the other day that invests solely in companies that have the best hiring record for hiring US military vets. Another one that fights obesity. So we’ve got products proliferating daily. Another fund that actually takes short bets on climate laggards, we’ve got an explosion of products out there and explosion of interest. Can you tell me, what is conspiring to make 2019, the year of sustainable investing?

[Nalini] I’ll start by saying that I’m not sure that this is the year for sustainable investing, I think this space has been emerging for some time. And I think the trajectory is definitely getting steeper, and the interest in this space is becoming more widespread, more mainstream, in terms of the number of different strategies and number of different products. I think it’s a testament to the education that’s been happening in the industry. I think, historically speaking, sometimes responsible investment or sustainable investing would be, you know, the same plane as just values-based investing or ethical investing. And I think that the space has evolved significantly, and that there are now a number of different approaches to responsible investment.

I like to think of responsible investment as the umbrella approach. Impact investment, which is what we’re here to talk about today is one of the underlying approaches. And so some of the products that you referred to are more thematic approaches, if we’re focusing on things like climate-tilted strategies, or obesity, these are themes that are now making their way into the mainstream products. But you’re going to also have a lot of market cap weighted strategies that are benchmarked in a way to the entire universe, but are more integrated from a bottom-up perspective.

[Jacqueline] Kelly, you’ve been in the business for 15 years, I understand. What do you see as happening in the last few years that’s made this really come to the fore? And is it really maybe a lot to do with the amount of money that’s out there just chasing something more than a 1.5% bond yield?

“This is no longer something that’s happening in closed-door conversations, this is something that is very present and real to all human beings. People are taking these conversations around climate, around inequality, around sustainability that they’re having … and thinking: how does this apply to the work that I’m doing? How does it apply to my personal finances? How do we fix this?”

[Kelly] Thank you for having me. It’s really nice to be here. And I’ll start with a disclaimer saying the views are my own. I think that there’s a few things that are that are going on. I think one of the most important things from a trend perspective is that everybody knows what we’re talking about now. This is no longer something that’s happening in closed door conversations, this is something that is very present and real to all human beings. People are taking these conversations around climate, around inequality, around sustainability that they’re having at home with their kids that they’re having at dinner parties, that they’re having at work and thinking: how does this apply to the work that I’m doing? How does it apply to my personal finances? And what are we doing here? How do we fix this? And so I think that’s a big part, you know, building on what Nalini said, around, those of us that have been doing this for a long time, we’ve been having these education conversations for a long time. And you know, they say with kids, you have to hear the same thing 15 times before it sinks in and you believe it. I don’t think it’s that different with grown-ups to be honest. And so the education foundation is there, and now it’s in social consciousness. You brought up a transfer of wealth. We’re seeing everybody’s aware that this transfer of wealth is happening, and that it’s starting to move towards millennials and women who have very different investment objectives than the previous holders of that capital. And so how that ties into the way that they manage that capital and what they’re looking for, from not just their advisors, the institutions that they work with and the way that their capital’s invested. We’re seeing really big, different questions that they’re asking in those conversations in terms of how they manage their wealth.

[Jacqueline] Is that what you’re seeing with your customers, the people that come to you for advice, are you seeing a different range of customers, younger, more women?

[Kelly] We are definitely seeing a different range of customers. I mean, we are at the deep end of the pool. So by the time folks come to us they have a very specific impact mandate that they’re looking to fill. And so absolutely, but we are seeing a very different range of customers. And we’re seeing even in the last 12 to six months, a lot more institutional capital, starting to ask these questions and really digging around what this looks like versus private capital.

[Jacqueline] And how is BMO changing its operations to deal with this groundswell new products as well as new demand?

[Nalini] BMO has been mobilizing in the space for a really long time, especially on the global asset management side, which is the division that I work with. You know, since the ‘80s, we’ve been looking at the space, we’ve been real proponents of being active owners of the assets in which we invest on behalf of our clients. So both engagement and proxy voting activities are at the core of what we do across portfolios. And that’s really another way that we like to drive impact. We think it’s important that if you have a seat at the table, if you’re stewards of the capital that you’re investing in on behalf of your clients, it’s important to take that responsibility seriously. And so we’re building dialogue with our investee companies, we have a suite of strategies that aren’t uni-faceted, it’s very multifaceted. So everything from the avoid approach through to the invest, and actually, let’s improve, let’s improve the business practices of the companies that we’re seeing in our portfolios that we believe can generate long-term sustainable returns.

“Impact is generally defined as intentionality. It is with respect to intentionally looking to create a positive environmental or social good alongside a financial return. It’s not about giving up your financial returns. It’s about intentionally looking for good.”

[Jacqueline] Kelly, let’s turn specifically to impact investing. That’s what your company focused on solely. How is it different than overall sustainable investment and all the other words that makes everybody up?

[Kelly] Impact is generally defined as intentionality. And it is with respect to intentionally looking to create a positive environmental or social good alongside a financial return. And so it’s not about giving up your financial returns. But it’s about intentionally looking for that good versus ESG integration or shareholder engagement, where you’re looking to manage for other risks within a broad universe. And so that is where we focus. And we do that across all asset classes, both public and private markets. And so I’d say that the public markets piece is something that’s really evolved. And those of us that work in the space have seen this change over the last four to five years, the public markets, there’s an appetite to understand how you can do intentional impact in the public markets at scale. That doesn’t depend on private equity or private debt vehicles that has scaled constraints, particularly for larger institutional investors.

[Jacqueline] And how are you measuring that impact?

[Kelly] Great question. Measurement is very important. There’s a number of data sources available, including Bloomberg, that look at impact, and that are available both in the public and private markets. There are probably too many frameworks at this point globally that have started to figure out how to do this. Internally, we have our own framework that integrates a number of data sources into a system so that we can compare and track impact both as we look at investments on the front end, and then also as post investment, once we’re monitoring them on the back end. And we’re looking to do that in a way that we can compare public and private equity within a given portfolio. Our clients, they usually have an impact perspective across all their asset classes, and they want to know, what is the impact that my whole portfolio is having, not just some private equity over here, regardless of what’s happening on the public side.

[Jacqueline] Maybe you could just highlight one or two impact investments that have been hot for you this year.

[Kelly] Sure. So I’ll stick to my roots. So there’s a private equity fund that that we really like right now. It’s called Deetken Impact, and they’re based on the West Coast. They have $100 million in assets and across a few different products. So they have a Women’s Empowerment Fund that funds growth stage SMEs in Latin America, looking at healthcare and business production for women-led businesses. And then they also have some renewable energy products. They offer this product in both private equity and private debt structure with varying returns. It’s got some scale and some track record, which our investors appreciate. But it’s got a really deep comprehensive impact thesis, both through the types of activities that they do and operationally and the way that they implemented.

[Jacqueline] Nalini, is it harder to do that impact side of investing on a larger scale?

[Nalini] No, I don’t think so at all. As Kelly mentioned, there’s a number of frameworks out there. The  Sustainable Development Goals is one framework that I think a lot of people are familiar with. We’re really harnessing that framework for looking at our existing and also future investments. When SDGs were published back in 2015, I think it was identified that we needed about $90 trillion of investments to solve for the world’s most imminent challenges, $15 trillion coming from governments, and maybe the rest coming from the private sector. So we look at the opportunities side of impact. Historically, ESG integration, looking at the risk side of the equation, we are looking at investments that have a long trajectory for growth, that are solving sustainability challenges. So we have global funds that are concentrated in nature benchmark to, you know, the world benchmark from MSCI, but maybe looking at specific opportunities in water management, for example, or in food and nutrition. So it’s really looking at the companies that are actually driving industries forward and measuring that benefit that they’re creating, and, and also creating alpha for our clients.

“What is the role of this capital? If it’s endowed capital, why was this capital endowed? Where did it come from? What are the roots of this capital? What does this capital want to do in the world?”

[Jacqueline] Right. So speaking of alpha, it’s great to be able to invest in products that you feel good about, but how do returns actually match up to regular investments? What are you finding?

[Kelly] We don’t have a challenge on the return side of things. I think it depends on what the investor’s goals are. And so we are client first, and we work with investors. We’ll work with our investors to meet their targets. So whether you’re a philanthropic foundation or private investor, we have investors that have target returns all over the map. And we can customize that portfolio, both from an asset class perspective, also from thematically in terms of the types of impact they want to target in order to meet those goals. Now, one of the big questions that we have with part of our investor base is what is the purpose of your capital? What is your capital here to do? So if your capital is here to make a certain threshold return? Great, let’s make sure that happens. But what is the role of this capital? If it’s endowed capital, why was this capital endowed? Where did it come from? What are the roots of this capital? What does this capital want to do in the world? And how can we do that, in addition to meeting your returns and keeping you sustainable, and all the rest of it? But what are the goals of this capital, and for many of our investors — like I said, we’re in the deep end of the pool — but for many of our investors, somewhere between the eight and 15% range, they’re not looking for 15% just for the sake of 15%. They’d much rather cycle that outsized return back into the impact or into additional investments so that they can continue to drive their impact goals, and not just make wildly outsized returns.

[Jacqueline] Are companies that pay attention to ESG values, ultimately, better run and better operated? And do they generate better returns?

[Nalini] I think it’s a really good question, I think it’s worth looking at the empirical evidence. So it’s one thing to hear from organizations who really care about the space, but it’s another thing to look at the data. There’s a few meta studies that have been done, looking at like 1000 underlying studies over the past 30 to 40 years. Companies that look at positive sustainability practices from an E S or G perspective, over 90% of the time have neutral to positive return over the long run. When you’re looking at data like that, it’s really hard to argue that being a responsible investor is a trade off in some way, or that you’re sacrificing or leaving some alpha.

[Kelly] I’ll just add that more recently, what we’ve also seen is from an HR perspective, huge upside in terms of being able to attract and retain talent, in terms of being aligned with their values, and also from a cost of capital perspective. We’re seeing that this is affecting cost of capital, which is affecting the financing overall of these ventures.

[Jacqueline] There is a lot of questions, though, about greenwashing, applying the ESG label willy-nilly, I know that seems to me ESG as a label may not be the best thing because I came across the MSCI ESG world leaders index the other day, and at the top was Shopify and below that was Fortescue, which was an iron ore company and below that was a chemical company, so lumping them all together. It seems rather odd, but how do we make sure that, you know, we’re not greenwashing here?

[Nalini] So I personally think it’s worth looking at the organization. It’s worth looking at the approach that the organization that’s managing a product or strategy is employing it’s one thing to slap a label on a strategy and it’s another thing to understand What is the strategy’s objectives? What are they aiming to achieve? So it could be an impact driven objective. It could be a risk mitigation objective, it could be a thematic objective, it could be, you know, a thematic-tilted portfolio. Asking the right questions can enable us to filter through a lot of the noise that we’re seeing out there.

There are a lot of stats about how many assets are now moving into sustainable investment from the mainstream. And I think you have to take that with a grain of salt. And I think we have to really look at the organization, the resources they’ve dedicated to the space and ask important questions about their valuation techniques, their investment process. We all see the quarterly reviews on products that we’re invested in, and they talk a lot about the team and the decision-making process. How much of that includes responsible investment in ESG factors?

[Kelly] The other layer is, you really just talked about it from an investor and asset manager’s perspective, but as an investor that’s looking at those products, asking the same question: What is the intention of this strategy? Some of those strategies that get called out for having names that maybe shouldn’t be there? So one question is, is the strategy designed from a products and services perspective, from a sector perspective, or from an operational perspective? Our view is that it should be all of those things. But that’s not the case for a lot of those strategies. They may be looking just a sectoral perspective. So you won’t see certain sectors in there. But you could still have companies in there that are really poorly operated or doing terrible things with respect to their employees or their supply chain. And so it’s looking at both of those pieces in terms of how you assess that strategy.

I think the other thing that’s important to say, and we’re getting tons of press in this space, right now, negative press, which is not great for those of us working in this space, but we need a ramp, we can’t have the no ESG, returns only and then the impact-only options; we need a variety of options that allow investors to move along that spectrum that aligns with their investment goals, aligns with their investment strategy. And so I think it’s OK to have some strategies that are green as long as it’s not a green washing issue. And we’re still having transparency around the fact that it’s intended to be light green; this is the impact or the issue that we’re intending to make. It may not be the deep end of the pool. And that’s OK, because we need a variety of vehicles to help to move the market, transparent.

[Nalini] A lot of the criticisms around branded products are coming from those who are values-based in their investing approach. So who do want to take a divestment approach, you do want to shrink the universe that they’re investing? And so seeing names, you know, these benchmarks that you didn’t expect to see, again, what is the objective of that benchmark? When they were constructing that portfolio, what were the factors that they were prioritizing, because ESG can often fight against when one another environmental and social issues, you know, there’s a push and pull there. And so, understanding that dynamic is important.

[Jacqueline] Kelly, do you think that oil sands company could be considered a sustainable investment?

[Kelly] The extractive sector is definitely a challenge in this space, and it’s a challenge in Canada, there’s no use trying to hide that fact. I think it depends on what your goals are as an investor. So for some investors, and I think it really depends on your size as an investor, too. So for large investors that are going to hold the market, they’re not going to pull out of the entire extractive sector. That’s not a responsible decision. And so the question is, then, what do you do with those holdings? So how do you engage those pieces? How do you talk about the just transition? We’re all aware that despite the negative impact of some of those parts of the sub-sectors, that we’re not going to be out of oil tomorrow, right? We need to be conscious of the transitional issues from here to there. And as much as they are environmental, they’re also deeply social, right? So if you look at the S, and the factors that happen on the S side, they’re deeply social in terms of what’s happened to economies in Alberta, and to different communities. And so thinking about that transition is really important. I think if you’re a smaller investor, and you have maybe less influence, or it doesn’t align with your values, and that’s not what you want to do, then divestment is an option for you. And so I think it depends on what your best tool is. You know, most of our investors are avoiding those sectors to be perfectly honest. But I think that’s a personal decision. And I don’t think if you’re a large universe holder that that’s an option for you.

[Jacqueline] Nalini, maybe you could spend expand a little bit on BMO’s view on that topic.

[Nalini] I would say, obviously, we’re a global company. And so, you know, sitting here in Canada, it’s really important that we’re cognizant of the challenges that we have, the percentage of our universe that this sector takes up. And I think there are a lot of companies in the sector that are doing good in their own way they’re diversifying, which I think is, as Kelly mentioned, part of transitioning, so we have to let them diversify, we have to let them invest in technology and research; we have to reward those that are making Delta improvements to the base of what their core competencies are. Because, as Kelly said, we’re not going to get there overnight. Understanding the leaders within those sectors, believe it or not there are leaders, and there are going to be laggards who are very skeptical of renewable energy. Engaging with those laggards, and maybe not investing in those laggards, but focusing on the top end of that sector, and taking an approach that works for the region in which you’re investing. My colleagues over in the UK and in Europe have found some really great opportunities in the sector for companies that have completely diversified wind farms, for example. I think you just have to look at it on a regional basis, and within the sector, understanding the differences as well.

[Jacqueline] We’ve seen a lot of changes in the sector over the last number of years, started off with exclusionary sort of approach, and moving into engaging corporate boards to shareholder action, community impact. What’s the next big thing in sustainable investing?

“One of the biggest things we’ll see in Canada in the next few years will be around conservation finance, because that’s a space that hasn’t evolved very well here, and has huge potential.”

[Kelly] Nalini talked earlier about some very specific targeted strategies around water and other things. We’re seeing a movement in that space, we’re seeing lots on the renewable side, we’re seeing specific pieces around ecology. One of the biggest things we’ll see in Canada in the next few years will be around conservation finance, because that’s a space that hasn’t evolved very well here, and has huge potential. We are obviously a massive landmass, we have massive conservation issues that are a really big part of the climate conversation, that financially haven’t really been explored, whereas that market is quite advanced in the US and in Europe and in other regions. So I think that’s one space that we’re certainly keeping our eye on. But overall, I’d say we’re just looking at a lot of growth, right? We’re looking at a lot of investor interest.

[Jacqueline] Can you give an example of conservation finance?

[Kelly] There’s tons of different products from a product perspective. The most basic of those is a basic carbon offset. But we’re seeing the same types of products with water, forest resilience, we’re seeing protection of lands, we’re seeing, efforts made to capitalize on lands versus having deforestation. We’re seeing wildlife protection pieces that are turned into different financial instruments where investors can participate in the conservation of those lands. And those funds then go back into that piece as well.

[Nalini] What I see going forward is a lot more intervention from a regulatory perspective. I know that’s not what we all want to hear. But I do think that with the Paris Climate Accord and really big initiatives happening around the world in terms of investors forming coalitions to engage with certain sectors, and corporates who, from a GHG perspective are off the charts, I think we’re gonna see more companies come out and make commitments to be net zero by 2030, by 2040, by 2050. We’re gonna see a lot more strategies that are aligned to the Paris Climate Accord and we’re gonna see what we think of as an inevitable policy response. And so like pricing in when governments are actually going to start panicking about our trajectory of a two degree scenario, and when it’s too late, it’s just going to kind of come crashing down. And so really understanding poses to be, you know, erratic but I think it’s really important to follow developments in Europe, even though we’re sitting here in Canada, because I think being a global organization, we need to be mindful about when things become law, how it’s gonna affect all of us.

[Jacqueline] I asked you on the on the phone in our pre chat to talk about one particular investment that you liked from a social impact point of view. Perhaps you could talk about your favorite this year?

[Kelly] I will talk a bit more about a category instead of a specific name. We’re seeing a lot on the gender and equality side. So gender, diversity and inclusion. And we’re seeing that both from specific funds and specific strategies, and also holistically and operationally. This is a massive trend in the US, tons of product in the US. It hasn’t quite hit Canada yet. We’ve got a few strategies here in Canada that are looking at how you can find alpha and capitalize on women-led and -run businesses, for sectors that affect specifically women and diverse populations. And then also operationally that look at that. I think we’ll see a big jump in that space.

[Nalini] One name that we have in a lot of our portfolios is a company based in the US, a water management company, they make up about 10% of that market. They’re a $15 billion company, and they’ve been super instrumental in a lot of ways in terms of developing technologies and supporting crises. So do you guys remember the incident where the Thai football team got stuck in a cave? You know, Xylem was definitely not part of the headlines, but they’re the ones who supplied a lot of the valves and the pumps needed to rescue them. And so they’re a name that we’ve been invested in for a little while now. We’re really excited about the work that we’re doing and we think, you know, the growth potential is massive.

[Jacqueline] Great. Kelly, Nalini, thank you very much.