Keep your seat at the table Keep your seat at the table\images\insights\webcasts\esg-beach-view-hong-kong-small.jpg March 12 2021 March 12 2021

Keep your seat at the table

Investing responsibly in a volatile world.

Published March 12 2021
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Podcast Transcript
Linda Duessel: Hello, and welcome again to Hear & Now podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist. And today, I'm joined via phone by Martin Jarzebowski, Director of Responsible Investing. In February, Federated Hermes celebrated its one-year brand anniversary. Since we introduced our brand in 2020, lots has happened within Federated Hermes to strengthen our commitment to responsible investing.
Linda: So let's start there by discussing FHI and responsible investing at our firm. I've read, Martin, that since ESG is relatively new in the United States versus Europe particularly, there are numerous definitions out there of what ESG investing is. How does Federated Hermes define responsible investing?
Martin Jarzebowski: Thank you, Linda. Well, certainly 2020 was a transformational year. And the marriage of Federated and Hermes has created a global leader and responsible asset management. We believe there's a couple of key components of being a responsible asset manager and that's the intersection of responsible investing and active ownership. Now, together these aim to generate long-term sustainable wealth creation for our investors through both prudent risk management and sound stewardship.
Martin: Now, a distinguishing characteristic is the firm-wide commitment to integrating ESG and active engagement across all investment teams and all asset classes. And that includes equities, fixed income, money markets, alternatives, and private markets. So we've got end-to-end solutions from integration all the way to impact. Now, to achieve this, we had to assemble a global team of 67 ESG subject matter experts across engagement, stewardship, and the responsible investing office to help execute this firm-wide mission.
Martin: In contrast to the mainstream who are still outsourcing all of their ESG research to third-party data providers, we've built a full suite of proprietary ESG data analytics for us by us with the Crown Jewel being our 16-year-old engagement database. So at Federated Hermes, responsible investing is the common thread which runs through our entire investment platform. And we're very excited to build on the legacy of Hermes who is a pioneer of ESG integration and active engagement.
Linda: Integration so key, and the active work that you're doing that you're speaking of as well, gosh, Martin, has gotten so much broader. Hasn't it? Than the socially responsible investing we grew up with where all it was about was, well, I don't want any tobacco or gambling in my portfolio is amazing. Isn't it?
Martin: Certainly.
Linda: And so now, Martin, what ESG topics are top of mind to investors right now?
Martin: Yeah, when we're speaking with a large institutional investors like pensions, endowments and foundations, you see there's a clear focus on ESG integration into their portfolios, but there's also a lot of hesitation around divestment and exclusionary strategies. So as you mentioned, divesting from particular sectors and industries, it's been a very, very popular form of sustainable investing for decades and it certainly gets a lot of press. But behind the scenes, I think many investors, they do have concerns which tend to revolve around three main limitations and that would be outcomes, momentum, and risk management.
Martin: So to start off, when you think about outcomes, if you're divesting from a particular sector industry, while you're losing your seat at the table, you lose your voice and you certainly you're losing your vote. So when you want to be able to advocate for positive change, if you walk away, well, you're losing that opportunity. The second one is around momentum. And I like to frame this up as almost like ESG timing. We've all been trained, don't try to time the market, you're not going to be able to catch it perfectly over long periods of time. And the same type of logic applies to ESG integration because we're finding that the alpha opportunities are actually in ESG momentum or the companies that are ESG improvers.
Martin: Think about it logically, if you're just buying something that is a Wall Street consensus long or a credit rating agency already deems to be of the highest quality, well, it's already appreciated and factored in to the valuation premium associated with that particular security. So for us, it's being able to hunt and identify those mispriced ESG opportunities in the marketplace so when you're engaging, you really keep your finger on the ESG pulse and you're able to monitor and understand if you walk away, you won't be able to have that type of oversight.
Martin: And the final point, risk management, I think this is the most intuitive where you spent many years as a portfolio manager. So this will resonate. If you constrict your investible universe, what ends up happening is, you're going to increase the deviation and the volatility of outcomes relative to your benchmark. Now, if you're an individual or an institution who has many long-term liabilities and obligations to fulfill, well, that volatility and deviation is not really desirable.
Martin: So if you're actively engaging with the portfolio holdings that you have, and you're doing that in a high-touch, long-term manner, well, you're keeping your seat at the table. You really can understand which particular securities are under-appreciated in the marketplace where there's mispriced ESG risk. And then certainly it is a core centerpiece of prudent risk management.
Linda: I really appreciate your breaking down the topics the way you did. That one comment that you made really hit me, keeping your seat at the table. And how relevant is that today? So much more relevant to a degree given that millennials, the largest generation now, and I understand the average millennial is age 30, just looking forward into their peak years.
Linda: Merrill Lynch report said that 77% of millennials either own or are interested in adding exposure to impact vehicles. The whole idea of the seat at the table, and working at finding investments this way seems so relevant right now. And it's a very exciting time. But now I'd like to move on, Martin, to ESG integration. ESG integration means different things to different asset managers. How do you think investors should be thinking about it, so as to avoid what they're calling a greenwash or so-called greenwash portfolio? And then what gaps exist in the ESG today? And how does Federated Hermes fix to bridge them when investing responsibility?
Martin: Linda, the way asset managers are being evaluated in their ESG claims it's rapidly evolving in the marketplace. So if you're shopping for a responsible investment strategy in a crowded supermarket with all variety of labels and acronyms out there, you have to take a step back and read the ingredients. Today, there's a lot of new attributes to look for in order to distinguish what many people are characterizing as authentic versus cosmetic ESG integration.
Martin: So for an asset manager to stand out from the crowd, they really need to have three distinguishing characteristics. And that would be a firm-wide commitment. It would be in-house ESG expertise. And then finally, proprietary capabilities. So when I say firm-wide, I mean just that. It's not about having a separate silo or division just for ESG and launching ESG products in order to ride the green wave. It's more about making a firm-wide commitment to integrate ESG into the DNA of all the different investment teams as a natural extension of the primary research that they perform.
Martin: So I always like to use a quote from Debbie Cunningham, our CIO of the Liquidity Franchise. When she says, If you believe that ESG adds value to the investment process, then why wouldn't you want it to be part of the research that occurs in all of your flagship strategies? Right.
Linda: Right. Right.
Martin: The second point is actually around people, because human capital is the lifeblood of any asset manager. So you want to see sustainability expertise in order to help customize the integration process and more importantly, to provide an informational advantage when helping to identify mispriced ESG risk in the marketplace. That's the name of the game. That's where the alpha opportunity arises.
Martin: So for us, we've got 67 ESG subject matter experts across engagement, stewardship, and the responsible investing office. So who are they? They're PhDs, climate change experts, lawyers, data scientists, former sustainability officers and consultants. Notice, I didn't mention CFAs or MBAs. So they provide the ultimate compliment to our fundamental investment teams. It's the best of both worlds.
Martin: And finally, proprietary. So proprietary versus outsourced is the new line in the sand between authentic and cosmetic ESG integration. At Federated Hermes, we built a full suite of proprietary ESG data analytics and tools for us by us. So if every investment manager is using the exact same ESG ratings off the shelf, then where's the investment edge? This comes back to that last point that you made about third-party data providers and potentially the gaps in data coverage.
Linda: Yeah.
Martin: Because third-party ESG data providers they're designed for corporate disclosure aggregation and not for alpha generation. So for us, we use 10 different ESG data sets, but it's still just the starting point of our research process. It's not the finish line. So we've got a global team of ESG engagement experts going directly to the source and meeting with the boards and senior management in order to keep our fingers on the ESG pulse of thousands of companies around the world. Now, this wealth of information it's stored in a proprietary 16-year engagement database to quantify and measure the ESG progress for over 18,000 companies. So a global team of ESG subject matter experts and a full suite of proprietary ESG data analytics, that's what we equip all of our investment teams across all asset classes for prudent risk management and sound stewardship.
Linda: That's excellent. And in my work as I study ESG, it may have started in Europe, but the idea ESG integration across all manner of investing is from the United States, and FHI clearly stands apart here. Now, I'd like to finally talk about the big picture and your outlook. Here we are still dealing with the pandemic and COVID. And I came upon an interesting quote by Mark Carney, Former Governor of the Bank of England, who said that many firms lacked proper planning in key areas, such as technology, finance and sustainability prior to the crisis, with nearly half of them saying they could have done more to prepare for challenges posed by the pandemic. Firms that aligned their business models to the transition will be rewarded handsomely. Those that fail to adapt will cease to exist. What a strong comment about COVID. And of course, now we have the new Biden administration. So what do you think all this means through Biden administration for responsible investing, ESG and engagement?
Martin: Oh, absolutely. Well, there's plenty to unpack in that question. But I'll start by saying that I agree with the consensus that the Biden administration is a positive tailwind for multiple ESG issues. But I think the momentum behind the demand for responsible investing that was already accelerating well before we knew who won the presidential election. So in 2019, I consider that to me the inflection point, especially in the US when you think about ESG demand in all statistical categories, whether you want to measure ESG-oriented fund flows, or Google Search trends. Now, the bottom line is that the ESG train has left the station.
Martin: So a couple of things that are worth mentioning from a macro-dimension, and I would say that's the DOL rule and energy policy. These are two things that should be coming to the forefront. So regarding the Department of Labor rule, and that's called the Financial Factors in Selecting Plan Investments, that took effect in January. And we actually wrote a really good white paper and the frequently asked questions and that resides on Right now, just went live.
Martin: And there's a lot of attention that's being paid to the use of ESG factors in pension and retirement plans. It's worth noting that the final rule does not mention ESG outright. Instead, it's really focusing in on the requirement of a fiduciary to make investment decisions based on risk and return. So this is where it's important to understand an investment products design. So the bottom line is that, if the investment product integrates ESG to help achieve its primary objective of long-term risk adjusted returns, then by definition, it's okay to be used in pension and retirement plans according to the final DOL rule. So now many believe that the Biden administration, they may overturn the final DOL rule, but we may not see a wholesale change if the essence of the rule permits ESG and responsible investing in pursuit of risk adjusted returns in accordance with prudent investor principles.
Martin: So now really briefly on energy policy, very hot topic. I like to say a change in an administration brings a changing climate. So in this case, you have to pay close attention to the initiatives which come in the form of executive actions, as well as direct legislation and regulation. So one of the first things that Biden did in office was declare climate change a national emergency, and he announced that the US would rejoin the Paris Agreement. Now, that's a very quick first step, but now there's a lot more heavy lifting, which will be required for policy changes, which as we all know, take a lot of time and compromise when it comes to Washington DC.
Martin: So it'll be interesting to see if higher tax breaks incentivize electric vehicles and alternative energy sources, such as wind and solar. It will also be very interesting to see in terms of regulations. We may see fuel economy standards rise, or potentially a mandating of carbon emission disclosures by corporations. Those are the things that we should keep on the radar screen as we move forward over the course of the next couple of years.
Linda: Thank you, Martin. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes' Hear & Now podcast. If you've enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear & Now episode. Plus our other series, Amplified and Fundamentals, for a global perspective on the issues, challenges and trends shaping the investment landscape.
Disclosure: ESG stands for environmental, social and governance. Views are as of March 4, 2021 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Alpha measures the excess returns of a fund relative to the return of a benchmark index. There is no guarantee that any specific investment approach will be successful. Federated Advisory Services Company 21-40147 (3/21)
Tags Responsible Investing . Active Management .

ESG stands for environmental, social and governance investing.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Alpha measures the excess returns of a fund relative to the return of a benchmark index.

There is no guarantee that any investment approach will be successful.

Federated Advisory Services Company