The Hire thru Retire Podcast
Breaking down E, S, and G with Laura Kane
As environmental, social, and governance (ESG) issues are playing an increasing role in the world around us, it can be difficult to cut through the noise when it comes to truly understanding the fast-changing landscape of ESG. In this episode, Bill is joined by Voya’s own Laura Kane from our asset management business, Voya Investment Management. Laura joined the firm last year as Head of ESG Research, responsible for leading the ESG investment research process across the firm’s equity, fixed-income, and multi-asset strategies. Tune in to hear more from Laura who explains what ESG is and why it has risen in importance over the past decade.
Bill Harmon is a registered representative of Voya Financial Partners, LLC (member SIPC).
CN2342646_0824
As environmental, social, and governance (ESG) issues are playing an increasing role in the world around us, it can be difficult to cut through the noise when it comes to truly understanding the fast-changing landscape of ESG. In this episode, Bill is joined by Voya’s own Laura Kane from our asset management business, Voya Investment Management. Laura joined the firm last year as Head of ESG Research, responsible for leading the ESG investment research process across the firm’s equity, fixed-income, and multi-asset strategies. Tune in to hear more from Laura who explains what ESG is and why it has risen in importance over the past decade.
Bill Harmon is a registered representative of Voya Financial Partners, LLC (member SIPC).
CN2342646_0824
You're listening to the hire through retire podcast with Voya bill Harmon, tackling all things from 401ks to HSAs and everything in between. We're talking to the best and brightest in the industry to bring you the latest in benefits, savings, and investment trends in the workplace. Come along with us on our journey to help all Americans become well planned, well invested and well protected.
Speaker 2:Hello everyone. And welcome back to hire through retired podcast. I'm your host bill Harmon. And today we have a very special guest from our asset management business boy investment management, and that is none of them. Laura CA Lord joined the firm last year as head of ESG research responsible for leading the ESG investment research process across the firm's equity, fixed income and multi-asset strategies. Laura's also been featured on outlets, such as CNBC, Bloomberg, CNN, and Yahoo finance. So Laura, thanks so much for joining us today.
Speaker 3:Hi bill. Thanks for having me on the show. It's great to be here.
Speaker 2:I gotta tell you, this is a great topic and there's a lot of discussion and I think there might be some confusion out there as to what, what it really is and why is everyone debating it and so on. So, I mean, it's it really in the end, it's undeniable that environmental, social and governance, which is ESG, the issues are playing, you know, and increased role in our world. And, and really, it's also true that it can be difficult to cut through the noise when it comes to really understanding sort of the fast changing landscape of ESG. And luckily we have a guide to help us navigate these waters. So Laura, I know you've forgotten more about ESG investing than I'll probably ever know. So let's begin with the basics. Could you just start out by explaining, you know, what is ESG and why is it really risen in importance over the past decade?
Speaker 3:Yeah, sure. I'd be happy to bill. So first things first as, as you spelled out, ESG stands for environmental, social and governance and in the investment context, ESG investing means taking environmental, social and governance criteria into account in your investment process. In addition to traditional factors like profitability and cash flows and the balance sheet. So to give us a little bit more color, let me walk through a few examples of the E S and G. So for the E a couple of examples of criteria that you might look at are carbon emissions and water usage for the S examples include employee relations and product safety. And then for the G some criteria includes for diversity and executive compensation. So as you can gather from these examples, ESG information can give investors a lot of information about a company's long term prospects beyond what can be found in the financial statements. So now that we've covered the basics, another important point to make up front, uh, is that there's many flavors of ESG investing, meaning that ESG criteria can be used and applied in different ways, which includes both positive and negative screening based on ESG criteria, or even targeting companies based on how their goods and services advance or detract from social and environmental goals. So it's one acronym that can mean many different things when practically applied. Now turning to the last part of your question. There's many reasons why ESG has risen in importance recently, uh, and just to put some numbers to the growth. It's estimated that ESG assets in the us grew by roughly 40% in just the past couple of years. So what's behind this, I'll touch on three points. Uh, first ESGs been being taken more seriously. There's broader acknowledgement that ESG information can be material to investment outcomes. And we've seen ESG strategies, weather, a range of market conditions, including a global pandemic. So ESG has proven its staying power. Secondly, ESG product offerings have grown and diversified. So ESG is no longer limited to values based exclusions. There are products out there to meet objectives ranging from maximizing risk adjusted returns to directing capital, to a specific social or environmental objective and the product opportunities now also span asset classes. So it's not just equities, but also fixed income and private markets as well. And then third, uh, investor priorities have brought in. So we've seen greater societal focus on issues like climate change and equality. And this has given way to the idea that the private sector has a role to play in addressing these issues. And ESG investing is seen as a way to direct capital to these so-called good actors and encourage better corporate behavior in greater transparency. There's a number of reasons behind this surging interest in ESG investing. Um, but I would say that we definitely think this trend is here to stay.
Speaker 2:I've seen article after article had conversations that people really do like to invest in companies that, that they believe in that they could really kind of put their heart and their wallet there. And so that obviously is trading some of that popularity, but let me go back to the thes and the G I, I remember back in the old days when I first started the industry, we had socially responsible funds, but now we're really kind of categorizing the E thes and the G, but they're really very different. So why, why group E S and G
Speaker 3:Yeah, I think that's a great observation bill. And I have to say, I've never even asked that question before. So it's very thought provoking. I'd say what they have in common is that they seek to quantify the impact a business has on the world, around them, including the environment and people. So that's the EES. And then where the G comes in that measures the safeguards a company has in place to minimize the risk of bad behavior and adverse outcomes. And one example I like to walk through is, is I always talk about this, um, hypothetical hotdog stand. So if you were gonna invest in a hotdog stand, you would, of course, wanna know financial information like sales, volume, profit margins, and cash flows, but there's other things that you wanna know as well, such as who's running it, who cooks the food. Uh, where is the meat sourced from? Has anyone gotten sick? Is the product contributing to long-term health issues like obesity and heart disease? Uh, what kind of packaging is being used? Can it be recycled? Have there been any complaints in the neighborhood about that smells or noises emanating from this hot dog stand? So, you know, these are the types of questions that ESG investors are asking. And as you think through these questions, you can see that they're material to the investment, but they're not necessarily found on the financial statements, but they all speak to this idea of the corporate responsibility of the business and the impact that it has on the environment in society at large. So that's how the E S and G fit together. They're very different on their own, like you mentioned, but they're similar in their objective,
Speaker 2:Laura, that's fantastic. You know, we talk about Saturday language and I don't know if it gets much more Saturday language than investing in a hot dog stand and understanding like how that could relate to ES G. So thank you so much for that. I think that's a perfect example. So then I think now that we've defined what it is, some of the confusion around ESG is really understanding to say, okay, well, I believe in it. That's great, but how do I know that it's doing well, if I'm making an investment with my hard earned money, how do I know, how do I measure or evaluate these factors? And are there some third party benchmarks that can help me along the way and making sure that this particular investment's doing well, or even that they are really doing well within their E their S and their G
Speaker 3:Yeah. So ESG criteria can be harder to quantify than financial information. And, you know, this is in part because unlike financial disclosures, there, there are no standards around reporting of sustainability information. So it's very difficult to compare across companies just based on, uh, self-reported data from companies. And that's where third party ESG ratings providers come into play. So they take all the data being reported from companies and they aggregate and analyze it and process it into scores that can be used for relative comparisons. And, you know, as you can imagine, since the data, as it's reported is inconsistent, there's an element of subjectivity to this scoring process. So for example, scoring providers use different criteria to measure the EDS and the G they also make judgment calls in terms of how material the information is to a company's bottom line. Some of them may also take into account companies plans to improve on certain metrics. So every provider has a different way of going about this. And, you know, there's, there's several, I would say roughly, let's say, you know, a handful of major providers and then a dozen, you know, a few dozen, um, more kind of startup companies getting into this industry. So, you know, we're not working with broad data it's data, that's been massaged and manipulated to make it the information more comparable across companies and industries. Now, just to give you a sense of what roll into these E S and G pillars, let me break it down. So, um, within environmental, some of the metrics factored in are things like carbon emissions, water usage, uh, whether the company is investing in opportunities related to clean energy, the S is considered much more elusive. It's harder to quantify. The scores are often based on policy assessments. So does a company have a parental leave policy or not? Do they provide health benefits? Are they undertaking community outreach, but lately we're seeing more advanced techniques that use things like natural language processing and artificial intelligence aimed at actually quantifying BS. So things like corporate culture, employee sentiment and customer satisfaction can be gleaned from things like, uh, reviews or news headlines. So over time you could see more precise measures of the S and then when it comes to the G, you can think of this as kind of a red flag based calculation. So the score ends up being a quantification of risk factors, like lack of board diversity or controlling shareholders with non equal voting rights, lack of transparency around accounting practices. So kind of the more risk factors or red flags, the lower the score will be so wanted to give you a sense of what are some of the factors that roll into the ES and G and, and how do we actually arrive at these scores that we're getting from these providers?
Speaker 2:So, Laura, I believe what you described is kind of with the industry, and it's a big and growing industry in the ESG world, um, how they would evaluate is that similar or different than how VO investment management would look at ESG.
Speaker 3:Yeah, so it's both similar and different. So we do make use of third party ESG score providers. They do a tremendous job of aggregating thousands of data points that are published in all different formats and units of measure. But where we differ is that we wanna own the view of financial materiality. So we take the data from third party providers, and then we reweight it, according to our analyst's views of what's most important for each sector. And then within equity specifically, we're very focused on this idea of financial materiality, and we believe that ESG can provide an information advantage in the market. So we've actually studied more than 20 different ESG data points and back tested them to understand if they're useful in predicting returns. And then we took the effective signals and aggregated them into a quantitative factor called the vs score that we use as part of our investment decision making for equities. So this focus on generating alpha with ESG criteria is a differentiator for us. And it's an area where we've done a lot of, uh, more advanced work with ESG information.
Speaker 2:We've done a really good job at defining what it is now. Let's talk about the investing part of it, because I gotta imagine our listeners may say, I love it, cuz I wanna invest in something that I believe in, but like, am I gonna lose performance on this? So I, I know that ESGs not solely about better, uh, financial performance, but I have read a lot that doing good, you know, brings good returns, good. And even better returns. Can you talk about, is there any type of historic correlation over time or how can we contextualize performance when it comes to investing in these, now that you've talked about what qualifies as ESG, you can talk about those types of investments.
Speaker 3:Sure. It's a great question. And it's perhaps the most asked thing about ESG. What is the performance? You know, unfortunately it's a difficult question to answer because it's hard to make generalizations about ESG performance, because like we talked about, there's so many, um, different types of ESG strategies and you can think of ESG criteria as really an input into the investment process. So it's interpretation application alongside a host of other factors is ultimately gonna drive performance of any given strategy. But of course, that doesn't answer your question. So all that said, um, let's make some generalizations. So ESG strategies on average tend to be overweight, growth stocks and underweight sectors like traditional energy and defense and in the environment that we're currently in, where we have rising rates, higher inflation war Ukraine, ESG strategies have struggled, but that doesn't spell an end to, for ESG investing all styles of investing. As we know, experience periods of underperformance, depending on market conditions. It's safe to say that ESG strategies have been around long enough to prove their weight. And if you look over a longer time horizon, let's say over the past five years, us ESG indice have outperformed their benchmarks. I would also note that, you know, despite recent performance concerns, uh, ESG active equity flows are still outpacing their non ESG counterparts. So while we may see a rethink on some aspects of ESG client demand is still very strong. I also wanna address one more point. Uh, one of the most common arguments among ESG skeptics is that ESG is all about exclusions, which limits diversification is therefore destined to have a negative impact on risk adjusted returns. Now that can be true in some instances, but ESG, as we discussed today has evolved far beyond values based exclusionary approaches at Voya. I am, for example, we take an inclusion approach and through our active ownership team, we actually engage with companies to improve on the ESG issues where they fall short. Uh, we also believe that we can find value in what are called ESG approvers. These are the companies that are, you know, looking just kind of average versus peers. Um, but they're improving and getting better over time. And I'll conclude with kind of my opening argument that, you know, while it's tough to generalize about performance, but we do see a lot of value in integrating ESG into our investment process.
Speaker 2:So if I could kinda summarize what you said, there are a couple neat things and there number one, doing good is good business, but it it's over the long term. And what I like is that the investors who really want to invest in something they believe in have really taken a long term view at it. And while maybe they've been underperforming based on current, uh, market climate, they have not stopped their contributions into it and their investments. And so that is a good sign. They're looking at the long term and still believing in what they're investing in. And she also mentioned something I wanna cover a little bit more on now let's talk about the critics. I'm sure that there's been well. I wrote a lot of discussion on, you know, point counterpoint on ESG and it can sometimes draw some criticism. And part of it could be that some of the ESG claims that companies can make our, our greenwash maybe define what that term greenwash. And I guess the questions, if their critics are saying that, do they have a point?
Speaker 3:Yeah. So you may be surprised by the answer, but yes, critics have a point, uh, at least on some of the issues they raise, you know, first things first greenwashing is this term that is referring to this idea that, you know, companies say they're doing sustainable or ESG investing, but when you look under the hood, um, they're not really doing what they say. So they're kind of making something look greener than it is that that's what that, that term means. And we've seen a lot of, uh, a lot of headlines about greenwashing this year. So let me walk through some of the key, you know, pieces of criticism and, and some thoughts on them. So, you know, first of all, I would say, you know, ESG product labels are in fact confusing since ESG information can be used in so many different ways in the investment process, it can be hard to interpret what an ESG label really means. So for example, there was a lot of confusion when Tesla was dropped from the S and P ESG index. And that's because the index criteria focuses on operational characteristics related to things like labor relations and governance, rather than on the goods and services the company produces. So in this case, the company's making electric vehicles, which should have, um, environmental benefits, you know, that alone, just the fact that, um, there's so many different ways of using ESG information. And, and this one term is, is, or this one label is attached to so many different products is a source of confusion. So that's something that critics have rightly pointed out. Secondly, ESG scores are not consistent. And I touched on this a little bit earlier, but according to MIT research, a correlation among prominent agencies, ESG ratings was on average, just over 0.6 by comparison credit ratings from Moodys and S and T are correlated at over 0.9. So the inconsistency is driven in part by the fact that there are no standard disclosures for ESG information today. So the rating companies are working with imper information, which leaves a lot of room for interpretation. And then lastly, I'd say, look with all of this in mind, greenwashing is a real concern given the high volume of ESG flows and the higher fees that asset managers tend to charge on ESG products. We saw a lot of companies rush to market to be able to capitalize on these trends. And in some cases, these ESG approaches were not as well formulated as communicated to investors. But the good news is, is that investment firms are being held more accountable for their ESG representations and with recent S E C proposals, we're actually on our way toward more standardized ESG product disclosures and labeling requirements that will help to alleviate these greenwashing concerns in the future.
Speaker 2:We've talked about how popular ESG is each ESG investing and why it is and what people believe and so on. But it it's kind of sense that you're talking about that mostly from a retail perspective, that people are going out on their own and looking for some investments outside of any type of employer sponsored retirement plan. But maybe if we could switch inside of that, because as much as again, that may not necessarily be the, your main point of focus, but there's a lot of investors inside of employer sponsored retirement plan. So I'd love to get your perspective here. Some Voya research has shown that 70% of 401k plan participants are interested in retirement plan, investment options that consider ESG factors. So we also know that these ESG factors have been important parts of discussions when it comes to specific guidance for employers, particularly given DOLs proposals around ESG investing inside of retirement plan. So here it is, you've got employees that are interested in having these types of options. You've got employers are saying, how do I introduce them when I'm not? So I don't feel comfortable necessarily with the guidance that we've been getting, or maybe it's a little bit confusing. So, you know, I guess what advice would you have for employers looking to incorporate these factors into their practice and into their retirement plans?
Speaker 3:Yeah, it's a great question, bill. So ESGs place in employee sponsored retirement plans has been hotly debated, and the guidance from the DOL has ping ponged. According to whoever occupies the white house, what has been consistent is the notion that planned fiduciaries must make investment decisions in accordance with Risa's fiduciary duties of loyalty improvements, which means that ESSU criteria can be considered as long as it's for the sake of improving the investment outcome. And not for the purpose of advancing some kind of environmental, social or political agenda, such as let's say, addressing climate change. So, as we discussed today, ESG criteria can meet this standard of being material to investment value. And the most recent DOL proposal makes this more explicit. So where we sit today, the pathway to ESG integration within retirement plans is more open than it was a few years ago. Now for employers deciding how to proceed, I would say it really comes down to optionality. And that was a great data point that you gave from voer research with the 70% of 401k plan participants, being interested in having ESG options and their retirement plan. And I think this percentage will grow as the younger generations, which tend to be more socially conscious and diverse occupy a larger share of the workforce in the future. And with that in mind, more choices are better than fewer each person's path to retirement will look very different. Everyone's value set is very unique. So providing the option to incorporate ESG into retirement plans can be a way of showing employees that you care about their needs, to the same extent that you prioritize meeting customer demands for customization. It can also improve overall perceptions of the employer, which can be beneficial to retention and recruiting as ESU principles are often seen as having this kind of humanizing effect, uh, making individuals feel like their company cares about them and in this case cares about their financial future. So overall, I think there are benefits to be had both in terms of the investment sense when it comes to considering financial material issue information, as well as providing more options to employees, to invest according to their unique needs and preferences.
Speaker 2:Yeah. And, you know, we, we had a great session with, uh, Nevin Adams and Fred re where we were talking about this topic and they really decided it mean document document. If you, if obviously you're trying to satisfy employees, there's a need, you know, work with your, um, plan advisor and fiduciary, and then just document the processes and the points you made are really, really great points. And, you know, as a company that provides a lot of tips and suggestions for how employers can best engage with their retirement plan participants, I, I tell you'd be remiss if I didn't point out that there are some operational and engagement efforts that you can take with, um, your plans that help support ESG. For example, you could actually create an environment where your own plan has ESG components, not just investments. An example of that would be reduced paper usage by providing, um, plan documents and other important information to individuals by using E delivery where it's available. Take a closer look at the, uh, retirement plan benefits that you can leverage such as maybe some of the auto features or maybe employer match structures and even different types of accessibility through plan design. So in a sense, as much as we've been talking about ESG from an investment perspective, you can actually even look at your own, um, plan ecosystem and create sort of an ESG type of a plan with those types of features. Any thoughts or comments to that?
Speaker 3:Yeah, I think that's great. That's putting a whole, a whole other lens on it in terms of, you know, how ESG can actually be incorporated into retirement plans. So I, I, I definitely like those, those ideas.
Speaker 2:It has been a great conversation. I love that we first started out. Cause I think there is some confusion on what is ESG and what's it really mean to me in the end. I know that my employees might be really interested in it, but I wanna find out what it could mean to me as a plan sponsor. And then we talked about things to consider within, as a planned sponsor, as a fiduciary and so on. So it's been a fantastic conversation. I really want to thank you, but for all this great conversation and one, I think that all of our listeners will value because it just continues to come up in conversation. Like you said, it seems to be ping ponging back and forth depending on who's in office. And I guess maybe question for you, does it continue to ping pong or do you think that we'll actually get some type of, you know, momentum and will this, will the current momentum continue and grow?
Speaker 3:Well? I mean, one thing that I think is becoming more well entrenched is this acknowledgement that ESG information is material to investment outcomes. I think for a while, there was a lot of debate around that, but I think, you know, as we're as these data sets are around for longer periods of time, and you can actually prove out the relationship between ESG criteria and returns. I think that moves us toward a more credible place where, you know, you can make the argument that this criteria, um, is really important to consider. I think we've also seen more regulation around addressing climate change. And when you think about, you know, the regulatory environment shifting in the future and how companies have to manage toward that, there's also an argument there that the companies that are better prepared for that regulatory shift are the ones that have the potential to outperform their peers. So the, the companies that are positioning for where we are going, those are the companies we wanna invest in that's that's advice that's, you know, as old as time itself. So I think there could over time be more of a convergence around the idea that, you know, ESG information does have a place in investing and that it's not something that's just a preference, but you know, is more widely acknowledged for its merits.
Speaker 2:Cause doing good is good business. And I, I really like how you said, I mean, this is where everything needs to go. And I'll tell you beyond that people want to invest in something that they believe in doing good is good business. Laura, I wanna thank you so much for joining us. This has been a great conversation and I look forward to continuing the conversation in the future.
Speaker 3:Great. Thank you for having me.
Speaker 2:And I also wanna thank our listeners, uh, for joining in and, um, I remind everybody, please, if you enjoy today's conversation, please follow and subscribe. So that you'll be the first to know when we have new episodes drop every other Tuesday. We'd also love to hear your thoughts. So head on over to iTunes, uh, to leave us a review. And I wanna thank you again for joining us today. Stay well.
Speaker 1:This information is provided by Voya for your education only neither Voya north representatives offer tax or legal advice. Any opinions expressed within do not necessarily reflect those of the Voya family of companies or its representatives and are not intended to provide specific advice or recommendations for any individual. Please consult your tax or legal advisor before making a tax related investment or insurance decision.