Total time: 18:19
00:01
Lily Tu: Hi, everyone, I'm Lily Tu. I'm a Vice President of Institutional Consultant Relations at Sage. With me today I have the CEO, CIO, Bob Smith, as well as our Senior ESG Research Analyst Emma Harper. Thanks for joining me.
00:17
Bob Smith: Thank you for having us.
00:19
Lily: So on this podcast, we're going to talk about how we integrate ESG into our enhanced cash management and short term strategies. But before we dive into ESG investing, I wanted to review some of the basics of the strategies. So one, they're available in an SMA format and can be implemented at very reasonable minimums. Two, we invest in investment grade cash bonds that include Treasuries, agencies, corporates and securitized debt. And three, to give you a sense of the risk profile, the duration for our enhanced cash is typically one year or less. And for our short term, it's typically under two years. So now that we've covered the basics, let's turn our focus to ESG. So, Bob, there have been a growing number of call it “passionate discussions” around ESG, some positive, some negative. But I think definition and intention are important to understand. Can you explain to the folks today, how do we think about ESG in the context of running a bond portfolio?
01:21
Bob: We believe that environmental, social and governance factors can have a material impact on a company's financial performance, and that they play an essential role in generating long term sustainable returns across all kinds of investment strategies. It's not just stocks; it’s stocks, it’s bonds, it’s cash, it’s private credit, it’s private equity. It is somewhat ubiquitous. And so we believe that ESG risk analysis applies to all the strategies in these asset classes. And we think that ESG integration, basically is part of the normal process of risk management and risk analysis in fixed income – just like credit analysis, just like duration analysis. And so ESG risk factor analysis is equivalent to and as important as those other considerations of managing the portfolio. I think it's really, really interesting to note that even as of today, that there was an article that was released and reported on a survey that was done by Morningstar. And it was reported that 70% of those surveyed in this survey, felt that ESG had become more material in the past five years, including 29% of the respondents said that ESG has become much more material. And that survey was conducted just this past March. It wasn't two years ago, three years ago, very current. It was 476 different asset managers, owners, insurance companies outsourced CIO, the whole gambit. And they all felt that materiality and the importance of ESG had become even greater than it has been in the past; 64% of these respondents were managing a billion dollars or more. So this was a substantial finding, in the sense of how important is ESG. So we believe that, ESG is a very important risk management consideration. And so, you know, when we look around, and we look at who else thinks as well, MSCI just released a report just this past winter in 2021. And they found that ESG-related risks were not fully captured in credit ratings. Amazing. This supports our assertion that ESG risk analysis and related ratings provide extra information beyond the limits of the credit ratings for investors. And as fiduciaries, it is our job to look at every potential risk that may adversely impact our portfolios, but also may give us a greater opportunity to generate excess return.
04:12
Lily: So you know, it sounds like ESG risk analysis is really just another tool in the toolbox in analyzing and assessing companies. Emma, there are many different approaches to ESG. There seems to be a lot of managers that market or take on kind of a more values-based approach. What differentiates our approach to ESG?
04:36
Emma Harper: Sure, so I would say we are pragmatic, and as Bob touched on, we are fiduciaries. We are working to be the best financial stewards of clients assets. So therefore, we use all available data at our disposal to make sound investment decisions. So through the incorporation of sustainability data on the issuers that we're investing in, we're able to enhance our risk management analysis and enhance our potential opportunity set. Company focus on managing ESG risks can have a material and beneficial effect on company's performance. So we focus on financial materiality. When analyzing sustainability information, we are wanting to separate out that “need to know” information from the “nice to know” information, and only incorporate what is impactful and material. From this analysis, we create our Sage ESG Leaf Score. And that gives companies a one-to-five leaf rating. And that's incorporated in client portfolio statements and is available to all clients to view. So the leaf score is our proprietary rating system where one-leaf issuers are considered laggards, five-leaf issuers are considered leaders. And this really helps tell the story of where we believe each credit stands from a sustainability perspective. And it lets clients see where their portfolio stands as well.
05:57
Lily: In a lot of conversations, we hear about ESG and this concept of impact, right? And there seems to be a blurring of lines between ESG and impact. Bob can you explain, can you get impact with ESG?
06:14
Bob: Good question. So let me answer the first part of it and provide some definition and some context because I do believe that people do get terms and the definitions and purposes kind of blurred between what is ESG, what is impact, what is SRI, sustainable, and so forth. And so, let's just lay down some definitions that we operate with that we would like to share with the audience. And the first is that ESG risk analysis really tries to supplement traditional financial analysis, not replace it, but supplement by identifying a company's ESG-related risks and opportunities. And there's a great number of them that aren't covered in last year's financial statements and balance sheet, income statement. And they are very much involved with things like human capital, brand, value, regulatory considerations, and so forth. And a lot of those things you cannot find in traditional financial analysis. And so there's where ESG really picks up and takes off and really gives you more of a forecast of the future, rather than what happened in the past. And so what we in this process, what we are attempting to understand is the potential adverse financial impact a company may suffer by not acting on those risks, as well as the opportunities for financial gain that they may achieve by successfully seizing on them. And so for us, you know, improved financial returns to risk reduction remains the primary objective of ESG investing. And that's the way we see that ESG investing. If we looked at the impact side or the impact and thematic investing, the primary purpose is to seek and develop positive social outcomes, that is their highest priority. And there are many ways of illustrating. I'll do that in a bit here. But what we're really looking at there is that investments and investment processes that need to work toward producing a tangible, social good. So the objective of impact investing is to help a business or organizations really achieve specific goals that are beneficial to society or the environment. Let me give you an example. One good example of impact investing or an impact might be one that funds nonprofit research in clean energy. Or another might be a publicly owned pharmaceutical company that funds and assists local governments in creating advanced transportation systems where the delivery of critical medicines to lesser developed and underprivileged communities. So there's all kinds of different examples of impact investing. And so getting to the bottom line question of can you accomplish both, I wouldn't say this: all impact funds are and should be ESG compliant. Absolutely. And that's the way we think about it. However, it's also worth noting that ESG compliant funds can but do not necessarily have to actively make an impact. They're not designed for that; it's a difference. And so, as of today, I will tell you that ESG integration remains probably the most commonly used methodology or implementation strategy by investors, and followed then by thematic investing and impact investment.
09:52
Lily: Reporting, as we all know, has become very critical to the ESG overall story. What can advisors and consultants come to expect from Sage from a reporting standpoint, Emma?
10:03
Emma: Absolutely. So we have a comprehensive package of reporting that incorporates ESG metrics, such as the Sage ESG leaf Score, impact influences, as well as climate-related reporting. So what can be expected is really a total complete package of the portfolio from a sustainability perspective.
10:23
Lily: And then, you know, in speaking with a lot of consultants and advisors, I've found some clients are actually hesitant to adopt ESG strategies because they simply don't want to forego returns. I hear this time and time again. Can you opine on this concern, Bob?
10:38
Bob: Sure, this one just, it drives me nuts. And for a variety of reasons. There have been now decades’ worth of meta studies that have examined the relationship between ESG and financial performance. And it's all there literally in the hundreds, if not thousands, both here, Europe, internationally, academic, industry wide, you name it, it's out there. And basically what these efforts produce an overwhelming weight of evidence, which clearly indicates that companies who pay attention to their respective ESG concerns, not every ESG concern, the ones that relate to their operations, do not cause a drag on value creation for investors. In fact, to the contrary, of all the skeptics that are out there, the research shows that companies who pay attention to their respective ESG concerns, in fact, enhance their financial outcomes through reductions in downside risk. And this is evidenced in a lot of ways. In fixed income, for instance, it's evidenced by the fact that you're seeing lower loan and credit default swap spreads, you see higher credit ratings, I can go on. But I think it's important also to kind of sit back and think about how this is all happening. McKinsey and Company did some really good research in this regard. And what they found in a study they've done probably about 18 months ago, is that companies that focus on managing and minimizing their respective ESG risk benefit their organizations and investors in about five key ways. One is the facilitation of top-line revenue growth. More business, reduced operating costs, running at a much more efficient level improves margins, which improves value for investors. They also tend to have a minimization of regulatory and legal interventions. When regulators come knocking on the door, you have to grab your lawyers, that becomes expensive, that holds up business and so forth. And so those organizations that tend to avoid those, because they pay attention to those potential risks, actually enhance the bottom line very quickly. They also find that they're good at increasing employee productivity, because human capital is a high priority for them, and nurturing that asset and improving on that asset and taking care of that asset, actually, is beneficial to the bottom line over the long term. And then lastly, very good companies are ESG focused and sensitive, are very good at optimizing their investments, and their capital expenditures to consistently improve upon their ESG risk management capabilities. So there was an extreme amount of information. And there's been a number of studies by very well thought of organizations, both academic and industrial, that would support the notion that ESG is beneficial, and indeed does not detract from improving capital value over any period of time for most investors.
13:59
Lily: So Bob, you recently wrote a piece “A Sustainable Approach to Cash Management.” How does ESG fit into short term fixed income?
14:08
Bob: I think that ESG fits into every asset class. And I believe that cash management is particularly enhanced by its application. Why is that? First of all, a lot of people disregard ESG with regard to short term investments, because like, oh, well, it only has a final maturity of less than a year. So why should I care about that? When you actually look at how much cash people actually have and for how long they have it, be it an S&P 500 company, be it a large not-for-profit, be a university and so forth. What you'll find is that cash is not a tactical asset, it is a strategic asset that gets redeployed and reinvested frequently over and over and over again. And what you find in those portfolios are very much the same names, the same banks, the same corporations over and over again. And in actual fact, people may own things like let's say, General Motors or Bank of America or some form of an asset-backed, not for just 90 days or six months, to the final maturity; at that maturity, they'll roll it again. And they'll end up owning that same paper, not for a year, two years, three years, could be four or five years, because they were proved. And those are the names we'd like to buy. And so in that process, you're really looking at risks that emanate from the ESG world that can actually adversely impact your cash management portfolio, if you're not watchful and looking for those risks. But you can, unfortunately, miss opportunities that are created along the way as well in terms of ESG that's managed well, that is not well priced in the value of that security at that moment in time. And so we're always looking for those securities that we think are underpriced or mispriced, because they're better from an ESG perspective, and that ultimately, that will shine through. And so we believe that in the cash management, liquid securities, short term liquid securities and so forth, that there is mispricing when it comes to looking at ESG-related risks. And so we think by the prism or using the prism of ESG risk analysis, that we can enhance some of the outcomes, the yields, and also the consistency of returns in cash management by applying ESG risk analysis.
16:51
Lily: You know, this was super insightful. I'd say there are really three takeaways from this conversation: one, ESG analysis helps to mitigate risk in portfolios in short and long-term horizons. Two, there are a myriad of approaches to ESG. So it's important for investors to understand and define what's important to them. And three, we at Sage incorporate ESG into our investment approach in a very pragmatic way, which leads to better outcomes for our clients. Thank you everyone for listening today.
17:19
Disclosures: Sage Advisory Services is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. This podcast is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.
