Episode 7: ESG Investing Not One Size Fits All

Integrating ESG factors is important for companies’ financial performance and sustainability, and equally important for active managers’ ESG investment analysis, including ESG “momentum” stocks.


ESG Investing Not One Size Fits All

Craig Blessing:  Hi, and welcome to another episode of Away from the Noise, Thornburg Investment Management’s podcast on key investment topics, economics, and market developments of the day.  I’m Craig Blessing, Client Portfolio Manager for International Equity at Thornburg.  Today, we’re going to talk about international ESG investing with Di Zhou, Portfolio Manager for International Equity and International ESG at Thornburg.  Di, sustainable funds attracted 21 in inflows in the U.S. last year.  That’s four times the previous year’s total.  Why are investors so interested in ESG?

Di Zhou:  Hi, Craig.  Yeah, that’s a great question, and, that’s something we are seeing globally not just, U.S. invest, U.S. based investors but also international based investors.  Because we think the, the increase in demand for ESG investing is because investors first want to, invest their money aligned with their values.  So, for example, if people care about environment, they want to invest in say climate-related investments.  And secondarily, just very simply increasingly we’re seeing regulators, mandating more ESG investments. However, ESG investing is still relatively new and, lacking consistent terminologies and which create a lot of confusion, so ESG investing is actually not one, one size fits all.  It’s, actually the opposite of that.  And when we talk about ESG investing, you know, it includes socially responsible investing, impact investing and everything in between.  So, for, for investor that’s actually very important to understand the difference. at Thornburg, our approach is to take an ESG integration approach.  We integrate ESG issues in investment analysis and investment decisions because we really believe ESG integration will enhance portfolio risk adjust returns for our shareholders.

Craig Blessing:  Di, as you mentioned, there are an awful lot of different approaches to ESG investing, and it can be a little confusing for the average investor.  You hinted at how Thornburg looks at ESG investing. do you wanna elaborate, on why, what approach Thornburg takes and why?

Di Zhou:  The reason why there’s so much confusion is there’s a lot of ESG factors out there, there could be thousands of different ESG factors for, you know, people care about different things.  And at Thornburg, ESG integration really means, finding the material factors.  So, you know, material factors that’s, important to company’s financial performance and sustainability.  So, for example, we use SASB material factors as a guiding, principle for our process.  So, as example, if we think about e-commerce, company, the material factors will be, one is energy management, right, ’cause they have to run the big, Internet platform, and, customer privacy, data securities are very important employee talent, management recruitment, retention that’s very important.  And, product design, life cycle management that’s really important because that’s, user experience related stuff, right.  So, you know, we actually think it’s fairly easy to find out the material ESG factors and to gather relevant data around it, but the most important part of the, of ESG analysis is assessment of material ESG issues.  And at Thornburg, we use a three area of trust framework to assess:  the board of directors, management team and company employees.  So, this qualitative of analysis that is most natural for fundamental managers like us to understand the nuances, within the issues.  So, so another example would be, say a very, you know, good independent board of directors who sits on ten different boards, you know, that doesn’t really do much value added to the company, rather than say just window dressing.  And, something like this as, you know, fundamental managers, you can appreciate the nuances, you know, behind just the data, disclosed by the company.

Craig Blessing:  So, there’s an awful lot also of different ESG rating services out there but different factors that they look at.   , and, and a lot of those rating services seem to base their ratings on companies that are already ESG leaders and ignore companies that might be on their way to becoming leaders tomorrow.  To you, does that present any investment opportunities?

Di Zhou:  Yeah, that presents huge investment, opportunities for us.  So, you know, when, when we really think about, two type of, ESG investing, or investment funds, you know, compare passive investment versus active investments.  So, if you’re quantitive pa, passive investment, you know, the only thing you can utilize is,  , rating agencies data and rating on the companies, and by and large you’re only investing in best in class ESG companies and really kinda ignore the,  , companies who do have lower,  , ESG ratings.  And we think there are fundamentally, there a lot of issues with that, that approach.  One is data disclosure is very different by sector and by geography.  So, you know, companies do not disclose enough, ESG related data to not score well, by, for, from rating agency’s, perspective.  Also, the datas, are backward looking they’re backward looking indicators, not capturing where the company is going.  So, for active manager, fundamental managers, you know, we don’t have to rely only on rating agency’s data, and we can actually capture the change in those companies.  And innovation really think active management and continuous engagement with company are the necessary parts of both building long-term value and creating better overall outcome from, this exercise.

Craig Blessing:  That’s great.  You, you hinted at the answer to this in, in the last question, but, but there are also obviously a lot of different ESG managers out there with different styles that range from active to passing, passive, and like we’ve seen in a lot of other investment arenas, passive funds seems to be getting a lot of flows.  In ESG, do you think either particular style of investing, active or passive, has an advantage and why?

Di Zhou:  I’m probably gonna be biased answering that question as a active manager, but our, thinking is, because ESG investing is still new and there’s still a lot of inefficiencies in, you know, data, and in disclosures, so, you know, capturing only best in class ESG companies is not going to be enough to, really deliver value for shareholders.  There are a lot of companies, what, what we call ESG moment  companies, optically from backward looking data,  , data says doesn’t look great, you know, from ESG perspective, but things are doing, are really, moving the companies in the right direction, so therefore we, we think those are ESG moment  companies could also create more value over a longer term.

Craig Blessing:  That’s great.  You, you manage international ESG strategies in particular, and do you think there are particular reasons that investors should consider an international approach to ESG investing?  And related to that, as you look around the world, I’m assessing there may be places where companies are more advanced than the U.S. or other places with respect to ESG and places where ESG investing is, is a little more challenging.  Are, are there regions like that?

Di Zhou:  Oh yeah, most definitely.  So, for example, Nordic’s companies, they tend to have a lot more best in class ESG companies over there just because they have been focusing on ESG issues for much longer term and therefore, you know, they tend to receive much higher marks on ESG issues, right.  And, also because, you know, another reason why if you think about internationally is, is the second part of your question.  There’s a lot of countries, do not have great disclosure.  Companies there do not have, great disclosure, but doesn’t mean that they’re not good ESG companies, right.  So, those inefficiencies also create opportunities for fundamental managers to extract value and deliver return for our shareholders.  And, and maybe another point if you think about from investing internationally is, you know, there are some key secular trends that’s really more pronounced in the international markets than the, than the U.S. market.  So, for example, electric vehicle supply chain  So, when we look at from mining companies to, you know, chemical companies making cathode or anode to, you know, battery makers or to automotive OEMs and really compare, you know, regulatory supports from different governments, you know, you will find most of those investment opportunities,  , exist outside of U.S., and if you want to get exposure to, you know, secular trends like that you almost have to invest in international companies.

Craig Blessing:  All right.  Thank you.  That concludes our podcast.  Thank you for listening.  You can find us on Thornburg.com/podcasts as well as on Apple podcasts where you can rate, subscribe and review us.  Please join us for the next episode of Away from the Noise.

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