(17 min podcast) In this episode of The Source, eVestment’s podcast covering trends and insights in institutional investing, we’re joined by Alex Hoy, vice president at Callan, where he works in Callan’s global manager research group.
Alex is also a member of Callan’s ESG committee, which is the primary topic of our conversation. Callan recently released its eighth annual ESG survey of U.S. institutional investors. We sit down with Alex to talk about the findings, how they’ve seen things change over time and what investors are looking for in the future.
eVestment has been collecting ESG data for years — but earlier this year we released the new version of our ESG questionnaire to give consultants and investors access to more information about a manager’s ESG philosophies, their approach and ultimately the impact. It also gives managers an opportunity to differentiate themselves and their ESG approaches. For information on how to access that data, or how to populate that data, please contact us at email@example.com.
Rich: Alex, thanks for joining us today. I want to spend some time talking about a recent survey Callan published around investor approaches to ESG, but before we jump into that, can you tell us a little about yourself and your role?
Alex: Absolutely, thanks for the time today, Rich. My name is Alex Hoy and I am a member of Callan’s global manager research team. I’m responsible for researching global and non-U.S. equity strategies and managers for our clients, and then working with the consultants and our clients to make what we feel are the best decisions in their portfolios.
Another role that I have is being a member of Callan’s ESG committee. I’m the global and non-U.S. equity representative on that committee. And there are about 10 of us from various parts of the organization on the committee, all rowing in the same direction to implement ESG, the best way possible for our clients.
Rich: Callan has been conducting the survey for a while. Can you expand on the history of the survey and the make-up of the respondents to give us some context?
Alex: This year was the eighth year that we’ve published the ESG survey. It began back in 2013 and we publish it every year. The respondents are public and corporate DB plans, and endowments and foundations. There’s a few other client types, but it’s meant to be the asset owners, the plans and the trustees that we are working with on a daily basis. And over the last four years, the respondents have ranged from 89 total responses to 102 responses, like we received this year. We get the majority of those responses from public plans, but there’s a good breakdown of the different plan types and also by plan size. We break it down in various buckets, but there’s a good distribution across smaller plans, medium-size and large plans.
Rich: Over that time, at a high level, what are some of the biggest changes that you’ve seen in the results?
Alex: For the asset owners, it’s really been a formalization of ESG in their plan and mainly in their investment policy statement. That was one of the most common ways that the respondents this year indicated that they are implementing ESG in their plans. And that’s something that we’ve seen grow over time. It’s just a way to formalize and codify the approach.
There’s also been a large increase in stakeholder demand from these plans, asking for ESG either to be implemented in their IPS or having a specific investment strategy in the plan as well. So those are two of the big changes that we’ve seen grow in prominence in recent years.
Rich: I know I want to touch on the stakeholder demand in a bit, but before that, in going through the survey, it was pretty obvious that the ESG approaches vary by investor type. It was pretty clear that corporate and public plans are doing something very different than a foundation and endowment. Can you talk about in more detail some of the differences you see in the specific investor types?
Alex: Over the years we’ve seen endowments and foundations really be more early and more consistent adopters of thematic or impact ESG strategies where they’re trying to achieve a specific outcome such as a positive societal or environmental change in their portfolio. Working towards that goal, instead of maybe another strategy that might be equally as focused on alpha generation as it is on achieving ESG goals or tilting the portfolio in that way.
The latter is more prevalent in corporate and public plans where ESG started as more of an option that was passive, giving those plan participants the choice to invest in this type of a strategy. But it was done passively where the screens, however they were implemented, resulted in the portfolio that those clients owned. More so lately we’re seeing a bit of a trend or more interest in active ESG strategies from corporate and public plans. So I would say that that’s adding more ability to add alpha from those strategies, while also it’s still highly skewed towards the highest rate of ESG competence.
Rich: One of the things you asked in the survey was reasons for incorporating ESG factors. And I think at the top, 60% of respondents said stakeholder concerns, followed by 53% said to align with their organization’s values. Down the list a bit, 28% said higher long-term returns. And that ties into the reasons I saw for not incorporating ESG into a portfolio was the unproven return expectations. Do you see ESG as a place where you can generate alpha? And if so, what do you think it’s going to take to prove those benefits to the naysayers right now? What evidence do they need?
Alex: So to answer the first question: yes, I personally, and at Callan, we think that ESG can have a material impact on returns over the long term. So what’s it going to take? Not to overuse this answer, but I think just more time. The way that ESG is being implemented has changed or has been enhanced in recent years to such a large degree that I think we really just need time to put these managers and these strategies under a microscope and see if any incremental alpha that they generated was due to ESG externalities or due to other factors or aspects of their process.
Specifically, I think we need a full market cycle, and particularly, one that’s not led by growth companies. We already know that a lot of these highly-rated ESG companies skew towards growth when you plot them on a typical style map. It’s a bit hard to disaggregate the returns from ESG versus the returns from just being growth or momentum-oriented since that’s worked in the market environment lately for the last 10 years. And then also alongside that, would just be better attribution of these ESG factors. Since ESG has certainly come under the microscope much more in recent years, I think everyone is still learning how to best analyze what these managers are doing. We’re learning as it’s coming towards us, how to analyze it, how to digest it. And it’s changing too. It’s getting better every day. It gets back to having more time to be able to see if alpha was generated by way of ESG or other factors.
Rich: Totally with you on things moving so quickly. We just released the next iteration of our ESG questionnaire to help consultants and investors get more information on the impact of a manager’s ESG policies, more than the upfront philosophy. But I think that’s the second time we’ve relaunched that questionnaire in the last three years. Because the demand for data is changing so rapidly.
Alex: And there’s no one way to approach it, too. I think what you guys just released is great. Certainly adds more detail, adds more pointed questions than ever before. And we’re trying to do the same things too. We’re getting better at asking these questions every single day, getting better at recording the answers and then ultimately being able to make decisions from them as well. But we’re all learning and getting up to speed together.
Rich: It was interesting in the survey too, to see how these positive impact investments that people have intentionally included in their policies have changed over time. So I think pre-2005, there might’ve been anti-tobacco focus and then alcohol following that. What are some of the more prevalent themes you’re seeing in more recent times?
Alex: One of the most prevalent themes is in embracing of clean energy or green energy. Elimination of fossil fuels. There’s many different ways to break it down, but that’s become much more of a focus of our clients. It’s an easy way to implement a more ESG-friendly portfolio, but also explaining to plan participants to say this is why we are doing these things and why we may see some headwinds for the areas that we are excluding going forward.
You could take it one step further and say that the rise of clean energy, or green energy, there’s just many more companies popping up every single day. Not to just pick on one in particular, but we’ve seen the rise of Tesla for example. It took them plenty of time to get to where they’re at today and they’re still evolving as a business, but there are others entering that space. And so as that business grows to focus more on battery technology and things along those lines, there’s going to be more investment opportunities. That’s been an area where we’ve seen both client demand, but also a lot of products being created by the managers themselves to keep up with that demand.
Rich: Good segue. You also asked where are investors looking for more product offerings across asset classes? What did you guys find there?
Alex: Our answers were actually pretty interesting there, in that the demand changed a lot from the responses that we received last year. At the highest level, there is demand in fixed income products. Why? Because there’s just not a lot of ESG-friendly fixed income products out there. They’re getting back to the green side of things. There are some green bonds that are coming to market that are resulting in investible products being created. So we might see more and more of that come in the future, but fixed income remained pretty high up on the list as an area where the respondents from our survey were interested in seeing more options.
And then it was more on the active side of things, both on the U.S. and the non-U.S. fronts. Like I said, passive ESG strategies were a really easy way for early adopters to get that exposure. And now that the data explosion in ESG has occurred and managers are formalizing ESG in their investment processes to a much larger degree than ever before, I think clients are starting to think about active ways to implement ESG in their portfolios. So we saw quite a bit of demand there too.
Rich: Lastly, we can’t do a podcast or have a conversation this year without talking about the impact of COVID-19. And that’s something you guys were able to ask about in the survey. So, what did investors say about the impact of the pandemic on their ESG approaches?
Alex: We had to ask exactly like you said, unfortunately, of course, and the responses were actually a bit surprising. 60%, if I remember correctly, of the respondents said COVID-19 had no impact on their ESG goals. So that was positive from a pro-ESG perspective, of course. And then the result was 14% of the respondents said that this year COVID-19 has actually caused them to speed up their planned ESG efforts. We didn’t ask why, but that was a very positive result to see. Only 5% of the respondents said this year COVID-19 is causing them to slow down their ESG efforts. Almost three times as many plans are going to speed things up rather then slow them down because of COVID-19, which was great to see.