Help Solve the World’s Most Pressing Problems with Sustainable Investing

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Welcome to On Purpose. I'm your host, Travis Allen, Senior Investment Strategist and National Director of Purpose Driven Strategies at Bernstein. Today, I'm delighted to be talking to Dan Roarty, he is the Chief Investment Officer of sustainable thematic investing at AllianceBernstein. Dan, thank you for joining us. Your portfolio has been a really big component of the purpose driven asset allocation that we introduced to the clients a few years ago.

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And we are now introducing the sustainable US thematic portfolio as a new addition to provide more optionality for clients who want to focus specifically on ESG issues and are really attracted to the UN Sustainable Development Goal framework. So I thought maybe you could just tell us what's special about the sustainable US thematic portfolio, but also maybe more generally about the sustainable thematic investing approach. Thanks, Travis. Very happy to be here and spend some time with you.

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Our sustainable thematic portfolios, including the US portfolio, they are portfolios with a purpose, so, meaning we're not only concerned with investment returns. So with all of our portfolios, we really have a dual goal. So we want to generate strong financial outcomes for our clients, but also positive social outcomes as well. There are three main pillars to what we do.

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So the first is that we invest exclusively in sustainable themes. What that means is that we target companies that are providing solutions to the world's largest and most pressing social problems and in that way are helping enable sustainable development on a global basis. We derive our themes from an analysis of the UN Sustainable Development Goals.

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So more specifically, that gives us exposure to areas like clean energy, sustainable transportation, clean water, medical innovation, food security, just to name a few. These are large, complex challenges and they present really attractive long-term growth opportunities for the companies that can provide solutions to those challenges. And those are the types of companies we own in our portfolios.

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The second pillar is ESG integration. So our view is that it is just not possible to separate economic analysis from social analysis. They're joined at the hip and so we integrated consideration of ESG issues into every single element of our process from how we build our universe, to how we evaluate companies, to how we build portfolios. We think that enhances our decision making and allows us to build better portfolios and generate stronger performance over time.

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And then the third pillar is active ownership. So publicly traded companies play a pivotal role in society, it's because of their massive scale and their massive reach. There's just no credible path to sustainable development that doesn't include them as active participants. So as shareholders, we have an opportunity to engage with them not only on material financial issues, but on material social issues as well.

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So that's our sustainable thematic story in a nutshell. We think that it helps us enable more positive outcomes for society, but more positive results for our portfolios too. Well, you and I spoke some time ago about the growth and strategies that are focused on the United Nations sustainable development goals. It seems to be becoming a more common way for the universe of responsible investing strategies to approach responsible investing.

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So maybe start by giving us a sense for how you distinguish your approach that you've been developing for many years, since even before the SDGs, and how it actually improves society. First of all, I think you're exactly right. It's true that we're seeing a lot of new entrants into this space in the last few years, and some of them are legitimate and they're really interesting strategies. And then some of them might be a little bit more marketing driven, maybe without quite as much real horsepower behind them.

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I think it's probably important to differentiate us both from some of the other active strategies that we might see coming into this space, but also the passive strategies that are involved because we're definitely seeing more of both active and passive. So I'll start with a couple of thoughts on passive. Because we're active, we automatically avoid a number of really important flaws or problems that you see in a lot of passive ESG strategies. And it's kind of a long list. But I'll mention just a few quick things here.

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The first is that passive strategies, they all rely on some sort of external ESG rating, something that says this company is a AAA rated ESG company and this company is a BBB rated company, for example. And the big flaw there is that there is no one standard definition of what good ESG is or bad ESG, not yet at least. So those ESG ratings are very subjective.

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Unlike credit ratings, which tend to look the same regardless of whoever provides them, ESG ratings for the same company can look very different, depending on which provider is giving you the rating. So investment outcomes really depend on which of those providers that you choose and know, that can be a real problem, especially when it's not always clear how the different rating agencies are coming up with their ratings.

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And then another flaw in terms of passive that I'll mention is that with passive investing, you don't get management engagement. So a few real important differentiators, I think, versus passive. But then as far as other active managers go, we have a few really important differentiators as well.

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And I think the first one that you alluded to is that we've been doing this for a really long time and that allowed us to be very early adopters of using the sustainable development goals as an investment tool. But perhaps the biggest differentiator I see and how is really how we use the SDGs versus how some other people use them. So for us, literally the first step in our process, it's our analysis of the SDGs. It's the identification of relevant themes and companies that are helping accomplish the SDGs. We toss everything else out that isn't helping positively achieve the SDGs.

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Our use of them really defines how we invest our portfolios. We use it at the beginning of our process and we use it for investment purposes. And we do see a lot of active competitors, by contrast, using the SDGs at the end of their process and doing it for marketing purposes. So they pick stocks, however they pick stocks, and then once they have their portfolio, then they look at the SDGs to see how they can kind of divide them up so that they can put the graphic in their marketing deck.

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So I really think it is a pretty big difference. And just the way that we approach it, I think we have important differences versus both passive competitors. But we also have really important differences versus active competitors as well. Yeah, thank you for that. And I'm certainly, I've seen those cases where it looks like the SDG label is just being added at the end of the process, as you said. And you've also been able to deliver really strong returns in the portfolio while also adhering to the Sustainable Development Goals.

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And so I have to ask, many of the sub-themes that you focus on in the portfolio have performed pretty well over the last few years. Have investors missed the boat or is there still a strong case to be made for these themes? Great question. It's one of my favorite questions. First, I have to agree, there was definitely some acceleration in some of our investment themes in 2020 and mainly as a result of COVID, as you mentioned. And our investment themes in our portfolios did perform very well.

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If I were to call out one example that we have, I'd probably use the fintech companies, the electronic payment companies that live within our financial security and inclusion sub-theme. So expanding access to financial institutions, to marginalized individuals who are not connected to traditional financial institutions is a key goal of the Sustainable Development Goals, and so is supporting the growth and the development of small businesses and even micro businesses.

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And that's exactly what a lot of these fintech companies do that live within that theme. So we own a number of those companies across the world as part of that theme and this broader theme of what we would call empowerment. So you can think of companies like Square and PayPal or maybe PagSeguro in Brazil. Adyen in Europe, there's GMO Payment in Japan. Right. There are a lot of companies that are all connected to this really important theme.

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And clearly, as our lives shifted a lot in 2020 during the lockdowns and they really shifted online, we all did more working from home and shopping, and learning, and exercising and seeing our doctors online. So the companies that enabled that transition to the online world were obviously really well positioned. So the fintechs and our financial inclusion names clearly got a boost from COVID.

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But it's really important to remember that all of our themes benefit from multi decade tailwinds. We've never been interested in themes that are going to play out over a year or less. Those would more be fads than themes and we're not as interested in fads.

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If I stay on that fintech example, they might have all been boosted from a better 2020 than they probably would have been otherwise. But we're still so, so early in the development of that theme. In 2019, e-retail still only accounted for 14 percent of all retail sales worldwide. After 2020, it's still probably somewhere in the teens. So again there's so much more room to run for that theme to play out in coming years.

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And Travis, I could really make that same case for pretty much all of our investment themes. So 2020 was particularly good, but we had definitely not missed the boat on a lot of these sustainable themes. And that's really why it's my favorite question these days, because, again, it was a great year.

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There is absolutely a lot more to come. Thank you for that, Dan. I appreciate you making the long term case for the sustainability and responsibility focus of the portfolio. But what about the return opportunity, given that things have gone so well, especially for faster growing companies, some of whom, of course, are benefiting from these trends? Are there still attractive investment opportunities around today? Yeah, another great question, and the answer is yes, there absolutely are. Thinking about valuations,

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they are clearly elevated across the board. And it's not just true for sustainable stocks. And we sort of view it as a reason to be certainly somewhat cautious. But I think even at these valuation levels, we definitely have opportunities to generate healthy returns in the portfolios. First, we always have to remember that there are very, very large, powerful long-term growth drivers associated with these themes. So some of these companies can certainly grow into higher current valuations.

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But there's another, I think, important benefit of investing the way that we do, which is having a multi-themed approach rather than a single-themed approach. If you only invest in one narrow theme, valuation levels, right, they can always get ahead of themselves in that more narrow part of the market as investors get really, really excited. But we don't have to invest in only one sector or one theme. And because we invest across three broader themes, again, what we call climate, health, and empowerment,

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and then there are 12 sub-themes that sit underneath those, we can at tactically allocate to parts of the market where we do see more reasonable valuations and avoid some of those areas that might be attractive longer term, but maybe where we do see valuations as particularly extended today. So I think fair observations that valuations are higher today, but it really doesn't dent our ability to generate strong returns, we think over certainly over intermediate or longer term periods.

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Great. So maybe a bit of a transition now then, as you know, as our listeners may not know, I'm here in Washington, DC, where we've had a very, very busy January.

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And the Biden administration will likely take a very different regulatory approach on issues that are pertinent to your investment approach. And so the question is, is there anything that you are watching really closely that may have an impact on positioning decisions within the portfolio? Yeah, so this is clearly an important question when we're thinking about really any portfolio, but probably especially ours.

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And when I think about which way the political winds are blowing here, I would say that by itself, the recent change in the US administration, it doesn't fundamentally change the opportunity that we see in front of us. It doesn't change the way we think about a lot of sustainable investment themes. But the truth is, it does matter who's in charge or how we think about portfolio returns. The change to the Biden administration is clearly a positive development for investors who care about social impact. Within the general category of climate,

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right off the bat, we rejoined the Paris Accord. Biden revoked the permit for the Keystone pipeline. He also reversed a number of rollbacks that we had seen on vehicle emission standards. So from our perspective, themes like cleaner energy and sustainable transportation within climate, right, these are going to be obvious beneficiaries of that. Within the broader category of health, he did a number of interesting things as well. We reinstated ties with the World Health Organization, and Dr. Fauci, who has become probably the biggest rock star of 2020, and people just love him,

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he's going to lead the delegation to the World Health Organization. Biden restored a global Health and Biodefense Directorate back to the National Security Council. The prior administration had removed that position from the National Security Council. So he just put that back. And, of course, we implemented a new national mask mandate. All of those things tell us that that seems like medical innovation and expanding access to quality healthcare, those are going to be clear beneficiaries. And then the third of our three themes, we call it empowerment, but it feels a lot with equality and rights. And there was a lot of activity in that area as well.

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Biden reversed the recent ban on federal agencies and contractors holding diversity and inclusion training, which had been, that had gone into effect, I think in last September. He ended the so-called Muslim ban. He restored DACA protections. He revoked a plan to exclude non-citizens from the census. He extended a moratorium on evictions during, while COVID is happening. So themes related to things like financial inclusion and education and employment, those are potential beneficiaries.

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So there are others that we could look at where we know that there's going to be some regulatory support even if we didn't see them in day one executive actions. Things like building out sustainable infrastructure is probably at the top of the list.

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So we're going to need to debate the efficacy of a lot of those moves and to think about the short-term and the long-term economic implications of what the Biden administration is starting to do. And they're certainly likely to be both positives and negatives. But again, I think none of those is really going to meaningfully alter the longer-term fundamental trajectory of sustainable investment themes. But in the short term, absolutely, we are going to get a regulatory boost from this new administration that's going to matter, I think, for the stocks.

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So with that, I'm sure companies are all paying very close attention to many of the changes that you just highlighted.

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Maybe we should talk a bit about engagement, because engagement as a tool for responsible investors, I think is oftentimes overlooked and underappreciated. But it's one of the key ways that you can invest in ways that promote positive changes. Is that something that you have been really focused on and maybe share some examples of how you engage, how you choose, which issues to engage on and how you track the impact you're having with those engagements? Yeah, so engagement is absolutely critical. So you're right about that.

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These large publicly traded companies that I own in our entire portfolios and that we talk a lot about know, remember, they employ the most people around the world. They use the most natural resources in their production processes. They generate the most pollution in their manufacturing and their distribution operations.

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And really importantly, they are the most politically connected entities in the world. And we've seen lots of examples of their political power. In fact, in your hometown, Travis, in just the last couple of weeks, these companies can make or withhold political donations. And business interests, by the way, typically account for the vast majority of all political donations.

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And media and social media companies can even exercise discretion over who gets to communicate to the public on their platforms. And therefore, they really directly impact information dissemination and knowledge sharing and can really shape the public discourse.

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It is so important to have a dialogue with these management teams and to engage with them on social issues and to make sure they're not overly focused on only meeting short-term earnings per share targets for shareholders, let's say. So last year, if you're thinking about some of our activity on our portfolios, we conducted 125 separate management engagements on different social issues. They range from issues like diversity and inclusion to employee safety to modern slavery, to carbon emissions, to executive compensation.

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It's a pretty long list and it's always hard to pick out just one or two because again, so many of these issues are important and it's also sometimes hard to pick out just one or two examples because engagement success is something that plays out over a long period of time. It's not something that happens in any one meeting. It would be great if we could think of some issue, call up the CEO and talk for 30 minutes, tell him or her what we'd like to see happen. And then it happens and we can cross it off our list.

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Right. And unfortunately, it usually doesn't happen quite that cleanly out there. Like, one example of that that comes to mind is in our portfolios, there's a company called Bruker. It's great healthcare company. We own it as part of our medical innovation subtheme. They provide different tools and instruments that are used in drug discovery that really help advance, they're helping advance personalized medicine. So a really good kind of pick and shovel provider within that healthcare innovation space. Well, we started engaging with them, I think, as far back as five years ago now on a few different topics.

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But on diversity, one of the things that we had observed is that they didn't have any women on their board and we had great conversations with them. They were certainly open to engaging with us. We would use those opportunities to really press them on the importance of diversity and challenging them on why they hadn't done anything about this yet. And I'd say after consistently engaging with them on this, again, for almost five years, Bruker now has, I think, three women on their board. And the three most recent additions that they've made to the board have all been women, which is great.

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Now, that's not entirely due to our engagements with them. Far from it.

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We are, I know we are one of many voices that we're engaging with them on this, but we absolutely helped get that done because we used our voice to accomplish something that I think is very clearly good socially. We also think it's going to be good financially for the company to kind of have that diversity in the boardroom as well. So just a flavor of some of the engagements that we do and some of the issues that we've engaged our holdings on. But again, I couldn't agree more that this is such an important dimension of sustainable investing and really making sure that we can do everything in our power to bring about positive social impact.

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Right. Thank you for sharing that example. You know, probably the last thing I wanted to to talk to you about today, Dan, is measurement. It's something you and I have talked about in the past. And I'm just curious about how you think about measurement of the environmental, social, and governance performance of the portfolio. What are the key metrics and how do you think the way you measure things and report metrics back to clients will evolve going forward? Measuring impact is the holy grail of this industry.

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And I think, the first word that always comes to my mind is humility, right? I think we all have to be humble here and realize that the truth is that all of us who do this, we're still quite early in our journey of being able to do it well. And there are lots of reasons for that. It's certainly not the intentionality or our desire to do it, but there are a lot of practical barriers to do it, to, I think, really doing this as effectively as we'd all like.

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Companies don't really have standards for how to measure the impact that they have, and they don't have many requirements for reporting on the impact that they have either. So we don't have great data. The data that we do have, you know, they're not very comparable on a lot of dimensions. They're often not very timely.

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So there are a lot of practical challenges that make it quite difficult for us to measure impact in a meaningful way and report on it back to clients in a meaningful way. So one thing that we can do is that we can measure the percentage of a company's business, the percentage of their revenues that they're generating from positively aligned products and their negatively aligned products. And we can look at the difference between those two. And that does give us some really good, clear insights and ways to dimension the product impact that companies are having.

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And then in terms of operational impact, we do have some things that we can measure today, things like board diversity, carbon emissions, worker safety, and various governance metrics. So as an example, whether any ESG metrics are included in the senior management compensation plans.

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So we do have a number of things that we can look at today to help us gauge the operational impact the companies have. But I would say that they're still somewhat imperfect and they don't really give us as comprehensive a view of any company's impact as we'd like. So I think going forward though, company standards are going to start to emerge, reporting requirements for a lot of these environmental issues and social issues and governance issues are, those requirements are going to increase and that's going to be good for all of us who care about social impact.

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Dan, thank you very much. It's always good to talk to you. I look forward to doing this again in the future.

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This has been On Purpose. Thanks for joining us. And remember, we all have values we hold dear. Now you can ensure your investments reflect them. You can reach me on LinkedIn. If you enjoyed the podcast, please rate us on Apple Podcasts, Spotify, or your podcast service of choice and be sure to subscribe. Thanks again. Bernstein: Making money meaningful for individuals, families, and foundations for over 50 years. Visit us at Bernstein.com.