We work with somelarge asset owner clientsthat have organizational beliefs and objectives aroundthe transition to a low carbon economy,how would we help them re-engineerthat Russell 1000 allocationto reflect the low carbon transition?- Tony, it's always great to have a conversation with you,so thanks for joining us today.- Great to be here.- Now, Tony, we're here to talkmore specifically about ESGand ESG initiatives.ESG itself has been on quite a journeyover the last few years.- The last time we spoke was a few years ago,so I wondered if you could just give us a bit of a summaryof ESG was so in the limelight in 2020and what you think the pandemic did to itand where we are today.- So, where we are today, I think is a growing realizationthat ESG just isn't a one size fits all kind of term.Really I think we would talk more aboutsustainable investment as an umbrella term,and within that we see probably three approachesour clients taking.One is ESG integration, which probably mostly aligns withwhat you're sort of thinking of ESGand the journey that we're all on.And that's definitely about, you know, looking atcompanies, environmental, social and governancerelated risks, how they're managing those,how well they're managing those.But that's a little bit distinct from two other categoriesthat we see many of our clients focusing on.One is the traditional exclusionary approaches,which is a little bit less about risk managementand more about,you know, what are the things I don't wanna invest inbecause they don't align with my preferences or beliefs.Maybe avoiding tobacco or weapons or fossil fuels.That's still very commonand is probably the longest running approachin this sustainable investment kind of area.And then the third is where we're seeing a lot of innovationis climate related and green focused investing.So kinda that E in ESG.You know, that's driven often by a lot of ourinstitutional investors that are focused on,you know, navigating the transition to a low carbon economy.What does that mean for their portfolios?And how can they as a universal owner often,you know, help deliver returns that reflect their beliefsaround the low carbon transition.- So you mentioned there abouta higher demand for those peoplewho are looking to investas the world is moving towards this greener economy.How are you looking to re-engineer indicesto sort of give more weight towards those companieswho are embracing that transition?- Well, it sort of has to happen in the contextof what the index is originally designed for.So, you know, many times these investors,usually large asset owners,are using the indexes as an allocation tool tocore equity or fixed income allocations.So there's an existing pool of capitalalready tracking the traditional benchmark index.Now, the re-engineering has to come inwithin the constraints of not totally,you know, disrupting the existing allocation model,risk return profile of that index.So for example, if we look at a US equity indexSo for example, if we look at a US equity indexlike the Russell 1000, and we work with somelarge asset owner clientsthat have organizational beliefs and objectives aroundthe transition to a low carbon economy,how would we help them re-engineerthat Russell 1000 allocationto reflect the low carbon transition?So one thing we've done thereis partnered with an organizationcalled the Transition Pathway Initiative or TPI,which is an asset owner led groupthat's trying to focus on this very question.They're doing it through data, through transparency,and through what I would describe as kind ofan evolving framework of approaches.This is not something that we have a clearcapital T truth answer to right now.We need a framework that can evolve.We need data sets that will be able to be appliedin a way that can be dialed up or dialed downdepending on your beliefs, your allocation,your geographic exposure, your risk appetite.So in that way we can maintaina broad market benchmark exposure,but in effect re-weighting towards companiesthat are better positioned for the low carbon transitionand away from those that aren't.- So the last time we spoke,we were talking about some of the hurdles that we all facein terms of actually decidingthe level of ESG that a corporation has.Transparency and disclosures were issues.Is that getting betterand is that helping people like you and otherscome up with a methodology and a benchmark, as you say?- Definitely getting better.Still a long way to go.So disclosure and data is kind of the raw materialthat feeds into any of this analysis.And oftentimes, you know, the bulk of thatis coming from the corporate entities themselves, right?So they're describing to the marketthe issues that they have and how they're managing them.That often comes in a narrative basedqualitative set of information.It's non-uniform in the way it's disclosed,how it's disclosed, who it's disclosed by.But there are some positive signs.Three that I would think of.One, the EU in particular has focused ona corporate disclosure regime that is still in draft form,but has the potential to be very stringent.The draft form has about 82 different indicators,things like greenhouse gas emissions, water, gender pay gap,also looking at things like third party auditing,and crucially the potential to impactnon-EU companies as well,depending on your sort of scale of operationsor size in the EU.So that could kind of set a global standard.Again, don't have the final rules just yet.In the US the SEC is stillto finalize their proposal on a climate risk disclosure.Now that's very specific to climate as the name would imply.- Yeah.- And a lot of anticipation on what that final rule will be.I know they had a record number of commentsduring the proposal period,over 15,000 or right around there.So a huge amount of interest andkind of we're a little bit behind the expected timelineof when that might get announced.But I think that reflects the importancethat the SEC and investors put behind it.And the third is maybe most interesting,the International Sustainability Standards Boardset up by the IFRS to kind of be an equivalentto the International Accounting Standards Board,which everyone kind of is used toworking with in an investment context,but for sustainability metrics.So the objective there beingkind of a global template for disclosure,you know, with really the potential to kind ofgive the markets a much more consistentglobal basis of information.But, you know, some years off,that work is really just kind of getting started.No matter what,the trends are all going in the right direction.And this is good news for investorswho want better raw information to feed into the things likeESG scores, ratings indexes,or whatever analytics they're looking for.What we try and do is,you know, try and see where investors are most interested.Where can we find some consensus?As I said, there's always a range of approaches,but there's actually one areawhere I think we have found some consensusand taken some recent actionwhere we looked at the concept of baseline exclusionsfor all of our sustainable investment indexes.Basically saying there's gonna be a set of criteria,transparent rules-based data-driven criteriathat we would apply across any sustainable investment indexthat says these types of companiesthat follow these criteria cannot be in the index.- Straighten out. - Exactly.Now it's,you know, it's very nuanced.We're looking at like the value chainof different products and services.We're looking at revenue estimations and things like that.It's very targeted.So tobacco was on the list.Things like certain controversial weaponslike landmines, cluster munitions, things like thermal coalwere all on this list.We had a public consultation.We talked to clients, we got market feedbackand there was broad support for using baseline exclusions.Most of our SI indexes, our sustainable investing indexalready had this covered.- Okay. - Some did not.You know, maybe if you had a clean energy indexor something that wouldn't necessarilyhave a tobacco screen a few years ago,if we were building it, now it will.And we're gonna roll that out across the board.So, again, there's different approaches,but what we found, there's still appetitefor this baseline exclusion concept,which would still reflect what we think to bein a baseline of consensus around sustainable investing.- As we move towards a more global greener economy,lots of debate about how much energy we're gonna need,where that energy is gonna come from.We're gonna need a lot more copperif we're gonna go down that road.To what extent is that a hurdle tothis sort of transition or this more ESG kind of focus?- I've definitely talked a lot aboutsort of the low carbon economyand the transition to that low carbon economy.And a lot of the clients that we're working withare approaching it from a risk management point of view.But there's an opportunity component to this as wellthat is very exciting for a lot of our clients.So we've done a lot of work trying to sort ofmeasure, identify, classify the global green economy.And there's a really interesting story there.First of all, it's large and it's growing.So if we looked at the beginning of the year,we're talking about $8 trillionand about 8% of global equity market cap.- Okay.So it's substantial. - Yeah.- Actually bigger than the oil and gas.Super sector in our industrial taxonomy.Now, that means there's already exposure to companiesthat have what we would call green revenues.And what I mean there is we've developed a taxonomythat has sectors and sub-sectors and micro sectors,just like traditional industrial classification systems,but are focused on green products and services.In that way it's a little bit more granular.What we found,we've researched about 16,000 public companies.There's really only about 3000that have any green revenue whatsoever.But with that information,you can start to really identify, classify,and accentuate exposure to those green companiesor that green revenue in your broader exposure.And the performance can also be measured as well,of course, if you wanna look at different things.Now, the interesting thing is that it's a diversified group.Everyone would think, of course aboutwindmills, solar panels.- Yeah.- The energy transition is crucial,but it's not just about generation,it's about energy transmission,it's about energy efficiency technologies,also about things like water, pollution control,agriculture, and food.So it's much broader than you might expect.And the performance has been very compelling.Now, 2022 was not a very strong yearfor a lot of green stocks,especially if you were comparing itto the fossil fuel industry.So if I look at our,I would say most appropriate broad global benchmarkfor the green economy,it's called the FTSE Environmental Opportunities All-Shares.It's about 700 names.What they have in common is20% of their revenue is from green productsas we classify it.But it's a big group,large, mid cap, small cap companies,emerging developed markets.Now, that was the worst performingsustainable investment index for FTSE Russell in 2022.About 6% worse than its benchmark.That came in the context of substantial growthsince the start of the pandemic and even before.And even that bad 2022 couldn't offset the previous high.So really over the last five years,that broad benchmark still had 4% per annumexcess return compared to the benchmark.- You need to be giving perspective to these.- Exactly.And you could actually look at 2022 and say,you know, what is this long-term trendaround the transition to a low carbon economy?You know, has that truly been disruptedand put onto a different path?I would argue no. - Yeah.- And you could even say that maybe some of thesort of valuations in that sector have nowbeen adjusted back to more of a normal trajectory.And in fact, if we look at Q1 of 2023,that same index, the FTSE E All-Share,Environmental Opportunities All-Sharewas the best performing of allof our sustainable investment indexes.- I just suddenly started thinking about nuclear then.To what extent could nuclear ever belike an appropriate form of energy?Could it be clean?- So when we classify green products and services,nuclear power is part of that classification structure.Now, we've been doing this for a number of yearsin terms of running a green industrial taxonomy.And what we realized some years agois that we actually needed to iteratefrom the first version,and we needed to provide a little bit more precisionbecause there are these questions around nuclear power,things like rare earth metals as well,which are crucial to deliveringa lot of the like hardware type products that we need.But, you know, have environmental consequencesin the way that they're brought out of the earth.And what we found is some clients were less comfortablein including those in their green portfolios,or in our case, green indexes.So what we decided to do was, in effect,in our taxonomy, our green sectorsand sub-sector definitions,we put all these groups into tiersof effectively dark green, green, and light green.And in that way we can sort of say,all right, well nuclear, that's in the light green category,all things considered.So then when we build an index,like the one I referenced before,the FTSE Environments Opportunities All-Share,we kind of don't include that light green categorywhen we're tallying up the 20% revenue thresholdthat we're looking for each company.I see. But there's flexibility therebecause we've also worked with clientswho are quite comfortable with nuclearand see that as a crucial technologyas part of the low carbon transition.So you want flexibility, you want good robust dataand then a flexible framework to apply it.- Well, Tony, it seems that this is all evolvingas the years go on and you're being able to getmore and more granular and specificand have clearer and clearer benchmarks, which is helping,but seems like everything is movingin the right direction, at least.- I hope so.- Tony, it's so, so great chatting with you.Thanks again for your time.- Thanks. My pleasure.
