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CALVERT Eaton Vance Management Two International Place, Boston, MA 02110 Susan Brengle Managing Director, Institutional 617.672.8540 Contents [email protected] April 2021 www.eatonvance.com

CLEARBRIDGE INVESTMENTS 620 Eighth Avenue, New York, NY 10018 STATE OF ESG 4 Vinay Nadkarni The pandemic has sharpened Managing Director, Head of Global Business Development plan sponsors’ focus on ESG investing, 212.805.2235 while ongoing regulatory initiatives [email protected] and demand for positive impact have www.clearbridge.com also encouraged activity

DWS 875 Third Avenue, New York, NY 10022 EXPANDING PLAN PRIORITIES 6 Laura Gaylord Key themes include climate, Head of Relationship Management, Core Institutional social issues and governance, 714.814.0100 seen through the dual ESG lens of [email protected] risk management and better outcomes www.dws.com Compliance code: I-082236-1 INVESTORS SHARPEN THEIR FOCUS 8 MANULIFE INVESTMENT MANAGEMENT ESG strategies get more granular within 197 Clarendon Street, Boston, MA 02116-5010 sectors and across asset classes Todd Cassler, Head of Institutional Distribution, U.S. and Europee 617.663.2714 [email protected] THE DATA EVOLUTION 10 www.manulifeim.com/institutional Data and metrics continue to improve, global standards move forward, and NATIXIS INVESTMENT MANAGERS asset managers sharpen their toolkits 888 Boylston Street, Boston, MA 02199 Jim Roach SVP of Retirement Strategies 617.449.2647 [email protected] www.im.natixis.com Compliance code: 3498558.1.1 This special advertising supplement was STATE STREET GLOBAL ADVISORS not created, written or produced by the 1 Iron Street, Boston, MA 02210 editors o Pensions & Investments and Suzanne Smetana does not represent the views or opinions Head of ESG Investment Integration o the publication or its parent company, 617.662.9919 Crain Communications Inc. [email protected] www.ssga.com

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4 ESG Investing

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The pandemic has sharpened plan sponsors’ focus on ESG investing, while ongoing regulatory initiatives and demand for positive impact have also encouraged activity

he COVID-19 pandemic has brought TAIL RISKS OCCUR of ESG thematic research at DWS. Besides a new to the front of everyone’s mind the “COVID-19 was a huge tail-risk event. It has shown understanding of previously ignored risks, like fact that [environmental, social investors that these tail risks can happen, and the impact of infectious disease on the economy, “T and governance] risks are very real they have financially material consequences, as there’s been an appreciation of ESG funds that and can have a substantial impact on business. It well as moral consequences in income [disparity],” outperformed last year, he noted. “But we need to has definitely sharpened asset owners, investors said Peter Mennie, global head of ESG integration be careful when breaking down that performance and business managers’ focus on the need to and research at Manulife Investment Manage- attribution. Typically, ESG indices were positioned understand social and environmental risk and ment. “Also, COVID-19 is a zoonotic disease. It to be underweight energy and overweight health- understand their businesses’ planning ability to passed from animals to humans, and that under- care and technology. And within that, there was manage through these evolving situations,” said lines the importance of nature as a sustainability outperformance of the better-rated ESG names,” John Streur, president and chief executive officer risk,” he said, pointing to the U.K. Government’s Lewis said. The asset write-downs by the oil and at Calvert Research and Management. recently published “Dasgupta Review” on The gas companies last year [have] led to consider- “The pandemic showed the importance of Economics of Biodiversity. ations of a potential repricing of long-term crude the ‘S’ in ESG. We really started to understand the The Review “drew direct connections between oil, he added. “Then there is corporate reputation importance of our workforce across all differ- how rising temperatures and poor standards of and the issues around racism, social injustice and ent industries. We realized that the healthcare sanitation could have contributed to the spread inequality. COVID has shone an incredibly strong systems being put in place by corporations and of diseases like COVID-19, turning the spotlight light on workers, women particularly, in frontline governments were critical to handle disruptions on sustainability issues. In our view that really sectors, like healthcare, retail and education, who to our economy and to the need to ask so much of increased the demand for sustainable investing,” have been most impacted by the pandemic.” our workforce when things changed abruptly, par- added Mennie’s colleague, Eric Nietsch, head of ESG “The COVID-19 pandemic underscored the ticularly in industries that were most disrupted,” Asia at Manulife Investment Management. importance of ESG issues and has highlighted four said Ed Farrington, executive vice president, “The pandemic has bought to the fore a range aspects of ESG adoption,” said Suzanne Smetana, institutional and retirement, at Natixis Investment of different issues: risk, return, write-downs, head of ESG investment integration at State Managers. reputation and recovery,” said Michael Lewis, head continued on page 12

Investor perception on ESG is changing Perception on ESG and performance (retail and institutional investor surveys) Survey question: What do you think: Does ESG integration lead to higher/lower/equal performance 100% e 80% ESG is viewed as having a positive impact on return 60% 40% 20% 0% -20% -40% vey respondents with a positive or -60%

% of sur -80% ESG is viewed as having a negative impact on return negative view on ESG and financial performanc -100% ) t & & ells & (2019) Feri Euro Riedl Wins Eccles FA ZEW (2007) Maastrich Gallup/Wrgo (2017) DV Bafin (2019) MIRA (2020) Rating (2009) Smeets (2015)Zwergel (2016)Fa RBC GAM (2017)RBC GAM (2018)RBC GAM (2019) RBC GAM (2020) BankInvest (2009University Erste(2011) Bank (2011) Kastrapeli (2017)

Source: DWS analysis 2020; ZEW (2007): German institutional investors; Feri Euro Rating (2009): German institutional investors; Bankinvest (2009): institutional investors from Germany, Austria, Switzerland; Maastricht University (2011): German retail clients; Erste Bank (2011): Austrian retail clients; Riedl & Smeets (2015): Mutual fund investor in the Netherlands; Wins and Zwergel (2016): German retail investors; Gallup/Wells Fargo (2017): U.S. private investors; Eccles & Kastrapeli (2017): global institutional investors; RBC Global AM (2017/2018/2019/2020): global institutional investors, RI / UBS (2019): global institutional investors, DVFA (2019): German institutional investors, Bafin (2019): German private investors, Macquarie Infrastructure Real Assets (2020): real asset investors. Forecasts are based on assumptions, estimates, views and hypothetical models or analyses, which might prove inaccurate or incorrect.

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Expanding Plan Priorities

nstitutional investors around the globe are than from any other country,” said Michael Lewis, “As an example, take the disruption we saw thinking about their governance approach and head of ESG thematic research at DWS. in Texas in February due to a severe weather risk management framework toward climate The focus on “climate risk has evolved from event that was supposed to be a 100-year event, Irisk. “The No. 1 concern for investors from an purely risk management, avoiding companies but it happens every five years. Investors are ESG perspective is climate risk. It’s front and cen- that have big exposure to climate risk. [There] is beginning to realize that was a climate issue and ter with the regulatory requirements in countries now a need to understand a company’s strategy a governance issue,” said Edward Farrington, around the world. The U.S. has been slightly tainted to get to net-zero emissions and to find revenue executive vice president, institutional and retire- by a perception of the federal level not being very streams associated with a zero-carbon economy, ment, at Natixis Investment Managers. “Many of ESG-minded, which is inaccurate. In the [United alternative energy and energy efficiency,” said those power companies that failed [in Texas] were Nation’s Principles for Responsible Investment], for John Streur, president and chief executive officer told that they needed to upgrade their systems, example, there are more signatories from the U.S. at Calvert Research and Management. but they didn’t. They choose to save money in the

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Key themes include climate, social issues and governance, seen through the dual ESG lens of risk management and better outcomes

short-term, but it’s going to cost them billions Initiative to advance solutions toward a low-cost, The considerations of active and passive vary in the long-term. Investment managers who low-carbon economy. across plan sponsors, Deutsch said. “The common- understand those themes are better positioned to “We’re seeing interest now in low-carbon solu- ality is asking all existing and potential external outshine their peers over time, and they can do it tions from an equity and bond perspective, which managers that hold positions in fossil fuel compa- by targeting sustainable investments as part of a are customized portfolios with specific client nies how and why they’re including considerations strong risk management strategy.” goals for carbon reduction within the constraints of climate risk in their process and better aligning of tracking error and of credit quality for a bond their strategies with the transition to low carbon,” DIFFERENT TOOL SETS strategy,” Smetana said. “Through portfolio opti- he added. With larger plan sponsors, there can be “There are a lot of good tools available for investors mization in our equity portfolio, we aim to achieve a range of approaches: Some may hire a director to address climate issues. Some investors want low- the most efficient trade-off between carbon of ESG investing to oversee an ESG strategy, carbon portfolios or investing in companies aligned reduction and tracking error while targeting risk some implement a prudently phased divestment to a particular temperature target,” said Peter Men- and return properties similar to the underlying plan and some develop watchlists of companies nie, global head of ESG integration and research at index. That allows clients to customize portfolios that they believe can benefit from more focused Manulife Investment Management. “Others take the to align with specific carbon goals or risk budgets, engagement on sustainability goals, he said. approach of investing in best-in-class companies in and they can add in exclusionary screens as well.” different sectors and have a really good steward- “Given the interest in ESG integration, more URGENCY ON SOCIAL ISSUES ship program that works with those companies to investors are evaluating tracking error against “From the ‘S,’ [or social,] standpoint, the news encourage them to reduce emissions,” he said. Eric standard benchmarks in terms of risk metrics,” story beyond the pandemic that really shook the Nietsch, head of ESG Asia at the firm, added, “There’s Smetana said. “Historically in passive investing, world was the need for diversity, racial justice and also innovation happening around debt instruments investors really focused on keeping tracking error equity, and that has become prominent for institu- like green bonds.” [against the benchmark] as low as possible. They’re tional investors,” said Natixis’ Farrington. “We are “Climate-risk identification is essentially a now realizing that from an ESG perspective, that’s in a new era where diversity will dominate because value-at-risk exercise done security-by-security not always optimal and are rethinking tracking- of a recognition that diversity is helpful in terms of to identify the revenue or credit risk that may error budgets against the new benchmarks.” running a business and that having multiple points arise due to exposure to carbon intensity or in- of view and multiple backgrounds at the table is a ability to transition to a low-carbon economy,” said BRING IN PLAN PRIORITIES benefit,” he said. Earlier this year, Natixis launched Streur. “Climate change mitigation is an analysis Derek Deutsch, managing director and portfolio an index-based Racial Equity Portfolio that over of the company’s strategy to transition to a low- manager at ClearBridge Investments, bifurcates weights companies with strong policies on racial carbon economy. Will the business benefit from concerns of pension plans and defined contribu- equity and underweights those that don’t. “Many the transition or will it suffer? Does the company tion plans when considering ESG investing. “For of the endowments that we work with are very have specific revenue streams that solve these public plans, one of the main concerns is whether interested in allocating capital in that way, and problems or are its revenue streams exposed to ESG is a fiduciary consideration. There’s huge we created a portfolio to address that need,” these risks? This is a more detailed and granular pressure because most plans are underfunded. Farrington said. analysis,” he explained. So getting the board comfortable [with the idea] “On diversity, we’re seeing many compa- “There’s no one-size-fits all climate approach, that return expectations can be met with an ESG nies providing EEO-1 [report] data, or workforce and we provide a high level of customization mandate is important. The other focus is setting demographics through another means. As an across our full suite of equity and fixed-income and aligning ESG goals and objectives with the investor concerned about a company’s ability to climate-investment solutions, depending on what financial goals of the portfolio, and executing the manage its workforce in a demographic that’s now clients want to do from a climate perspective,” plan,” he explained. much more diverse, we need to know what the said Suzanne Smetana, head of ESG investment “On the DC side, there is legitimate concern workforce looks like at every level,” said Streur at integration at State Street Global Advisors. That about the [legal] implications, that if ESG doesn’t Calvert. “A big second piece is understanding how ranges across best-in-class solutions, climate perform well, could the plan sponsor be held well the company is managing its culture. Human mitigation, exclusionary screening, divestment, liable?” Deutsch said. “Also, about 90% of DC plans capital management, culture, diversity and inclu- and stewardship and engagement focused on invest in target-date products, so is there an ESG sion are all very interrelated in impacting business climate, she said. State Street Global Advisors sup- target-date strategy? And with the low utilization outcomes.” ports the Task Force on Climate-Related Financial rates of ESG options by participants, what’s the “We’ve been working on [identifying] what Disclosures, or TCFD, in carbon-pricing initiatives education component that needs to be included we call ‘gender washing,’ in other words, trying to and engages with groups like the Climate Fund with any strategy?” continued on page 16

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Investors Sharpen Their Focus

ESG strategies get more granular within sectors and across asset classes

limate risk and its impact on the invest- “If you take climate-transition risk, you need investment portfolios that are more resilient, likely ment portfolio has been the priority for to understand it not just at a sector level, but at to be lower risk and more future proofed in a way,” many institutional investors. They first an individual security level. Sectors like industrials he said. “On top of that, we have the flexibility to Cmoved to reduce exposure to high-carbon have high climate-transition rates, but within respond to the different ways that clients want to emitters and improve exposure to low-carbon, it, you can find building-materials and energy invest, as well as a stewardship program to engage zero-carbon and other sustainability leaders. efficiency companies with fantastic prospects be- with companies through the investment cycle, to Now, as their knowledge of environmental, social cause of their low-carbon transition,” said Michael achieve better outcomes for our clients and the and governance issues has expanded, many are Lewis, head of ESG thematic research at DWS. “You planet at the same time.” using a more sophisticated lens within sectors and need to be very granular, because if you start to across asset classes. remove a sector or a subsector, you potentially THE ACTIVE EQUITY LENS “The correlation [between] investment remove nuggets of quality within them.” ESG investments are available across the active managers integrating ESG and their ability to At Manulife Investment Management “we view and passive equities spectrums. The latter uses outperform is becoming quite clear,” said Edward sustainable investing as a standard that we want publicly available data, usually through the MSCI Farrington, executive vice president, institutional to offer in all asset structures,” said Peter Mennie, or Sustainalytics ratings, to construct portfolios and retirement, at Natixis Investment Managers. global head of ESG integration and research. “That based on the indexes. “Even more compelling “Across all asset classes, managers are taking ESG doesn’t necessarily mean having exclusions in your are the active ESG managers, who have shown information from almost all companies and draw- portfolio, but rather understanding all invest- solid performance over multiple periods, mainly ing conclusions on how that relates to potential ments through a sustainability lens, as well as because they do fundamental research and can investment opportunity.” traditional investment metrics, in order to build effectively interpret and apply the ESG data,” said

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Natixis Investment Managers’ Farrington. “They corporate engagement and activism geared to DOING GOOD, DOING WELL do company visits with that data in hand and help companies improve and better drive long- “As a long-only active equity manager, we’ve been begin to build a picture on whether a company and term value creation. And it applies to both active an ESG investor for over three decades,” said Derek its management is going to have headwinds or and passive investing.” Deutsch, managing director and portfolio manager tailwinds. We believe the active space will be really A related priority is impact measurement and at ClearBridge Investments. “Our philosophy is compelling in ESG for the coming decade.” management, particularly in terms of the metrics that putting capital behind large public equities “The shift from risk avoidance/risk mitiga- implied by the [Sustainability Accounting Standards who are sustainability leaders can have a positive tion to positive impact driving positive change Board], added Streur. “It’s having the ability to impact, and it would benefit from scale.” is something that’s happening across asset understand, using scientific methods, the actual One example is Ball Corp., the leading manu- classes,” said John Streur, president and chief impact that a company, business line, or revenue facturer of aluminum cans, which has benefited executive officer at Calvert Research and Man- stream has on the environment and to do so with a with strong revenues from consumer preferences agement. “As that relates to equities, it means level of specificity that allows us to integrate this for environmentally friendly manufacturing and an increased focus on proxy voting, stewardship, information into financial metrics,” he said. continued on page 18

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The Data Evolution

Data and metrics continue to improve, global standards move forward, and asset managers sharpen their toolkits

he challenge of uneven ESG data and the high cost of different types of data are no surprise to institutional investors, whether Tthey are at the start of their environmental, social and governance investing journey or on a more advanced path. But investors can take comfort from the continued evolution in data quality and availability, supported by regulatory oversight, global standards, corporate disclosures and the application of advanced data technology. Many of the largest asset managers have also developed their own internal ESG ratings, while others use third-party providers of ratings. The Sustainability Accounting Standards Board, or SASB, the Task Force on Climate-Related Financial Disclosures, TCFD, and the Global Reporting Initia- tive, GRI, are all frameworks that underpin ESG metrics. “It’s really important to have good expectations for what your investment manager will provide you on ESG data and to expect that the data will continue to improve,” said Peter Mennie, global head of ESG integration and research at Manulife Investment Management. “You should expect a high quality of data on climate change. And as initiatives like the [Task Force on Nature- Related Disclosures] and others work through to conclusion, we will continue to see more good data in other areas.” “More and more issues or securities are reporting under SASB standards. We see that in pockets — not uniformly, but in pockets — the data has improved massively, and there is continued improvement in this information set occurring by asset managers and data providers and dif- risks and manage the risks, and we don’t have a daily as a result of TCFD, SASB and investor de- ferent opinions are being formed,” said Edward government body or an accounting body provid- mands in corporate management of these issues,” Farrington, executive vice president, institutional ing this information, so a lot of it comes from said John Streur, president and chief investment and retirement, at Natixis Investment Managers. disclosure initiatives,” said Michael Lewis, head of officer at Calvert Research and Management. “It actually allows for us to interpret and begin to ESG thematic research at DWS. It’s also important draw conclusions that might be different from our to understand the implications of the largely MANAGERS DIGEST THE DATA counterparts, which is the very basis of alpha,” voluntary disclosures on ESG issues by companies “We spend too much time criticizing the lack of he said. so far, he said. “A lot of companies provide us with uniformity of ESG data as opposed to just acknowl- “There are a lot of burdens that have been information that basically makes them look good. edging that this is an evolving space and data is placed on the asset manager when it comes to That’s why we need mandatory reporting with being offered by companies. It is being digested ESG. We have to understand ESG risks, measure the the proper framework, because we can’t just let

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companies do it for themselves. It’s just a conflict MULTIPLE INPUTS investments are actually making a difference. of interest,” he pointed out. When considering ESG metrics, it’s important to ‘How effective is the stewardship program?’ ‘What DWS believes that ESG data and informa- determine which ones are financially mate- measurable outcomes can we see?’ It’s that mea- tion should be free in order for ESG to become rial to an organization and which ones are not, surement relative to the stewardship and pushing mainstream investing, Lewis added. “It should be said Suzanne Smetana, head of ESG investment for that evidence that will probably drive inves- audited, it should have an accounting framework integration at State Street Global Advisors. As an tors’ interest over the next five years,” he said. like [Generally Accepted Accounting Principles], example, she pointed to the differences in water ClearBridge’s Deutsch said he sees the be regulated by governments and provided free to use at a mining company versus a financial bank. small-cap sector as an overlooked ESG investment all asset managers and asset owners,” Lewis said, “A mining company requires access to large opportunity that will attract more interest in the noting that as a big asset manager, DWS has the quantities of water in its operations, and the years ahead. On the equity side, most ESG strate- resources to get the ESG data it needs. “In time, availability of water is a financially material ESG gies have been focused on large-cap names where datasets will get better, they’ll be more accurate factor because without it, they can’t operate,” there’s better ESG disclosure and reporting, while and they’ll probably be audited,” he expected. she said. “For a bank, certainly water is important smaller companies are more focused on growing To illustrate the evolution of ESG investing, for building facilities, the cooling system and so their businesses, he said. “With our partnership Farrington, of Natixis Investment Managers, used on. But if it didn’t access water for a day, it would approach, we’re helping small companies we the analogy of a handful of asset managers who not have a significant financial impact on the engage with develop strong ESG practices that pioneered the use of computers in quantitative organization.” will position them well to be tomorrow’s leaders. research to narrow down the investment universe. To help all its investment teams across all as- We see small caps as an area of significant “Now all managers use some type of quantitative sets with ESG financial materiality considerations, performance opportunity, as well as a growth op- screening methodology to narrow the universe State Street Global Advisors has a proprietary ESG portunity, for ESG investors to get broader market of opportunity and then do further research,” he scoring system, called R-FactorTM, for over 7,000 exposure beyond blue-chip, large-cap companies, said, explaining how the same will come about issuers, Smetana said. It combines data sets from because there’s a lot of innovation and disruption for ESG. “Everyone will incorporate ESG in some multiple vendors and aligns them with SASB’s happening at these new companies.” way, shape or form. But there will always be the materiality map, which helps identify ESG material innovators, managers who are always finding that factors by industry, sector and subsector. THE DATA VIEW WIDENS new edge, those data points that are true signals “That being said, industries and companies Asset managers expect to see more convergence versus noise. So there will always be a space that change. [The ESG scoring system] provides a start- across global bodies for standardized ESG disclo- we define as ESG, and those who excel at it will ing point and helps provide focus, as there’s a lot sure. “This year will be a big year to see more align- continue to thrive.” of noise in ESG issues,” she said. “Investors want ment between the SASB and the GRI. The CDSB, to make sure they make investment decisions on the CDP and others are also working together, DUE DILIGENCE IS KEY what’s financially material, unless, of course, they which is important for both asset managers and “Plan sponsors and institutional consultants who are managing a strategy that also has a nonfinan- corporates,” said Eric Nietsch, head of ESG Asia at are selecting asset managers are asking about cial metric, such as outcomes related to diversity Manulife Investment Management. The CDSB is the not only the ESG investment strategy, but [also] and inclusion,” she added. Although “sometimes Climate Disclosure Standards Board and the CDP the manager’s overall ESG firm policy,” said Derek those nonfinancial outcomes can lead to positive is a nonprofit that runs a global environmental Deutsch, managing director and portfolio manager financial outcomes.” disclosure system, formerly known as the Carbon at ClearBridge Investments. “They want to know Disclosure Project. how it’s being addressed at the fundamental WHAT’S NEXT “ESG data is improving as a direct result of research level, as well as the scope and impact of What needs to happen next with data? “If every- increasing disclosure requirements. With improved corporate engagements.” body reported under the SASB standards, we’d be quality and availability of ESG data comes more Deutsch offered a cautionary note on third- in great shape because those are well developed specialization,” said Smetana at State Street. “It party ESG data. “There is significant dispersion and built on sector specificity and financial mate- could enable investors to tackle more sustainabil- and low correlation in third-party ESG ratings, and riality,” said Calvert’s Streur. “Asset managers and ity challenges, like racial inequality or diversity and investors who rely heavily on them could have asset owners need data produced under rigorous inclusion, which are hard to quantify.” very different portfolio outcomes. That’s because standards, using scientific methodologies, so that “Over the course of the next five years, all there is uneven data disclosure and subjectivity we have facts, and we can parse the data properly investment decisions across asset classes globally involved in how [third-party providers] make these and build it into financial models. That’s what’s will incorporate ESG information,” said Calvert’s determinations,” he noted. An investment man- beginning to happen and that’s what we need the Streur. “Will this information be used well, and will it ager should have a clear and integrated approach regulators to back.” be used to drive positive change? While it’s exciting on a company’s ESG performance based on its own A majority of ESG dollars are currently in to see the utilization of this information across in- due diligence, preferably though a specialist team strategies that use negative screening and strate- vestment decisions, will it actually strengthen the that analyzes ESG metrics alongside traditional gies with ESG integration, said Mennie, of Manulife productivity of the overall system, create a better metrics, and with regular and direct engagements Investment Management. “What investors will society and economy, and drive greater long-term with companies on their ESG practices, he said. be looking for is an understanding of how their value creation?” Z

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State of ESG real-world impact? Are you addressing these pants because ESG factors are financial factors. continued from page 5 societal issues? Are you addressing climate risk or If they don’t incorporate this data, participants getting outcomes based on net-zero? If you don’t potentially take on more risk or may miss opportu- have a very strong engagement policy, then you’re nities,” Farrington said. probably not. So while the risk management is one “It’s fair to say that the Biden administration has Street Global Advisors. “The first is that the ‘S,’ or aspect, engagement is a big part of having impact really hit the ground running. President Biden has social part, has become even more important to on outcomes.” proposed a very ambitious $3 trillion infrastructure investors, both in equity and fixed income, where plan that is expected to include carbon emissions we see the creation of social bonds to combat REGULATORS STEP UP goals, such as eliminating carbon emissions in oil the effects of the pandemic. Second, there’s an While there’s extensive interest in ESG strategies and gas by 2035 and net-zero emissions across increased focus on climate risk, even in the midst by defined contribution plan sponsors, many have the economy by 2050,” said Smetana. “The SEC of the pandemic, notably in the U.S. Third, we have been cautious in moving forward due to potential will continue to focus on disclosures in four areas: seen that ESG funds performed well during this litigation risks over fees or performance as well as environmental disclosures, with a focus on carbon period of a global crisis, and the year opened with the uncertainty over the Department of Labor’s fi- and greenhouse gas emissions; board-level diver- continued strong flows into global ESG funds. The nal rules in November 2020. These rules stated that sity disclosures; disclosures concerning workforce fourth aspect is the importance of asset steward- fiduciaries acting under the Employee Retirement diversity, inclusion and equality; and corporate ship through engagement that should focus on Income Security Act of 1974, or ERISA, must use political spending disclosures,” she added. risk mitigation, from short-term impacts to longer- ‘pecuniary’ or financial factors in selecting plan The SEC has clearly signaled that it is prepar- term business sustainability.” investments, but the rules did not make explicit ing an ESG framework to support use of data by reference to ESG considerations that had been investors and disclosure by issuers and product ENGAGING ON ALL LEVELS included in the DOL’s earlier reviews. providers, such as mutual funds, exchange-traded The breakout of the pandemic led to more Regarding the DOL final rules, the department funds and others who state they use ESG in the important and more frequent engagements with “has recently stated it ‘will not enforce either the process, said Streur. He said he expects new rules the companies in their ESG portfolio, said Derek final rule or otherwise pursue enforcement ac- within the next 12 to 18 months that will reference Deutsch, managing director and portfolio manager tions against any plan fiduciary based on a failure the frameworks of the Sustainability Accounting at ClearBridge Investments. “We issued a state- to comply with those final rules with respect to an Standards Board, or SASB, and the Task Force on ment [in April 2020] on [how] responsible manage- investment,’“ said Smetana at State Street Global Climate-Related Financial Disclosures, or TCFD. “We ment by companies in a time of crisis [should] Advisors, adding that more clarity by the DOL on anticipate a continued acceleration in disclosure include issues like employee well being, safety the rules is likely by the fourth quarter this year. under SASB by issuers year-on-year, and market and retention, having transparency and frequent “Some plan sponsors will be comfortable with this infrastructure is going to continue to get built communication with all stakeholders, including announcement and move forward with adding ESG under that.” their customers, suppliers and the communities in strategies, while others will require more explicit “COVID-19 shifted the consensus thinking which they operate. We wanted to make sure that safe harbor protection before moving forward.” around fiscal spending, and policymakers around actions that might involve a short-term economic “We are amongst those who have said the the world [have been] introducing stimulus pack- sacrifice were weighed against the long-term ben- financial factors rule, as it stands, does not preclude ages in a way [that’s] not just about recovery, efit of their business and stakeholder resilience, the use of ESG in ERISA plans. It simply sets forth a but looking to build back better,” said Nietsch at their brand reputation and long-term success,” standard of financial materiality that must be met, Manulife Investment Management. For example, Deutsch said. which we agree with,” said Streur at Calvert. “The South Korea issued the Green New Deal, pledging “No one has experienced anything like this Biden administration is favorably inclined towards more than 60 billion in U.S. dollars to sustainable [pandemic] before and we are all learning as consideration of ESG factors in the investment programs. we go, with the goal of better outcomes for our decision-making process,” he said, adding, “They will “With the Biden administration, the most investments and for the responsible strategies likely clarify the rules to make certain that the DOL’s important thing will probably be a shift to clear that would impact all the stakeholders” of the guidance supports that position.” recognition that sustainability factors are companies, Deutsch added. “If you look at [the position of] every govern- important both to the planet and from a financial “We’re now seeing a much larger majority of ment agency and look at the research from asset materiality perspective,” added Mennie, from investors in the U.S. and around the world saying managers and asset owners, it’s quite clear that Manulife Investment Management. that ESG [has] a positive impact on return,” said ESG factors are, in fact, financial and economic Lewis at DWS (See graph on DWS’ ESG perfor- factors,” said Natixis’ Farrington. Federal Reserve CORPORATE MOVES mance survey). Plan sponsors are also exploring Chairman Powell “mentions ESG risks in every one ESG disclosure by issuers around the world is being engagement and impact, Lewis added. “A lot of of his talks. The [Securities and Exchange Commis- driven by events in the real world, including the ESG investing today is risk management. Asset sion] examination unit is looking at the consistency increasing frequency of climate-related events managers are basically bringing in ESG data and and adequacy of ESG data disclosure and reporting (See U.S. climate disaster map). Companies are they’re reducing risks within their portfolio. Now for asset managers,” he said. “At this point, plan also joining global initiatives to encourage greater this might be good on an institutional-level basis, sponsors taking a conservative approach and not commitment to a more sustainable future. This that you’re protecting the portfolio and building continuing to consider adding ESG until further year, BlackRock announced its commitment to that resilience, but are you actually having a clarification comes at the expense of plan partici- continued on page 14

12 ESG Investing

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State of ESG continued from page 12

U.S. 2020 billion-dollar weather and climate disasters

Central Central Severe Weather-Derecho North Central and Ohio Valley Tennessee Tornadoes and Severe Weather August 10 Hail Storms and Severe Weather Southeast Severe Weather Western Wildfires, July 10-11 April 7-8 March 2-4 California, Oregon, Midwest and Ohio Valley Washington Firestorms Severe Weather Fall 2020 March 27-28 Southeast and Eastern Tornado Outbreak Western/Central April 12-13 Drought and Heatwave South, East Summer-Fall 2020 and Northeast Severe Weather Central and Eastern Febuary 5-7 Severe Weather May 3-5 Hurricane Isaias Southeast Tornadoes and August 3-4 Northern Storms and Flooding January 10-12 South, Central and Southern Severe Weather Eastern Severe Weather April 21-23 May 20-23 Central, Southern and Eastern Severe Weather April 27-30 Hurricane Laura Tropical Storm Eta South Texas August 27-28 Hurricane Sally November 8-12 Hail Storms September 15-17 May 27 Hurricane Hanna Hurricane Delta July 25-26 October 9-11 Hurricane Zeta October 28-29

This map denotes the approximate location for each of the 22 separate billion-dollar weather and climate disasters that impacted the United States during 2020 Source: NOAA National Centers for Environmental Information (NCEI) (2021). https://www.ncdc.noaa.gov/billions

achieving net-zero greenhouse gas emissions by “The issues associated with risks regarding “There’s a need across the board for more 2050 and urged other corporations to do the same. climate change, carbon emissions and the plan to standardized ESG disclosure and many of the main “The impetus for more disclosure by com- decarbonize, water scarcity, social issues, human standards disclosure bodies are working on that panies is really the groundswell of broad-based capital, diversity, inequality, are increasing in convergence,” said Nietsch at Manulife Investment investor interest, which is also expressed in terms of their impact on corporate performance,” Management. For instance, he said he expects to regulatory interest,” said Deutsch at ClearBridge. said Streur at Calvert. “Companies are measuring see more alignment between SASB and the Global “Companies are increasingly aware of the need and managing these issues internally more ag- Reporting Initiative, or GRI. Manulife Investment to act to fight climate change for the safety of gressively than ever before. It’s becoming a bigger Management works closely with the companies their own business, and their assets that are at determinant in the long-term value creation and in its portfolio on best practices in disclosure, he risk due to climate change. They see disclosures security price discovery process,” he said. noted. such as carbon emissions as necessary steps to More than 90% of S&P 500 companies publish “Companies want to have clarification of navigate how they manage their own business sustainability reports, said Farrington at Natixis In- the disclosure rules and clear standards against as the climate becomes more turbulent and vestment Managers. With many using SASB report- which to report for specific areas,” added his col- potentially harmful to their business,” he said, ing, disclosures are becoming more standardized. league Mennie, pointing to several recent moves, adding that more companies are moving to align “Companies are recognizing that investors, wheth- including the phase one activation of the European with the United Nations [Sustainable Develop- er institutional or individual, will crave transpar- Union’s Sustainable Finance Disclosure Rules and ment Goals] and, in some cases, report how ency [both] in how companies operate and respond the International Financial Reporting Standards they’re addressing them through their business to ESG issues that are material, and in how they’re Foundation setting up a sustainability board with a operations. managing these risks,” Farrington said. strategic focus on climate-related reporting. Z

14 ESG Investing

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Expanding Plan Priorities continued from page 7 Corporate board diversity by industry Share of board seats filled by directors who are Hispanic, Black, 19% Asian-American, Pacific Islander or Native American. Information Technology Consumer Staples 18% Utilities 17% Communication Services 16% 15% Consumer Discretionary Materials 14% Health Care Industrials 13% Financials 12% Real Estate 11% 10% Energy 9% 8% 7% 6% 2017 2018 2019 2020 2021 Source: Institutional Shareholder Services ESG, 2021

understand whether the balance in the workforce “Three ESG themes are especially relevant in ability businesses that are aligned with long-term is truly effective,” said Mennie at Manulife Asia: climate change, corporate governance and outperformance. Investment Management. “It’s easy to measure the continent’s aging population,” said Nietsch DWS is strongly promoting water risk as a certain statistics, such as the number of women at Manulife Investment Management. As Asian separate ESG theme, said Lewis. “Water crises on a board. But where is the true influence? Are economies continue to grow and their energy have been listed in the top five risks of the World they empowered to make decisions? Are they in needs rise, they are incentivized to transition to Economic Forum for the last decade. There hasn’t revenue-generating roles? That’s the crucial thing renewable energy and invest in energy efficiency been any significant investment in the sector in when you’re looking for improved diversity bal- and storage capacity, he said. decades, and we’re not pricing water correctly,” ance.” Also, corporate boards in the U.S. have not “On governance structures, 43% of the world’s he noted. One initiative to watch is by the Climate made much progress on adding more underrepre- top 5,000 companies by total revenue are head- Action 100 Plus group to engage with the largest sented minority members over the past few years, quartered in Asia1, but the contradiction is that water-consuming companies on improving water according to Institutional Shareholder Services’ Asian companies typically score lower on most efficiency, wastewater treatment and related ESG division data (See chart). global corporate governance rankings,” Nietsch issues, he said. Lewis and others also point to the said, adding that identifying the good governance emerging focus on biodiversity. “Similar to the GOVERNANCE IS KEY names can be a meaningful source of alpha. TCFD, there’s now the Task Force on Nature-Related “Governance continues to be a critical component The rapid pace of transition to aging demo- Financial Disclosures, [or TNFD,] that addresses of ESG analysis. While it’s not new — it’s not in the graphics, which is occurring within the timeframe biodiversity risks,” Lewis said. headlines — there is a renewed emphasis on the of a single generation in Asia, coupled with the “We are now in an environment where global specifics of governance structure,” said Streur, pressures on the region’s pension systems, has agreements could be more likely than they were and that “includes diversity, executive compensa- created a strong need for investments in research last year — whether dealing with tech companies, tion, audit and finance, and the need to regionalize and technology to improve the lives of the elderly, corporate tax policy, climate, nature or biodiver- and contextualize governance globally.” he said. sity. You get the sense that a number of different “One area that we don’t think of necessarily as players in the U.S. are moving very quickly,” said a governance issue is supply-chain management. EMERGING THEMES Lewis. “There’s a sense of urgency in the U.S. to It has become such an important topic, whether While many managers use the United Nations catch up and potentially overtake other countries for vaccine distribution or for simple household Sustainable Development Goals, known as SDGs, as with these issues.” Z goods or how you’re sourcing energy or water. a guide to adopting sustainable investing strate- We’ve become much more aware that supply gies, they also conduct their own deep research 1 “C orporate Asia: A Capital Paradox,” McKinsey & Co., chains can be disrupted,” said Farrington. to identify sectors and companies in sustain- January 2020.

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Investors Sharpen Their Focus more-scarce critical resource. So the valve com- continued from page 9 pany that can make those systems more efficient and will [benefit from the need] to upgrade our infrastructure becomes a very compelling story and has great growth prospects,” he said. the continued prospects of growth in replacing “The business of investing is a business of single-use still-water bottles, he said. “Aluminum looking for change,” pointed out Streur at Calvert. is infinitely recyclable versus single-use plastics… “What is happening that is not expected?” He There are 500 billion plastic single-serve water noted that Exxon Mobil recently proposed as a bottles sold globally every year, if you can get your board director Jeffrey Ubben, an activist focused head around that number. Much of that plastic on sustainability. “The American Petroleum Insti- ends up in the ocean, unfortunately,” said Deutsch. actually need to do?’ Well, you can start to improve tute just came out in support of a carbon tax or a Another example is Aptiv, an automobile the energy efficiency of a building, its water effi- formal cost-of-carbon metric as preferable over supplier of products used in the electrification of ciency, improve air quality, these all have massive potential mandates or regulatory action. I think vehicles. Deutsch explained how, “with electric benefits both for the owners and the occupants.” we’re going to be surprised by the oil industry’s ef- vehicles and autonomous-driving technol- Some of DWS’ thematic funds include [a Sustain- fort to transform itself into something other than ogy becoming a much larger percent of vehicle able Development Goals] fund, a green-bond fund a hydrocarbons business,” he said. production, Aptiv has significantly outgrown the and a blue-economy fund for ocean sustainability overall auto markets by focusing on these areas. to be launched later this year. ENGAGE OR DIVEST At the same time, by participating in the transition Eric Nietsch, head of ESG Asia at Manulife “The debate over whether to engage or divest of the market away from combustible engines to Investment Management, points to energy use when a company fails to meet ESG expectations more environmentally friendly electric vehicles, it in real estate as a key theme in Asia. “We’ve seen will come into the spotlight this year,” said Suzanne helps reduce emissions and improve vehicle safety a number of green-bond issuances towards the Smetana, head of ESG investment integration at as well.” design and construction of green buildings. For State Street Global Advisors. “Each approach has instance, one green-bond issuer has a majority of its positive and negative aspects. It’s important OTHER ASSETS FOLLOW SUIT its portfolio green-certified, while another issuer that investors take all considerations into ac- “Where ESG integration is almost maturing when doesn’t have as many green buildings but is using count before making these investment decisions it comes to managing equities, there’s still a long its green-bond proceeds for new green develop- because one or the other does not necessarily way to go in fixed income — but it’s happening ments,” he said. The lack of standardization in data solve the problem. We’re seeing this more so in the very quickly,” said Natixis Investment Managers’ and metrics is particularly challenging in Asia, he energy sector,” she pointed out. Farrington. “That’s not only with green bonds, but noted, so working with a firm that has a large and “We are already seeing asset owners joining with corporate bonds, and how ESG correlates to a dedicated Asia team can help identify problems companies and governments to reach net-zero, company’s ability to sustain itself and, therefore, like green washing and social washing. and that’s driven by regulation and changing pay back its bondholders.” sentiment,” Smetana said. “It’s really in vogue “With private equity taking a hard look at the USING A MACRO LENS right now to align to low-carbon transition. Gone ability to gather necessary metrics from private “With the COVID pandemic, there’s naturally are the days where people could ignore that this companies, [investors’ moves to seek positive been a much greater focus on social issues and is a problem. So it’s been wonderful to see asset impact] are assisting in value creation there,” said diversity,” said DWS’ Lewis. “It’s led to an expanded owners embracing this to make positive change.” Streur at Calvert. “Positive impact in fixed income focus beyond sectors like oil and gas that you’d “We have to accept that the solutions to is not new either, but it’s becoming much more typically look at to include, for instance, the gig sustainability challenges will come from across widespread. How can we use this information to economy service companies. What are they doing the economy. Many sectors that we might consider improve management, improve companies, derisk, to look after their workforce?” he asked, noting to be problem sectors can be part of the solution and drive positive change across the board?” he that DWS has been screening companies to see to climate change,” said Mennie, from Manulife added. if they are in breach of international norms, such Investment Managament, using the example of “We look at ESG investing in terms of public as the U.N. Global Compact, in which companies offshore drilling companies whose technology and private markets because we are much more pledge to meet universal principles of human could be applicable to carbon capture and storage. passionate about impact,” said Lewis. One example rights, labor and other societal goals. Working with asset managers who have a is a DWS partnership with the United Nations Farrington at Natixis Investment Managers strong corporate-engagement policy is key, Green Climate Fund to provide clean energy to provides an example of using a wider lens on a said Deutsch. ClearBridge “meets with about households in Africa. “Within alternatives, real traditional investment like a home and industrial 1,000 companies a year. We ask all our oil and estate as an asset class has the greatest links to water valve manufacturer. “Historically, you’d gas-related companies how they are preparing sustainability,” Lewis said, noting that DWS’ real look at a company that’s making valves as being for a future when fossil fuels are going to be used estate portfolios have had carbon-reduction fairly predictable. But when you recognize that in far less frequently and renewables are going to programs for over a decade. “These really reso- the U.S., 20% of water is lost when it moves from continue to gain market share. So what they are nate to this ambition of net-zero because when point A to point B, and we have a failing water doing to transition their business for that future is people think about net-zero, they ask, ‘What do we infrastructure, you realize water is becoming a part of our engagement with them,” he said. Z

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