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THE DATA BEHIND ESG RANKINGS: HOW TO MAKE INVESTMENT DECISIONS BACKED BY NUMBERS

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Making investment decisions based on environmental, social, and governance (ESG)
criteria is a trend that's gone mainstream. Investors and their financial
advisors look to data to determine which companies and funds are truly meeting
their ESG goals. Making things more complicated, every investor has their own
views on which ESG priorities are the most important. 

Two leaders in ESG data and investing will discuss what sort of data is
available, how to know if data is useful, and what metrics can help investors
understand a company or fund's ESG orientation, as well as where the ESG
investing focus is headed next. 

Transcription:
Chana Schoenberger: (00:15)
Hi, nice to meet everybody. Um, with me here today to talk about ESG, I have two
experts, Linda-Eling Lee, who is the managing director and head of ESG and
climate research at M S C and Jay Koh, who is the managing director and a
co-founder of the late Smith group. Thanks Jane Linda for being with us today.
Um, I just wanna start off by figuring out how you, who you two are now your
college friend, and you both ended up in the ESG world. Do you wanna just tell
me how that happened separately?

Linda-Eling Lee: (00:50)
Sure. So hi Channa. Hi Jay. Good to see you guys. Um, so that's a pretty good
question. I don't actually recall that Jay and I ever talked about climate
change or sustainable finance or actually about invest at all. So it is actually
pretty funny that we both end up in the investing world. Um, I actually think we
met through some mutual interest in policy international relations. We spent a
lot of time, I think putting together these big international student
conferences that where we could all pretend to be making important, you know,
trade policy decisions and things like that. So I guess the, the main common
thread is that both motivated by, I think tackling, uh, systemwide problems that
we, I think probably came through to this field and, and through very different
route, you know, for me, uh, it was really extremely accidental. I really
discovered it completely, um, fortuitously.

Linda-Eling Lee: (01:36)
So post my doctorate, um, in organizational behavior, I was doing academic
research at Harvard business school on the drivers of, of long term corporate
performance. Um, really looking at what are the measures that account for which
companies actually outperform, um, over a 10 year timeframe. And, and those tend
to be quite intangible measures like, you know, a company's innovation capacity
or, uh, their leadership agility and things like that. And so I was just
researching what was out there for these types of measures. And I completely
ran, randomly stumbled upon people who were trying to score companies on their
governance quality, how well they managed their workforces, their environmental
footprints. It was totally foreign and weird to me. Um, and they were basically
creating these CSG ratings of companies and I got totally hooked. Um, and, um,
and I devoted the last 15 years of my career, um, a really furthering and
solving this methodological challenge of really trying to measure companies, um,
environmental, social, and governance, um, risks and opportunities. So that's
how I can do it.

Chana Schoenberger: (02:36)
So that's journey

Jay Koh: (02:37)
That I really never talked about is very much in the beginning, but, um, I spent
most of my career as an investors, so right after college, um, spending some
time in the England, I started working in private equity at Carlisle in the very
early days of, um, that kind of investing. So there's only about 24 people there
at the time and about a hundred million dollars and only one office in
Washington. So I sort of grew up in that investing world, investing in security
technologies and telecom technologies, uh, and really driven entirely by trying
to maximize risk and return, uh, for investors on a lunch term basis. But then I
also had a chance to serve in the us government of the Obama administration as
the chief investment strategist and the head of private equity at an entity now
called the us development finance corporation or the DFC.



Jay Koh: (03:21)
It used to be called OPIC, and it has an extremely strong focus on
environmental, social and governance standards. It follows the, if C's
performance standards, because it operates on behalf of us taxpayers to promote
private sector development in emerging markets and developing economies. And
that's where some of these issues are the sharpest where environmental issues,
social issues, governance questions become really critical, uh, in terms of
making sure that you're investing taxpayer capital, um, in a responsible way,
but also really addressing what our extremely important operational list. So
that was my first exposure to the world of ESG. Um, through that we started
looking a lot at different aspects of the climate challenge first on the cause
of, of climate change, reducing greenhouse gas emissions through things like
renewable energy and energy efficiency, and then really beginning to focus for
the first time on what happens when climate change starts to flow through the
economy and society as we unfortunately seeing now.

Jay Koh: (04:14)
So thinking about that physical risk and impact and how that intersects with
thinking about how companies, um, can actually analyze that measure that avoid
that I anticipate that be resilient to that became a really important focus, uh,
for, for me. And so at the end of all of that, coming back to the private equity
world and then working on launching light Smith, which is a sustainable private
equity fund, um, we, you know, came back around and, and into Linda cuz we have
been tracking each other for time as friends, uh, and said, wow, this seems to
now be converging where the world of ESG and sustainable investing, which I
think five or 10 years ago, would've been an outliers now much more, uh, kind of
one of the critical components of how people make investment decisions. And now
increasingly how that world has to, uh, actually address and incorporate climate
change risk into how we think about, uh, risk moving forward.

Chana Schoenberger: (05:04)
And despite your complimentary positions in the sector, you've never been on a
panel together before. So thanks for being here with us today. Um, let's start
with nomenclature because I feel like a lot of these terms get tossed about, and
they mean different things to different people. So what are we talking about,
Linda? You had some interesting ideas about this.

Linda-Eling Lee: (05:22)
Yeah. So I think it's always important in any of these kinds of conversations to
really level set and define our terms because that really is one of the
fundamental problems, um, in this field is that people actually mean very
different things. Sometimes when they say the same words like ESG investing or
sustainable investing or they use the word impact, um, and then everyone gets
confused because they're actually talking past other. So, you know, Adam, you
know, we think the most fundamental distinction you should make, um, and that we
always make with our institutional investor clients is, um, between an
individual driven rationale, individual preference driven rationale and an
investment driven rationale for incorporating ESG considerations and ESG data
into the investment process. So the individual preference driven rationale means
that, you know, you're trying to align a portfolio or a funds holdings with an
individual's preference and those preferences are going to differ.

Linda-Eling Lee: (06:12)
You know, you may not want to be associated with tobacco or fossil fuel. You can
screen those out. Um, if you wanna have a positive impact by holding companies,
let's say with strong diversity and leadership, you can screen for only those
companies into a fund or a portfolio. So in the individual preference driven
case, what you're doing is you are using ESU data about the company to imagine
individual's preference for either screening in screening out. So that's one
way. And then the other term really is, um, when people talk about ESG or
sustain investing, it's really much more of an investment driven rationale,
which is a different approach. And it's really at the core of what we consider
to be modern day ESG investments. And what's driven really all this huge core
in, in this area. Um, what we're talking about is really, really investment
driven rationale is where ESG data or ESG factors are actually being used as an
additional signal alongside traditional financial considerations to reduce risk
and improve returns.

Linda-Eling Lee: (07:09)
And so here, the important thing is that you're incorporating only those ESG
factors that are going to be financially relevant or material for a company,
which is going to be differ, um, by industry. So for a food company, you can
imagine product safety will be part of the ESG data. You really need to assess a
company's resilience to ESG risks. Um, but for say a utility or power
generation, company's not, it's not product safety. It's going to be it's carbon
emissions or other types of air pollutants that are the ESG data and factors you
need to incorporate into its ESG risk assessment now. And like the individual
preference driven case here in this investment centered case, you don't get to
express preference, right? There are financially relevant ESG factors that are
going to matter for these companies, regardless of whether you as an individual
have values about them or care about them at some sort of social impact level.
So, you know, Yana, maybe you don't care that much about water resources because
you care about some other types of issues, but how a semiconductor company in
your, uh, portfolio actually manages water scarcity risks, um, really has a lot
of, um, bearings on its operations on its ability to create value for holders in
the long run. So that's how we would.

Chana Schoenberger: (08:23)
So really, okay. So, so basically if I am looking at a semiconductor company and
I understand how its use of water is going to affect its results, then it's not
that I have an opinion about water scarcity. It's just that I want the company
to make as much money as possible. So I need to know how it's exposed to that
risk.

Linda-Eling Lee: (08:45)
Yes. So that is one approach when people talk about ESU investments, um, and
that doesn't mean that you couldn't have a different approach, right? And, and
so the, but it's very important to know which it is that you were talking about
individual preference driven or investment risk driven.

Jay Koh: (09:02)
The other thing I'd add here is in the private, on the private investment side
and private equity, um, you know, there's anticipation of how public markets
analysis is gonna occur, right? But, and you have, in some cases, much more
access to information. If you have a control position or, uh, a board seat, uh,
which, you know, light Smith and other private equity growth equity firms will
tend to take. So instead of relying on disclosed public information, you can
actually get, uh, information rights to get much more deeply involved. And I
think we would approach it by thinking about kind of two different aspects to
the difference we between sustain sustainable investment or ESG screened
investment, let's say, uh, versus, um, trying to express certain investment
preferences or objectives, even from an investment outcome standpoint. So at,
in, at light Smith, we have two different systems by which we actually address
this set of topics.

Jay Koh: (09:52)
The first is we have an ESG risk management set what's called environmental
social, uh, monitoring system SMS. And it's based on the IFC, the international
finance corporation, private sector arm of the world banks performance
standards. So it has different sets of tiers or environmental risk type of
investments. It focuses on social issues like, um, avoiding child labor, making
sure you, you pay your workers, that they pay tax Xs and governance issues like,
um, not bribing people, right? So in that sense, these are kind of negative, um,
screening or downside risks that are end up being really important from a
management standpoint, to avoid, uh, all kinds of the negative consequences of
those kinds of actions. And those will have severe negative impacts on valuation
on the exit, if something bad happens or line risk to the operation of your
company or regulatory risk. And so on.

Jay Koh: (10:39)
In addition to that, because we have an, a strategy of focusing on, um,
companies that will benefit from and help to support, uh, the management of the
effects of climate change. So that's our affirmative strategy. It might be the
way we express a particular investment preference. We have a very specific
process by which we identify those types of companies. And then we measure the
impact that they generate in addition to the financial returns that they, uh,
that they create. And those will differ in a way similar to what Linda's saying
by sector. So if we're investing in say a company like source global, which has
solar powered hydro panels that generate drinking water from the air, um, you
know, the relevant, uh, factors in thinking about their upside potential, in
addition to the financial performance of those panels, um, is how much water
they generate and whether that water's being generated in a drought prone area,
um, the health effects, uh, of that might not be as relevant.

Jay Koh: (11:35)
Um, its impact on the supply chain might not, is relevant. It has a limited
amount of effect on agricultural productivity. And so those are factors that we
won't affirmatively measure for that, but we will make sure that they don't use
child labor and that they pay their taxes and that they're not dumping effluent
into the river and these kinds of aspects. Um, and then on the other side of it,
we'll in all cases measure G HG, uh, mission reductions, you know, water is
very, um, uh, carbon intensive. And so reducing, uh, the cost of generating
that, uh, water and making it much more accessible, uh, as dramatic reductions
in that side. So I think about it as sort of a downside case on the risk factor
analysis piece of it. And we use a standard set of those risk analyses. And then
on the upside case, looking, um, on a targeted basis at what factors, uh, we can
measure to, to identify what the non-financial quantitative impact is of the
investments we're making. But that's because we're again driven by a primary
thesis where the companies we're investing, we think will benefit, um,
financially, uh, from the value that they're generating in a non-financial
sense. So if you look at other private equity approaches, um, most of them will
start by taking the first step into, um, monitoring their ESG risk on the
downside. Uh, and then some of them on a selected basis will try to measure, uh,
the upside risk.

Chana Schoenberger: (12:54)
Do you, is it too early to say whether that's true? Like, do you know if those
companies are actually going to do better?

Jay Koh: (13:03)
Uh, in our case, we've just started investing. And the thesis that we have is
if, uh, you see the impact of climate change, start to become more complex and
important, which we're seeing right now in fortunately, um, then tools to
analyze those effects will become much more important, uh, more valuable, and
you kind of want them to be more important, more valuable. So we have seen
accelerating growth in the water harvesting technology company we invested in
and accelerating growth in the supply chain, uh, of food and agriculture company
that we've invested in, which is dealing with a lot of the disruption and
increasing efficiency of the supply chain as a result of, um, some of the
disruptions that we're seeing out there. So I think the, the, the medium term
thesis we'll see how it plays out, but, um, you know, we're pretty confident
that we may not know much about consumer behavior or the credit cycle, but five
or 10 years from now, climate change will be much more complicated than it's
today.

Chana Schoenberger: (13:58)
Great. Certainly not gonna go away in the next five years. Um, unfortunately,
okay. I just want, unfortunately not, um, I wanted to return to something Linda
said a minute ago about investing as a, as a way to either express your values
or just as a way to make sort of a, a, a bet on how of the company is going to
respond to some of these challenges. So if an investor wants to go find
companies that, that are living values, that they care about, and of course
every investor has their own set of values that they care about, which is kind
of a fascinating thing, the way that ESG can mean completely opposite things to
different groups of investors. How do you use data to, to determine these
factors about public companies?

Linda-Eling Lee: (14:45)
So I think that the institutional, um, investment world that, that we serve for
our clients. So, um, many of the largest asset, um, managers, as well as the
pensions wealth funds and, um, and wealth managers actually kinda use our data,
right. And what they're doing is they're taking the data and they're able to
kind of match them to individual securities. And so you can actually have, um,
for any particular fund that, um, that they're putting together, you can
actually start to see, say, for example, what percentage of the companies in
their portfolio, um, have more than three women on the boards, right? So, and
that could then be matched to, um, particular clients of theirs that are
expressing a certain preference, um, with regards to diversity. And then you
could have a different set of metrics around climate or, um, around kind of, um,
whether it's alignment to climate goals or whether it's about reducing, um, the,
the, the risks from, um, from carbon intensive industries.

Linda-Eling Lee: (15:41)
Those are the kinds of things that, that you can actually match now because
there's such a wealth of data out there. And it's more and more precise. Now, if
you're, um, someone kind of out in the public was just interested in looking at
this, um, you can't, there's a lot of, um, publicly available information. So we
have made the, um, ESG metrics of, I think, over 30,000 funds available, um, on
the mse.com website. So you can actually just go and look it up and it will tell
you what is the carbon footprint of, um, of, of, of many of these funds. Um, you
know, so there are different aspects that you can look at. And really, I do
think everybody should go and avail themselves with this new type of data that's
available because, um, as we know what funds actually call themselves in their
label, um, again can mean different things to you.

Linda-Eling Lee: (16:30)
And to then it does to me. So why don't you just kind of look underneath the
hood and be able to kinda actually see what's in it, and what's not in it. If
there are certain things you really don't want, for example, there are investors
that really do not want to be holding any fossil fuel, um, companies. It's very
easy to be able to see what percentage of the companies actually have fossil
fuel production. You don't have to guess, you know, so, so I do feel like, you
know, there's too much, um, um, there's too much kind of going by the labels, if
you will, and, and really should not judge a book by cover.

Chana Schoenberger: (17:03)
Well, a lot of the labels, of course, you know, especially of the, the newer
funds tend to just be pure marketing, you know, they'll, they'll often you see
companies will take a fund that already, and they'll add the word green to it or
sustainable, which could mean something or nothing.

Linda-Eling Lee: (17:21)
Yeah. And that is

Chana Schoenberger: (17:22)
Way to tell

Linda-Eling Lee: (17:23)
That, you know, and I do feel like, um, this is an area that will improve in
terms of clarity. Um, not least because I think regulators are getting involved,
right, depending on, um, what a jurisdiction you're in. I mean, certainly in the
EU, they are putting in quite stringent, um, standards and criteria by which you
can name certain things. Um, and also you have to more proactively actually
declare what type of a fund. Um, it is if you're going to call it some sort of a
sustainable or, or, or ESG claim, you have like different categories of
greenness, if you will. Um, and here in the us that we don't have necessarily
that kind of a criteria or set thresholds or, or this kind of much more
prescriptive taxonomy that the EU has, um, um, is more prone to how, you know,
the S E is very interested in and has started to look at, um, fund naming so
that it can actually bring more clarity to this market. And, and Hannah, as you
said, you can't just then decide to not change anything in a portfolio, but just
except for the name,

Chana Schoenberger: (18:24)
Right? The idea there's look at this,

Jay Koh: (18:28)
Sorry, there emerging professions is here too. So we we're, we're a Luxemburg
based fund actually. So we are an article nine fund under European regulations,
and there's certain specific sets of, uh, procedures that you have to adhere to,
to continue to have that type of status. Um, but you know, in the climate
context, you're starting to see specific kinds of data start to emerge that are
address in different parts of that set of risks, right? So on the kind of carbon
footprinting side, that's been something people have been working on for a long
time, looking at different types of emissions that are either generated directly
by your activities or from your supply chain or through other activities that
you're involved with. Um, with this idea of attempting to get to, uh, an
understanding of how your investments are supporting are, uh, reducing the scale
of the, uh, greenhouse gas emissions, uh, problem that we're breeding for
ourselves.

Jay Koh: (19:16)
One area that is now also emerging. That is the focus of our investment strategy
really is around the physical risk side of, uh, climate change, which is at an
earlier stage. The question is you, if I buy a house on the coast, you know,
what to it over the next 5, 10, 20 years physically, do I have more risk to
getting it flooded out or destroyed by hurricanes? If I own a mortgage that's,
um, associated with that house or the pool of mortgages, do I have more risks
now than I used to do? I have wildfire risk that I didn't use to do. I have
storm risk, et cetera. And so there's now an evolving set of information, uh,
uh, to that physical risk analysis. Some of that has to do primarily with just
understanding where all your stuff is, right? So if you have an extended supply
chain, uh, for a manufacturing company, um, in 2011, there's a famous, um, tie
storm that destroyed about half of the world's hard drive manufacturing capacity
all at once.

Jay Koh: (20:09)
And so hard drive supply, I collapsed, uh, and prices went up, it had impacts
on, um, major, uh, it companies, it also destroyed huge pieces of the audio
auto, uh, manufacturing sub, uh, subcontractor area. And that had impacts on
Japanese man manufacturers as well. So when we face an increasingly risky set of
conditions, having the data to help us understand different potential outcomes
going forward is gonna be increasingly important. And I think regulators now
looking at that aspect, in addition to the carbon intensity as something that's
important, right? Like, you know, a couple years ago, PG E the 10th largest
utility in America in California, went bankrupt and was convicted of
manslaughter multiple times because of its negligence related to its power lines
causing massive fires in California. This was not something most investors
expected to be a risk when they bought municipal bond, um, mutual funds thinking
that their bet was, we think Californians will still need electricity in 10
years. So analyzing these kinds of new risks is gonna be increasingly important.
It's great to do that against a backdrop and a lot of the work that's been done
in gathering data about other risks, but this will become unfortunately an
increasingly important dynamic area.

Linda-Eling Lee: (21:22)
So Anna, if I can, um, add to that, and also maybe we talk a little bit about
what, um, what it means to when we say data and when we say kind of climate
data, because what, what Jay just talked about too, is just, there are these
different dimensions of climate risk, right? And these different dimensions of
climate risk actually need you to, um, need investors to be looking at different
data and then putting together differently in order to kind of measure these
different exposures, um, um, of their investments. So, so I think, you know,
very broadly speaking, um, I think there're probably three kind of buckets of,
um, climate, uh, data that many of our clients use. And, um, one is around
what's called transition risk, right? And so these are risks that your business,
um, or company portfolio company might incur, um, in terms of cost from
transitioning our energy system to a renewable based, uh, uh, economy.

Linda-Eling Lee: (22:20)
And, um, that could be because climate policy and carbon taxes, uh, affected in
some jurisdictions, or it could be through technological change trade. And so
the question is really around how fast that transition would be and how much
that would then impact, um, a particular kinda investment. And so traditionally,
um, when we talked about kind of carbon footprints or carbon emissions, you
know, what we're doing is really looking at, um, any company, um, any company
that's disclosing their emissions, what, whether that's their direct emissions
or some of their indirect emissions. Um, and more and more, I think regulators
are looking into, um, and standard centers are asking companies for the value
chain emissions, but today that's really kind of a, a, just a snapshot of today
based on your activities from the last, you know, year or two, kind of what a
snapshot today of how, how carbon intensive your business might be, that might
then have it be subject to these different kinda transition risk scenario.

Linda-Eling Lee: (23:14)
So that's one set of data when people talk about carbon footprint, carbon
emissions, that's what they're talking about is only about this transition risk.
Now the second, um, type of data is really around these physical risks that,
that J story to talk about, um, which is about, um, exposure to weather events
and changing temperatures. And that's a really, a very different set of data
that we're collecting and that we have to model typically, um, for, um, for, for
companies and securities, because what you really need, there is very location,
specific data, and you need a, a company's facilities, um, what they're actually
doing, where, um, whether they're generating revenues there or what's their kind
of asset value. So, so what a lot of my team does is actually just the modeling
around, um, taking each company apart, if you will, and put them in different
locations and segments and, and so forth.

Linda-Eling Lee: (24:03)
And so the, we can actually then overlay these types of, um, weather related,
um, hazards, um, to be able to aggregate, um, at a company level, what is
propensity, um, over the next, you know, 30 years and 50 years or 70 years to
experience these different types of negative physical hazards. So that's kind of
a second category, um, of climate, um, we related risks. And then the third, um,
that I think Jay also touched on is, is many investors are now very interested
in, um, what the alignment and what's the impact. What's the contribution of
their, um, investments to the, uh, two global warming and to this temperature
rise and here, what it doesn't really help you to know what the company did
last, last year in terms of how much emissions it put into the air. What you
kind of need is to a projection of how much emissions is going to put into the
air in the next, you know, 30 or 50 years such that it brings the world to a
certain, it contributes to the, the amount of emissions that might be warming,
um, warming the world.

Linda-Eling Lee: (25:05)
And so for that, you were really need to model going forward. You know, whether
a company is, um, is over emitting, you know, it's share or under emitting it's
share for keeping the, the, um, the, the world to a certain scenario of, of
temperature. And that's why there's a huge amount of, um, uh, uh, of development
at the moment research and, and analytics. You not just by, by M sci, but by
others to develop these new types of measures. For example, you know, we put out
something called an implied temperature rise metric, and it's really measuring
for any given company, you know, our estimate of, um, the emissions path that is
on. And whether then it's aligned to, for example, a two degree path or a, or a
3.2 degree path, or a 1.8 degree path. And that's really more of projection. And
so these are different types of climate related data, if you will, that I think,
um, investors are, are looking at because they're measuring, you know, different
concepts really around climate change and climate risk.

Chana Schoenberger: (26:05)
Yeah. Those are all different things. So given on all this and given what you
two have chosen to do with your lives, I'm, I'm guessing that you can help me
answer this question, which is occasionally you'll run across people who will
say ESG is a fad, and that investors in the markets will stop caring about this
eventually. And they'll move on to the next thing. How do you, how do we refute
that?

Jay Koh: (26:27)
Why don't I start by saying, you know, I don't think that we any longer have a,
you know, no child labor set of investments and child labor investments. We, we,
we don't let people do that anymore.

Chana Schoenberger: (26:40)
Nobody's pro child,

Jay Koh: (26:42)
Well, I mean, we're, we're, I, I have children, so I, there's a whole different
conversation about homework we can have, but the, the, so you're

Chana Schoenberger: (26:49)
Definitely proton.

Jay Koh: (26:50)
I am I'm pro uh, in-home child labor for, for certain sets of, uh, important
household activities. Let's put it that way. And that is, that is a minority
opinion of this household. Unfortunately. So, um, the, the point is, I think a
lot of these things will become standardized. And there are also markers from
the standpoint of investors of better management, right? If you don't know
whether your employees are bribing people or dumping affluent in the river, or
hiring child labor, uh, or maltreating their workers, then you probably don't
run your company that well. And that will show up in a whole bunch of other
ways. Um, so I think at the fundamental, like, you know, basic table stakes
universe, like we don't let people, like, not know whether they're funding
terrors anymore. We don't let people do money laundering. We don't let people do
a whole range of things.

Jay Koh: (27:36)
And that, that frontier of what is acceptable in terms of environmental, social,
and governance risks continues to move. And I think it's important that it does,
right. We'll have interesting conversations about diversity and case always
moving out. Yeah. And well, I mean, look, you know, you've seen movement on
gender inclusion requirements on boards in, in Europe, which have been very
effective. I think that debate is still, you know, very much open here in the
United States. Um, the other side of it is some of these risks are ones that you
think you might think are a fad, but you don't really have that many choices
about, right. So in the kind of physical risk and impact side of the climate
change problem, you know, maybe five or six years ago, this would've been
discussed as well in 2100, there'll be fewer polar bears and coral reef.

Jay Koh: (28:19)
And that makes me sad, but what does that do with me and my 401k or my house or
my company. And now, um, I think the perspective is quite different after
several years in a row six or seven years of massive fires in California, 200
people being killed and flooding in Europe last year, you know, a successor set
of storms here in New York, which were very different than the hurricane Sandy
impact, uh, 10 years ago. Um, I think people are now aware that climate change
is here and the physical risk and impact is manifesting and that's a
humanitarian issue. And it's also now a real economic and financial and
investment issue. And so you can think that that might be a fad. I think
unfortunately physics and time are probably gonna disagree with you. And so if
you don't take account of some of these risk factors, they will manifest in your
portfolio, whether you are particularly interested in them from a political
standpoint or not.

Jay Koh: (29:12)
So we all exist in a, in a set of assumptions about the risk that we live in.
It's mostly forensic, right? We're looking backwards, uh, at the last 20 or 50
years of environmental conditions. And that's how we plan our days. The
challenge is now we're gonna have to look forward, right. Drive looking through,
um, the windshield, not through, uh, looking the rear rear view mirror because
the risks are going to be changing on us, cuz we've created that set of
situations. So I think, you know, kind of a nuanced way of thinking about
broader approaches on ESG and climate risk are, are to think about them as ways
that they actually practically intersect with, uh, financial institutions in the
case of investments and your own, uh, portfolio of investments, right? So, you
know, if you buy a house and you wanna live there for five or 10 years, you
might have expected that you'll just get fire insurance every single year, cuz
you've had fire insurance every single year.

Jay Koh: (30:03)
That's no longer the case in California, uh, and flood risk, uh, in the east
coast of the United States is gonna change dramatically too. So you have it till
you don't have it. And then the value of your assets doesn't change until it
suddenly changes sometimes. And so thinking systematically about that and having
the data to inform those, I think is really important for everybody, right?
Investors at the institutional level, individual investors, governments,
communities, and then, uh, the applicability of that data to disadvantage
populations are also really critical as we kind of think about how we come out
of COVID. So maybe a fad for some people, but I think it's gonna be a really
long term experience in for, for everybody else.

Linda-Eling Lee: (30:45)
So I would echo what Jay says about, um, certainly about societal expectations.
I think that they are just higher in terms of what it is that we expect, um,
how, how we expect companies to behave and, and not behave. And I think a lot of
it is actually also enabled by technology. I mean, it is just very difficult to,
um, to do something in the back corner somewhere or in some far flowing location
of the world and not have it be known that this is the way you're treating your
workers or that this is the way, you know, your decimating on community. Right.
And so I feel like that transparency that's enabled by technology G these days
just hold companies to a higher standard. I don't see how that's gonna go away.
I think that the societal expectations will continue to rise. And, um, and so I
do feel like, you know, for companies, um, and their investors, I think that
that is a, a reality.

Linda-Eling Lee: (31:36)
I don't think that that's gonna be necessary if that now, if I, um, if I answer
this question more from a practic kind of, um, more flows THG funds kind of a
way, like, is that going to end? Is that a fad? So I, I think that there are
probably, um, you know, well, you know what I said earlier about the fact that
there are two types of motivations for incorporating ESG, there's the individual
preferences and then there's the investment risk. And so correspondingly, um,
you know, looking at this question of, um, whether EEG fund flows will continue
in this way. You know, if there there's sort of these twin drivers of greater
flows, right. To different types of ESG strategy. So one is that there's been an
expression or, or an uptick in people who wanna express their values. That might
be a change in the belief system.

Linda-Eling Lee: (32:22)
There might be more people on a general term for, for their savings in a certain
way. Now that impulse is probably gonna be stronger than some cycles than
others. Um, for some, it's gonna be a little bit of a luxury. Good, to be
honest. Um, but there's also evidence that a lot of sort of wealth management,
um, institutions, um, have brought to there that, that there is, um, there's
more of a structural generational change, right? That, so the, the younger
generations just don't think that you have to invest in only one way and that it
is possible to generate, you know, similar or possibly even better returns well
attending to your values. And then they have that choice. So is sort of depends
on, I, I don't know whether, you know, the jury is out, but I certainly, there
is a real belief that there, there is a generational shift, um, in, in that.

Linda-Eling Lee: (33:07)
So that's not necessarily a fad. Now, the second driver, um, of more flows into
strategies that incorporate ESU is, um, is because of this kind of ESU
represents more information about a company and more information you call better
investment decisions. Now I don't think that that's gonna, that's a FA I don't
think you can put like all this new information into some back into the, you
know, um, the genie kind of out of the, out of the, the, um, out the bottle
there. So it's, you know, there's just so much evidence piling up at this point.
Um, in terms of the fact that integrate financially relevant HG factors, they do
actually reduce risk and improve long term returns. And this is here, I'm
talking about the public, um, legal listed universe for which we've been rating,
you know, almost 10,000 companies. And we have data for over 13 years.

Linda-Eling Lee: (33:53)
And so in our own studies, there are very large scale that span thousands of
companies globally over 13 year period. We can that the companies that are
better than their peers and managing just their financially relevant ESG issues,
they have been more profitable over this period. They have experienced, you
know, three times fewer incidents of very sharp, um, sells because of negative
events. They are less volatile than their peers, you know, so over time they've
just accumulated higher risk. And so that's not something that's like a belief
system. That's just something that's just data and you can go and look at. And
so I do feel like in the investment world, um, there is more, uh, you know, it
is, it is, you know, driven by whether or not you can, um, have lower risk and
higher returns over time. And I think that the evidence is there to kinda
support, um, the use of the ESE, um, integration in, in, in these ways.

Linda-Eling Lee: (34:44)
Um, I also think I would just say that, that I think that ES she indexes, um,
um, there are some very new ones, of course, but there are some with very long
historical track records. And so you can actually go and look at the live
performance of them. I think I would say, however, that you just have to be very
careful that you're comparing apples, um, and not comparing apples to oranges
because there are very many different types, um, of ESG indexes. And I think if
you look at the ones that are broadly diversified, um, the, the, um, broadly
diversified ESG indexes that have had a long track record, they actually do have
shown, you know, better, uh, the same or better performance over very long
periods of time. You know, so, but don't compare those necessarily to the ones
that are like very, very concentrated and sector specific and are very, you
know, because then you don't have anything to really compare it to. So I would
just say that just based on the, the track record, I don't think that this is
going to be a effect.

Jay Koh: (35:47)
The other thing just to add here, cuz I, I feel like I'm like the, you know,
asteroid's gonna hit the earth and everybody should just buy helmets kind of guy
in this conversation, um, is, uh, you know, ESG and then the broad category of
sustainability and thinking about what the world looks like going forward, um,
is not just avoiding risk, right? It's not just say, okay, I'm gonna sell my
coastal real estate and move to a mountain and hope it's not one that's gonna be
led on fire. Um, it's also about thinking about what preferences are gonna look
like going forward and what kinds of companies are gonna be more successful by
virtue of that way that they approach managing their activities and what
technologies that they develop. So we're, we, we're trying to go with a better
way of describing that than better, but I think it's sort of like better
investing, right?

Jay Koh: (36:30)
So if you look at Tesla motors, for example, you know, if you had gone and had
this conversation 15 years ago, the idea that electric vehicle transition would
be inevitable and incredibly valuable, would've gotten, you laughed out of most
rooms, right? So since the financial crisis, since the transition, since all the
other factors that have kind of contributed here, you, I think are now in a
situation where most people are pretty sure that there's gonna be a substantial
amount of, uh, um, mobility sector. That's gonna be electrified, right? And
there have been electric vehicle companies for a very long time. Most of them
have tried to build golf carts, right? Like, Hey, have an electric vehicle. It's
better for the planet. And it's only 40% crappier than your current car and
unsurprisingly, that was not like an awesome consumer preference. Uh, and part
of the idea here is in the transition to, uh, a more climate friendly economy,
um, you can choose to have companies that have better sets of outcomes or better
sets of experiences or offer a better value proposition taking account of the
new set of conditions and circumstances or ones that don't or ones that don't
even take account of the set of conditions at all.

Jay Koh: (37:40)
Um, the opportunity is to find companies that are going to understand how the
future looks a little bit better than their competitors, and that still use
innovation in entrepreneurship to seize out an opportunity to get a better
experience in that new environment. Right? So there are people that have never
adjusted their supply chains and try to distribute, uh, their products, uh,
through the course of COVID disruptions last year, and then compounded by
freezing olive, Texas for seven to 10 days and lighting most of California on
fire. They probably didn't make their shipments on time in the same way that
supply chain management companies that provided data analytics around weather
disruption, uh, as well as the ability to anticipate some of the trade and other
shutdown issues from COVID were able to supply their customers. And so the
winners in that from an investment standpoint and the winners from that in a
kind of value proposition standpoint are people that have those technologies and
that account, not just for the fact that the world is changing in a more complex
and potentially risky way, but that can deliver a better set of outcomes in that
environment.

Jay Koh: (38:44)
And they will win share, and they will be more valuable and you will want them
to win share, and you will want that to be more valuable. So it's simply to say
that, um, all these changes that we're seeing, uh, and the climate side are not
just risks that we're all going have to factor in. That's certainly something we
need to address right now, but they also create opportunities for technology and
entrepreneurship and investment to generate better sets of outcomes and people
that see those will.

Linda-Eling Lee: (39:11)
I agree. So I, I, I know that that whenever about climate, it starts to be like
very sort of, you know, downside, but, um, but what's actually really a huge
change is I think in the investment world there is that it's the, the fear
versus greed, I think right now there's a lot of greed. Um, and so I, I actually
think it's a huge opportunity, um, as well, you know, as Jay says, and I think
that there is way more, um, focus now, I think, um, certainly among the
investors that we work with on kind of what are those pockets of, of opportunity
and, and because some of them are going to be huge. And so, you know, how do you
seed those opportunities because this transition is going to happen. And, you
know, I think it's instructive for us to think about like, what are the 10
largest companies today, right.

Linda-Eling Lee: (39:55)
Um, and you know, when you look at a, I don't know, more than half of them
didn't even exist 30 years ago. And what we're talking about with climate change
is the next 30 years. And I think in 30 years time, you are going to get a set
of companies at the top that probably don't exist today. Um, and certainly not
in the form that they are. And so I do feel like a lot of investors are, are
that long view and starting to kinda place more bets in this area because we're
gonna have a very different economy, I think, um, you know, with the transition.

Chana Schoenberger: (40:29)
Great. That's super interesting. So this leads me to what I think has to be our
last question. Luckily, um, people have been, um, typing questions into the chat
and you've actually answered almost all of them just organically, which is the
best way. So let me ask one more, which is what is the most surprising thing
about ESG investing and risks that you think investors should know Other than
don't buy coastal California real estate?

Linda-Eling Lee: (41:00)
I don't know. Um, I don't know about surprising, I suppose. Um, I think one
thing that is really important to know is what might seem like a niche concern.
Like I think you're gonna hear about issues or ESU topics where you're like,
what, who cares about that? And those kinds of concerns are actually becoming
investment risk very quickly. And we're seeing, seeing the cycles beat up more
and more. So every year we write this, um, um, outlook piece, which is our ESG
chance to watch. And this year was the 10th year that we, we put out this trends
piece. And so we went back and did a kind of a historical look through of, you
know, what did we actually say in 2012 and so forth. And I think back then we
talked about privacy and data security. You know, the collection use of personal
data was a concern only to some civil liberties advocates. They seemed kind of
niche to, and it was only, uh, pertaining to tech companies. And of course today
it's at the heart of kind of generating destroying tremendous amount of value
for companies across so many industries. Right. And so I think that there are
lots of issues like that, where it seems like there's some sort of a, um, niche
issue. And I, I do feel like everyone needs to understand just how to incredibly
dynamic, you know, all of these social and environmental issues are that are
turning into investment risk, like in a nanosecond.

Chana Schoenberger: (42:21)
So we should read your annual predictions report almost as a, a trend trend
forecasting piece, you know, like the color of the year.

Linda-Eling Lee: (42:30)
Yeah. I know I like the forecasting piece, but it is a that we write to, um,
surface issues that we think that investors and companies are probably gonna be
paying more attention to in the coming years.

Jay Koh: (42:41)
Yeah. I think the, the same, same way I would put it is some of these things
take longer than you think, but then they happen faster than you think. Right?
So we have been focused on looking at the physical risk and impact of climate
change of light Smith for, or five years. And, you know, last year at this time,
February 9th or right after the, uh, inauguration, uh, president Biden, that's
also 35 billion of private equity and growth equity and venture capital raised
for climate change. That all happened in a year, right previously that people
were like, well, you know, Cleantech 1.0 was, you know, not an awesome
experience for a lot of people. Some it was successful, some was radically not
successful. Um, you know, climate change is an important thing. People care
about it in Europe. There's a lot of politics around it. How does it have
anything to do with investments?

Jay Koh: (43:26)
And then suddenly, uh, the signal changed a little bit and there is now I think
a, a much stronger amount of focus, uh, from investments standpoint here. And I
think again, like, uh, these things that, uh, percolate at the edges become
really critical when events manifest, right? So we'll have another massive flood
this year, somewhere in the Midwest and giant fires in California and huge
rainstorms in other places. But, um, I think the recognition that these risks
are here now is very different, uh, than it was before. And that will
unfortunately increasingly change, right? So five years ago, when you thought
about climate change, childhood asthma was not at the top of your list of
problems, but it turns out if you light everything on fire all the time, um, you
exacerbate the amount of particular in the air and it causes huge impacts. Uh,
and if you live in California or increasing other parts of the world that are,
are gonna be subject to that, then your healthcare is gonna look very different
than you anticipated. So it's not just about sea level rise and polar bears and
coastal, uh, you know, reef for you. It's now about, um, your kid's health and
your health, right? And I think that that's one of the most dynamic aspects that
we're gonna see play forward, which is unexpected secondary tertiary Ary, you
know, in causation terms, but immediate effects that we're gonna see happen as a
result of some of these changes.

Chana Schoenberger: (44:47)
Yeah, no, it's really interesting. I, uh, was on, on the highway the, this
morning and I noticed for the first time, just how many solar arrays are just on
exit exit ramp, you know, those little areas by the exit ramp where you, you
can't really build anything else there. And they're just covered with solar
panels now, which is not something you would've seen five or 10 years ago. It's
kind of amazing. Well, we've run out of time, but I wanna thank you so much,
Linda and J for this was a really interesting conversation. Someone asked also
where they could get the data Linda was talking about. And I think it's
said.com. Is that right?

Linda-Eling Lee: (45:21)
Yes, that's

Chana Schoenberger: (45:21)
Correct. Yes. Great. Okay. Thanks very much and have a great day.

Linda-Eling Lee: (45:27)
Thanks everyone. Bye bye

Chana Schoenberger: (45:30)
Bye bye. Thank you.


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Leaders Wealth management Financial planning Corporate ethics Innovation
Speakers
 * Linda-Eling Lee
   Managing Director and Head Of ESG & Climate Research
   MSCI
 * Jay Koh
   Managing Director and co-founder
   Lightsmith Group
 * Chana Schoenberger
   Editor-in-Chief
   American Banker
   (Moderator)


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