The Journey to a Sustainable Portfolio

With:

And Jackie VanderBrug

Head of Sustainable and Impact Investment Strategy Chief Investment Office,

Merrill and Bank of America Private Bank

Joe Quinlan

Head of CIO Market Strategy Chief Investment Office,

Merrill and Bank of America Private Bank

 

Marisa Sullivan

Senior Research Analyst and Head of U.S. ESG Research BofA Global Research

 

Title card:

The Journey to a Sustainable Portfolio

Recorded on 4/06/2021. Please read important information at the end of the program.

 

Jackie VanderBrug:

[LOWER 3RD]

 

Jackie VanderBrug:

Hey Marisa. And Joe Quinlan, head of CIO Market strategy for the Chief Investment Office, Merrill and Bank of America Private Bank.

 

Joe Quinlan:

Hi Jackie, thanks for having me.

 

Jackie VanderBrug:

Hey Joe, I'd like to start with you. As we've just seen sustainable investing has grown considerably. Some would even say it's becoming mainstream. Morningstar's Behavioral Research team found that 72% of Americans across all demographics are interested in a conversation on sustainable investing. I'm curious what you see as the key factors driving this growth.

 

Joe Quinlan:

Well, Jackie, I think there's multiple factors at work here, but one in particular is that investors, consumers, companies;

[GRAPHIC]

What’s Driving the Growth

·         Growing stress on our Earth & environment

They’re realizing how fragile Planet Earth actually is. There's a tremendous amount of stress with 7 billion people moving about. And we saw that related to the pandemic, how greenhouse gas emissions, they actually declined last year as we stood still as humanity.

 

[LOWER 3RD]

Joe Quinlan

Head of CIO Market Strategy

Chief Investment Office, Merrill and Bank of America Private Bank

But nevertheless, last year was one of the hottest years on record. So, there's a recognition, clearly, amongst all the stakeholders that we need to be better caring about our earth. And so that's one key issue.

 

[GRAPHIC]

What’s Driving the Growth

·         Growing stress on our Earth & environment

·         Need to solve social issues here in the U.S.

There's also large segments here in the United States under stress, whether it's single moms that have to work, frontline workers, African-American and other minorities; there's a lot of work to be done here in the United States when it comes to really going local and solving some of these social and political problems that have been around for quite some time.

 

[GRAPHIC]

What’s Driving the Growth

 

·         Growing stress on our Earth & environment

·         Need to solve social issues here in the U.S.

·         Global challenges exposed by the pandemic

So, the last component is the pandemic itself. It exposed how fragile we are with Mother Nature and how -- what can happen in one part of the world can really transmit and go around the world and create its own challenges for everyone. So that's where we stand today.

 

Jackie VanderBrug:

And Joe, those needs are very felt. They also dovetail with two common misconceptions about sustainability. First, that it's just a nice thing to do, but that you need to accept lower returns as the trade-off. And also that it's just about excluding certain companies and industries from your portfolio.

 

At one time, these were valid concerns, but at the CIO, we've been clear that we believe you don't have to accept lower risk adjusted returns if you invest in sustainable strategies.

What's the situation that you see today?

 

Joe Quinlan:

Well, Jackie, it’s not all or nothing-- you can do well, you can do good. And I think that's kind of the mantra of a lot of U.S. companies out there as they become more involved with our communities, they see the stakes when it comes to the inequalities that we have to address. So, they want to do good, they want to do well, because it does drive growth. It does drive incomes and employment and productivity. So it's not an either-or-situation anymore, the way it used to be in the 1980s, for instance.

Jackie VanderBrug:

And Marisa, I want you to pick up here because your team has done some amazing work in the whole area of ESG. For example, your research has shown a direct connection between a company's financial performance and its progress in environmental leadership, as well as in diversifying its workforce and specifically ensuring women and people of color are represented in leadership positions and on corporate boards. Tell us about some of the key findings that you've uncovered.

Marisa Sullivan:

LOWER 3RD

Marisa Sullivan

Senior Research Analyst and Head of U.S. ESG Research BofA Global Research

I would definitely echo Joe's point that when it comes to sustainable investing, we do not think it's a trade-off. In fact, our research has shown quite the opposite--that incorporating environmental, social and governance considerations can actually enhance one's investment process, not detract from it.

 

So, you mentioned diversity and let's take that as an example.

[LOWER 3RD]

 

Companies with greater gender, ethnic and racial diversity in management and boards see tangible financial benefits.

Source: “An equity investor’s guide to diversity,” BofA Global Research, 3/08/2021

 

What we found is that there are tangible financial benefits for companies that diversify their human capital. That is, companies with greater gender, ethnic and racial diversity in management and on the board, tend to see greater profitability, lower earnings risk and even a lower cost of capital than their less diverse peers. [Source: “An equity investor’s guide to diversity,” BofA Global Research, March 8, 2021.] And that's just one example.

 

We've also found that considering other types of ESG factors can help investors identify companies that are more likely to see stronger performance, again on fundamental metrics, like return on equity and earnings volatility. [Source: “ESG from A to Z: A Global Primer,” BofA Global Research, November 25, 2019.] So, again, when it comes to sustainable investing, we think there's very compelling evidence that you can do good and do well.

 

Jackie VanderBrug:

So, I'd love to unpack that evidence just a little bit more, because at times it can be confusing. Can you give us a few examples of the actions that companies are taking, which would directly translate to this better financial performance you're talking about?

 

Marisa Sullivan:

Sure, and just maybe to start with some examples when it comes to environmental factors. This could mean include looking at whether a company has environmental practices that will prevent it from getting into costly, legal trouble that can come from, you know, as we've seen with oil spills or other types of costly litigation.

 

It could also mean how a company is managing its climate related risks. And this isn't just the risks that might come from disruption to its operations from, you know, extreme weather events that are arising more frequently. But it's also how companies are managing the risks stemming from a transition to a low carbon economy. Are they positioning their businesses, their operations to seize new opportunities, you know, for growth that might come from emerging technologies and this transition? Or could they face serious challenges to their business model from policy changes or a transition to a low carbon world?

 

When it comes to social factors, this could include whether companies have programs and benefits to attract and retain talent and thereby avoid costly turnover. It could mean do they have a culture that fosters engagement and innovation that can really drive new products and services?

 

Does it have policies to keep its workforce safe and prevent disruptions, for example, like we saw last year with the pandemic? What does it have in place to ensure workforce productivity? Does it have systems and programs to make sure that their products are safe and quality to avoid costly recalls? So, there's a lot of different factors that this can encompass where environmental, social and governance factors can really impact the bottom line.

 

Jackie VanderBrug:

Joe, you've also been writing about the momentum behind what's being called “stakeholder capitalism.” While some might see this as an abandonment of shareholders, we really see it differently. Tell us a little bit about the role that it's playing in what we're discussing.

 

Joe Quinlan:

Well, Jackie, we're not abandoning shareholder capitalism and profits of companies because that's what they do. And that's not going to change anytime soon. But stakeholder capitalism is about everything Marisa was just talking about: being good stewards to the environment, working with your labor force, working with their customers, households.

 

This is the future. And it's going to be more, I think, intertwined—the goals of the community, of the consumers, of the workers and the companies. And then you overlay government regulation, and the more insight that's -- or oversight that's coming from the government. So everyone I think is aligned to help drive more stakeholder capitalism. And I think people, investors are gonna be surprised because you're gonna have more earnings, better quality of life, happier consumers, and much workers that are much more productive and earning higher wages.

 

Jackie VanderBrug:

Marisa, we also know that sustainable investments and companies with strong ESG records were much more resilient during the deep market downturn in early 2020. Talk about what you discovered during that period; for example, what did you see in terms of investment flows?

 

Marisa Sullivan:

It's a great question, because one of the critiques that we would sometimes get was that sustainable investing or ESG was really just a bull market luxury. And that, you know, when times are good, you can think about these types of issues. But when times get tough in periods of market turmoil, investors and companies alike would abandon ESG in favor of more traditional financial metrics.

 

[GRAPHIC]

During the 2020 Bear Market

·         Inflows into sustainable investments continued at a record pace

 

Source: “Bull market phenomenon? Quite the contrary,” BofA Global Research, 3/25/2020

And what we actually saw in 2020, during the bear market was quite the opposite. So, not only did we see that inflows into sustainable investments continued at a record pace, and it happened against a backdrop where we saw investors, you know, really reducing their equity exposure. [Source: “ESG Matters: Bull market phenomenon? Quite the contrary,” BofA Global Research, March 25, 2020.]

 

So, it was a signal to us that sustainable investors were stickier investors and that they really weren't, you know, going anywhere as the market turned.

 

[GRAPHIC]

During the 2020 Bear Market

·         Inflows into sustainable investments continued at a record pace

·         Companies with better ESG scores saw smaller cuts to earnings

Source: “Bull market phenomenon? Quite the contrary,” BofA Global Research, 3/25/2020

The other thing that we saw and what was really interesting at that time was that companies that had better ESG scores actually saw smaller cuts to their earnings. [Source: “ESG Matters: Bull market phenomenon? Quite the contrary,” BofA Global Research, March 25, 2020.]

 

So again, that to us was evidence that incorporating ESG considerations can help you identify companies that might be more resilient to market fluctuations and during times of turmoil. And we've seen more recently that considering ESG characteristics can also be additive under different styles of market leadership.

 

Jackie VanderBrug:

Those are really interesting insights, Marisa and I think it let’s us turn from what we saw in the past, what we're seeing now, to some of the future -- what we're seeing in terms of changes in Washington and how that might play a role.

 

So, Joe, the new Administration has made areas like social equality, climate change and renewable infrastructure a big part of the agenda for this year and beyond. What could that mean for potential investment opportunities?

 

Joe Quinlan:

Well, Jackie, there's plenty of investment opportunities coming out of our infrastructure. And by the way, the American Society of Civil Engineers just came out with a report card; they issue it every four years on our infrastructure. And the grade was better than before, but it's still a C- minus. A C-minus when you grade -- look at our levies, dams, bridges and roads. So, we have under-invested for quite some time in this country.

 

And the Biden administration is bent on overcoming that challenge because an infrastructure -- with an infrastructure we have today, it does not create productivity. It's a drag on growth. It raises costs. And keep in mind that when we compete with China right now, what we're looking for, we're really looking at innovation and infrastructure. And this is where the administration looks to compete. And whoever has the most productive, efficient infrastructure, heading deeper into this decade is going to have the most productive economy.

 

[GRAPHIC]

Opportunities in Infrastructure

·         Renewable energy

·         Electric vehicles

·         Batteries & storage

·         Commodities

 

So, the infrastructure focus, think renewable energies, electrical vehicles, batteries, storage, on down the line, commodities as well because the green revolution, it requires a lot of commodities as we've transitioned to the other side. So, there's going to be plenty of opportunities in the next couple of years for folks to put a lot of money to work and very strong long-term investment opportunities.

 

Jackie VanderBrug:

And Marisa, let's continue this theme. What could these type of large scale policy initiatives mean for different sectors of the economy, like industrials and energy?

 

Marisa Sullivan:

Yeah, I think it's pretty clear that a transition to a green economy will be front and center in any infrastructure bill, whether that's investments in public transit, electric vehicle charging stations, upgrading the electricity grid, you know, making buildings more energy efficient, and doing climate related research and development.

 

So, we think this green infrastructure spending will be a net positive for the economy over the long term; and that beneficiaries could include some cyclical sectors, like industrials and materials.

 

Now on the flip side, companies in the more traditional commodities-driven sectors, like energy, they could face long-term headwinds unless you see a pivot from brown to green. And as our energy team often points out, energy companies do have an important role to play in an energy transition. And many are doing more around reducing their carbon intensity and promoting carbon capture technologies and storage and managing methane emissions.

 

So, we are seeing more investors not count the energy sector out per se, but think about, you know, whether there are investment opportunities within energy; kind of an ESG improvement story. Or where a company or an industry that's really going to be a critical to pivoting to greener technologies. And we think that this could be another area that creates opportunity for sustainable investments in the energy sector.

 

One other thing I did want to mention in the discussions around infrastructure; you are seeing a strong equality focus within many of the proposals. And we think that's important because as our economists have written, there's significant costs to inequality from a GDP standpoint. And so when it comes to closing some of these racial and gender gaps, we think there could be huge gains to be made in terms of the boost to GDP, and that could benefit companies and sectors broadly. [Source: “Everybody Counts! Diversity & Inclusion Primer,” BofA Global Research, March 2, 2021.]

 

Jackie VanderBrug:

So Joe, if we take this growing focus on sustainability and realize that it's not unique to the U.S., I'm curious, what kind of interest and changes you're seeing in other areas of the world?

 

Joe Quinlan:

 

Well, Jackie, it's certainly not unique to Europe as well. The European Union has been out in front actually for the last couple of years, talking about climate change and how you go about dealing with it, moving into the next renewable frontier. So, when you look at the European Union's Economic Recovery Fund, there's actually metrics designed to increase climate change initiatives. So, they really focus on it. Their renewables, I would say, powerhouse in the making, whether -- it's across the board, whether it's solar, wind, biomass, circular economy, you name it. Europe is a leader and they’ve been out in front.

 

Also in Asia, Japan, South Korea, even China, folks are realizing—regulators, policy makers— they’re realizing that their quality of life revolves around the climate. So, there's a huge focus globally as the emerging middle class comes forward, demand safer food, cleaner air, that governments have to respond and they are responding. So, this is a global initiative. It's not just

U.S. focus, it's global in nature.

 

Jackie VanderBrug:

So, this is great information. I want to shift to explore how we can put all these ideas into action. Joe, let's talk about how someone interested in sustainable investing might get started, because investors bring different motivations to sustainable investing; including avoiding harmful practices, potentially mitigating sources of volatility, or contributing to measurable social or environmental outcomes. How do you think about it? Is this an all or nothing approach that they need to take?

 

Joe Quinlan:

Well, I think of it the way Marisa just laid out, in terms of looking across various asset classes. Whether it's small cap, large cap, U.S., non-U.S., green bonds; it's really across the board, Jackie. And I think investors have to get comfortable, you know, remember that transition, right. I mean, as Marisa said, energy companies -- they're going to be a big part of the movement towards the Green Revolution. So, they’re still in play.

 

So, I really think you've got to really look across all asset classes, look at various styles and put the money to work slowly but surely, in the leaders or -- and also the disruptive technologies, right? Disruptive technologies, they're going to help us get to the other side as well. So, there are going to be a little bit, you know, growthier, a little bit more risk, but we want those considerations in the portfolios.

 

Jackie VanderBrug:

And Marisa you mentioned those that are seeing some momentum in terms of ESG. It feels like we're entering this period of greater transparency, where more companies are taking steps to be more open and more candid about their progress on ESG.

 

For instance, some companies are adopting a new set of Stakeholder Capitalism Metrics developed by the International Business Council and four major accounting firms focused on four key pillars: People, Planet, Prosperity and Governance. It's a great example of how companies are disclosing progress they're making in addressing important social priorities.

Can you talk about other promising signs? What are you seeing?

 

Marisa Sullivan:

 

Yeah, so I think there's no question, we're seeing a significant increase in corporate engagement and disclosure when it comes to sustainability and ESG efforts. So, companies are increasingly implementing ESG or sustainability programs, and importantly, they're measuring them and they're reporting them on an increasing basis.

[LOWER 3RD]

 

And thanks to all of you for joining us. We've covered a lot of ground today. Here are three points that I hope you'll take away from our discussion.

[GRAPHIC]

Key Points on Sustainable Investing:

1.       Is continuing to build momentum 2. There are no “tradeoffs” involved

3. Can be done according to your timeframe and goals

 

The first is that sustainable investing is continuing to build momentum as more investors become aware of the benefits that it can offer. Second, there’s no trade-offs. You can seek competitive financial returns, while making a positive impact with your investments. And third and finally, this is not an all or nothing approach. You can do it in a way, in a timeframe that's most appropriate for your goals and situation.

 

And if you're working with a financial advisor, please reach out to him or her with any questions you might have about the ideas that we discussed.

 

Thanks again for joining us and being part of this conversation.

 

 

 

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