Episode 06: Responsible Investing – Industry Trends and Best Practices from Canada

TRANSCRIPT:

Dustyn Lanz: Responsible investing is not brand-new, but I think what’s happened over the past few years is that the business case has gotten so strong that perhaps some holdouts just started moving forward. In a recent survey, Canadian investors reported the top five reasons for considering ESG factors were, one, to improve risk management, to improve returns over time, so if you’re improving risk management, you’re likely going to see better returns over the long run, and there’s a growing number of studies, including industry and academic studies showing that responsible investments tend to perform just as well, if not better than traditional investments.

Michael Torrance: Welcome to “Sustainability Leaders.” I’m Michael Torrance, Chief Sustainability Officer with BMO Financial Group. On this show, we will talk with leading sustainability practitioners from the corporate, investor, academic and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment, business practices and our world.

Legal Disclaimer: The views expressed here are those of the participants and not those of Bank of Montreal, its affiliates or subsidiaries.

Manju Seal: Today, we are focusing on the growing significance of responsible investment and specifically, what is the state of its landscape in Canada. We have two expert guests on the show. We’ll talk with Alison Schneider, the director of responsible investing for AIMCo, or Alberta Investment Management Company, based in Edmonton. AIMCo is a Crown corporation that is responsible for the investments of 31 pension, endowment and government funds in Alberta. It manages over $110 billion. We’ll also talk with Dustyn Lanz, CEO of the Responsible Investment Association in Canada. So what is responsible investing? Here’s Dustyn, who sat down with Michael Torrance in early June.

Michael Torrance: So for listeners who aren’t familiar, can you tell us about the Responsible Investment Association, what it does and who its members are?

Dustyn Lanz: Sure. Yeah, so we’re Canada’s industry association for responsible investment. We’re a membership-based organization with more than 100 institutional members and a few hundred individuals who practice and support responsible investing. We’re composed of asset managers, owners, advisors and service providers who support our mandate of driving the adoption of responsible investment in Canada’s retail and institutional markets. Our membership has doubled over the past 4 years, as more and more investors are adopting responsible investment strategies.

Michael Torrance: Responsible investment, when I get asked what it is, sometimes it’s hard to define in an easy way. How would you define what responsible investment means?

Dustyn Lanz: So I’m glad you asked this question because just like investing, there is no one-size-fits-all when it comes to responsible investing. In general, responsible investment refers to investments that incorporate environmental, social and corporate governance factors. Generally speaking, there are five prominent responsible investment strategies or approaches. The first, which would be most intuitive, I think, for our listeners, would be screening. So you can exclude investments that you may have a moral objection to, or you can use positive screening to screen in investments that you feel are, say, leaders within their sector, so that’s the sort of … the traditional approach is screening, but what I want to make very clear for our listeners is that, that’s not the only approach. There are numerous other approaches to responsible investing that do not involve exclusions. For example, shareholder engagement refers to the use of shareholder power to influence corporate behavior on sustainability practices. For example, an investor can engage with management to ask for, say, more women on boards of directors, or they could engage with, say, a fossil fuel producer to improve their environmental footprint, so this is one powerful approach to responsible investing that can have a big impact on corporate sustainability performance. Another prominent approach to responsible investing is known ESG integration, so this refers to the systematic inclusion of environmental, social and governance factors into financial analysis. So let’s say you’re looking at a company, and they’re having, say, some human rights issues in their supply chain. As a financial analyst, you might flag that in your, say, your discounted cash flow model as a potential risk that could impact the profitability of this company following, say, you know, negative headlines. So this is an example of ESG integration, and this is the most prominent strategy in Canada. In addition, there are a few other strategies that are more nascent but growing rapidly. Thematic ESG investing, so this refers to investing in specific sustainability themes like clean technology or women in leadership or water. You can choose to invest in funds that focus specifically on these sustainability themes if you want to have an exposure to them. Impact investing is another big one. So this refers to investments that are specifically intended to solve social or environmental challenges in addition to having a financial return.

Manju Seal: I talked with Alison about AIMCo’s approach to responsible investing and strategies employed and how they think about their mission values.

Alison Schneider: So AIMCo’s approach to responsible investment is definitely one of ESG integration, but it is also supplemented with a couple of features that you mentioned, so we do have, as I mentioned, an exclusions policy, so the exclusions policy, for example, for tobacco, we do not invest in tobacco. We had to … It’s very difficult to implement an exclusion. There has to be a line in the sand. For us, the line in the sand is if the company produces 10 percent or more of its revenues come from the production and manufacture of tobacco, then it qualifies for our tobacco exclusion. Weapons of mass destruction are in there as well. Weapons of mass destruction, we’ve expanded that exclusion so that there’s systems integration, for example, so the computer system that enables that weapons of mass destruction company to actually, you know, operate, that would be included as well, so there’s … It’s difficult to implement exclusions. There has to be clear parameters around that, so we do have exclusions. Our exclusions on … Of course there are exclusions that everybody has to abide by because it’s the law. Whether it’s United Nations Act, whether it’s SEMA, the Special Economic Measures Act, there’s certain companies where Canadian institutional investors are prevented from investing in those companies because there’s certain people on the board which our Canadian government has said we can’t invest in those companies, so we’re obviously compliant with that, but overall, I would say that we don’t want to focus on reducing the investable universe. Our philosophy is voice over exit. We prefer to engage with a company and advocate for positive change rather than divest of that company and unnecessarily reduce the investable universe.

Manju Seal: Absolutely, and I think one of the styles of investing that we … in the previous list that I just went over was also the proxy voting, which I think is a combination of that and ESG integration is often seen for larger institutional investors, that’s what they practice.

Alison Schneider: Right. For proxy voting, you know, I think what’s really important with proxy voting is we get to exercise shareholder voice, and we’re really proud of our proxy voting processes, so we do not disclose how we’re going to vote in advance of a vote. According to Alberta Securities Law, we can’t be doing that because we can’t be influencing shareholders in advance. Other provinces don’t have that restriction, but we do. Once the vote is passed, we do disclose not just how we voted but also the rationale supporting that vote, and we are very proud of our proxy voting processes. We subscribe to both Glass Lewis and ISS. We’re the only institutional investor in Canada that I know of that does subscribe to more than one body of proxy research, so we really do a deep dive before we actually decide to vote.

Manju Seal: And that’s terrific. AIMCo’s vision statement, which says that enriching the lives of Albertans by building prosperity, security and opportunity across generations. When we think about responsible investing and you as an asset owner or AIMCo as an asset owner, how does long-termism actually inform, you know, in your day-to-day or in your style of managing the portfolio?

Alison Schneider: Again, I think it goes back to we are investor fiduciaries, and so it’s our duty to make sure that we are investing for generations to come. We are investing on behalf of all Albertans, so that … We need to have, of course, some liquidity considerations, which are basically from our clients’ SIP&Gs so that they can pay their beneficiaries, but overall, our focus is definitely on the long-term, and certain asset classes, for example real estate, infrastructure, you know, tend to be much longer. We hold those assets much longer.

Manju Seal: Welcome back to AIMCo’s style of approaching responsible investing with Alison, a seasoned practitioner from Alberta. Here, we ask Dustyn about the trends that we are seeing in the space today, including the key reasons for the area’s growth.

Dustyn Lanz: Canada has reached a tipping point in the last year. The latest data shows that there are now $2.1 trillion in assets in the Canadian market that are managed in alignment with one of those strategies that I mentioned earlier, so that’s up 41.6 percent or up from 1.5 billion just 2 years ago, and for context, responsible investing now represents just over half of all professionally managed assets in the Canadian market, so to say that responsible investing is growing rapidly would be an understatement. The market has doubled in size over the last 4 years, and so within that growth, we’re seeing the most prominent strategies would be, as I mentioned, ESG integration, so the systematic inclusion of ESG factors into financial valuation, as well as shareholder engagement, and there’s also a search for impact across asset classes, so as more foundations and mission-driven investors are looking for impact investments, that’s leading to questions like, “What does impact investing look like in public equities?” We’ve seen a rapid growth of impact investing in public equities, but questions remain about exactly what that looks like and how you measure impact in public markets, but these are some trends, definitely, to watch.

Michael Torrance: And so what role are institutional investors playing in this space?

Dustyn Lanz: So institutional investors have been playing a leading role. They’ve been actually some of the key change agents trying to get government to catch up in many ways. Investors recognize that an energy transition is coming. The market is moving that direction, so they want to make sure that it’s a smooth transition. They don’t want an abrupt change of asset pricing, so that means they want a clear policy framework. They want pricing of carbon or other externalities to facilitate a smooth transition and avoid basically a rapid correction that could destabilize the financial system, so institutional investors have been playing sort of a leadership role here, and I think that’s part of their role as stewards as large pools of assets, and as part of, I think, a modern interpretation of fiduciary obligations, the idea that, you know, you need to consider all material factors that could impact your investments, and so some of the leading investors are recognizing that climate change is certainly … has material implications for assets, so we’re seeing a lot of leadership from institutional investors.

Michael Torrance: So, I mean, there’s obviously a lot of good reasons for this kind of approach to be adopted, but it’s not, you know, exclusively the approach of investors as we know. What kind of barriers to adoption of a responsible investment strategy would there be in your view?

Dustyn Lanz: I think the biggest barrier is a lack of awareness among two stakeholder groups: the investing public, number one, and then investment advisors and other intermediaries who serve investors. You know, people who don’t work in finance, which is most Canadians, typically rely on financial professionals for knowledge and advice about investments, and so the lack of financial literacy among the investing public means that many Canadians may not feel equipped to talk to their advisors or the consultants about responsible investing, especially if the advisor doesn’t know about it either, in which case it might be an intimidating conversation for the client to have, which really doesn’t serve anyone in that exchange, so I think that public awareness is an issue, and then I think a lack of awareness among advisors and consultants is also a barrier to the adoption of responsible investing, which is why we would advocate for, you know, going back to the expert panels report. One of the recommendations from that report was to create more opportunities for investors to invest in climate objectives, and so on that note, I would argue that if a client is interested in sustainability, and if the advisor or the consultant doesn’t know that, then I would argue that the advisor doesn’t know their client well enough to make suitable investment advice.

Manju Seal: For institutional investors like AIMCo, responsible investing can be spread across a wide variety of asset classes. How do you integrate responsible investing at AIMCo? Would you like to comment and share what are some of the asset classes you’re looking at and what are some of the ESG focus areas you have, and overall, how does your responsible investing process come together?

Alison Schneider: Right, okay. Yeah, so basically we started out … It’s been an evolution. We started out really more hanging our hat in the public equities space with, of course, proxy voting and engaging with companies in our key ESG focus areas. From there, though, it expanded across asset classes, so one of the things that we’re really proud of is that we’re cofounder of GRESB infrastructure, which is a sustainability benchmarking tool for infrastructure investments, so we’ve actually had impact globally in that way.

Manju Seal: Would you like to spell out what GRESB is for our listeners who may not know?

Alison Schneider: Sure. Well, GRESB is actually just GRESB, G-R-E-S-B. Originally it was an acronym for Global Real Estate Sustainability Benchmark, so they started doing benchmarking, sustainability benchmarking for real estate investments. I had the privilege of chairing a investor working group, Global Infrastructure Sustainability Council. We were trying to come up with an infrastructure sustainability benchmarking tool. We approached GRESB. They took it over. We did the MLU in 2015, and we’ve been members on the real estate and the infrastructure side ever since, so, you know, it is quite embedded, but we do have sustainability guidelines, as I mentioned earlier, across all asset classes. For private equity, I would say we get more involved in the due diligence side of things. With real estate as well, although of course, we have a sustainability dashboard. We collect all of the information in terms of … mostly environmental information in terms of energy performance per square foot, water usage per square foot, so we track that. AIMCo tracks that. For infrastructure, we also … As I mentioned, we have the GRESB survey. Infrastructure does their own, so my team doesn’t necessarily do the ESG due diligence for infrastructure. They will hire out service providers simply because we’re talking about very, very large investments, so it’s a much deeper dive.

Manju Seal: Mm-hmm. I think this is great, what you shared with us, Alison, because often, folks who are not in the nitty-gritty of actually making responsible investments hear a lot of about the importance and the rise of importance of ESG factors that are integrated in the process, and it sounds very simplistic, you know, environmental, social governance factors, and some of these ESG analysis was incorporated historically, for example, in the credit analysis, you know, when you looked at management or so on and the quality of the management, and that now is obviously under the world of governance factors. So having said that, we also know that there is about 85 percent of the S&P 500 companies today release sustainability reports. So one could argue that there is a lot of data out there that can be utilized by practitioners such as yourselves and your team to really make very thoughtful and find a distinguished voice in terms of how to select good quality investments and make decisions around it. What are some challenges you’re finding in all of this?

Alison Schneider: That’s a great question, Manju. Basically, the reporting landscape is getting noisier and more cluttered, and it is becoming more difficult to navigate. Quite frankly, as an investor, we’re used to data that is financial data that has been verified internally and externally and that sits in the financial statements and is easy to roll up and compare. The problem with a lot of the sustainability reporting data is, even though the landscape is becoming more cluttered and there’s … Investors are encouraging disclosure, which is great. However, it’s not easy to compare across asset classes. The data, for example, for carbon footprinting is often not internally verified or externally verified, and very seldom do you see suitability data actually reported in the financial statements. We think this is going to change as the reporting landscape becomes more cluttered. Once the regulators start to issue guidance or even if the industry associations start to issue guidance, we think that there will be more consistency, and that certainly would be helpful.

Manju Seal: So one of the other questions or discussion that would be great to have is around, you know, the rise of the importance of TCFD in our … in the world of investing, right, and this whole movement that is going towards, you know, looking at climate risk in our portfolios. Would love to get your views for our listeners on how AIMCo is supporting TCFD, what does TCFD very … stands for, and also how are you assessing the climate change readiness for some of the investments that you all are making?

Alison Schneider: Great question, Manju. So AIMCo has come out in support of TCFD, and we’re also a member of the investor … of the G7 Investor Leadership Network, which has three streams. One is women in finance. One is sustainable infrastructure, and one is on climate-related disclosure, and I sit on the Climate Change Action Committee, which is tasked with issuing guidance … TCFD reporting guidance for other investors. Of course, this is somewhat similar to trying to come up with a recipe for a cake, and baking the cake, and eating the cake all at the same time, so it’s going to obviously be an iterative process because of the underlying issue of the access to data and the quality of the data, and one issue with TCFD is that it’s really focused on scenario analysis, and it’s more future-focused, so carbon footprinting can be historical, but the TCFD is asking companies to … and investors, frankly, to report on their governance of climate change, their strategy … forward-looking strategy for climate change, their risk approach to climate change, including scenario analysis over time and also metrics and targets to address climate change, so this is not very easy. There’s not a lot of specificity. It’s not industry, sector, you know, specific, and so we are all trying to get ahead of this. However, it’s complex. Methodologies need to be informed by philosophical approaches, so as an investor, for example, we have to ask ourselves, you know, first the question for our own carbon footprinting, we have to ask ourselves, are we looking only at public equities for an owned emissions approach? Are we looking at public equities and fixed income? Are we looking across all asset classes? And how do we do this effectively? So if you’re looking at a financed emissions approach, of course, then you are looking at debt plus equity plus all the other asset classes. There’s the question of shorts. Do you include shorts or not? You know, from a financing perspective, there’s certainly, you know, supporting philosophy to say that that’s a valid strategy. It’s a hedging strategy. For derivative exposure, it’s a little less … It’s a bit more difficult. If you have a look-through, of course, you can capture it, but if you don’t, that has to come off a denominator, so even on a best efforts basis, my point is, it’s almost impossible to capture the carbon footprint across all assets under management. It has to be informed by methodology … by philosophy and then the methodology that you’re using. There’s many other components, proxy methodology for example, for nondisclosed data. There’s various different types of proxy methodology, but the ultimate issue goes back to what is the quality of the underlying data. Can you trust it? Do we, as investors, just need to become more comfortable with murky data that is unverified, that is future-focused, that is the company’s best stab-in-the-dark of where they’re actually going on climate resiliency. So these are questions that are difficult. We have to wait to see how the reporting landscape shakes out. I do think there’s a regulatory gap, and there’s an opportunity for regulators and, quite frankly, industry associations even, to issue more specific climate-related reporting guidance.

Manju Seal: One of the other things that comes up around, you know, the ESG strategies is about the governance aspect that you just mentioned, and we know that equity investors can address issues, vote on opinions and decide to stay engaged or divest from a stock, but debt investors obviously don’t have that option, so, you know, what are the similarities and differences you see between the asset classes when you work in this area and when you’re looking at how responsible investing has to be put into practice? Do you see ever any collaboration between asset classes in your … on your responsible investing team?

Alison Schneider: Great. Great question. Yeah, so basically as debt holders, the leverage is obviously different. Having said that, the landscape, the regulatory landscape is changing. So if you think about the Redwater case on January 31 of this year, the Supreme Court of Canada ruled that oil and gas companies that go bankrupt must first pay their environmental liabilities before they pay their debt-holders. Well, that just changed the risk profile of corporate debt for oil and gas companies, right? So it’s obviously earlier in the process … in the investment process where you need to assess ESG risk and see, you know, how is that impacting the balance sheet? At AIMCo, within our fixed income department, we develop our own notional ratings system, which includes consideration of sustainability factors such as the quality of board governance, and that impacts our assessment of the quality of that underlying investment. In terms of my team, my team, the Responsible Investment team, is getting involved even in structure. For example, our mortgages group recently asked us to do … to look at their due diligence questions and do a scrub to make sure that they were asking sufficient ESG questions, and then we actually developed an ESG due diligence questionnaire for them. So that, I would say, is an example of collaboration between departments. You know, similarly, we were invited recently to do a due diligence for a private equity … I’m sorry, a private debt fund, which we were happy to do, so there is definitely more interaction all the time between the asset classes and the different departments.

Manju Seal: I think private equity has often been talked about as one of those asset classes that some of the processes and learnings from that area is very much applicable now to what is being done in responsible investing, right? Would you agree with that?

Alison Schneider: The interesting thing about private equity is that – and you actually see a trend of some public companies going private recently – is that the disclosure is not as prevalent on ESG matters.

Manju Seal: But the due diligence process.

Alison Schneider: Yes, is deep, and so it actually speaks to the value that an ESG due diligence can actually provide. What we do when we’re doing an ESG due diligence for private equity, is we’ll pull publicly traded comparables so we know what we should be looking for, what we would expect, and where there is missing data or where we can’t fit all the pieces together, then we can basically frame those questions back to the fund or the asset and ask them what they’re doing on those particular areas, or we can, you know, proxy what we think is going on, but with private equity, there’s not as many holdings, so it’s easier to actually interact with the company, and the portfolio managers have that type of relationship, so they can go back and ask to fill the missing pieces, and it’s good for the companies to know that investors are concerned about their ESG performance. I think by knowing that this is something that we’re concerned about by putting it on their radar, it becomes more important to them, and it actually does help facilitate change.

Manju Seal: How much of your $110 billion portfolio is dedicated to pure SRIs or pure responsible investing strategies? Would you say that it’s integrated across the entire portfolio?

Alison Schneider: It’s integrated across the entire portfolio. We don’t have any particular portfolio that is dedicated to responsible investment only. In fact, I think our philosophy is that it should be integrated across all assets under management. Now, there are some institutional investors who will say that they have a portfolio that is, you know, their showcase portfolio for responsible investment. That’s great, you know? Kudos to them. We don’t look at it that way. That doesn’t mean that we’re not invested in the exact same companies, but – or a very similar mix of companies – but we just see … We see that the business case is embedded, and so for us, it wouldn’t make sense not to integrate it across all assets under management.

Manju Seal: So you just heard the importance of TCFD in AIMCo’s responsible investing practice, as well as the various aspects of due diligence in responsible investing. Thanks to Alison for sharing her viewpoints as a practitioner and Dustyn as a key market participant giving us the industry overview. Hope you enjoyed the valuable insights. Until next time, I’m Manju Seal.

Michael Torrance: Thanks for listening to “Sustainability Leaders.” This podcast is presented by BMO Financial Group. To access all the resources we discussed in today’s episode and to see our other podcasts, visit us at bmo.com/sustainability leaders. You can listen and subscribe free to our show on Apple Podcasts or your favorite podcast provider, and we’ll greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO’s marketing team and Puddle Creative. Until next time, I’m Michael Torrance. Have a great week.

Legal Disclaimer: The views expressed here are those of the participants and not those of Bank of Montreal, its affiliates or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, strategy or security. This presentation may contain forward-looking statements. Investors are cautioned not to place undue reliance on such statements, as actual results could vary. This presentation is for general information purposes only and does not constitute investment, legal or tax advice and is not intended as an endorsement of any specific investment product or service. Individual investors should consult with an investment, tax and/or legal professional about their personal situation. Past performance is not indicative of future results.