ESG Investing

In a sense, I think of ESG really as externality captured at the company level. I also believe ESG has an unstructured data problem from the perspective of a public money manager. From a company perspective, the climate risks are so distributed across the system it's historically been very hard for one specific company to have incentives to address a lot of these issues. But what's really happened over the last decade is that technology has created an environment where anything can be measured, and social media has created a level of transparency that was unimaginable until more recently. And it makes it increasingly pertinent that companies really have to look at these risks, as it's dangerous increasingly to not do so. In terms of outlook, I would say a few big buckets. It seems like every country or jurisdiction is going about their own sustainability regulation. As a result, I think ESG is going to become very regionalized over time.

I suspect that the ESG integration category or concept is going to fall by the wayside as we have more guardrails around what is an ESG fund or an impact fund or a climate fund, specifically. I also believe carbon accounting will become very, very important over the next five years in a way that was unimaginable previously. And I also think sustainability data over time will become very similar to financial data and released in a similar frequency. I think there are going to be a lot of variations in this space, and climate, for example, on its own is going to be a massive topic that specific funds will be on the market to address. So I know I covered quite a few things, but I think just in a nutshell, I think it's going to be a space that has a lot of innovation and looks markedly different when you look 5, 10 years on than it does today.
EMS:Yeah, Ima, absolutely. So I wanted to ask you to take a deeper dive into ESG, and what are some of the greatest opportunities you see and why?
IE:Yeah, it's kind of similar to some of the topics I just touched on. I think the unstructured data challenge within ESG was really underappreciated until very recently. The core ideas of a lot of this stuff aren't new, but the methods are increasingly regulated and actually does leave room for innovation within the asset management industry in a way you can't find in many other areas of finance. I think carbon accounting will become very important as people start trying to allocate emissions to specific entities and specific companies. Again, the methods are new, they're not straightforward, there's a lot to address, but I think there's going to be quite a bit of stakeholder pressure to get this done in a pretty speedy fashion. I also believe the impact and outcomes category will eventually grow to be a pretty large space as people look for impact strategies that have their values kind of baked into those things and have some kind of real world impact.

And then the last thing I would say is there's going to be a greater focus on adaptation. I don't think we're taking adaptation to a lot of these climate risks serious enough. But the conversations are starting to change. And I think as the trends continue to change, the conversations will continue to change. And you see that with something like water, which as a theme is going to become more and more important. And we're going to have to address some of the demand side issues of the equation, because a lot of ESG today tends to really look at the supply side of things and not really the demand side of things. And I think that's going to change as more people, more sophisticated eyes come into the space.
EMS:Oh, absolutely, Ima. So I wanted to shift gears a little bit and ask you what are some of the greatest challenges you face in this space and why?
IE:Again, although the ideas aren't new in the space, the packaging under the ESG umbrella term is relatively new for most people. It remains unfamiliar in the mainstream on the whole. That's changing over the last six months as it becomes more politicized. It also confuses investors. It's unregulated, underrated inside. And I think just generally, people continue to talk past each other. If I were to put it into three bullet points, some folks view ESG as a distraction and don't believe a lot of commitments are going to be met.

Some folks don't believe it's measurable and the aggregate scores have little meaning. And others believe that there's no relationship to financial performance. I think the most interesting thing about all this though is that despite all these challenges, companies seem to be spending more, not less time and resources to a lot of these ESG endeavors. And so I think no matter your viewpoint, ESG considerations are becoming more, not less important in companies' decision makings as the real world impacts continue to escalate.

And then I think the last thing I would say is the quality of ESG data and understanding the size of the market has been pretty difficult. The quality of data makes it very hard to structure these products across different asset classes or even within equities. It's a very different ballgame between large cap versus small or mid-cap just because of the data quality. It's the first inning, really, is kind of how I look at it on a lot of these ESG trends. And as more and more participants get into the space, as more clients demand products that have some of these traits, I would expect a lot of innovation in this space going forward.
EMS:Very exciting, everything that's going on. So Ima, I wanted to ask you more specifically, how does Franklin Mutual Advisors integrate it both at the macro level and via the fund level?
IE:Yeah, I think I'll talk about this more from how do funds just generally should think about more integration. A lot of ESG fund selection today is based on a concept called single materiality. And the idea behind that is that the impact of a changing world on a company's profit and losses are most important, not the reverse. And I think that concept is really at the heart of a lot of the miscommunication with ESG, is not really understanding that single or double materiality lens. I think over time what's going to happen as well is the sustainability preferences of clients will become more important, just given how bottoms up ESG has been from a driver's perspective. I think knowing the preferences of our clients will allow us to deliver solutions via SMAs that match preferences to a better degree than they do today. And I look at integration really at the fund level as a very systemic thing.

So I think it affects strategy, it affects capital allocation, and over time, companies will be able to provide better data around this that allows us at the fund level to get a fuller picture of companies' activities and be able to structure better products that our clients are actually looking for. But ultimately, I don't think there's a right way to really integrate ESG, is kind of what I'll say. I think what people are going to learn as they try to put out these strategies is that whatever asset class specific strategy you're running within that determines how you go about ESG and what aspects of it you decide to focus on. So again, I think just trying to integrate will lead to innovation that's tied to your core investment strategy.
EMS:Ima, we've covered a tremendous amount of ground today and I wanted to see if you have any final thoughts you would like to share with us.
IE:Yeah, I guess the last thing I'll say is that as ESG becomes talked about a lot, politicized, et cetera, that's normal. I think a lot of these concepts are new to the financial markets. There's going to be pushes and pulls as people figure out what this means for them and their strategy. But at the end of the day, I think ESG funds are simply products. They don't replace public regulation or private externalities. It's actually dependent on regulation for a lot of stuff to work over time. As a whole, I think we have a steep learning curve ahead with climate investing, with carbon accounting. We're really seeing a different way to analyze investments, and that's bringing in social and environmental externalities to our analysis. It's not a copy and paste or check box exercise. Investors, companies, regulators, even myself, we're all on a learning curve. And I think one thing that really excites me about this space is I feel like I learn new things pretty much every month, whether by force or not, just because it's just changing so much and there's so many things happening.

And one of the jokes I've made to myself is I think ESG is the fastest, slowest space out there because it seems like nothing is happening, but so much is happening simultaneously. But I guess I'll leave it on a personal note. I really look forward to the next generation of investors, whom I believe will have a more natural bias to this style of investing just given their lived experience. So I think it's an exciting space and there's going to be more to come. And thank you so much for having me on your podcast and giving me the opportunity to share my perspective.
EMS:Absolutely. Thank you so much for sharing your perspective with our listeners. And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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