What’s the Deal With ESG ETFs?

knowing what that acronym is. It stands for Environmental, Social and Governance, which is sort of like the three pillars that generally are used as screens to find out which companies are, you know, sort of progressing in the world in terms of how to behave And it's sort of a way to grade companies um on things that aren't just profit right, it's sort of the other side of

the equation besides just making money. And it's become much more popular in recent years and and there there's a lot of speculation that this could be a massive opportunity as an investing thesis going forward. The hype is unbelievable. E s G articles are plant of full, They get a lot of great press. People seem to be into it. I mean, who who wouldn't be into Its really good? Right? Yeah, there's dozens and dozens of E t s being launched every year that are in the E s G themes,

So there's plenty of product. However, the app assets are kind of lacking. They have it looks like six point eight billion, right, so that's not a lot. Okay, that's some Yeah, the Banguard takes that in a week, all right. So there's a little bit of a gap between the hype and assets, which I think is really what we want to explot to day and also practically how you use them. This is one of those topics that I've been picked on Twitter about. People do want us to

do an E s G episode. So here we are, we are and joining us to help us make sense of this is someone that you brought in and you guys are up in Boston today, I'm in New York. Who do you have with you? Here with us are two experts from the E s G field, but in different ways. Graham Sinclair, who I know on Twitter and actually met through a friend a long time ago, who is the at E s G architect, So he's he's

literally that's his whole life. He isn't a consultant to companies about E s G. He'll go over that in a minute. And Matt Bartolini from State Street. He has to take E. S G and make a product out of it and then try to get the products sold. So I think we have, you know, the two sides of the equation in terms of trying to figure out what's going on with S G T S and how to use them. This man, trillians, what's the deal with E? S G, E T S. Matt Graham, thanks for joining

us on the show. Graham, you actually didn't come alone, did you. You brought someone with you who'd you No, We've got a fairly aggressive intern program at Sincoe s same of S and consulting it. I came in with my daughter. Friday's a geogik and daddy days alright, child labor. We have a couple of questions we'd like to ask her. Uh, yeah, that'd be great, and to be clear, not childly, but it's extreme millennial. By the way, what generation would she be? Is she z or is it? Are we beyond that?

With her? Well, I'm pitching it's it's double A. I will say she's the youngest guest we've had on this podcast, and potentially the youngest guest in the studio. I could tell from the looks we were getting from a lot of people talk about a lot of people talk about E s G as the future. So let's actually talk to someone who's rooted in the future. What what does your daddy do? Spinning? Spinning? It's pretty instructed, he's he's um, he's an expert at E s G. Do you like

E s G? You haven't been there yet. It's it's a pretty it's an interesting place to visit. Well, you like clean water, right? And trees? Trees? Can you tell um, Mr Eric, are you watching puffin rock? Right? And do they like to swim in the clean ocean or the ocean? All? Right? I think I think she's on word, Graham. Once you get someone sold on clean ocean and water, you're pretty much halfway there with the s G pitch. It's interesting

she said E s G as a place. Um, you know, I think my kids probably think E T F is a place and I live Daddy lived there. You guys have done the dad episode. You gotta do the kid episode. That okay, So Graham, Matt, let's let's have a better sense of what what you guys do and how you got into this space. Joel, I got into retirement funds Investments out of law school back in South Africa, rolled up through a various shops, ended up at SCI Investments, which explains how I ended up in the U S.

I didn't mean to be. I was abducted by a beautiful, brilliant woman. I am an E. S. G architect, which means I take an investment problem and I integrate environment, social governance factors into solving that problem, into the management systems and the processes, the manufacturing, the marketing. And the other way we come at it is if if there's an issue that we need to develop the investment thesis for the investment case. An example would be how designed

the access to nutrition index? And the other question came from the Gates Foundation Foundation a couple of lines to improve nutrition UH, And the question was how do we make nutrition a serious investment issue? To Wolf Street UH. And that's how we developed the investment case. And Matt, can you talk a little bit about what you do

at State Street? Yeah? Sure, So within State Street and the Spider Et f business and the head of research for for that area and sitting within a broader asset management firm, one of our goals is to solve clients issues and one of those is how to align financial goals to also social goals and that's where E s

G naturally fits in. So how do you be able to provide you know, long term diversified returns, but do it in a way that matches how you feel about you know, your carbon footprint or about gender diversity and you know, that's really what the solutions that we have within our firm we're trying to do. And then it

just comes down to just portfolio construction. And that's a big part of my role is taking all of these different et s, not even just from ourselves, but other actual wars and their neutual funds and different other managed accounts, and what happens when you blend them all together? Do you start to have overcrowding risk and enter into something that you maybe not want it? Just let's just define E s G. I've been on panels where it takes thirty five minutes. Can you guys give me the one

minute definition of E s G dumbed down? Um, and each of you do it that way people can just get their handle around what exactly it is. Gham. The investment case summarizes the forward looking business case for put photo companies. At any point in time, all factors matter to doing business in the twenty one century, all factors, including environment, social, and governance factors. They're on the side

onto corner on something you plug in later. If you are building a business on investing on planet Earth, using humans to move money or do things or buy things, and you rely on the rule of law to make sure stuff ends up what it's meant to end up and you get your money back. This environment, social, governance and every investment decision, the biggest question has to be why hasn't this always been profiles proactively managed about the

investment industry. It's getting better. It's coming from a long way back. There was like five lines what's yeah. I mean, I think it's it's a it's a problem to label it, and I think it's it's really hard because even if you look at the US listed E t F industry, and we look at the funds that are classified as e s G by data providers anyone focused on the US,

there's sort of dispersed amount of returns last year. It's difference between the best performing and worst performing e s G fund So classification is one of these problems that as an asset management firm and someone deeply engaged in E t f s, that's really hard for to do, and I think that's why you do to Eric's point earlier, you don't see that big of asset growth because you needed it's a very personal decision. What is the most E s G fund? Does it not invest in any oil?

Or do is invest in some oil? And I think that's one of the biggest problems of creating a deep rooted classification system. It also feels like it's become hot relatively recently. But that naive perspective is it how much data is actually out there so that we can make informed decisions here? Well, if you check your Google search

as you'll see it, it goes ballistic. Even even on analysis of studies of the impact of environment, social governance factors, the studies themselves from early seventies, almost nothing from nineteen seventy, when Milton Freeman has had this classic business of business as business misunderstanding through the fifteen it's just basically it's a hockey stick. So even studies of studies of what's happening in the investment units universe has ramped up. Absolutely

there's a lot of hubris. There's there's a lot of hype, there's a lot of greenwashing. There's there's situations where companies claim to do things and they don't. I mean, how many of you believe those towels that you hang back in the rack is because the hotel company is trying to be sustainable, you're supposed to hang him back on the rack. You leave them on the floor to get

it a clown one. Let's just think about an E S G approach, right, are you screening out for things or are you going and trying to track companies that are literally making solar panels? What's the method that's really the the best way to do it? So, working with the institutional investor a house, he's making these decisions. It starts with how you view the world, what do you believe? So in Kelpus rebuilt the whole investment process earlier this decade.

They started with what I believes, how do we see the world? What is our That rolls into what is our investment philosophy? And then you work through the various elements of what are your processes? Were the people you're gonna put in place, how you're going to build these portfolios. How are you going to attract the impact and the performance. So E s G is really a systems level issue.

That's why I came to the Monica at s G architect the same way that investment today relies on digital on software to execute and make things happen and inform making it better. So too with the E s G. E s G sits across the investment life cycle. Yeah, and I think there's there's different levels of E s G. Same with smart data. You can have something that's like a factor tilt that invests in every stock in the SP or you can just do high octane the fifty cheapest stocks for a value screen. E s G is

somewhat similar. You can do something where you just divest from energy companies that have proven fossil fuel reserves, or you can take the m s C I ACQUI optimize it to have the lowest carbon footprint for a level of tracking error. And there's sort of those two spectrums of purity versus something that will give you a benchmark like return, but in a more E s G framework. I'd like to just jump on Eric please if we could,

on your awesome podcasts. Could we walk away from using language like doing good, soul, feelings, values, personal, This is this is just the way investment will be in future on one planet, using humans, using a rule of law. There's there's no extra earth, there's no extra water, there's no extra clean air. Right, so part of this is and your your fingers curled up every time you watch

these interviews. It takes about three questions and then the talking head is gonna ask the investment specialists, so can this match your values? You know almost here that the change in the chan technical this is architecture. Well this brings up one thing I hear on Twitter a lot when I point out, like when Vanguard launched the s G and it was cheap, I was like, well, now we finally got dirt cheap e s G. Now we now we know whether it was, you know, a cheap

thing or just an E s G issue. And a lot of people replied with it doesn't matter what the cost is. It's too subjective. Vanguard thinks you're supposed to screen out alcohol, tobacco, this, that, and the other. Actually only think three of those things are important, those other two are fine, and so subjectivity of what's important to you. I've heard makes people is sort of stop from applying it to investment and maybe do it in their own way,

in their own like personal life. But the idea that your state street going to decide for me what is E s G and what isn't. Yeah, And that's one of the problems that you do run into is that it goes back to that personal decision. So I've had conversations with investors and advisors of all walks of life, and I was talking to one of them and they say, well, we invest in a separately managed account focused on animal welfare,

so companies that have really strong animal welfare programs. That's really hard to package into an e t F because the impetus for an e TF was to offer democratized access to an area, and you want to make that broad and appealing to a pretty wide swath of investors, and something like animal welfare that might not be as applicable to something that is maybe just you know, uh, fossil of your reserves free, something that's broader. And that's one of the adoption challenges within E s G is

that to your point, everyone has a different classification. What it means to me. I don't want to own anyone that ever interacts with oil. That's a that's a harder broad exposure to give someone because there might not be that many people out there for that. Let's just talk about oil for a minute. I always find this to be somewhat hypocritical. I think the term is slacktivism. You know, you tweet something and all of a sudden you're a

good person. Um, you know investing in a say s P y X, which is yours, which is the S and P five hundred x fossil FUELU. So you carve out a lot of oil uh producers in their oil companies Exon and such. But a lot of people still use oil, right, so they are actually not investing in a company they helped make profitable. So isn't the real answer to just get an electric car and then not

invest in it? Because if your goal is to have a portfolio that makes money and you're not willing to not use oil in your day all life, what would be the point of not investing in that company? Yeah, I mean that would be you know, you'd be hedged, right, So you want to make sure that you still have the oil upside beta. But you know, yeah, to your point, like, if you're going to invest in this way, you're likely

going to be living this way. And if you're not there, that's a different of aligning your financial values to your social ones. You know that that just creates an asymmetric profile. And I think to your point about you know, how do you construct these exposures. There's to some extent people that would you want to have no exposure even to the oil refineries because they're still conducting in the business

and supporting the oil industry. And you know, that's why, you know, if you look at firms that are really at the innovative state of renewable energy, you might want to look for those first. And in some instances they actually might be in the traditional energy sector, like a

company like enter Bridge. They definitely run a lot of natural gas pipelines, but they also have a significant amount of wind farms across the United States in North End Canada, so there are This is where it goes to the environmental space where you want to actually look what these firms are doing and how they're actually organizing their business. Because climate change is real in companies interacting in fossil fuell understand that there's gonna be a natural shift towards renewables.

We're definitely going to see that over the next ten twenty years where renewables take a bigger stage in terms of um energy production. And there's also regulation coming down the pike, which changes the whole model for portfolio companies. When regulation changes, then it doesn't become an issue of oh do I have a green investor brown investor. Then it's just I'm a company. I need to work in this environment. I need to upgrade the way I'm working.

And the classic example is a circular economy and McDonald's or Starbucks in the UK following Blue Planet too horrific images. People realize this plastic floating around the world. Now they're going to say McDonald's, Starbucks about all that plastic and those cups that you you put into the trash. It's your problem, now go and solve it. Yeah, and these

disasters definitely can can hurt a company. And you know, let's talk about this this sub brass tax of investing, right, So the biggest E C S G T F no offense MATT is from my shares, It's s U s A, it's the M S C I, E S G it's the only one over a billion, and it it to me it's kind of embodies a typical E. S G fund. It's a little overweight tech and it's a little underweight energy. So in the last twelve months, right those fang stocks, the tech stocks didn't do well, so this was down

one percent more than the market. Talk about how someone might need to stomach under performance to go all the way with this, But obviously if tech does better and energy struggles, you might do a little better. So talk about the both you guys, the performance aspect and selling people on that regard. Yeah, I mean, part of it comes down to just index construction, right, So the ability to be craftsman in creating this exposure to not introduce

any Indian syncratic risks. And you're talking about sector sector weightings. So obviously you know our phosilphy or reserves free spy X. We are naturally underwraight energy. So if the energy sector pops by because of for some catalysts, you will underperform. And having that level of intelligence while entering that product is important so you can understand what that client experience

will be. The same thing was she we knew that we didn't want to just look at the firms with the best gender diversity and then just allocate to those because sector biases can play a huge role into it. So think about the close lower volatility strategies that become just utilities and reads funds. They become very highly correlated to whatever that sector is doing. So you want to really let that stock selection in the index construction drive returns.

And that's what we have with SHE where you have more of a sector controlled bias. So it just comes down to understanding the index construction and being comfortable with the potential return path, knowing that yes, I'm going to be underwraight energy of energy is I'm going to underperform. But my viewpoint is that overall a long time frame when we talk about this shift more renewable energy, that firms that are embracing that renewable capability will lead to

better performance. And you know, I understand that going into and that's that's the big problem, was just knowing what you own. I mean, that's the old Peter Peter Lynch adage and that applies to anything. Yeah, and and something we haven't touched on Eric enjol that you know I really follow trillions, and I really enjoyed what you guys do. That the technology, the method, the vessel, the vehicle that these investment opportunities come through, the same way. We love

Jack Bogle for how you change the industry. That's a great shot you put up recently, Eric about the average cost of managing money through Vanguard or mutual fund business others. Is the availability through e t F. The E t F is the right structure. So what I don't prefer to see is fund manager ABC with you know, wood paneling and high end cappuccino machine talking to me about sustainability and the STU for moments in fact of their portfolio.

But they're still delivering it in a sleeve with a big fat one two up to two and a half percent fee. It's got to be low priced and delivered delivering the Well, here's the follower that question, which is what would E s G be without E t S. I mean, so in mutual fund land, there's actually a sizeable portion of E s G products. There's actually more

assets and more products in within mutual fund structures. However, the direction I travel is more launches within the et F structure, likely or a result of some of the benefits that E t F have relatives mutual funds. All the money is going there, Yeah, that it flows to that. And how many more E E s G E t F s do we expect to enter the market going forward. I think any fund, any strategy, is trying to do that.

And a green Alpha advises the guys who co branded with the Sierra Club, they used to run a mutual fund, they shut it down, was unsuccessful. They've got a new strategy. The twenty nineteen toss list top of list roll out of E t F. I think every strategy and what I enjoy about the low fee structure and the ability to be tactical rolling out product into the E t F space is that it means you can cater for

for nuance and for a variety of opportunity. So it's not just it's each it's E s G or not no, no, no, it's E S G. And it's got a tilt towards focused on how do we focus on people solving for water? It's got a tilt, how do we solve for people solving for dirty year? How do we tilt for diversity, you know, race, gender, and so on. So E t

F gives you that opportunity. There's even a vegan e t F coming out soon which a claims to save seventeen animals per ten tho dollar invested in the e t F. So I do think we're going to get to these levels where they're actually going to post what

you're doing with the purchase. Um. I want to ask just about one of the things about E s G that might be a limiting factor and also penalizes investors, is that it's a really tidy way for investment management companies to make a little bit more money, right because the feast can be high. Uh is that is that gonna stick around? Or will the will that has to

be downward pressure to get the fees down. Well, I mean, I think if you look at the average fee and the anything classified as E s G, I thinks about forty six basis points, which is roughly the average fee

of ETF. So they're kind of on par. I mean, our philosophy is that if you're intending for I know we said we don't want to use these terms earlier, but if you're intending to do good in portfolios and be good actors and try to enrich in the environment or you know, the call for governance that we have that you shouldn't have to pay a ton for it. So we have a pricing philosophy around that. They're very

cost effective. And I think that that's going to be the trend going forward, is that investors are to make this decision. They don't want to be charged fees that are you know, in the eighties and nineties. Well let me just jump in here with this because I know what she's saying. Um, thematic ETFs in particular, I think are really where you see some of that sixty seventy basis points, but most of these are twenty or below point to percent or below. And listen, compared to what's

going on in the mutual fund area. I mean the amount of money taken in these you know, four or three B plans and the loads and the expenses, this is nickel dime. I mean, this is not much fees at all. Plus there's no capital gains distributions. Um. Look, the e t F fishers have to live in a virtual terror dom with where there's no revenue so that investors can have like this paradise portfolio. So in general I find that punching down is E T F S.

Punching up is two mutual funds. I don't find a lot of slickness in terms of E t F E S G E t F fees. I think some of the early ones were fifty, but they've now been competed out Goldman vanguards. They story have come in under twenty. And I think every area has this fee pressure. Some just take a little more longer to catch up than the plane vanilla area. So let me jump on the end there, Eric, So I agree, and E t F is the onset to um acid gathering funny shop right

now and should be going full it. I also want to investment professionals, So remember the basis of your question there is, oh, we cannot consider environmental, social, and governance factors when you make decisions about a company. And if we put it in there, uh no, we're gonna charge

your extra fee. That is that is intellectually bankrupt. Like I will laugh at someone who tries to make that argument to me in a pitch deck or presentation on It's like going to a restaurant and saying, uh, you know you're gonna buy the food, You're gonna pay extra for the fork, the plate and the air conditioning. E s G is an every decision of planet Earth using humans, using a rule of law. And just to the mutual funds the track E s G. We looked at this.

The average fee is about one percent and they have sixty billion, whereas the E t F average fees UM well, if you asset weight at average is more like thirty um, and so you know you're looking at a third of the cost. So, if anything, the e s G E t F would be a smart move for the people in the E s G mutual fund. And a lot of those mutual funds underperformed general benchmarks as well, so I think a lot of that money is probably going to come over eventually. The question is can you get

new audiences too? And there's guys who haven't talked much about the alpha opportunities. Let's there's the best study that the most the broadest study out in Twitter December twenty fifteen by Germans. They're going to be pretty thorough right if we're working uh stereotypes. Yet of the studies two thousand, two hundred studies of performance and connections between portfolio performance company performance in s G of studies found a non

negative relationship. Thirty five percent were positive, seven percent were negative. Ms c I E s G Leaders Emerging Markets Index one three and five year has outperformed the MSc I Emerging Markets Index without an E s G tilt an E s G filter to it. So it's there's an alpha opportunity that we really haven't addressed yet. I think, guys, we should come back and talk about the alpha opportunity. I will always welcome the opportunity to talk about alpha.

Graham Matt, thanks for joining Central. You guys totally outperformed. We also just want to take a moment and give a shout out to Jack Bogel, the founder of Vanguard who passed away last week. Yeah, I mean huge loss. Uh. This is a guy who, in my opinion, will probably have ended up having the biggest impact and the at least the investment space, if not the whole financial industry

over a hundred years stretch. He is different. You know, there's great people running money Warren Buffett, and that's not He was about something completely different, and I think it was interesting how he changed the system. But he was invented the index fund. Millions and millions of people have a retirement basically thanks to him. But the bigger deal was the mutual ownership structure of Vanguard, you know, having

the fun investors own the company. Every time they had profit, they would vote to lower the fees, not to pay the managers more and or expand end and so over the thirty years, if I showed you a chart of Vanguard's average fee, it goes about sixty five and nine and just slowly goes down to now it's average ten basis points right. And they were lowering fees when no one cared in the nineties, you didn't have to lower your fees. People a buying mutual funds didn't know what

they cost. So he had to wait thirty years really for his idea to catch fire. And you got to take your hat off to the guy, and he sacrificed some personal wealth. He was definitely wealthy at eighty million net worth. But I think history is going to be very very kind to him, especially as these new generations come up and think more about incoming equality. He'll be revered more and more and I only see his sort

of legend growing. So if you haven't checked out our interview with him, we had him on the show over the summer, and then he again makes an appearance on our other show, The et F Story. I was really happy we got that interview. Um, there's a lot we can actually go into the file and I think bring out and have a part two down the road. But man,

he riffed on everything, especially he spun it forward. He talked about the future of the advice business, the future of money management, and I loved he dropped a lot of little pearls of wisdom Ben Franklin style. We got just an incredible hour and a half with him and in one of the last interviews. So Mr Bogel, thank you. Thanks for listening to traits until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcast, Spotify,

and wherever else you like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Webber Show, He's at Eric Ball Tunas. You can find Grahamson Claire at E S. G Architect and you can find Matt Bartolini at State Street E T S. Trillions is produced by Magnus Hendrickson. Francesca Levy is the head of Bloomberg Podcast. Bye