Episode Transcript
Speaker 0 00:00:01 Welcome to the Definitive Sustainability Perspectives podcast, where we share examples of leadership and innovation. Small entrepreneurial businesses, large mega corporations, and all types of enterprises in between are seeing a global shift in perspectives around the role of business in society. From ESG investing to sustainable finance to social impact in our communities, we're on a journey to leverage data and intelligence to make the best business decisions possible. Enjoy the podcast. Hello everyone, and thank you for joining. This is Kesa Shrine, and our guest today is Bridget RL Muto Lala, head of Environmental, social and Governance Research at State Street Associates. Bridget has over a decade of experience as a sustainable finance specialist. She advises the Columbia University trustees as a member of the advisory committee on socially responsible investing and serves on the E S G integration Group as a policy expert at the Emerging Markets Investors Alliance. Bridget, thank you so much for joining us. Thank
Speaker 1 00:01:12 You for having me.
Speaker 0 00:01:13 Well, in August, 2019, state Street in partnership with Harvard, released the paper Decarbonization Factors, which explores decarbonization factors and investing, and you had a huge contribution to this. We wanted to speak about that, but first we wanna know how are institutional investors, so the, the funds and the individuals, the members behind those institutional funds, how are they driving interest in E S G investing in green bonds and that sort of thing.
Speaker 1 00:01:42 Thank you so much for having me here, and thank you for asking that question for institutional investors. And when we talk about institutional investors, think of pension funds, insurance and mutual funds, this, there's an increased number of investors who see climate change as an economically significant event, not just in the long term, but affecting portfolio performance now. And we see this happening slightly differently in, in two different regions. So in Europe, in the us, Europe being much more of a regulatorily driven market, and the US really being market driven, so, so less regulation in that space. But what we're finding is there is a relationship between flows and the risk return profiles of the investments that they're investing in, which is traditional. We see this in in other factors as well. We had not yet seen it for low-carbon strategies. And so it's, it's what's exciting about this space and what we see in the European space, if we dive deeper.
Speaker 1 00:02:38 So this is a regulatory space. They have carbon pricing schemes that have gone on since really got serious in 2012, but before 2012. And when you focus, take a razor focus to France, they have legislation like Article 1 73 that really maps different frameworks. And this kind of patchwork of standardization of E S G really maps that guidance from the task force for climate related financial disclosure into that legislation. And in that country, we, we saw one of the first sovereign green bonds demonstrating that this is really a systemic level and so a systems level approach to climate finance. And so, you know, if we're thinking about how institutional investors are driving us, we're, we're seeing a lot, uh, a lot of movement and a lot in these different regions. That's
Speaker 0 00:03:28 Great. And so you talk about what Europe is doing and the regulation that we're seeing there versus the us not as much regulation as you pointed out. Um, one thing I think that I'd love to talk about, one way Europe is responding to climate change specifically is by instituting a pricing system for, for carbon emissions. So could you tell us more about that system and how businesses are impacted and also what does it look like for America? Could that possibly be the case here? I've heard rumblings about establishing some sort of pricing system, so do you see that coming about soon?
Speaker 1 00:04:01 So in Europe, they started the pricing. So it's the EU ets, so emissions trading system, and they started it before 2012. The reason why 2012, we see an inflection point in our research is because that's when the Kyoto protocol, so there was a global agreement to start to lower emissions, and that's when those kind of deliverables really started to kind of, um, come to fruition for, for Europe. And that's when we see, you know, an uptick in, in these low carbon strategies in Europe, but also in in flows mm-hmm for the us you know, the EU kind of has this system to work together and uh, you know, a group of democracies kind of working together in that space. In the US we do have some states that have carbon pricing. I don't know how much I can, I can predict it being at a federal level. That being said, there's new legislation off coming from the, uh, house financial committee on E S G, so that's HR 43 29, which just came out, uh, September 13th. And so this might be a change. Um, we can't yet say, and so it'll be interesting to see what comes.
Speaker 0 00:05:10 Absolutely. That sounds great. And you talked a bit about the legislation requiring public companies to disclose ESG metrics, um, and possibly the impact that that could have, um, in terms of what's going on with the House Financial Services committee. So I guess stay tuned on that front. Yes,
Speaker 1 00:05:25 Very much so. Oh, and one other thing I wanted to add. Sure. So we have, you know, um, so our ceo, uh, Ronald Hanley went to the Vatican this summer and there was a committee of, uh, financial institutions and also, um, or a group of financial institutions as well as, um, oil and gas, um, organ companies that signed, uh, signed an agreement saying that this is something that they think could help the economy. And when you were asking about kind of what this means for companies, having a price on carbon, when carbon is something that's material to your operations, really provides clarity on these economic externalities and how that's actually hitting your impact, it's quantifying it and it's putting it on your balance sheet. So that's, from a company perspective, it's quite real. And from an investor perspective, it only kind of helps clarify this integration of environmental metrics into valuations. So
Speaker 0 00:06:17 How, how has that worked? So it's been implemented in Europe and we're beginning to see, okay, once this is implemented, we see this as a result. What's been the result? Have companies voluntarily pushed back in some way? Um, do we see this moving in a positive direction? So if it does happen in the states or in any other region, what could they expect to see based on what we're seeing in Europe Now
Speaker 1 00:06:41 From our research, and, and this is on, so this was the decarbonization factors paper that we just put out with, you know, collaboration with George Sera and my colleagues at State Street Associate, Alex Chima, Fox, Stacey Wong, and David Turton. What we are finding is there's alpha to find in this space from an investor perspective. So we defined six decarbonization factors in the US and the Europe to really fine tune and hone into your point, what are the impacts of, you know, of carbon pricing and really this transition to a low carbon economy. And what we find is that not only do the most aggressive decarbonization strategies produce the most alpha over time, and this is a 2008 to 2000, excuse me, 2009 to 2018 period, but that, that's actually across both regions and, and we actually find low correlation between the regions, which is to say there's a lot of differences, <laugh>. So this was one similarity that we actually found quite striking. So this is an opportunity for investors to get involved in. Um, and, and yeah, and happy to kind of extrapolate more about the, the relationship with flows into these factors and, and, and what insights we can pull from there.
Speaker 0 00:07:53 So, and that's a great insight, just layout for us. Um, just to frame this, what was the objective of decarbonization factors? So what did you set out to prove? And then as you were saying, what did you prove even some things that you maybe didn't set out to prove, but you found what came from that paper?
Speaker 1 00:08:09 We wanted to understand the relationship between a really fine-tuned metric. So I, we didn't wanna study E S G as kind of an aggregate, you know, and environmental, social and, and governance metrics all aggregated up at once and potentially getting a muddled signal. We wanted to get a clear signal on carbon intensity, so carbon emissions per million dollar of revenue. And we wanted to understand how is this metric interfacing with other factors in the market with, you know, size with investment, with, uh, momentum with other traditional factors. And what we found was a lot, so <laugh>, we found a lot more than what we kind of went into looking for. So we found that timing matters around this. This is not static. So, um, the performance of low carbon strategies changes over time. We saw an uptick in returns after 2012, after, uh, for both regions, but um, for the US we saw outflows for, um, for investors after 2016.
Speaker 1 00:09:15 So there seemed to have been an inflection point in the US that we didn't see in the US in, excuse me, in Europe. And the other thing that was interesting to us, so timing matters. I had mentioned how you decarbonize matters, those least restrictive, most aggressive low-carbon strategies, picking the best firms across the market produced the strongest alpha over time. So decarbonization matters, regionality matters. So your exposure to these two regions matters. And that speaks to kind of the inflows and the, uh, risk return profile in both, not that you are sacrificing, but that it's much stronger in Europe, both with the inflows and the alpha. And then, uh, so timing decarbonization flows matter and there, and this, the, the regional exposure itself. And so we found a lot, and we studied this with flows that were at the same times as these trades were happening. And so what we wanna do is kind of tweak it for more of a lead lag relationship to identify predictive measures.
Speaker 0 00:10:23 So you mentioned an inflection point at 2016. I'm curious what was going on then? <laugh>, let's talk about what was going on then to cause this inflection point.
Speaker 1 00:10:32 So what's what we're anticipating, and again, so this is very much so, you know, data-driven research. Um, I am not a, a policy expert for, you know, this, this, uh, space. But I will say what happened in the US was there's a big change in administration and that it was interesting that we did not see that impact really the European strategies, but for, I wanna say it was three or four of our strategies in the US saw a stark, um, outflow, um, of institutional money, which is to say that investors were less confident in the risk return profile and the, in the, the fundamentals around low-carbon strategies after the change administration. And we've seen since then a rollback of epa, um, regulations and, and confusing, um, messages from the s sec around fiduciary duty and incorporating ESG metrics. So it's, it's cognizant, um, you know, investors are cognizant of what's going on in their region and, and in investing accordingly.
Speaker 0 00:11:36 I'm wondering too, um, noting you're not a policy expert in that way. Do you see Brexit as maybe having the same sort of impact just considering where things are now versus where things were when you began the paper? Perhaps?
Speaker 1 00:11:48 I think that's a really great point. I will say there's such a trend in Europe and there's so many other large institutions at play. I cannot have clarity on kind of what that impact, if that will be outflows in Europe, even subtle in a subtle inflection point. Um, and when that will happen, as, as none of us have entire clarity on kind of when exactly this is happening. Um, but, but it could be, um, another inflection point and it goes to, um, we're studying Europe as a whole and not just, um, England and, and, and that space. So, okay.
Speaker 0 00:12:27 Well, I want to dive into some figures from your paper and, um, some of these figures were quite alarming to be frank. Um, in your paper, you, you say that we're seeing an average sea level rise of over 2.6 inches with the rate of annual increases accelerating. So we don't see that slowing down and particularly startling given about 3 billion people or 40% of the world's population live within 200 kilometers of a coastline. With that number increasing, um, given urbanization, twen, um, trends, we also see from the paper that the UN has already linked climate change to increasing land degradation and aerification to rising hunger exemplified by severe water shortages and major metropolitan areas like Cape Town, alarming and sobering, Bridget. Um, and I wanna just talk a bit about the faces, the reality behind these numbers and behind the paper. Does the paper lead us to any sort of clarity in terms of how we see the structure changing, how we see these big metropolitan areas changing, or just how humans will be impacted by these events?
Speaker 1 00:13:38 So I'm really glad that you brought up these, to your point, really startling figures. It's, it's the, and I'm excited about this research that we're doing because it engages investors who were previously potentially scared about sacrificing alpha to be in this space, to leverage capital markets to make progress and, and basically hope, hope to hold off some of these really this inclement weather and desertification and rising sea levels that we're seeing. Um, I think in terms of empowering the market, I think that having more research and being that it's moving to this more quantitative space leading to easier integration into investment processes, I think that that's exciting. And I do think that the uptick in investor interest, um, has continued to increase. And to be honest, while I talk about, you know, um, outflows in, in 2016 in the us the US is still seeing, you know, a trend up. And so there's, while it's, you know, slightly less strong in the US and Europe, it's still quite persistent and it's why we're encouraged to continue to do research in this space.
Speaker 0 00:14:49 So what is the boldest correlation that you feel this paper makes? For example, are you saying that the paper makes it clear that climate change directly impacts what investors are expecting from their portfolios? What bold, um, declarations can we say that this paper makes in terms of alpha and in terms of the relation of the relationship between alpha and climate change?
Speaker 1 00:15:11 Investors need to pay attention to carbon in their strategies. It can drive alpha, that's, investors are looking for it, they need it. And so, you know, previously this was a risk conversation and now we're having an alpha conversation, so you're leaving it, um, you know, on the floor if you're, if you're not looking at this also in terms of, in terms of the actual environment that you're working with and the envi the regulatory environment that you're working with. Investors are not only concerned about, you know, the physical risks and the alpha that they're potentially losing, but also the regulatory risk risks in this space. There's, uh, you know, a growing uptick in regulation and, and, uh, transparency in Europe around ESG metrics and integration. And it's a trend that we anticipate will, um, continue at different speeds globally. Okay,
Speaker 0 00:16:02 Great. So in terms of moving forward, we see this is not slowing down.
Speaker 1 00:16:06 Yes. And carbon is definitely something you need to consider for your strategies. Got it.
Speaker 0 00:16:10 I wanna talk a bit about the bridge between financial services and academia. As we mentioned earlier, you support, um, the board for Columbia, Columbia University, and do you see these types of partnerships between financial services are big corporations in general in academia, do you see these evolving in terms of how it can add to the narrative and the conversation around sustainable investing and how so? Yeah,
Speaker 1 00:16:34 I think it's really exciting when, when you think of, um, universities, it's really their members, right? So kind of like a pension fund. A university has an endowment and they, they wanna represent their members and kind of the thoughts and, and, um, sentiments of those members. And so there's definitely a trend with universities to take ESG metrics into consideration for their, for managing their endowments. And I think that this is, it's, it's very encouraging that they're thoughtfully assessing their strategies rather than oftentimes it's sent to a, you know, a management team and, and kind of out of, out of sight, out of mind. And so I think it's really encouraging and I, it's a continued trend in terms of conversations that I've been having over, um, you know, my years in this space. In you've got these institutions and, and universities, but also nonprofits that again, wanna align their investments with their constituency and their missions. Got
Speaker 0 00:17:32 It. Got it. So last question. What is the big idea, what do you see in terms of trends, in terms of these types of partnerships or just overall in terms of where we can find Alpha as related to the changes in the climate? What do you see as the big, big idea that's gonna really take us by surprise in the future?
Speaker 1 00:17:52 Well, one thing that won't take people by surprise but is a huge idea that is really con that investors have really kind of grasped onto it's materiality is important and it's not going anywhere. Materiality is the concept that not every ES and is created equal and they're in different, e es and G metrics are important for different industries and firms. What's exciting about this and what I think is, you know, kind of what we're speaking to for what's up next is diving deeper rather than having things aggregated at, you know, an e s G, you know, rating at the top, what's in, what's kind of the big idea is to dive deeper and really scope research so that we understand and can quantify the relationship for an e S G factor, an e factor, an S factor, a G factor with other factors in, in the market. And so that allows us to identify by and, and let us really create bespoke strategies to drive alpha for different portfolio managers and, and, and investors in the space.
Speaker 0 00:18:54 Great. So quantifying the relationships between environmental, social, and governance with other factors to drive the alpha. Yes. Great big idea. Bridget, thank you so much for joining us.
Speaker 1 00:19:04 Thank you so much for having me <laugh>.
