The Exchanges

Q So Wendy, as you start to pull out some of these examples, you have these one set of companies that are great stewards and another companies that are improving, and then you have an example of a telecom company. If you take a step back or Wellington's a big organization, how do you think about the lens of sustainable investing effectively across the whole firm?

A So to answer that question, I think it probably helps to have some context for who Wellington is as an organization. We're a large global asset manager. We manage about a trillion dollars in assets under management for clients across the world and across public securities primarily, but we also have a few private markets funds and we're a privately held firm. And importantly to our business model, we have this orientation of no CIO, which means we don't have a single decision maker that everyone is feeding the insights to. Instead, we have this concept of having a community of investment boutiques where we have 50 plus investment boutiques in each of those boutiques has a decision maker that has a strongly held investment philosophy and process. And the reason I highlight that is we like the model because it attracts this type of investor who wants to own their outcomes, who have these strongly held investment beliefs. They want to align with their clients in terms of the outcomes that they're achieving and be held accountable. But it also means that those investment philosophies differ and the inefficiencies that they see differ. And so when I was talking about those two strategies, one team that was focused on these compounders and the other team that was focused on these improvers, if you will, we want that to be the case across all of our strategies where the ESG integratio…

AI assessment note: “ESG integration is genuine and credible and intrinsic to the investment philosophy”

Q Where have you seen interest across the spectrum of the types of investing that you described at the onset?

A We see a lot of burgeoning interest in public securities impact investing, and I think it's because it's such a new field, and we were one of the first to offer a strategy in that era. There's been a ton of interest in that. There's also a lot of interest in our climate work. Another one of the inefficiencies that we observed in the space was This concept that a lot of people have been focused on climate, and within climate research, there's two main threads. One is transition risk, and the other is physical risk. And transition risk is focused on carbon, and mitigating emissions, and whether or not we'll see policies, or a carbon dividend, or a carbon tax, or changes in consumer preferences. So when you think about transition risk, think all about Carbon and who emits, which companies emit, but there's this other category and area of research that's physical risk, which is the result of those emissions over time, and it can affect any company's value. So how much more heat will we have and where will that be? How much more drought, hurricanes, wildfires, floods, access to water? And so when we looked out, we saw a lot of people were focused on transition risk, which is incredibly important. And not very many people were focused on physical risk, and so we decided to spend a lot of time, attention, resources, partnering with a science organization, Woods Hole Research Center, t…

AI assessment note: “We see a lot of burgeoning interest in public securities impact investing”

Q And then what did you proceed to do after the heat study?

A Oh, from heat, we went to drought, and that's actually kind of an interesting story, too, because we were originally slated to go to hurricanes, and you'll recall the California wildfires. Erupted while we were starting, while we were doing the heat work. Our wildfire work did not precede that, but our investors said, wow, you know, all of these wildfires are happening. Can you focus your time and attention there next? And the order heat and drought need to come before wildfire. So we moved from heat, we reprioritized our research agenda, moved from heat to drought, then to wildfire. And of course that was helpful in thinking about California and Thinking about the response to the California wildfires, also thinking about what happened in Australia in December.

AI assessment note: “from heat, we went to drought, and that's actually kind of an interesting story”

Q Well, Wendy, this is a wonderful start to this series, and it's gonna be a lot of fun to continue to explore it. But before I let you go, I want to ask you a few closing questions. What's your favorite hobby or activity outside of work and family?

A Well, for work and personally, prior to the COVID crisis, I travel a fair amount, and of course, when I'm traveling to prepare for those meetings, I read a lot of research, and I look at the economic data, and I read history, but one of my favorite practices and hobbies, I guess I would say, is to read a novel of a local author, and I've really come across some interesting authors and works via this practice, and I think it, at least, I may be overestimating it, but to me, it certainly adds to my enjoyment of the trip, and I think it adds to the richness of my understanding in some cases, and so I would highlight an author, a Chinese author, Yu Hua, Who wrote Brothers, which is a wonderful novel, and another wonderful novel, To Live, which I think really has the way the writing itself, I think, is informative, and the subject matter addressed is informative. For The God of Small Things, in the case of India, also pretty informative. For This Earth of Mankind. Which is maybe more controversial about Indonesia. Just reading a novel in the voice of someone from that place, I find that very enjoyable.

AI assessment note: “one of my favorite practices and hobbies, I guess I would say, is to read”

Q All of trying to outperform is trying to find some competitive advantage. So what lens do you use to try to figure out how can you do this in a non-concessionary way?

A Our portfolios at Wellington have what we believe is a credible and well articulated investment philosophy and process. Across our entire platform, we think that this is the key to success and the key to adding value and client portfolios and that investment philosophy statement has to answer three questions. What market inefficiencies do you see? Because inherently, if you're an active manager, you think that markets aren't efficient, that you can beat them. Why does that inefficiency exist? And how are you going to take advantage of that inefficiency? And we apply that same principle of investment philosophy and process to all of our strategies, including those that have a sustainable investment lens. And in many cases, because sustainable investment is rapidly evolving and changing and misunderstood, and the definitions aren't well known, and the data isn't great, we think that there's actually a lot of inefficiencies created in this rapid change that you can take advantage of as an investor, and it's a great way to add value, and in certain cases to have impact in other ways.

AI assessment note: “investment philosophy statement has to answer three questions. What market inefficiencies do you see?”

Q How have you thought about the research angle on the social considerations?

A I think engagement is imperative and you learn a lot about a company, not only about their social practices, but about their culture and their leadership style in a crisis. And so their reaction to this crisis and what they're doing, I think, informs our investors about whether or not those companies are actually aligned with their investment philosophy. And I said, we've done 3100 meetings with company management teams. During the first nine weeks of quarantine, all of those have been designed to really explore what are you doing in this environment? How is it impacting you? And sometimes there's these tricky questions because you're asking you, how has it impacted your cost structure? And the company's trying to figure out, do I say that it's become more expensive because I need to bake in social distancing in my plants? Or do I try to say that my margins are going to be the same? And What is the right answer here? And of course there isn't a right answer. It's like, what is the answer? And then we'll try to figure out whether that's going to be sustainable over time. So it's been a fascinating time to engage with companies and there have been a variety of responses across the board and some that we would deem to be better from a long-term value standpoint and some that we would deem to be less high integrity.

AI assessment note: “we've done 3100 meetings with company management teams... designed to really explore what are you doing”

Q As you sit in the intersection of a firm that's doing all this research on this area, and then as a large group of clients, what do you think this looks like in terms of activity over, say, the next five years?

A On the climate side of things, I focused a lot so far in our discussion on physical climate risk. I alluded to Transition risk as well. And I want to spend a little bit of time on that because one of the things that I see picking up across the globe, not so much in the US, but definitely in Australia and Canada and Europe is this concept of carbon footprinting. And so carbon footprinting is the act of looking at what you hold as an asset owner in terms of securities and what the emissions of those securities are. And trying to understand your own carbon footprint. And then once you have a handle on that, which is imprecise, of course, but once you have a handle on that baseline, the instinct for most investors is how do I get that to be lower? And interestingly, I think that act in and of itself may facilitate a more rapid energy transition than we had been anticipating. Because as you have more and more capital focusing on the largest emitters in their portfolio and wanting to reduce their emissions overall, you start to find that by making small changes, you can reduce your carbon footprint by 20 or 30% with a 50 basis point change in tracking risk. So it seems like a relatively small change in tracking risk or volatility versus some benchmark for a relatively big change in carbon. That's usually attributable to just a few securities in the portfolio. And so one of the pieces…

AI assessment note: “one of the things that I see picking up across the globe”

Q A lot of the focus on sustainable investing, certainly earlier this year, was on this climate issue. How have you thought about the S and the G? So let's just start with the social aspect of sustainable investing.

A Yeah, if you think about the progression of ESG in the marketplace, early days, when people started using this moniker, most investors would say something like, well, I've always, always focused on G, which I think is generally true, like, governance has been a focus of most investors, and so the E and the S were newer areas of emphasis across the marketplace, and then people really rapidly started to lean into understanding the E more based on The climate change imperative, and I think that will continue to be the case. That dial really turned, if you think about a volume on a stereo, if you will, showing my age, that, that dial went from two to 10 on climate in a very short period of time within 2019. Lots of intensity of interest that I think is going to have Lasting repercussions in terms of pricing. But what's happened in the COVID crisis is S, which would have been relatively maybe underserved in aggregate, Has really come to the fore and trying to understand these social practices, whether it's burden sharing or labor practices or safety and security or product quality and safety or supply chains. That's all come to the fore. And so now I feel like you have this more holistic. Maybe everyone isn't recognizing that they're more fully embracing all three letters, but that's what I see in the marketplace today is all three letters. Are coming more into the general investmen…

AI assessment note: “what's happened in the COVID crisis is S... Has really come to the fore”

Q What do you see as the risks of this trend not playing out as it appears to be?

A I will say that because it's a new and evolving space, people are tackling it differently. And in some cases, because there's so much interest from the client side of things, you will see some investors clamoring to meet that interest. And maybe you'll see what I would think a less high integrity offering where you take a vendor score and you say, I'm going to apply that to my process and I'm not going to buy fours and fives. And that'll be my ESG version of whatever portfolio I manage. And the reason I think that's problematic is it's not intrinsic to the investment thesis to the investor himself or herself. And I just think that that whole process makes it less sustainable over time and less likely to generate good outcomes of any type over time because you're taking this external View that you did not generate, nor do you necessarily subscribe to, nor does it interact with your investment thesis and you're applying it. So when that doesn't work, how do you defend it? How do you stick with it? How do you articulate when add value over time or in any way, shape or form financially or otherwise, if it hasn't been embedded and it isn't intrinsic. So I do worry about that, that there's been a lot of new concepts introduced and a lot of approaches and that they'll all Some will be higher integrity and some will be less high integrity and, and that maybe some of those that don't wo…

AI assessment note: “maybe some of those that don't work out, you'll start to see articles”

Q In addition to sort of that research with Woods Hole, which is very focused on climate, there's a lot of the climate and maybe even some of the social considerations as it relates to labor that relates to eventually regulation. What have you seen happening from the regulatory level on some of these major shifts?

A Europe is very active and hard to came up with, I will say, and some of it is by country, and some of it is at the EU level, and we see similar activity in Australia, for example, and in Canada, less so in the US. You may see some state by state. We've seen some state by state, but this idea of embracing this information as a part of your fiduciary duty, not leaving it out of your investor toolkit, Is really, I think, coming to the fore across all of those. It takes different shape and form in different countries, but across all of those, you see some element of that coming into play, which I think really starts to get asset owners asking more precise questions. We're early days in some markets of this. But once they see the variability and the answers to those questions, because they have the benefit of engaging with a lot of different managers, then their questions get richer and more nuanced over time. And again, it just pushes people on this dimension.

AI assessment note: “Europe is very active... and some of it is at the EU level”

Q Are there other inefficiencies that you point to?

A I mentioned earlier that asset team about seven or eight years ago, we started to develop this concept of trying to translate best practices from private market impact investing to public market impact investing. And I do think that there is a And inefficiency there in that this concept of impact investing hasn't really existed in public markets. So it's almost like the ultimate inefficiency. There's not a universe that's predefined of impact stocks that you can choose from or impact bonds that you can choose from. You have to identify those yourself. And the act of doing that means that you're looking at these companies in a different way than the rest of the market. You're identifying Impact companies. They haven't been pre-identified by someone else. So just analyzing whether they're valid for inclusion in the universe is the first step in the inefficiency because you're thinking about them in a way that isn't common. And to me, good investing and good investors do this very well, right? They identify something, an area of the market that's changing or that's misunderstood, that isn't well-followed. Impact, I think, fits that criteria. And then they look at companies or their potential investments through a different lens. Again, impact fits that criteria as well. So on the equity side, identifying the universe was a major inefficiency. And then on the bond side, there's act…

AI assessment note: “identifying the universe was a major inefficiency. And then on the bond side”

Q So if this work with Woods Hole bridges the gap between climate science and investing in the capital markets, are you using the climate insights you're getting from this in any other way beyond your clients' portfolios?

A You know, Ted, I'm really glad you asked that because it's a very important point. When you and I started talking about this climate research that we're doing, we talked about these two streams of climate research and climate risk, transition risk and physical risk. And of course our Woods Hole partnership is focused on physical risk. And one of the reasons for that is when you start to study physical risk, one of the things that you quickly learned that I was not aware of as a lay person is no matter what we do with regard to emissions. In other words, there's these RCP scenarios, representative concentration pathways. That represent different paths that we can take with regard to our own emission behavior. And if we stop admitting everything today as a society, or if we continue on the same path that we're on, that basically forms two bounds of reasonable outcomes we could expect with regard to our emissions behavior. And when you start to look at physical risk, one of the things that you learn is no matter Which of those two paths that we're on or any of the paths in between the physical manifestations of climate risk over the next 10 to 15 years will be the same. And they're more consequential than I knew. And then maybe, you know. And once your eyes are awakened to that, once you see that, you really feel compelled to share that insight more broadly. Because we need to ada…

AI assessment note: “one of the ways that we try to help with that process is by meeting with companies.”

Q What's an example of something you found actionable in the markets or in your assessments with that research with Woods Hole?

A Well, we started partnership September of 2018, and I rattled off some of those variables that we wanted to think about, and there were six that we wanted to get through in the year 2019. The first one that we focused our attention on was heat, and the way that the partnership works is Woods Hole gives us a bunch of literature. They do a literature review, and they say, here, Wellington, read all of this, so that we have more of a basis For our questions. And then we get together and we say, these are the types of capital markets questions we think we want to answer. And then based on those questions, the scientists help us pick a metric That's going to inform our view. So in the case of heat, we picked a metric that was the combination of temperature and humidity called the heat index because of its impact on the human body being more consequential than just heat alone. So I grew up in Louisiana and I referred to my mother as having said, it's hotter here in Louisiana than it is in Arizona because Arizona, it's a dry heat. Versus a wet heat. And she was actually right. There is a difference, and it is more consequential when you combine the two. So once we pick that index, Woods Hole goes off, and they create these granular grids that are maps of different geographical areas about how this index or how this metric changes time period over time period, geography by geography. A…

AI assessment note: “in the case of heat, we picked a metric that was the combination”

Q There's always this phrase of doing well and doing good. You are Wellington, an active manager. How do you think about that potential intersection of what matters more?

A Well, I might switch your question up a little bit because the most common question that I get from clients is does sustainable investment add value, which is a version of what you're asking. And I often refer to that as a trick question because that suggests that. Let's take an is one thing and what we find is that there is this continuum and dependent upon portfolio construction investment philosophy and process. You can have a sustainable investment strategy that is designed to be philanthropic or one that's designed to achieve marginally lower returns with higher impact. Or ones like the ones that we strive to create that are what we call non-concessionary, meaning they're trying to beat benchmarks and philosophy led that. What that means is that by looking through a sustainable investment lens, we think that we can add more value. We think this is a unique perspective that leads to differentiated insights. And so therefore it's non-concessionary and we can beat benchmarks by doing so. So the reason it's a trick question is there isn't an answer to that. It depends on your portfolio construction, investment philosophy, and process.

AI assessment note: “Well, I might switch your question up a little bit”