Building the Green Investor Toolkit

Welcome back to the Green Investor, powered by Investopedia, and happy New Year to you and your families. What a year 2021 was in terms of climate disasters. It was happening all over the world, and here in the U.S. it was a tale of two countries: East and West. In the East, record rainfall pummeled Tennessee, triggering deadly flash flooding back in August. Hurricane Ida drenched the entire South and then merged with another storm front to drop record rain in New York and Pennsylvania. Tornadoes ravaged the Ohio River Valley in December, killing 90 people. Meanwhile out West, severe drought and forest fires plagued states from California to Colorado and temperatures spiked all the way up to western Canada. We can blame La Nina for some of this, she's that periodical weather phenomenon fueled by Pacific open temperatures that tends to leave the Southwest drier than normal and the North and much of the Eastern half of the U.S. much wetter, but global warming is having a massive influence over these weather patterns as it fuels extreme dryness in some areas and extreme rainfall in others.

When it rains, it pours. And that extreme weather is costing hundreds of billions of dollars in damages. Ten of last year's most destructive weather events cost a combined $170 billion in damages, according to a new study from Christian Aid, a U.K.-based charity. Hurricane Ida killed at least 95 people and cost the economy $65 billion back in August. A month earlier, floods in Europe caused 240 deaths and an economic loss of $43 billion, while floods in China's Henan province in July killed more than 300 people and cost in excess of $17 billion. 2021 is expected to be the sixth time global natural disasters have cost more than $100 billion, according to global insurance giant Aon. All six of those years have happened since 2011. Remember what Spencer Glendon said about the scale of risk around climate change in our first episode? This is what he's talking about.

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Meet Shila Wattamwar

Shila Wattamwar is an experienced advisor and the executive director of client relations at Sustainalytics Morningstar. In this role, she oversees Sustainalytics’ strategic partnerships globally and assists clients with integrating ESG and corporate governance data into their investment processes. Shila is also responsible for the development of Sustainalytics’ distribution strategy, in addition to working closely with the broader Morningstar organization.

What's in This Episode?

We get a lot of questions here at Investopedia about how to invest along with your environmental or social preferences and what tools to use to find the right securities for your portfolio. Preferences and tools, two of the key components every green investor needs on their journey into green investing. Sustainalytics, now part of Morningstar, has been building those tools for years and has a pretty good handle on investors' preferences.

Today, we're going to get into the tools that investors and financial advisors can use to screen for the companies that align or don't align with their environmental considerations. We're delighted to welcome Global Head of ESG Retail Wealth Strategy at Sustainalytics Morningstar Shila Wattamwar to the Green Investor podcast to talk more about this. Welcome, Shila.

Shila:

"Thanks, Caleb. And thanks for having me on. Looking forward to speaking."

Caleb:

"So good to have you here. You know and we know that there is so much interest in ESG or sustainable investing or whatever we're calling it these days, and it keeps growing every year, the assets keep flowing in, but there's still a lot of confusion among investors about what that really means and how to get started. How are you trying to solve for that at Sustainalytics and Morningstar?"

Shila:

"Great question. And, you know Caleb, I think back to when we first spoke, it was probably about five to six years ago when we first launched the Morningstar Sustainability Fund Ratings or the Globes as they're often called. And at that time, it really was an introduction to sustainable investing to the retail and wealth investor. And I think it's been on their mind for a while but they really didn't necessarily have the tools and insights that they needed. And so now come six years later, that's really still a big focus of what I'm doing at Sustainalytics Morningstar. I'm thinking about what does it mean to provide those ESG insights and tools to the retail investor, such that they can more effectively engage with this concept? So that they can understand it and so that all of the different stakeholders involved, including the individual investor, the financial advisor, the asset manager, and the wealth manager can all effectively contribute to what it means to invest sustainably."

Caleb:

"Morningstar, which is your parent company, just released the Sustainable Investing Framework. We're going to link to it in the show notes folks, so you can take a look at it, but Shila, just give us the 50,000 foot fly over so we kind of have that baseline of knowledge."

Shila:

"Absolutely. One of the things that we're seeing in the retail space is that there are just new assets coming in. Assets coming in from all different types of investors, younger investors, and investors in different global regions. And that is really associated with people wanting to invest in particular ways, in more personalized ways. ESG or sustainable investing is a really great means to personalize those investments. And that really is the premise of the Sustainable Investing Framework. It's to showcase that sustainable investing is not just one thing but rather it's evolved into an umbrella term that allows someone to approach sustainable investing in a more personalized way, in a way that better matches or more aligns with the motivations that they have and the benefits that they're looking to get. Some of these approaches and how they differ include those that are really focused on applying exclusions. They just want to divest or reduce their exposures."

Caleb:

"Take all the oil and gas out of my portfolio."

Shila:

"Exactly. Or tobacco or whatever it may be that's personal to them. Others are actually looking to limit their ESG risks—the primary benefit there is to just, in general, reduce risks and make sure that they're well situated from a performance side and they want to make sure that their investments are mitigating against very material, environmental, and social risks and governance risks. Others are looking to seek opportunities. Those that they think are really alpha oriented within the ESG space. Others are thinking about whether their investments are actually practicing active ownership. Are there funds or asset managers going out there and voicing concerns and speaking to the companies? Another approach could be target sustainability themes, or targeting particular positive impact areas, those that align with the SDGs. Affordable housing, being an example, or renewable energy—themes that are very positive oriented."

"And finally, the last approach that we talk about is assess impact. Making sure that there are approaches that are assessing, that are looking to really measure the impact, because the benefit for that investor may be not necessarily performance based but maybe actually the positive impact they're able to impart."

"And so that's a quick overview of that sustainable investing framework. Again, key point there is that it can really be a personalized approach to investing and you can approach sustainable investing in a variety of different ways. It's not just for those that are looking for positive impact and that's the primary focus. It's everything that I've mentioned just now."

Caleb:

"Yeah. And what is important for you may not be important for me or may not be important for somebody else. You talked about two key things here: personalization and customization. That seems to be the way the investment industry is moving anyway, when you look at direct indexing, when you look at all the specialization in ETFs, when you look at all the different themes and styles you can invest in, that's where we're going and that's where the tools are going and that's effectively what you're creating. But can you really do that in ESG and sustainable investing to the minutia that I may care about? I may care about firearms, as you mentioned, or I may care about tobacco and not having that in my portfolio. Can you get that granular today in 2022?"

Shila:

"Absolutely. And how Morningstar ourselves is almost like the market, we are absolutely leveraging that framework internally and organizing the plethora of ESG data and research that exists today. Not only is the framework meant to be a concept but it's meant to also be a guidance tool that allows people to understand some of the ratings and data points that are out there. I had mentioned limit ESG risk. Well, absolutely the Globes are actually looking at how a fund is limiting exposure to material ESG issues such as bribery and corruption and human capital. You can get quite granular there as well as excluding certain areas. We have probably about 20 different areas that you can really dive into and look at your fund or company's exposure to those areas: tobacco, alcohol, fossil fuels, thermal coal, and cannabis. Again, to your point, different things are important to different people and so we want to make sure we offer that amount of granularity so people can really personalize this at that level."

Caleb:

"Yeah. Have it your way, just like Burger King used to say back in the day, because that's what people want. They want it their way on their platforms, along with their preferences. Europe's come a long way in this. Their reporting requirements are much more stringent in Europe than they are here in the U.S. And it feels like they're a little bit ahead of that, lots of issuance of green bonds and ESG-related securities over there, where in the U.S. it's coming but it just seems to be catching up. Let's talk a little bit more about the confusion around the industry. Investopedia and Treehugger recently ran a survey of our readers to find out what they know and what they think they know about ESG, SRI, and these impact investing themes. Shila, you're not going to be surprised to hear that there's lot of interest and a lot of people who think they're investing along with their environmental or social principles, but they actually aren't once they dig inside their portfolios. How do we clear the confusion and make these themes as understandable and transparent as traditional debt or equity investing?"

Shila:

"Great question. And I think actually this is where the Sustainable Investing Framework can really come into play. There again, I think a lot of sustainable investors have a misconception of what they're investing in because they're thinking about it from maybe a positive impact standpoint and not thinking about it from that risk mitigation standpoint. And so I think really providing those insights so that people can invest in a way that's most important to them will really help reduce that confusion. And I think it's not just up to one part of the investor ecosystem. I think what's really important is that we offer a common language across that ecosystem. Making sure that individuals who are thinking about this are speaking the same language as their advisors, who are then speaking the same language to their home offices and the wealth advisors and the asset managers. And then the asset managers are reporting out in the same way that individual investors understand it. That cohesion and that consistency of language is something that I think is very important to help reduce that confusion."

Caleb:

"Simplifying tunes, those three things, is not easy for the financial services industry just because there's so many lawyers involved and we're talking about money and we're talking about securities. But to take that point a little bit further, Apple and Beyond Meat, not to pick on companies, or Tesla, these are sort of brand name companies and Tesla makes EVs, people that we survey think it ranks very highly or they think it's the most sustainable company in their portfolio. It might very well be, but it doesn't always score that well when you look at ESG ratings, similar with Apple, similar with Beyond Meat. Beyond Meat makes those non-animal based meat products. It has other issues. When you look at a brand and why so many investors who don't understand this are attracted to a brand and what they think is right, but it's not necessarily always 'what is the company that scores the best' along with the criteria they think is the most important, right?"

Shila:

"Those are two great examples. Tesla, to your point, creates EV, very positive product. And so from an impact standpoint has high positive impact. But when you look at it under the lens of ESG risks and how much they're exposed to and how well they're managing those material ESG risks, they actually don't rate as well. They rate as high risk because they have human capital issues and product governance issue. And so it is again very important to understand the lens in which you're looking at a particular company because it can really lead to a fund or portfolio of very different investment vehicles."

Caleb:

"Yeah. There's no one size fits all and it is about preference and the thing you care about, but there are so many tools out there and filters and way to screen companies, including the ones you've been building for years and the ones you're working on now that help investors say, "No, these are the things that matter to me." And you can get very granular in your own portfolio. But for new investors out there, Shila, trying to construct their portfolios or even for the seasoned investors who are trying to green up their portfolios, so to speak in air quotes, how do you suggest they get started?"

Shila:

"It's something that we think about a lot. And so over the last year, I've kind of broken it down into any investor or any part of the investment process has to think about three things. They need to think about how to construct their portfolio, manage their portfolio, and then communicate out on it. And so in that construction piece, I think one of the first pieces is to really understand your preferences or, in the case of the advisor, their client's preferences. Understand what part of that ESG framework or the sustainable framework a client cares about most. What aligns with their motivations or the benefits that they're looking to get? And as a result of what preferences come out of that, they can then better construct the right fund or the right portfolio of companies that align with that so they are indeed getting what they need. They are actually investing in the companies that they thought they were investing in, no surprises, no confusion."

"Asset and wealth managers need to create those funds and portfolios by choosing the right funds and making sure that they're choosing the right companies through the research that we provide, through the analytical tools and capabilities that we provide, so that, again, they can make the right choices in accordance to that. Financial advisors also need the ability to construct those portfolios with the right funds, considering their client's preferences. There you would need screeners and, again, research on companies and funds. Basically those insights that you'd need to make the right choices based on those preferences."

"Once you've kind of gone through constructing the portfolio, we think about, well, what does it take to manage that portfolio? How do we make sure that we're still keeping up with what we want to capture within our investments? And so there again, the investors need the ability, they need the tools to manage those funds. Track them, make sure that they're meeting the requirements on an ongoing basis. Those are some of the tools that we think about at Morningstar."

"And then finally communicate. Investors are just demanding more and more transparency. Exactly to your point, they're surprised at what they're invested in because they care. They want that transparency. They want to know exactly what it is that they're holding. And so reporting is an extremely important piece to that communication. Reporting provides, again, that transparency and it shows an investor what they're exposed to in their portfolios, making sure that we're creating the right portfolios for them. And so, again, when I think about all the tools and insights needed for the retail wealth segment, I think those are all crucial because it allows investors to really engage with sustainable investing across their investment process."

Caleb:

"And you learn by doing that because you actually discover the kind of investor you really want to be, and you learn so much about these companies and how they actually operate. Such a great educational opportunity. For years, Shila, we've talked about this since the first days we met, there was the performance issue. I want to invest along with my conscience but I'm not willing to give up alpha. I'm not willing to give up returns on that."

"That's not the case anymore. But when you look at inside a lot of the biggest ESG funds or SRI funds, you're going to find the biggest companies in the world, which is another head scratcher because how could a Google Alphabet or Microsoft or an Apple be in an ESG fund when they use a lot of energy for their storage farms or they use a lot of metal or lithium but that's what you find in a lot of the biggest funds out there. But it's not just limited to the big funds anymore. You can pretty much have it your way across ETFs or mutual funds or individual securities if you really want to do this the right way, am I correct?"

Shila:

"That's absolutely right. And as it relates to the large companies, again, that's an approach where investors are still looking to really looking at the best in class companies. They may not want to take on risks associated with lack of diversification. They still want market exposures but they want to make sure that they're invested in companies that are doing the best that they can, that are mitigating against the risks that they face, that are managing some of the risks that they face. And so that's why you see some of those large companies within some of those sectors, even though they may be high impact. That best in class approach is still something that we see all the time. It's not to always say divest out of anything that's high impact, it means there could be different ways to approach sustainability."

Caleb:

"And we know so many new investors joined the stock market in the past year and a half, amid the pandemic, started investing or trading for the first time. But we also know, you see it firsthand, so many of these people want to invest along with their conscience. As you build tools and you've been building them and working with your clients and partners and across the Morningstar Sustainalytics universe, what are you looking at for 2022 and beyond? What's next? What do we need that we don't have? And what are you hearing? You've got your finger right on the pulse of the individual investor like us. What do you sense that they want?"

Shila:

"I'd say that people want more insights. Climate and impact to being a big focus. Climate is something that kind of goes across the spectrum. It feeds into the risk that companies face from both the perspective of transitional risks, meaning companies that are going to be heading into a net zero economy or those that actually have physical risks that are in danger because of the different weather patterns or the emerging weather patterns. And climate is also something that really touches people from a positive impact standpoint. And so across the board, climate is something that people are thinking about. And climate is certainly also something that regulation is thinking about. As we think, as I look at regulatory intervention really across the world but even here as it relates to the SEC and so forth, I know climate is at the top of their mind. It's exactly what they're thinking about as it relates to some of the disclosures that they're requiring from both companies and funds."

Caleb:

"Yeah. It's the one thing you really can't avoid. You could turn your back on a company if it's not performing well from a governance standpoint or it's not doing the right thing from a social messaging standpoint or maybe it's a polluter, but when climate change comes to your doorstep, like it's come to cities across the world in force in the last year, you can't avoid it. And I think you're absolutely right. And that's one of the reasons the Federal Reserve is considering it very highly. They study this pretty closely as well and you're going to start to see a lot more disclosure. I think you guys are right on it."

"So good to have you on the Green Investor. Folks, you got to check out what's going on on Morningstar and Sustainalytics. Use the tools, read their blogs, follow Shila. There's so much good stuff there and it is a delight to have you on the Green Investor. And we are going to put all that stuff in the show notes, folks. Thanks, Shila."

Shila:

"Thanks, Caleb. Nice speaking to you, as always."