Animal Spirits Podcast - Talk Your Book: Investing in Sustainability

Episode Date: January 17, 2022

On today's Talk Your Book we spoke with Jim Madden from Calamos Investments about ESG investing and how it's changing the investment landscape.    Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Calamos. The Calamos Sustainable Equity team has more than 30 years of experience. They were doing this before it was cool. To learn more about their team, go to calamos.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holtz Wealth Management, All Opinion expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may

maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Michael, on a recent episode, we talked about ESG, the fact that it's starting to move markets in terms of fund flows and people wanting to invest based on their values. There was a recent article in the chief investment officer about how the New York pension plan is now going to invest, let's see, $2 billion into the Russell 1,000 TPI climate transition index. And finance professionals will argue about the efficacy of ESG and whether it can really make a difference. And I think that's a discussion for another time. But regardless of why it's happening, I think you're going to see a lot of these, especially institutions where

they have big-time stakeholders and people who can kind of press the leadership to do something, I think this is going to continue to happen where you're going to see these big funds make this move. The argument about not really making change because these are already public securities and somebody has to own them, I don't think that matters anymore. In fact, I think it never mattered. People are going to invest the way that they want to invest, whether or not it has, I guess this is a debatable underlying influence on the company and their ability to raise money and perform in those sort of things. And I do think eventually when CEOs start to see the fund flows, and they realize, wait a minute, if we start doing this stuff and check off these six boxes to show that we're

improving, we can get on all these other ESG index funds or ESG platforms. So that's where it matters. A few episodes ago with Paul Kim, we were talking about flows and indexes and how that matters. If enough money comes out of these names, influences their stock, influences their ability to raise debt and do acquisitions, you better believe it matters. Right. So for today's episode, we talked to Jim Madden, who is a co-portfolio manager at Calamos, and Jim and his team recently joined Calamos. He's been doing this for a long time.

He started, I guess, back in 1999, when I don't even think ESG was the thing. He was kind of a pioneer in this space. So it's interesting to hear Jim talk about how this stuff has changed over time, and how much harder it was to do back in the day versus now, where you have the ability through technology to make a lot of these changes and make a more unique portfolio. So I don't see this stuff going away. I think it's just going to get bigger.

Indeed. All right. With that, enjoy our conversation with Jim Madden. Today's Animal Spirits is brought to you by Calamos. We are joined today by Jim Madden. Jim is a co-portfolio manager. Let's start here. Jim, you were doing ESG investing before it was cool.

So according to August 2021 press release from Calamos, you and Tony Turson, helped set industry standards for ESG-focused investing at Portfolio 21, where they developed one of the first sustainable research platforms in 1999, 99, wow, combining environmental criteria with fundamental research to identify companies positioned to thrive in an evolving environment. If you could, rewind the clock back to when I was 14 years old in 1999, what were you doing back at the turn of the century? Well, of course, I was 16, too, so I started to go early. At that point, Tony and I worked for a company called Progressive Security, which was a boutique investment company founded in 82, all back then was called SRI investing.

So really one of the pioneers out of Portland to Oregon. 97, when Tony came aboard, we were just doing SMAs, domestic concentrated SMAs, stocks and bonds for folks, with pretty standard, which again, back then, SRI criteria, which were fairly anecdotal back then. There was no MSCI, there was very few third party folks out there. they're digging out data and doing ratings and all that stuff. So come around 98, we thought to ourselves, geez, these environmental risks, these seem to be the big risks for society and of course also for the companies within. These are very material risks for companies. And they seem to be measurable. So let's take a stab. I mean, you guys know, this business, you've got to have an edge. There's way too many smart people, way too many computers out there. So hey, maybe this is our edge,

environmental risk and opportunity, which companies get it, which companies are planning ahead, which companies mitigating risk, taking advantage of opportunities. So, well, how we do it, we said we need some criteria. How do we identify these companies so we can aggregate a new investment product? We employed a environmental scientist's name of Susan Burns, who became later to the CEO of the Global Footprint Network, and she helped us look at the metrics that we needed to focus on to show which companies were indeed ahead of the pack as far as risk and opportunity in environmental space, social and governance as well, but we really were kind of big E, little S, little G, back in the day. So we developed seven criteria, 27 sub criteria. The thought

was, hey, let's make a domestic mutual fund. We applied those criteria to a big chunk of the S&P, and lo and behold, we had very few companies and a way to make a portfolio. So we could either water down the criteria, which we didn't want to do because that was our edge. We said, okay, let's open it up. We will be global, thanks to Western Northern Europe. for the most part. We were able to populate the portfolio to satisfactory level and launch the product in September of 1999. We see all these numbers these days, and I feel like depending on the source, you're going to get a different number, but they say that there's a huge amount of money in ESG already. How much of that do you think is just sort of watered down, and how much is

actually doing something that actually makes sense and actually is some sort of screen, either inclusionary or exclusionary, that actually matters these days? It's a big tent. It means a lot of things to a lot of people. As you guys know, you get a very visceral reaction when you say ESG these days,

both sides of the ball. And rightfully so. To answer your question, I don't know the number, but you get so many different things that can maybe rightfully so, maybe not be labeled ESG. The breakdown that people tend to use

is, hey, look, there's impact ESG, which tends to be kind of local, issue-based, community-based, somewhat private solution kind of vehicles where you're looking to solve, all the problem in a community or societal issue. Market return is not necessarily a big part of that or the primary goal.

You then have what brings the big reaction, the values-based ESG, where people say, I want my investments to reflect my values. The companies I invest in or do not invest in are the kind that make me feel better about myself and my investments. Again, not necessarily return prioritized. And then the third kind of catch on, and I guess where we would follow the integrated. ESG, where you're just essentially taking these non-financial metrics and including them in your investment process, which does back in the day and to this day, just feels like a better way

to invest. So some of the ESG that we've seen is almost too integrated. We'll get to that in a second, but just for a sense of the numbers of where we're coming from, I remember, I don't know when this started, the ESG talk 15, 16, maybe. It was just that. It was talk. It was just a lot of talk. ESG is coming.

And then it came like a tidal wave. 20 and 21. According to the Investment Company Institute, Assets in 40 Act funds that apply exclusionary, inclusionary, or impact investing screens, rose 45% to 2020 totaling $465 billion at year end. I'm sure that number for 2021 is even higher. The thing that rub some people the wrong way is that it's too integrated. So what I mean by that is Ben and I spoke about this a couple of weeks ago on the show. I'm looking at the biggest ESG ETF and the top 10 holdings for the S&P 500, there's like 96% overlap. Does this grind your gears or does this make you happy that you have more interest in the space? It gives you the ability to differentiate yourself.

What's your take on the water down? I'll use the word bullshit ESJ. Get that big. Once you reach some sort of critical mass, everyone want to get in the tent. And so you've just got funds. The ABC Global Fund is now the ABC ESG Global Fund because they paid MSC at $12 to tell them it was okay. So yeah, there is, as you put it, there is a lot of bullshit. You follow the money. That's just the way this business works. So from our perspective, it's good because, and I think that's one of the things Calamos was looking for. Hey, we want authenticity. If we're going to get in the space, we want authenticity. We want to be able to back it up with doing what you say you do and producing the returns that you've produced in the past,

hopefully. How much has your philosophy on this evolved earlier since you started in 99 to now what you're doing at Calamos? And how many more companies actually could make your original screens? Have companies gotten much better in the last 20 plus years? I really have. There's been more. especially in the States. Again, Europe was ahead of the curve. They've continued to be so. A-PAC continued to trail.

So it's a double-edged short. Many companies have improved because they understand that it makes them a better business if they take these things into account. You're just a better business. You shouldn't be a business that says, how can we be better ESG? It's how can we be a better business? So you're getting those companies who get it.

Then you get the companies who just want to put out a CSR report with some fuzzy kittens on it and we save 12 gallons of water and look at this beautiful report. I think 90% of the S&P now puts out a CSR report. compared to when we started, I would assume 10%, maybe. So there's a lot more greenwashing going on at this point in time, just because, again, there's money to be made and there's games to be played. There's games to be played with the rating agencies now.

The companies are doing that. So once you get all this attention, you're going to get that in the space or any space and not unexpected. Let's talk substance. Why do companies that are more, I don't even know how to not use buzzwords, but that are better for the environment, better governance, better sustainability. Why should they have better performance in their business and ostensibly their stocks? It's a company that understands that there are risks out there that are non-financial now and ultimately they will be folded in.

I mean, I really believe that a lot of these ESC factors will just be investing. How can you say that you have a whole view of a company if you ignore the fact that all the employees are unhappy? When we started, we used to tell that to people, we'd say, well, look, do you or do you not agree that a company that keeps their employees happy and productive is going to be a better company than a company that does not. It's very simple. But now you're really seeing that manifest these days. And so these things are about companies that understand that, and they understand those risks

and opportunities before they hit the P&L. The companies that don't, they have to wait until they hit the Pia down and then they take the hit. So there's plenty of opportunities across depending on what kind of company you are to take advantage of that versus your competitors. More people are paying attention to it now, but there's, again, the innovative, adaptable companies tend to stay ahead. If you're thinking about ESG like a factor, like it's a value or momentum or quality factor, there's a few different ways you could look at it. Like a negative

screen, like we're going to try to take as many bad companies out as we can or a positive screen. Like we just want to overweight the companies that are doing really well. Do you have a preference over which one that you look to when you're trying to build these portfolios? Yes, absolutely. We're risk-based from the beginning. Absolutely no values in the portfolio construction. So we were the oldest fossil fuel free fund in the States. Whatever that meant back then, there was no such phrase. But the reason we were fossil fuel-free was because in 1999, we said to ourselves, well, look, the oil and gas sector is in secular decline.

It's harder to get stuff out of the ground. Legislations running against it. Renewables are getting cheaper. Why do we want to put long-term client money in a sector that has those characteristics? So we did not, and we have not. So I think those are the kind of decisions that we make, all risk-based. So there's a negative screen around metals and mining. It's not because we hate mining and think it's bad.

obviously it's a big part of VVs and electrification, but do you want to invest in the minors or do you want to invest maybe in the tools? There's so much environmental risk and safety risk in the miners themselves. There's better ways to play that in our opinion. So all risk-based for us. This is a two-part question. How do you measure employee satisfaction and how important is governance to a company, whether you're looking at diversity on the board or things like that in leadership roles?

How does that actually filter into business performance? The S part is the squishiest part and the hardest part to measure, for sure. So right now, the most scientific way to do employee satisfaction is really is glass door. You look at glass door and you see what folks have said about the company. It's very hard to get a read on that. And then diversity is the same thing. I think what you'll see coming is right now diversity. Oh, you got to have it.

You should be scared if you don't have it. But hopefully what we're going to see down the road is there'll be some nuance to that. So a shareholder resolution comes to a company and says, well, your board isn't diverse enough. And then another company has a more diverse bird, but what if their minority candidates are all overboarded, which is worse, to have a less diverse board or an overboarded board? So right now it's pretty ham-handed, some of this stuff. I hope that we'll get a little more nuance around that as we progress. And then the governance stuff, yeah, again, open to a lot of interpretation. We invest in a lot of European companies that are noblemanordist majority held by a foundation.

The governance structure, well, maybe that's seen as less than optimal by some folks. For us, it is optimal because they look to the long term. I would imagine that you could look at simple things like employee turnover. Like, is that data publicly available? Absolutely. Bloomberg even now is really one of the leaders and just they have thousands of data points. They're not out populated for all the companies, but things like that are starting to get populated, absolutely.

How much nitpicking do you get from investors about any of your companies? Are there any companies that sort of are a lightning rod where maybe like a company like Facebook where people say, well, they're not dumping nuclear waste into the rivers or something, but Instagram is making teenage girls feel worse about themselves and causing depression. How drilled down do investors get into the actual companies? Do you think people are just looking for more broad-based ESG themes and not worrying about the actual outputs? Yeah, we do get a fair bit of questioning from folks who care, I think, and ask why or why not, Facebook, and expect us to have a thoughtful answer.

And that's the kind of stuff that we'd like to hopefully provide Calamos' folks on the website, Twitter, blogs. Like, why do we do this? What are the reasons? What are the risk-based reasons that you do? or not doing this. Because back in the day, portfolio 21, when it was started, was kind of a go-to for advisors and so forth, people who wanted to understand ESG so they could explain it to clients. We would really like to get back to that point where we can help people understand

why we do what we do and let them digest that. So we had somebody from Calamos on the podcast sometime last year. And if I recall correctly, there was already an ESG overlay or some sort of integration into the portfolio management. Am I remembering there already? If so, can you talk about that? We're still the newbies here. So I know when we came on, yes, there is no relay. It is looked at across the strategies. I think different managers use it in different way. So I think as we come more integrated with the other teams, we'll find out what that is. And hopefully we'll be able to spread a little bit of what we do and see if people find it useful. Do you find ESG works for investors more as a behavioral tool where it can keep people

invested if they believe in the companies they own and it can make them more long-term investors and maybe more buying a hold and not have to jump in and out of these funds? Or do you think that this can really add as a factor that can outperform over time? I think both. I think make no bond to buy. We're long term. We've owned some of the same company since the inception of 99. We like companies to feel the same way and invest the same way.

So I think maybe that it bleeds over. I've always said invest enough because we're going to try to give you the best return that we can versus the benchmark of lower volatility. If you feel good about those companies and they provide some sort of ancillary benefit for you, that is fantastic. That's gravy. Our job, we're fiduciaries, we're risk managers. We're here to steward your money and tell you how and why we do it. So I assume that means if you've held a lot of those companies since then, that there's probably not a ton of turnover. Have you been surprised at all

in your 20 plus years of doing this at any companies that were excluded at one time and now included because of the changes that they've made? Yeah, there's plenty of them. And I think most of them are around disclosure. We wanted Apple for a long time. We scored Apple continually, but Apple wouldn't give any information around what their supply chain was, who was in their supply chain. Did they have any standards in their supply chain? What were their energy uses, anything like that? So to us, hey, there's a risk, and we don't know the answer to that.

So that's an unknown risk and too much of one for us to invest in a company until we know. So, yeah, there's a lot of companies either that have gotten it and started to disclose more or who have changed their business model to reflect reality. So how long would that take for Apple to do that? Hopefully they did it in like 2011. Evans, you could invest it a good time? Yes, it was a good time. I believe it might have been.

Probably our routines. They filled out the carbon disclosure product questionnaire or project questionnaire. And that was the first step for them kind of coming out and saying, okay. And I think Tim Cook has said, look, we want to be as transparent as Tim Cook can be about this stuff. So you run a global, sustainable equity mutual fund, and there's three separately managed account offerings. There's a global, the international and U.S. sustainable equities. Let's get into the meat a little bit.

I would say that this is what you want to see if you're investing in an ESG portfolio. There's 51 holdings. It's not a duplication of the S&P 500. What are we looking at? If somebody were to look under the hood, so I'm looking at the top 10, and there's names in here that I would not expect to see in the top 10 if this is just watered down. So talk about how the construction of this portfolio takes hold. Sure.

And I'll talk about it in the context of the fund is 125 names versus the acquit. So it is concentrated versus the aci, but it's a little bit bigger. And so obviously it's global as well. When Tony started the three SMAs, he was constrained by not being able to trade local shares. So we were looking at ADRs and stuff that he could get his hands on. So that it was the start of it being a little more concentrated. But I'm happy to talk about any of those names in there, which ones are of interest to you or which ones you thought wouldn't be in there.

The top four are big names, Microsoft to Apple. So I'm looking at U.S. by the way, U.S. only. Microsoft to Alphabet, Apple, Verizon. I'm still not used to calling it alphabet. that. But then you've got Texas Instruments, Quanta Services, Ball Corp, Jones Lang LaSalle, Sisko, and into it. Part of this obviously is driven. As you guys know, the market, the big names, if they're investable, you got to play them. And these are good companies that we feel that those top four you talked about, those are fine. Hopefully we're getting into a market where there's a little

bit more dispersion there. But it's what you don't see there also, Amazon, Facebook, that would be in there in a usual U.S. portfolio. So there, we take the place with these high conviction names like Quanta, which is a great example, the type of company that we like. So it is two-pronged. They do pipeline work. They do some work with the oil and gas industry, which gives us some exposure that we don't have otherwise. But it's a very flexible business model.

So they can flex on, flex off with when the pipeline work is there and not. But mostly they work with transmission and distribution in the grid. They're there to harden the grid, to repair the grid, to expand the grid. So obviously the grid needs a lot of work in general, but also the grid. grid needs to be connected to these distributed renewable energy projects out there. You put a wind farm out and farmland, you've got to get that energy back to the grid somehow so it can be used. So here's a company that's because of its flexible business model, just positioned in our thinking

anyway at a real sweet spot. And then that's why it's kind of a snid name in the top 10. One area that's conspicuously absent from this portfolio is Berkshire Hathaway, which is a top 10 pretty much anywhere. But Berkshire is the biggest conglomerate in this country. as far as I know, it's in everything. Industrials, energy, electricity, utilities, all that sort of stuff. Talk about why Berkshire got the boot.

We have to think to yourself, we love Warren Buffett. I love Warren Buffett. Our CEO had lunch with Warren Buffett and tried to talk him into ESG a number of years ago. I would have loved to be a fly-in-half of that one. He drinks too much cherry Coke. Yeah, exactly. Well, yeah, we had to say to ourselves,

you know, what are the businesses that he owns? We just look at those businesses, and very few of them are businesses that's we're highly in our way of thinking. So to be true to what we do, we couldn't invest there. How much of your process is like qualitative versus quantitative? And how much of this do you think has to have a little subjective element to it? Like, if you just ran a screen, like do you think you could get pretty close to what you're doing now? Or do you have to have some subjectivity in there to be able to override some of this stuff? Yeah, I think the latter is

the truth. And I think the latter is what we talk about when people say, well, what's your advantage? You're still small. You're a three-person team. Now you get Camel. Sure, that's great. Well, I think the advantage is, look, we have been looking at documents from companies and NGOs and third parties for 20 years. So it's the filtering now that is the key. It's being able to determine what is material to a company. The same thing on the fundamental side, if you run an RIC screen, can you get the same portfolio? Yeah, but if you could do that, everyone would do that. So the same thing holds true on the other side of the ball.

We're very happy that none of the rating agencies agree because they shouldn't. you should have to go in there and decide for yourself what's important. And I think we have a lot of experience doing that. So there's a big qualitative component to what we do on top of a qualitative scoring process. I've noticed that over the years, correct me if I'm wrong, the S has shifted from social to sustainable. How do you think about the S? Because to me, the social aspect of it seems so personal.

I don't know how you could offer a mass market product with that. Yeah, a little bit of a misdemeanor for the social. I think it's always been about employees and how you relate to communities in which you operate in and that type of thing. So I don't think that's changed other than, especially in the U.S. now it's shifted more towards diversity inclusion type of issues that you're seeing brought to companies, release your EEO1 data, that kind of thing. So I don't know that it's changed in my perspective.

It hasn't really changed that much. It's just more focus on recent events that have brought some of the irregularities or the disparities between classes of folks to the four. Do you see a lot of companies in leadership that are taking some of these steps to improve this stuff strictly because this is becoming such a bigger space for people to invest in and the funds are making this so? Has that been a concerted effort where you've seen noticeable changes because there's such a groundswell for these funds now?

Meaning companies, public companies taking steps to curry favor, so to speak. Yeah. I think companies have seen, like if they can be included in some sort of of index fund or whatever for Vanguard, they know they're going to be owned by a whole bunch of of people. And if they could be on a lot of ESG funds as well, that's also potential for their stocks to be held in a wider variety of people. So have companies taking heat of that, basically? Yeah, you're seeing a lot more companies gaming, especially overseas. You see a lot in China. But here in the States as well, yeah, why not? But the pandering to the rating agencies

and that kind of thing, to us would be kind of a red flag. Again, the changes that you want to make will make your business model stronger. It won't make the rating agencies just like you more. And I think you can really, you're able to discern between some companies do both. That's great. But the latter is much more important to us than the line. Hey, Jim, Ben and I just got done having a friendly debate about the Fed and macro issues. And I know that's pretty far filled from what you do on a day-to-day basis, but certainly you are investors and you have to be aware of the macro environment.

How does that at all shape what you do in the portfolio or literally not at all? We're pretty macro agnostic. I mean, it's just not our core competency. We're aware of it, of course, and we're aware of it in the way that it makes opportunities for us. So if something happens, the Brexit happens or something happens in China and stocks become available at a cheaper price that we still believe in, that's the way we look at the macro.

But, yeah, if you ever hear Tony Rob Blavin about the macro, it's chances that we've had like way too many beers because that's not where we play. All right. So could you maybe talk about like the composition of the portfolio? Are you trying to stay relatively glued to the sector composition of your benchmark? Yeah, I think over the 20-odd years that we managed the fund, we outperform short, medium, long-term with lower volatility, and that was almost all through stock selection. So 20-odd years of our performance, we realized we put all our resources into discovering

these global leaders. That's what we want to drive the performance. So yes, we do tend to pay very close attention to the benchmark sector, region, country, industry group waitings. How many people are coming to you for education in this space saying, like, hey, we know we want to have more of a values-based bent or focus more on the environment, whatever it is, but we have no idea where to start because there's all these different companies and funds that do things differently? So if people come to you, like, how do you start that process and

where can people go to learn more? We're in the process of doing that account most with the sales folks now. It's a little bit different product that you're used to selling, and they're very excited. I think they've had a lot of interest in it. So we're doing some of that education. We were down in Neighborville a couple of weeks ago doing annual sales meeting down there. And again, I really, because of the reach of Calamos, the website now, the blog, LinkedIn, they all have some thought pieces that we've already been able to put up there to enable folks to understand what we do, how we do it, how we do certain issues. And we really feel now that we're, have the resources, we'll have much more time to do that

to reach out to folks, to go on the road, to, again, the Omnichannel media stuff. We'll get all that out there and be very transparent about what we do and why we do it. And hopefully that engenders more conversation, authentic, good. conversation rather than why didn't you invest in this AAA company and why I invest in a single B company. Okay. So tell us a good place people to go to kind of learn more about you, your team, your fund, and where they can learn about this more.

Sure. Yeah, go Calamos.com and there's a section there on sustainable investing. There's also the Twitter feed on there that we've populated with some articles. CalMust, LinkedIn is also a good way to have a look and that should continue to increase in volume. All right. We'll link to all this in the show. It's nice to talk to somebody who we think is doing ESG in a real way.

And so, congrats on the move and wish you and your clients and the team, nothing but success in 2022. Really appreciate both of you, Ben and Michael. Thanks for having me. I look forward to for the talks. Thanks to Jim for joining us today. Remember, go to calmost investments.com. Send us an email, Animal Spearspot, at gmail.com, and we'll see you next time. Thank you.