ETF Edge - New Activist ETF & Defining ESG

Episode Date: June 28, 2021

CNBC's Bob Pisani spoke with with Jennifer Grancio, CEO of Engine Number One – along with Arne Noack, Head of Systematic Investment Solutions for the Americas at DWS Group. They discussed the intersection among activism, ESG and indexing – three red-hot themes in the ETF world this year. What’s next for the company that managed to put pressure on Exxon-Mobil to move toward a cleaner energy strategy? And what will fuel the rapid growth of ESG investing for the rest of the year? In the 'Markets 102’ portion of the podcast Bob continues the conversation with Jennifer Grancio from Engine Number One. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to EATF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, and we're breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll talk about the intersection among activism, ESG, and indexing. three red-hot themes in the ETF world this year. What's next for the company that managed to put

pressure on ExxonMobil to move toward a cleaner energy strategy? And what will fuel the rapid growth of ESG investing for the rest of the year? Here's my conversation with Jennifer Gransio. She's the CEO of Engine Number One, along with Arnie Noak. He's the head of systematic investment solutions for the Americas at DWS Group. Jennifer, back to you. You won the proxy fight with Exxon. Now you have an ETF to buy shares in companies you're going to use in upcoming proxy fights. Can you explain to the viewers how you're going to use this ETF and what you'll be doing with it? Explain the strategy behind it. Thank you, Bob.

Engine number one, we have a new paradigm. So as a firm, we are looking to take data and do a better and better job of how the impacts that companies make link back to their long-term economic value. And so as a firm, we'll do this in a range of ways. We think it's time for investors, whether they're public plans, wealthy families, or, frankly, millennials and personal investors, it's time, and there's a demand for people to be active owners. They want to be activists. They want to have their views reflected in what these large companies do and how these large companies manage for long-term economic value overtime.

So what we've done with the engine number one ETF is we've created a product. that simply holds the largest 500 companies to start. So passive isn't bad. Indexes aren't bad. And then we are long-term owners and long-term managers of those companies. And so we'll be very active. Every year we'll be very assertive on how we vote all of those shares on the behalf of the clients. And we also, as the fund grows, have an ability to have conversations with these companies

and be very active on how they understand their impacts today and how they drive to long-term value over time. So more to come from us on the specific way we're going to work with some of these companies. Well, let me try to nail you down a little bit here. Are you, are your next target going to be a specific target like Exxon Mobile or suddenly you're going to be involved in a number of different board fights with a number of different companies? Give me a sense of the roadmap here. Yeah, if you think about traditional activism or traditional impact activism, like what we did with Exxon, that's a very big deal. And there's a lot of work ahead on that one, I would say.

And so our objective is not to always do something that's as big as axon. Our objective is not to always do something where there's a proxy fight. There are a couple of companies that we're already looking at and working with that actually are positive examples where we think they're doing the right thing in understanding transformation in their industry. And so there, they may actually be undervalued today because they're not getting credit for decisions they're making that will drive long-term outperformance.

So to answer your question, in every case in the Vote 500, we will be active voters. Sometimes we will do a campaign that's as big and leads to a proxy battle like an Exxon. And in many other cases, we will be working with these companies with the data to show them how they can address impacts of their businesses, whether they're on customers or workers or communities or whether they're on the environment and on climate.

and help them realize higher long-term value. So there'll be a range of ways that we work with these companies. You know, Arnie, what I like about this whole, this particular ETF, it's a little unusual, but what I like about it is it's the intersection of three very interesting themes. Number one is ETS, number two is ESG,

and number three is activist investing. I'm wondering what your thoughts are here. You run two of the largest ESG funds that are out there. How are you participating in this debate? Are you planning to take a more activist stand or the company itself that you represent, DWS? Thank you, Bob. And first of all, congratulations to Jennifer and the team for the launch. I think it's personally, I think it's a very, very interesting launch,

and I'll keenly be following the product. And, Bob, with regards to our portfolios, and in particular, let's say, S&PE, and you can think about it as very similar. There's two layers to our process. On the one hand side, we follow the S&P 500 ESG index, so already the companies in which we invest are the best in class companies of each industry group from an ESG perspective. And then on top of this, at DWS, we have a history of engaging with proxy voting

and engaging with companies globally as a global asset manager on ESG-related issues. So I wouldn't necessarily think of us as an activist investor per se, but we in all of our financial and stewardship considerations globally take ESG considerations super super into account, and it's incredibly important for us and has been for a while, in fact. Yeah. Jennifer, your campaign with Exxon was successful because you enlisted the help of Exxon's biggest shareholders, the Black Rocks, the vanguard, the state streets out there. How confident are you that they'll go along with other proposals down the road?

I mean, do you believe you have a solid climate change voting block? Does that actually exist out there? Have you created it? What's your sense about that? Yeah, I think in terms of how other companies vote over time, you should ask those companies. I would never want to speak for them. But at engine number one, the way we think about it is there's a relationship from the data that we see on climate. climate is easier today than social.

But in the case of climate, we can see the value of these impacts, and we can see how the markets are transforming. And so doing the work to make a good case on how does a company transform in their particular industry, what their footprint is today from a carbon perspective, what can they do about it to mitigate it over time as regulation comes in, as technologies change. And so our take on it is that we will be more successful. on these issues if other investors come along.

But it's our responsibility in each and every case to do the work and put the case together on why change needs to happen. And, you know, we're a purpose-built firm to do only this. We don't have trade-offs within our business. And so if it works for us to be the tip of the spear on these issues and it makes it easier for others to follow on some of these issues, that's terrific. That's terrific for investors. But you've said you're the tip of the tip of the issue. You've said you're the tip of the sphere. I think that's a very apt metaphor. Did you, to get the Exxon story through the three boards, did you go to Vanguard and BlackRock directly and enlist their help? I mean, how did that all come about? Just give us a quick sense of that, because people wanted to know how the coalition was put together. Yeah, and I'll spend a minute on that.

And then within engine number one, Charlie Penner led the Exxon campaign, and there's a lot of work ahead. And so I think there's an opportunity, another time with viewers to go very deep on that. But I would say that the Exxon campaign was about doing the work, looking in an example of an industry, and energy is the prime industry where the world is changing. And for companies to make sure that they understand how things are changing, they have the right. skills and they can maximize their financial value over time which it's a climate issue but it's also a long-term shareholder value issue we did the work we put the data together and then we took that data to everybody that holds shares in

that company and so it allowed other people to come along on an issue with us yeah Arnie let me ask you about a broader ESG issue and I get this all the time from investors and viewers above ETF Edge the SEC chair Gary Gensler has said he wants to take a look at the ESG business in general and how something kind of gets into or out of this ESG bucket because there's not a lot of agreement on what exactly constitutes that ESG bucket. So there's a feeling that the first round of ESG metrics by some people really didn't get the job done.

And we sort of need to advance this conversation about what is and is not ESG. In your opinion, is there going to be an attempt to more carefully define what ESG is in 2021, with or without the SEC prodding you? Yes, Bob. I think the general heightened awareness on what qualifies or constitute an ESG type of product is, is both needed as well as, from our perspective, very desired. And even within the broad spectrum of ESG products, you can have lighter green or darker green type of products.

And typically the way I encourage or we encourage investors to think about it is you have broad benchmark products such as SNPE that really, you know, give exposure to the broad-based market, but through an ESG lens and utilize good, non-financial, environmental, social and governance-related data points to construct a portfolio that is very holistic and can serve as a building block. And then on the other hand, you have more thematic exposures. You know, you can have clean energy type of ETS.

You can have electric car type of ETS. You can have specific themes that in and as a climate, themselves track a specific theme that could qualify as an environmental theme or it could qualify as a social team. And so there isn't that much consensus in relation to what is ESG. However, that heightened scrutiny and heightened awareness will lead to a heightened and elevated understanding of investors, and that in our view is very much a good thing. And we as a product provider as an asset manager want to be here as a resource to help in that education process, to help with the transparency that is needed for investors to come to their conclusions

in terms of which type of product is right for their specific portfolio and their specific purpose. Yeah, Jennifer, you want to weigh in on that? I know vote is not specifically in the ESG category necessarily, but you're in the ESG business. Would the whole industry benefit from a little more consensus on what exactly constitutes ESG? Because obviously the SEC seems very interesting in this question. Yeah. Yeah, I think to Arnie's point, it's things are evolving and things evolve.

And so our perspective on this is that sometimes for investors, investors want to jump to the answer. They want somebody on their behalf to make these decisions. And so a lot of the ESG products that are out there to date, they take the weight of a company down or they screen out potentially bad actors. And our view and what we're trying to do at end to number one is advance the ball a little bit. and invest in these companies and help to transform them and drive them in the right direction. And so I think any degree to pin down a rating system or a category to a point in time is a little bit challenging. And in this space of linking, you know, the social and the climate and the governance and turning them into economic factors that we can all use to make decisions, I think more conversation is great, but I think we're going to see a lot of evolution.

And our view is people want to be active, but they also want to drive transformation in these companies. So with Vote, for example, at Engine Number One, you're tracking the index, you're not tracking a custom index, and then we'll be active owners to drive these outcomes at these companies. Yeah. I've been of two minds on this. And for the first couple years, my thought was this is just all over the place

and nobody can agree on anything. But now I'm sort of of the mind that you should allow, as long as people clearly define what their goals are, what they're doing, I don't know why you would try to pin it down to some kind of specific formula. I don't necessarily think you can even do that. So my own thinking has evolved on that front. Arne, let me just move on and ask you, you know, the big knock on ESG in general has been, other than it's broad and hard to define.

It tends to mimic essentially big cap fund with a quality bent. So if you look at USSG, which you run, it's 20 percent. Microsoft and Alphabet, and it performs very close to the S&P 500. In fact, within a percent or so. How do you respond to that criticism? You're essentially mimicking big-cap quality funds. Oh, Bob, I actually wouldn't see it as a criticism at all, personally. When I think about USSG as well as S&E, so the comments go for both in the same way,

same for our small-cap fund, SMLE, or the mid-cap fund, Mid-E, the whole idea behind those funds is to have an investment profile, a risk and return profile that is extremely similar to the non-ESG benchmark of their respective segments. So when we look at the construction methodology, for example, of our USSG portfolio, the idea and the intent behind it is to have a roughly sector-neutral approach, but with significant elevation of the environmental, social, and governance-related profile. Similar for SNPE, there we don't look at sectors, but we look at industry groups. So we are a little bit more granular than for USSG. Again, we look at every industry group, which are the top performance from an ESG standpoint of each industry group and include those in the portfolio. The outcome really is, and the intent of those portfolios is to give investors something that they can use as, let's say, an S&P 500 ETF replacement, but elevate the ESG profile. And not have to change, let's say, the investment process, but can do that as a plug-in place.

type of solution. Jennifer, you want to weigh in on that? I mean, my point is, the ESG people or the investors always bring this out to me. Bob, the S&P is up 14% this year. The average ESG fund is up 14% this year. Arnie's reply here is yes, but we own slightly different things than the S&P 500, so we're getting an equal amount of performance with a better ESG tilt. Is that the right way to look at it or do you have a different way to look at it?

Yeah, I think any time you tilt off a benchmark, you will have under or overperformance. And I think the legacy first-generation ESG rating systems, some years they're above the index, some years they're below. And so I think our view at engine number one is over time, we can work as investors, maybe less with rating and screening systems and more understanding the fundamentals of each company and financially understanding how what they're doing on governance

and workforce and climate affect their long-term return. But I do think that transforming businesses and industries to take impacts into account, it is a long game. It's not something where you should be judging that on quarterly performance. So I think that's an important question for investors. And that's why for engine number one, we went with the strategy we did with vote, where it is the index. And if you're owning those shares, we can then be very active and activist in helping those companies transform over time. Yeah, very good point there. are less ratings and screenings and the more activist investing.

That certainly seems to be what you're all about. Fascinating conversation. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the markets 102 portion of the podcast. Today will be continuing the conversation with Jennifer Granzio from Engine Number One. Jennifer, thanks for sticking around for the ETF podcast. One of the things that I wanted to talk to you about besides climate change was another area

that I know engine number one has expressed interest in, and that is human capital. You've said you want to try to measure the investment made by companies in their employees. I take that to mean human capital, things like diversity and pay. But can you tell us what does that mean for you and what might you be doing in the future about it? Yeah, that's right, Bob. Thank you. So at Ender No. 1, our business is all about understanding the impacts companies have. on climate and the environment, but also on their workers, their communities,

and their customers. So I guess that's the human capital portion. And we think of our business as working with data and helping companies do the right thing. And so when it comes to social, the data's not as robust today as it is on the climate side. On climate, we've got disclosure on carbon and scope one, two, and three emissions.

There's a lot to work with. However, on the human capital side, we can see that with companies that do a better job on paying above living wages, reinvesting in communities and diversity in their businesses that represents their customers and communities, these companies tend to do better over time. And so that's absolutely a priority area for us. And we're spending quite a lot of time with the data and partners and a network of academics so we can build it out in a dollar and cents impact way for these firms.

Is there evidence, and I know this is all a little bit fuzzy, but is there evidence that companies that pay higher wages to their employees tend to do better or perform better or have higher happiness metrics? And is there a way to measure that? We think there will be better and better data. And as the data gets better, we will be able to do a better job of measuring it. And so it's early, but that doesn't mean that we as investors, that any investor, frankly, that wants to be active and has a view on how companies manage their business or that boards and CEOs don't care about these issues. And so we're going to start with the data that's available that does suggest a combination of paying above a living wage plus benefits plus employee training makes for better, happier,

more loyal employees, which helps the company and also helps the consumer want to do business with a particular brand. And you can see it in the high percentage of the S&B 500 company's values that actually come from goodwill and from brand and are built over time. But we expect to iterate on it. So as the data gets better, our ability to be active on the social will also get better. Yeah, you said to me before you'd like to see a little less rating and screening and more activist investing, which is sort of what the purpose of engine number one is, that makes absolute

sense to me. And you've got certainly a successful strategy with Exxon to show for it. But as you know, you're getting a lot of pushback. The SEC is getting pushback from people who say that the purpose of the SEC, for example, is not to promote what they would call activist agendas, things like climate change or human capital. How do you respond to people who say, forget about the SEC? should not be concerned with those kinds of things that their businesses to make money and to provide profits to their investors?

Yeah, and to number one, our view is capitalism is the answer, but the capitalism that we're all exhibiting today has gotten too short term. And maybe that was okay 30 years ago when there was less data available. But now we think the data is available, very much so on the climate side. It's starting on the social side.

And from an investment perspective, It's not short-term activism. It's just running your firm the right way as a board or CEO to understand what impacts you have on workers in social and climate, how these impacts relate to how your company will perform over time. In a way, that's the essence of capitalism. And so our view and our paradigm at engine number one is not to do last-generation activism

or last-generation indexing. Our view is that it's time to use all the data that's available to run these companies in the right way to drive value for stakeholders, but also to maximize value for financial shareholders over time. Now, you've had a big victory with Exxon. You've got three board seats. Can you update us on what happens next? When will your candidates be seated on the board? When's the next board meeting? Just what's next with that whole part of the story? Our role on the Exxon campaign, and again, this work was led by Charlie Penner at Engine Number One.

Our work was really to be the tip of the spear, put the data out there, help the shareholders drive a change in Exxon so that Exxon can be very successful over time. And so with the three new board members, they're not our board members. They're independent board members that have been elected by the total population of shareholders onto the Exxon board. And so they're now part of that system. And in the next meeting, board meetings over the summer, we'll see what their roles are, what committees they end up in. And we, from an engine number one perspective, will continue to do the work to do the analysis,

work with other large investors to provide, let's just say provide support to the conversation on how Exxon manages through time. Yep, we'll see. It's certainly going to be very interesting over the summer. Jennifer, I appreciate you coming on. Can we get you or Charlie back to bring us up to date, what your next moves are? Absolutely.

We would love to come back and talk more. All right. Jennifer, thanks very much. We really appreciate it. Jennifer Gransio, everybody, is the CEO of Engine Number One. Thanks for joining us. InvestcoQQQ believes new innovations create new opportunities. Here's the greater possibilities together.

Learn more at investco.com slash QQ. Invesco Distributors, Inc.