ETF Edge - The Big ESG Debate – Bulls vs. Bears 10/3/22

Episode Date: October 3, 2022

CNBC’s Bob Pisani spoke with Todd Rosenbluth, Head of Research at Vetta-Fi – along with Vivek Ramaswamy, Co-Founder and Executive Chairman of Strive Asset Management and Arne Noack, Head of Systematic Investment Solutions for the Americas at DWS Group. They dove into the big ESG debate – pitting the bulls against the bears to lay out all the arguments for and against ESG investing. Some are even calling it a ‘sham’ – so what’s the verdict? And what steps can ESG advocates take to improve visibility and criteria to convince their critics otherwise? In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Todd Rosenbluth. 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 ETF Edge, the podcast. If you're looking to learn the latest insights on all things exchanged, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, breaking down what it means for investors. I'm your host, Bob Pizzani today on the show. We're diving right back into that big ESG debate. This time fitting the Bulls against the Bears to lay out all the arguments for it against ESG.

investing. Some are even calling it a sham. What's the verdict? What steps can ESG advocates take to improve visibility and criteria to convince their critics otherwise? Here's my conversation with Todd Rosenbluth, head of research at Vettify, along with Vivek Ramoswamy. He's the co-founder and executive chairman of Stride Asset Management, and Arne Noak is the head of systematic investment solutions for the Americas at DWS Group. Mr. Ramoswami, thank you very much for joining us. Really appreciate it. Very vocal claiming ESG is an example of woke capitalism. Your strive U.S. energy E.T.F. D.R.L. That's the symbol, tracks an index of energy stocks which attempt to use proxy voting to influence energy companies.

Tell us what kind of engagement you had with the companies your fund owns, like Exxon and Chevron. Are they listening to your message? We've already engaged with 10 publicly traded energy companies. I wrote a public letter, a shareholder letter to the board of directors of Chevron, and I was pleased to see the company was engaged in mutual dialogue. I had dinner with the CFO recently in New York City at the request of the CEO. And that's what I think we need more of in the boardroom. More open debate representing a more diverse set of perspective than we've heard in the boardrooms of these companies over the last several years.

Our perspective is that U.S. energy companies should be focused on drilling, on fracking, on doing whatever allows them to be most successful over the long run without regard to any other political, social, or environmental agenda, leaving politics to the politicians. Now, people on the other side of this ESG debate understandably say that this isn't about politics, this is about maximizing long-run value. You don't know what I say? Great. Let's have that debate because I think what's actually been happening is there were social agendas

packed in starting 2018 and 2019 that have been recharacterized as being in the long-run interests of companies when, in fact, they are not. And I think that that honest debate, I think, is going to be good both for capital markets and for corporate boardrooms. That's what we're hoping to bring to the table. Arnie, I find it amusing that ESG is getting attacked from the left and the right these days. Yesterday, I opened the New York Times opinion section. There's an article that says ESG is a sham.

I'm quoting. They call it a sham because it makes companies look more socially responsible than they really are. And what the Times article argue is we need more stringent ESG guidelines, that they're too lax, which is why they called it a sham. You run several ESG funds. What criteria do you use for these funds? And is ESG a sham like the Times said? Yes, thank you Bob for giving me the opportunity to speak with you today.

So first and foremost, it's most definitely not a sham. What ESG investing is is very simply put an incorporation of publicly available data into investment processes. And, you know, none of this is done opagely, all of this is done very transparently, so no, it's not a sham. I appreciate Vivek's perspective in relation to the honest debate. That one I can very much agree on. That is a debate that we should be having. And because from our perspective, from my personal perspective, the idea behind ESG investing really is that you generate profits

in a healthy and sustainable way through the different companies that you invest in. Yeah, Arnie, I've had my own issues with ESG, and you and I have discussed this over the years. Mr. Vivek might have a slightly different perspective on it, but we both have issues with ESG. You did a piece a few weeks ago, weeks ago pointing out that for all of this crazy debate about ESG, it actually is getting a lot more attention that maybe it deserves. It's a very, very small part of the ESG universe. We're talking

at 6% of the ETFs by number of ETFs out there, 1.5% by assets for the ETF universe. This is a pretty low number for people to be paying so much attention to it. Why is it getting? Look at these numbers. It's pretty small. Right. So ESG is a very small slice of the the ETF marketplace. And in particular, we're seeing the money itself is in an even smaller slice than the number of products that are out there. ESG is a way of getting exposure to certain trends, environmental, social, and governance, but it's a wide range of products that we're talking about.

You've got socially responsible ETFs like she, which focuses on corporate diversity and exposure there. You've got products like Tan, which is the Invesco Solar ETF. which is focusing on trying to prevent climate change. And you've got broad market products like what ARNA has at USSG, S&PE, ESU. There's a wide range of these products. And the fact that we group them all together makes it hard to even have that healthy debate that we're talking about. Yeah.

Mr. Ramoswami, I hear this criticism, the funds that have ESG are pushing a social agenda. But aren't they just providing a product that some people want? I mean, your fund, DRLL, L, you've garnered 300 million in assets. in a couple of months. Hats off to you, that's a very respectable number for a new ETF product. Should be very pleased with that. But you're providing a product. Somebody wants that product. You're providing. Isn't BlackRock or Vanguard? Aren't they just doing that as well? Look, I think that that's great. I think a diversity of perspectives and a diversity of client demands deserve to be served. But I think it's actually really important to point out one aspect of the last discussion you just had.

Yes, ESG ETFs are a small portion of the total if you divine ESG on the basis of stock selection. And that's where you get into the debate about green smuggling. Are these funds actually doing the thing that they say they're supposed to do? I'm actually focused on a different problem, on greenwashing. I'm actually focused on the different problem of what I call green smuggling, which is actually the broader range of ETFs that aren't marketed as ESG at all, but are using ESG-linked voting guidelines and shareholder engagement principles to engage with companies and to vote their shares even in funds that were not marketed as ESG in the first place.

And in that case, you're talking about a much broader swath of the market. So the way I look at it, is if you're an owner of capital and you want with your money to tell companies to pursue environmental agendas or social agendas, it is a free country and you are certainly free

to invest your money accordingly. But the problem that I see is a different one where large asset managers, including the big three, are using the money of everyday citizens to vote their shares and advocate for policies in corporate America's boardrooms

that most of those owners of capital did not want to advance with their money. So I think that transparency is really important and you're right. Everyone does deserve a choice, but the problem that I see is that the large asset managers are green smuggling, are using their non-ESG funds to vote their shares in accordance with ESG principles. And that's really where the betrayal of trust occurs and even that fiduciary gap that I sometimes talk about. That's that fiduciary gap, using somebody else's money to vote in ways that they wouldn't want you to vote if they actually knew what was going on. Yeah, I want to go back to the proxy debate in a minute and talk to Arnie about that.

But I just ideologically want to sort of make this simple for the viewers, because it gets some confusion. Vivek, this debate's been around for a long time, right? The discussion we're having here, Milton Friedman argued 50 years ago that the sole responsibility of a company is to make profits for its shareholders. And in recent decades, you know this. There have been other points of view, the stakeholder model, for example, that posits there are multiple constituencies impacted by businesses, the employees, the suppliers, the communities that should be considered. So ESG sort of comes out of all of that, right? So you're sort of representing a particular ideological position on what the proper role of a corporation is in the world, right? I'm not sure I would call it ideological, but I do think it's really important to identify the best argument for stakeholder capitalism.

So look, Milton Friedman made that argument, you're right, but in the subsequent years, Klaus Schwab and others in the stakeholder capitalism movement have made the point that society gave great benefits to corporations and their shareholders like limited liability. and that entails a grand bargain to say that corporations have to take social interests into account. I'm sympathetic to that position. I don't agree with it. I wrote a whole book unpacking this, but I think that's a worthy point of view. I think the odd thing that's happened in the last couple of years, though, is that asset managers have started to say that's not what they're doing. This isn't about earning their social license to operate, which is what Larry Fink said they were doing a couple years ago. But this is just about maximizing long run value.

And I think that confuses the debate because at the end of the day, either there's a tradeoff, or there isn't, I think there are worthy arguments in favor of the stakeholder model and the trade-off. But if that's really what we're doing, let's talk about that. If we're just talking about value maximization, then let's have that debate. But I think part of what's happened in the last couple of years is the debate has gotten confounded by the jiu-jitsu, the verbal jiu-jitsu of talking out of both sides of their mouth. And I think that honest debate, I think, will hopefully progress this debate forward in a more productive way. Well, let's talk about proxy voting. Arne, you've got two ESG funds. You've met you run them. What is your position on proxy voting?

Explain what you do here because this is obviously a concern to Vivek. It's a core issue with him, the proxy voting. What do you do? How do you handle this? Yes. I would actually argue that it's not only a concern of Vivek, but a concern of all of our investors and investors generally that that transparency that Vivek speaks of is there.

And as such, as a U.S. registered investment advisor and U.S.-based asset managers, we have to publish our proxy guidelines, meaning anyone who invests, with us can at any point in time by our website or consulting with us understand what are the guidelines that in our case, DWS or all of our competitors actually apply to our funds and what that means concretely. So the transparency to some degree is there. We can have a healthy debate whether that's sufficient for the end investor, whether, you know, an average investor in the U.S.

Do you participate in the proxy voting? Yes, for sure. Yes. This is sort of the core of the issue that we're discussing here. And how do you do that? Explain it to the viewers. Yes, so proxy voting is relatively basic. If you're a shareholder of a company, then you have the right to vote, assuming you hold voting shares of that company,

and you're entitled to express your opinion on uncertain matters that are being put to a vote. And as fiduciaries or as fiduciary asset managers, fiduciary asset managers have the obligations to say what it is that they do with those votes. And so here it then becomes a case-by-case decision-making process that each shareholder and each asset manager needs to decide how do they want to explore and implement their voting policy in such a way that it is in the best interest of shareholders. You know, Todd, I've got to get back. This irony is really striking. We spent, you know, I've been talking about ESG for years and all of a sudden, it's getting attacked politically in a way it never was before. but on the right and on the left here. The New York City comptroller, Brad Lander,

just sent a letter to Larry Fink, the head of BlackRock, demanding that the company bolster its climate disclosures and publish a plan that establishes a commitment to net zero greenhouse gas emissions across its entire portfolio. So, you know, people are trying to get involved on all ends here, trying to get more and more companies

to do whatever they want to do. And it's getting to be a real, mishmosh. It's not an intellectual discussion anymore about what is the proper metrics or are ESG funds mislabeled, which I think many are. I have an issue with ESG on that front. But it's amazing to me how suddenly political this has become. Yeah, ESG has become the stand-in or the villain for so many of these, for people on both sides of this. If you want to be able to have somebody be focusing more on it or less on it. And so that's what's intriguing to me.

You know, I Shares has I Shares global clean energy, ICLN. That's the largest of those clean energy ETS. But they offer exposure to energy companies. They offer exposure to technology companies through more traditional ETFs. They are not an ESG ETF provider. They are a provider of ETFs that includes ESG products, the same way that's Stage Street, the same way that DWS are. That's what these firms are.

They are not ESG only firms. So the fact that we have an anti-ESG, a couple of firms that are out there is ironic because there is no ESG only firm of any size and scale. Yeah, and then we have Texas officials saying that people who buy ESG funds are boycotting energy, and yet you pointed this out for even I shares, their funds, their largest funds, ESG funds, have a substantial energy position, partly because of the way the funds are constructed. They're required to have a proportion. So it's a little tough one.

Did you want to say anything? I'm sorry. Yeah, I just wanted to draw one important clarification, because I think this gets confused in the debate all the time. You're right that there's no one such thing as an ESG firm if you're talking about ESG funds as it pertains to stock selection. And you know what? I think it is kind of a shallow critique to say that these firms are boycotting energy

when they have energy funds. However, these firms are ESG promoting asset managers as a firm when it comes to their advocacy behavior and their proxy voting behavior. And that is exactly what the New York City Comptroller was talking. about because New York and California, what they did to Black Rock and Vanguard and State Street and other firms is that they said you need to adopt firm-wide commitments to advance the goals of the Paris Climate Accords to get to net zero by 2050 to advocate for modern diversity equity and inclusion standards. So with all due respect, I think it's not accurate to say that these

firms are not using ESG-link principles to vote all of their shares. You're right, if you're BlackRock, only 2% of the AUM of externally managed funds is indeed in ESG funds. That's true. The rest of the remainder of 98% was not invested in ESG funds. And that is actually the heart of the problem, in my opinion, is that it's not just the 2% but the 100% that lives by this firm-wide commitment that, yes, some clients demanded, but other clients didn't necessarily want. And so I think it's really important not to conflate the stock selection side of ESG with the shareholder engagement in proxy voting and advocacy side of ESG, where absolutely,

with all due respect to Todd, there are absolutely ESG firm-wide commitments that each of these firms have made at behest of some of their largest clients, including California and New York. Well, actually, it sounds like we're arguing the other side of it, because if the New York is saying that they're not going far enough, so you're saying they're going too far, and New York is saying they're not going far enough. Not quite. They're probably somewhere in the middle, and what people are doing is putting money to work into a broadly diversified ETFs and getting exposure to the market, not necessarily getting

the market as it relates to who owns those individual shares. That's not what New York said, though. The New York City Comptroller said that that ran against BlackRock's prior commitments. And so this is the heart of what happened in the last four years. And this isn't that well known, so it's important to see it. California and the state of New York and other large investors, including pension funds, went to these large asset managers and said, you need to adopt firm-wide commitments with all of your capital

to vote your shares accordingly and to advance certain important goals, Paris Climate Accords included. And so when they did that, that was a firm-wide commitment across all of their funds, not just the money they were managing for states like New York and California. So when BlackRock is now saying that they don't actually impose these emission standards on companies, states like New York are saying, wait, that violates those prior commitments that you've made. So I don't think that it's about being somewhere in the middle.

I think it's the fact that with the voting guidelines, that was something very different that happened than with the ESG funds. And one of the failures in this debate publicly in recent months is that the stock selection side of ESG, which is only a small portion of the total, has become conflated with the voting an advocacy side of ESG, which is rampant across all ESG and non-ESG funds managed by these large asset managers. That's the heart of the debate, and we can't confound that with saying that this is just a matter of a misunderstanding. Now, Arne, let me just move and address these accusations that what the Times said yesterday, these ESG funds really don't do what they imply they're doing,

and this is a problem I've had with ESG for years. I mean, if you look, most of these ESG funds, and you run of them. The S&PE leans towards big cap tech funds. They tend to pick like that way. Apple, Microsoft, Amazon, your largest holdings in S&PE. This is an ESG fund you run. Along with ExxonMobil, you have a 2% position in ExxonMobil in this. But this has been a criticism for years that, you know, you have these big holdings.

And there you have what you have in this fund right now, the S&PE. And yet it looks like a big cap growth fund, essentially. And is there a way to improve the criteria? If you really do want to go with what the criticism, The York Times said, which is this is a selection process that lacks refinement in it, if you really want to deal with ESG. On the other hand, can you argue you're choosing the best companies for that particular interest, for the ESD interest? Yeah, so Bob, I would say all of those positions aren't actually mutually exclusive or controversial as such. So, regarding the point, is it possible to improve upon ESG scores? Do ESG scores broadly represent what needs to be represented within ESG context?

I would argue that, you know, whether you look at scores from MSCI, Sustainalytics, which is used by SNP, is there room for improvement? Yes, there always is and there always will be because you don't start at perfection. Perfection might be something you strive towards and as long as you can operate within excellence, which we believe we do within our ETFs, that is something that I would say is commendable and noteworthy. So to your point on SNPE, that fund in particular is designed to be an ESG version of the standard SNP 500 index.

So in makeup, both in terms of industry group or sector composition, it will be extremely similar to the standard SNP 500, except for within each of the industry groups, we don't invest in 25% of the worst companies from an ESG perspective of each industry group. So do we ban energy companies? No, absolutely not. Our weight in energy will be roughly equivalent to that of the S&P 500. Which is 4%.

Exactly. Right. So you're going to own 4% of the energy companies. Exactly. Yeah, but how are you going to choose energy companies within that 4%? What criteria are you using? Yes, so imagine all of the energy companies that are in the S&P 500. These are ranked by ESG scores.

So essentially from top to bottom, you have the top-ranking ESG companies, such as the ones that we just saw on screen, and you have bottom-ranked companies that don't do so well from an ESG perspective. And we screen out those bottom-ranked companies only investing in the top 75%. Right. So Vivek, his fun, for example, does, you do exclude tobacco, for example. We have certain business exclusion. Controversial weapons, I know that. Do you have a problem, Vivek, with the fact that he actually owns 4% energy stocks in his fund,

but he ranks him by an ESG criteria. So he's not excluding itself. Your point of view, I understand your point of view, but you understand what he's trying to do. He actually owns Exxon Mobil. Yeah, and I have no problem. I have no problem with the approach just described. I think that every investor with their own capital deserves to have the kind of exposure that they want, as long as it's a problem.

that's transparently communicated. So I have no issue with funds that have even exclusions. Let's say it was a fund that's still outright excluded energy. I still have no problem with that. The problem that I have is let's just get in a really specific examples. I'll give you two. The scope three emissions reduction proposal

at Chevron in 2021 that the board recommended against or the racial equity audit at Apple, which was proposed this year that Apple recommended against. Both of those carried majority shareholder support with supporting votes from BlackRock and State Street. And Black Rack and State Street did not use the money from their ESG funds to vote in favor

of these ESG proposals, not just the ESG funds. They used the capital of all of the funds that they managed to vote in favor of the scope three emissions reduction proposal at Chevron and this racial equity audit at Apple, in both cases proposed by nonprofit or nonprofit-like groups that said they had no profit motive and that the boards initially opposed as well.

To me, that is the slate of hand. That is where I do have a problem, is using the money of a bunch of everyday citizens in ways that frankly many of them would disagree with if they actually did know what was going on it just most people go on apple they don't think that they were voting in favor of this your position is your position will be black rock or

a black rock should not vote on something that's not in the c sg on that apple proposal they should just be neutral what what would what should black rock do look i think that they should vote according to what they told their investors they were going to do with the sole focus on maximizing the pecuniary interests of stockholders. And I find it very difficult to believe when the person who put up the racial equity proposal

and Apple's board, who disagreed on whether to adopt it, still agreed on one thing, which is that it had nothing to do with Apple's pecuniary interests. I have a problem with using the money of somebody else who invested in funds with the expectation that the person who's voting those shares is only going to take pecuniary interest into account, actually taking these other social factors into account instead.

That's the slate of hand. Different than the fund you were just talking about with Arnie, which is, hey, it's free country. You know, you can offer whatever kinds of stock selections in and out. I have no problem with that. But using someone else's money to vote or advocate for policies that they don't believe that they're actually advocating for with their capital. That's the problem, and that's why I, you know, aim to bring added choice to the marketplace with the ETF that Strive launches. We're ETF nerds here.

I just want to ask you about the fees of DRLL. The expense ratio is 41 basis points. But you're running essentially a big cap oil fund here. It tracks the largest energy ETF, the XLE, which only charges 10 basis points. if you're a real nerd around this, and we talk about fees all the time, it's a lot to pay for essentially a big cap energy fund. What do you respond to people when people point that out? Thanks for bringing that up.

So we've launched two funds to date. One is DRL, that is the U.S. energy ETF. The second is STRV, the Strive 500. That one is five basis points, tracking 500 of the largest U.S. publicly traded companies. In fact, in both of the cases, we look to other large firms, like BlackRock, like the big three that we're aiming to compete against, to set a fee benchmark. And at the time that we launched DRL, I believe that BlackRock's U.S. Energy Fund, you could look up what that fee is.

It's, you know, I think today 39 basis points. I think it was 41 basis points around the time that we filed for our product. But the point is here for investors, the key differentiation that Strive wanted to bring to the market was not stock selection. These are, after all, index funds tracking just an underlying index. You're right. Passive asset management. But bringing it actively engaged voice and vote to the table, both through proxy voting. as well as through shareholder engagement.

You take the public letters that I wrote to the boards of Chevron, of Apple, of Disney. You know, that might be the kind of thing that you see from historically activist funds. Well, this is a passively managed fund, but taking an active approach to shareholder engagement. And, you know, one is 41 basis points, the other is five basis points, and you can take a look at where BlackRock is across the board. That's kind of one of the things we looked at as well. Well, that's a fair point. You know, his point here is this is competitive with ESG products out there.

And what you're paying for is the active engagement. That's essentially, I mean, Vigvick is not disagreeing that it essentially is a large cap oil fund. But he's choosing BlackRock as the villain in this case. He's not choosing State Street that has 10 basis points for its exposure. He's choosing BlackRock because, in his opinion, BlackRock is doing something contrary to what the shareholders should be doing. That's his opinion for that. Investors are going to make that decision. But I would note that the I shares U.S. Energy ETF saw significant,

inflows within the past month, even though this product has come to market. So again, investors have choices, but IYE is out gaining DRL. Well, it helps that oil has stabilized. I mean, there is a fundamental story here around energy. That certainly makes a lot of sense. 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. We'll be continuing the conversation with Todd Rosenbluth from VETify. Todd, I want to switch the conversation around to move it away from ESG and talk about the final quarter of the year and the second half in terms of flows of ETFs. It's been a crazy year of volatility. We are continuing to see inflows,

overall inflows into the U.S. market. 400 billion so far, close to $7 trillion in assets, and yet most of those inflows are still plain vanilla. It's just S&P 500 funds, things like that, right? That's right. So we just talked for a bit about ESG. That remains a very small slice. of the overall ETF pie. Most of the money has been going into these broad market ETFs, your I shares core S&P 500, your Vanguard total stock market, ETF, and in fact the

ETS that are tied to the S&P 500 have seen net inflows this year despite the fact that we are in a bare market for the S&P 500. Investors continue to allocate in using the opportunity to take advantage of the sell-off and allocate towards equity ETFs to continue to to gain exposure, but we've seen value, we've seen dividend, we've seen low volatility investment styles pop up quite notably compared to, for example, growth.

Yeah, and one of the things that's interesting is outflows. Europe's getting killed, right? They're seeing significant outflows. That doesn't really surprise me that much, right? Investors tend to be late and reacting. This may be the bottom in Europe, who knows, it may be a great time to invest, but we're seeing outflows from Europe, right? Strong dollar, I see outflows from emerging markets, for example.

Right. address that. Right. So we've seen ETFs that are specifically dedicated to Europe. So the JP Morgan Beta Builders, Europe, ETF, BBEU, the Vanguard foots of Europe ETF, seeing significant outflows, but investors

are still allocating towards broad, diversified international equity. So, IShares, Core, MSEI, IFA, ETF, or Vanguard's ETFVEA, have seen net inflows. And of course, that has exposure to both continental Europe and Japan. But we've also seen outflows towards some of the higher risk assets, high-yield bond,

ETFs like YG and JNK from I shares in State Street, respectively. People are not willing to take on the risk within a fixed income market. They're hunkering down into safer treasury products this year. I wonder how much this is. We haven't seen a down market like this since 2009, really. And everyone has been so used to the idea that, you know, there's a whole group of investors who've never seen a down year in their investing career.

And the down year in bonds and stocks is really a rarity. So the S&P's been up 15% a year on average it's 2010. And you know the historic average is closer to 10. So the significant outperformance. And now we're finally having a down year. Part of this is due to what happened with COVID and the inflation. Part of it is the effect of withdraw on the Fed stimulus over the last 12 years. Do you think this time next year, let's assume we're flat this time next year

from where we are now? Do you think we're going to still see inflows? I do. I think what we saw, what's impressive is we've seen money continue to move in during a down period. But you just remember, we had record inflows. Almost a trillion dollars of money went in to ETFs last year, in part on the back of strong equity and strong fixed income markets. I think what we're going to see is many investors are looking to 2022 and their mutual fund statements seeing the losses pile up and they're going to move into ETFs in 2023 because why am I going to pay? so much money to lose money and also pay taxes, perhaps, at the end of the year. So I think we're going to see January, February, be very strong for ETFs, even if the equity market recovers. Remember, we're talking to an ETF guy here, so take that with a grain of salt, but that makes

perfect sense in terms of an analysis. I'm going to have to leave it there. Todd Rosenclos, the head of research at Vetify, and everybody, thank you for listening to the ETF Edge podcast. Investco QQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQ, Invesco Distributors, Inc.