ETF Edge - The NAACP ETF & Social Justice

Episode Date: June 15, 2020

CNBC’s Bob Pisani spoke with Marvin Owens, senior director of economic programs at the NAACP, Ethan Powell, founder and president of Impact Shares and Ben Johnson, director of global ETF research at Morningstar. They discussed the rise of ESG, transparency in Corporate America and the Impact Shares NAACP Minority Empowerment ETF (NACP). In the 'Markets 102' section, Bob discusses socially responsible investing. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things exchange-created funds, you're in the right place. Every week we're bringing you interviews, thoughtful market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll take a look inside the world's first racially empowered ETF. That's the impact shares, N-A-CP, minority empowerment, ETF.

The symbol is NACP, and why ESG may not be as hard. to define as it seems. Here's my conversation with Ethan Powell, CEO of Impact Shares, and Marvin Owens, the senior director of the NAACP Economic Department, along with Ben Johnson. He's the director of global ETF research at Morningstar. Marvin, let me talk with you or start with you, giving us a little bit of background on this particular ETF. It's been around for a couple of years. The assets under management are still pretty small, although they have been growing. discuss how this was created briefly and what you're trying to accomplish here. Well, thanks for having me.

We see this fund as the next evolution in our corporate advocacy work around closing the wealth gap for African Americans in this country. The NWACP had been doing corporate scorecards for the last 25, 30 years in which we would gather data from corporations and score and rank those companies, along their commitments to hiring in C-Suite's, supplier diversity, community engagement programs, and the like. And we saw this as an opportunity to really kind of take that advocacy to the next level. It was a wonderful opportunity presented by Rockefeller Foundation and Impact Shares. And we wanted to get involved with this because it's important that corporate America really do more than make statements about their commitments to closing the wealth gap and,

ending racial discrimination, but really take steps internally and externally to make sure that's true and gets lived out in how they function and operate as businesses. So you've been doing a corporate scorecard. You mentioned this for 25 or 30 years. Sounds like the NAACP has been doing ESG, a sort of ESG, is what you're describing, for a long, long time. How do you feel, Marvin, about how the whole ESG business is evolving? Is it involving in ways you think is the right way? to evolve? There's a lot of debate about what goes in these, what the emphasis is on them, for example. Yeah, I think it's a great point. We have been added for a long time. The problem that has existed with ESG is that the S has been very, very difficult to define. And that's why an

organization, like the NAACP, with its 11-year history of being advocates for African-Americans in this country, is the right kind of organization to be partnering on this kind of work. Because we've had the track record in history of doing this work. That's why I think it's going to change in terms of creating some sort of standard, some sort of baseline for folks to understand what does it really mean to work hard to eliminate racial discrimination in a corporate environment. So that's why I think it's important for us to be having been involved in this effort. Yeah, Ethan, let me turn to you. You were involved in creating this and I want to get to talk a little bit more about what Marvin said about what is in the S and ESG. But you know, what's your market?

to me when I look at this, is there, again, I see a very heavy emphasis on Amazon as an ownership stock, Apple, Microsoft, other big cap names, Johnson and Johnsons of the world. How do you decide what goes into this kind of fund, what decisions go into it? And why are so many of these ESG funds so similar? Why do they all have the same mega-cap names, it seems like? Hey, Bob. That's a great question. And for us, it's really about evaluating the social and environmental outcomes based off, do you have the right people process and philosophy to accomplish what you're setting out to accomplish? And just as you might pay a sub-advisor for an actively managed financial outcome, in this particular situation, we're paying the NAACP, all of our

net advisory proceeds to help fund their corporate engagement and to achieve these actively managed social and environmental outcomes. So, and then to answer your question as far as the underlying holdings, we don't pick the holdings, right? So we work with the NAACP to craft what it means to be a good corporate citizen through the lens of the NACP specifically as it relates to issues impacting people of color. So as Marvin pointed out, that's supplier diversity program, that's digital divide programs, that's diversity on boards and senior leadership, that's anti-discrimination, hiring, paying promotion practices. So once we craft sort of the priorities, from a social standpoint.

Sustainaletics, who's our ESG research partner, scores the public companies based off of those criteria, arrives at the top 200 scoring companies, and then Morningstar, as our index partner, creates a index that is designed to minimize tracking error to the broader market. So you've got your financial data with what we call social alpha,

and financial alpha, superior risk-adjusted returns, social alpha, superior corporate social outcomes relative to your social and environmental priorities. And, you know, there are some crossovers and mega-caps are disproportionately represented because, frankly, they're the ones that are committing the resources, not only to having these programs in place, but also reporting on the programs. And it's a lack of transparency and data in a lot of cases that ends up crafting who actually gets in the index.

Yeah. Well, let me just talk about what goes in the index because, Ben, Morningstar, you've got the Minority Empowerment Index. That's what we're using here. That provides exposure to U.S. companies that stand out for their commitment to racial and ethnic diversity. Tell us about that index. Tell us about how you decide what goes in that. And is this part of a broader trend, particularly this ETF here we're talking about today, more specific ETFs in the ESG spaces? that address specific social issues rather than just rather broad ESGs, for example. Is there any trend here? Yeah, Bob. So, well, I'm coming at it from a research perspective, and my team's not directly involved with the manufacturing of the indexes. I think one of the key points that both Marvin and Ethan have touched on is data and data availability and the quality of data that is available to form the foundation of all of these ESG

indexes, be they. focused on a more narrow theme, as is the case with NACP, or be they broader spectrum ESG? There are inherent challenges in this space defining what is success and what is failure across all of these different criteria. And generally speaking, what you've seen is that among the 90 or so ESG ETFs that are out there today, there's really only a small handful that focus on more narrow. spectrum social issues. So nine of the top 10 ESG ETS right now account for about 70% of all the money that investors have put into these funds. And nine of those focus broadly on ES&G. And look to balance

as Ethan deemed it, the financial beta. So investors want broad market exposure, but they want broad market exposure while also simultaneously trying to invest with those companies, they're going to make a dent across all three of those criteria, be they environmental, social, or governance related. And we've seen real meaningful flows into all of these funds in recent years. And I think it's a trend that's only going to continue. And I think the data and the definitions are only going to get better with time. Yeah, that's part of the problem I have with all of this. The definitions are a little slippery. But Ethan, you brought up a very good. point. I keep asking, why are mega-caps so strongly represented in these ESG funds? Your point was

that reporting, they do better reporting than everybody else, about what they're doing. And there's a certain lack of transparency when you get further down, the food chain, I think. I think that's a very good point. What, if anything, and Marvin, this addressed to you, can we, what can we do to get companies be more transparent so we can measure this a little bit better? I keep complaining. I keep complaining. that part of ESG is a lot of this falls into what we call qualitative research, which is very difficult to put numbers on, to quantify in a way. So Ethan and Marvin, both you take a shot of this. What can we do to increase transparency around these issues?

Yeah, I'll go first. I think it's important that we make the case that by engaging with an organization like the NAACP and being more transparent about what's happening is going to be. want to sort of increase their opportunities in the market. The kind of engagement that's kind of resulted from this fund for us as the NWACP has resulted in companies who wanted to talk more about what can we do to change? What can we do to improve in these areas around supplier diversity and recruiting more diverse candidates for C-suite opportunities? It's the engagement that has allowed for improvement. Yeah, and Bob, I think I would just echo what Marvin said, but what we're

trying to do here is provide incentive for corporate America to report because I think it's one thing to be in an ESG fund that is that is trying to be all things to all people because it's hard to communicate what that actually means. It's a very different thing to be able to say, you know, we are in the NWACP Minority Empowerment Fund because these are the 10 things that the NWACP cares about and we do a better job relative to our competitors, right? So our goal is to have inclusion in this fund become a compelling point of differentiation for corporate America. And that's when it starts to justify the cost of compiling and reporting some of this data, because if not, you're going to get left behind by your competition in a world that is

increasingly difficult to separate your products and services in. Yeah. Ben, this is a very slippery subject, but take a swing at it here. I mean, for me, social investing is the most difficult of the ESS. to really define. It's pretty broad. I mean, what's the criteria that you're using? Is it how you treat minority employees, for example? Is it how much money they donate the social justice causes? Is it how much weighting should be given compared to other social issues or against environmental issues or against governance issues? You can get different outcomes. Some companies will include oil companies in their ESG, even though other companies consider oil companies.

not to be involved. Some people want oil companies that are the best ones doing the least polluting, for example. I'm using a little environmental, but social is a really tough one to define. Well, Bob, I would argue they're all very tough to define, and really the devil's in the details. And the details depend on the provider of the data, the supplier of the data in question. And so it really is incumbent upon investors when they're looking at all of these different funds to dive into the specifics. And if they see an oil fund in the portfolio, you know, they might be scratching their head. But that might be one of the better actors among all of the different oil producers that's out there. They might be investing at the margin to increase their exposure to clean energy and renewables.

So, you know, it gets back to the fact that this is very definitionally dependent. for all intents and purposes, it's a form of active management. It's an active construct. So investors need to know that every portfolio is going to be distinct, that it might get you various levels of ESGness from watered down to very potent, and that you're going to get something different from the market over a long period of time. So, again, if we look at where the vast majority of money is now in these funds, it's invested in those funds that have the highest financial beta, right?

So they look the most like the stock market, which explains why you have regular showing from all of the mega-cap names that we all know so well. You know, that will continue to evolve over time. I think the choice in the space will continue to evolve over time because my ESG is not your ESG is not the next guy down the road's ESG. It's a very sort of personal topic. So I think you're going to continue to see an evolution in the space and more and more. choice, be it in terms of broad-spectrum ESG, or funds that focus on more narrow issues like NACP. Yeah, it's always interesting that Occidental Petroleum always shows up in these ESG funds that

include energy because it's, by the criterion that are normally used, particularly on environmental, Occidental does better against various metrics than most of its competitors. So there it is, and yet people say, why is Occidental there? I say, well, they're less polluting. They're more environmentally friendly than there are other competitors that are out there in the same space, essentially. Marvin, I'm going to give you the last word here. Of course, every investor wants to know, I want to do the right thing. I want to invest in socially responsible, socially just causes, but I also don't want to lose money. Have you been heartened at all? What's your reaction to investors as we're grappling with these issues of social justice? Do you see a real awakening, and I don't just mean on the social front, I mean actually on the investing front. Do you think that this could actually make a sea change, a real sea change in

difference? ESG has already been moving in this direction, but that this could push it even further and more carefully define the boundaries of what constitutes ESG? Well, I absolutely think so. And I think in the current environment where everyone is kind trying to figure out how can I get involved, what can I do? Capital has the power to make social change. And I think that theme is something that we're seeing get played out as investors began to look. I mean, this has been more than 10 years now where investors were making decisions on their investment based not on not only on returns, but on the quality of the companies that they were investing in by their commitments to sort of environmental issues. Now the same thing

is beginning to happen on social issues. And I think when it comes down to investors influencing what's happening, I think the truth is it's going to happen. I think the reality is investors are going to be able to push a process that results in real change on a social and social justice. And I think companies are getting the message as well, because as they really grapple with how to show up the right way in this moment, they're being challenged by the NAACP and other organizations to make sure that the rhetoric that they're using around on making commitments, public commitments to stand against racial discrimination, is actually getting played out and lived out in the way they do business internally.

I think this is really a watershed moment, and I think we're just at the beginning of it. I think investors are going to be raising their voices in more powerful ways in the future around social issues. Yeah, I agree with you, Marvin. I think this sounds like something that actually is not something we do for a week and then the news cycle overtakes us. This has a feel of more permanence to it.

I hope that is the case, long overdue. Now it's time to round out the conversation with some thoughtful analysis and some perspective to help you better understand ETFs. This is our Market 102 portion of the podcast. Today we'll be doing a deep dive on social justice, what it means and how investors can think about it in the context of ETFs.

My producer Kirsten Chang joins me now. Bob, we've hit on ESG in previous episodes of the show and the podcast, but given the turmoil we're facing across the country and really the world, talk to us a little bit more about the elusive S in that social. People hear ESG and they think of socially responsible investing, but is there a difference between socially responsible and socially just? And how can investors better define that? You know, Kirsten, the problem I've had with ESG, with environmental, social and governance funds, is that the definitions are really slippery. So environmental criteria can include almost anything. It can include a company's energy use or climate or renewable energy or waste or pollution or ownership of contaminated land.

It can even include the treatment of animals. I've even seen that. Governance is really slippery too. It can include accounting methods or voting rights or conflicts of interest from the board members. It can include inclusiveness or executive pay and even how the board addresses environmental and social issues. But of the three, the social criteria one, that's the one that's most difficult to characterize. So in theory, you're looking at a company's relationships with employees in the outside world. That's social.

But it can include engagement with charities. It can include employees and their volunteer work. It can concern how much is shown for employees' health. It can include diversity. It can include fair wages. But it can also include privacy and product safety. It's a pretty broad category, and that's the problem with it. It can include how much other stakeholder interests are respected.

So stakeholders are people and institutions besides the shareholders who are impacted by the company. This interest in social justice falls squarely into that S part of ESG, but depending on your preferences and how hard you look, you may find it very underrepresented in these ESGs, depending on what you think is important in this social part of this. So what's the criterion? Is it how they treat minority employees? Is it how much money they donate to social justice causes? Is it how much weighting should be given compared to other social issues or against environmental and social governance? You see, there's a lot of tradeoffs in all this, and it's still in the process of being defined.

And what I suspect is there's going to be a bifurcation. You're going to get some broad ESG groups, and then you're going to get some, like the one we were discussing today, that very specifically discusses particular issues. Is the universe of companies that satisfy the criteria big enough to warrant more ETF creation in the long run? We don't have that many at the moment, but what do you personally need to see to believe that it could really gain traction among folks out there? You know, Kirsten, even before all of this happened, the ESG funds were getting big inflows into the U.S. and it's a really established investment ideology in Europe. It has been for a number of years. But these are really broad investments, these ESGs, the way we talk about it, as a component of the process when they're building their portfolios and choosing investments.

They cover very broad topics. What I think might change now is you may find more focused ESG groups. I mean ESGs that are expanding what constitutes, for example, today, social investing. And I think we're going to get very specific investments like this impact shares, NAACP minority. Empowerment ETIF that we were discussing today. So these funds focus very specifically on broad themes around social or environmental impact alongside financial returns. But I think you'll see them even more focused. For example, I think you're going to see more funds around social justice. I think you'll see even more funds that combine things like social justice and renewable energy

or even gender equality, for example. My point is, I don't think that what we're seeing around this discussion of social justice is something that it's just part of the news cycle that goes away. This has a feeling to me of being much more permanent and getting much more embedded in corporate thinking processes.

And that's a good sign. It's a good sign for ESG. It's a good sign for governance. It's a good sign for inclusion. It's a good sign for the way boards will look at their responsibilities. I view this as all very positive and I think ESGs and ETFs are going to be very broad beneficiaries. That's it for today. I'm Bob Bizani. Thank you for listening and make sure you tune in next week. And in the meantime, you can tweet us your

questions or topic ideas at ETF Edge, CNBC.