96. Why social issues have been wrongly ignored by investors

1 October 2020 (pre-recorded 29 September 2020)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Sam Slator (SS): I’m Sam Slator from FundCalibre and today I’ve been joined by Katherine Kroll, senior sustainable investing specialist at Brown Advisory. Hi Katherine.

Katherine Kroll (KK): Hi Sam, I’m so happy to be here. Thanks for creating a space to address this issue.

[INTERVIEW]

[0:18]

SS: You’re very welcome. So, historically a lot of investment research for ESG issues has focused on the ‘E’ – environment and the ‘G’ – governance but the ‘S’ for social has taken a rather back seat. Can you perhaps explain to our audience what social issues are and why perhaps this has been the case?

KK: Yeah, absolutely. So, maybe just starting from the top, I think social issues fall under a pretty wide umbrella. You can think about them as any company or issue or action that impacts people, and that can range from how a company manages its waste, in a way that might contaminate a water source, or the products or services it makes that have a footprint on human rights, like responsible or sometimes irresponsible technology, or maybe most obviously the quality and safety of the job it offers, human capital management, right?

And I think top of mind recently is how company action can proliferate or alleviate racism, which is an issue that, that white folks and white passing folks, as a generalisation, don’t even like to talk about, let alone analyse as an investment risk. So I would argue that that’s part of the reason among others, like issue sometimes being more qualitative than they are quantitative, that we’ve really seen the investor community swarm around the E and the G of environmental social and governance investing. And sometimes at the expense of the ‘S’. I mean, in some ways it’s impossible to completely ignore social issues, right. Just given how interconnected they are with business fundamentals, which I think is why Brown Advisory and many other ESG investors have been looking at social issues at the intersection of sustainability and fundamental performance for years. And it doesn’t mean we’ve cracked the code. There’s so much more work to be done and said, and a lot of it will mean doing a better job at centering impacted identities. But if you really look under the hood, I think [inaudible] doing deep due diligence on a name and not take into consideration the materiality of social issues.

[2:26]

SS: And you’ve talked a bit before about environmental injustice, can you perhaps explain this to our listeners as well? And give us an example?

KK: Yeah, I think… so maybe just flipping that on its head and defining environmental justice, there are a lot of different ways to think and to define it or ultimately make sense of it. But I think about environmental justice or EJ as really being at the middle of environmentalism and justice efforts and including the historically marginalised communities were most impacted by environmental degradation and placing them at the centre of conversation around environmentalism and the company, an issue, or activity that impacts them most.

I think it’s unfortunate how many examples there are to pull from when we think about environmental injustice and ‘unfortunate’ might be the understatement of the century really, right? I think Flint, Michigan in the United States is a pretty recent and completely egregious example, which tells the same story that happens around the world: that certain communities are disproportionately burdened by environmental contamination and health risks. And statistically, those places tend to be locations where poor people and people of colour are concentrated. So in the case of Flint and in the event that it’s an unfamiliar story, the public drinking water was contaminated with lead, and this was as early as I think 2014, fast forward a few years, we’re in 2020, and there are still more than potentially 2,000 impacted pipes. That’s a lot of time to have not gotten an answer, right? And you have to wonder what role do the demographics of Flint play in the lack of solution or justice? Think about the fact that it’s at least 50% black or African American.

And I think it’s risks like these that have led a lot of investors, including our fixed income team, to pass on potential investments that could put similar communities in disproportionate danger. And just one of the many reasons why investors have a responsibility, both in terms of saliency and materiality to understand the full picture.

[4:50]

SS: Obviously there’s been a lot on the news lately and a big shift in public opinion to get some of these things to change. It’s bringing the social to the fore much more and generation Z, – so teens and young adults – are particularly relevant, as they’re pushing a lot of this change and they’re obviously the next generation of investors too. So, do you think we’re finally going to see social come to fore now?

KK: I don’t want to speak for Gen Z, and my comments are obviously informed by conversations with them, but I think you’re completely right that this is a generation that more than ever cares about the values of where they put their money. So, I think it’s good news for investments and for our civil society, that attitudes around social issues are really changing. I think some 90% of surveyed Gen Z or support the Black Lives Matter movement. And it’s really seemingly a generation that values authenticity and can really sniff it out. And so if the company where they’re buying their products from, or the investment manager that they’re trusting with their capital, isn’t meeting them where they’re at in terms of aligning themselves with their values, I think they’ll just look elsewhere. And I would imagine that this would trickle down across, really all economic activity, including the investment profile, just like we saw with millennials.

[6:26]

SS: And thinking about Brown Advisory specifically, and your investment teams, how are you including these social issues in your processes?

KK: So ,when we do our research across our equity and fixed income portfolios, we’re looking at a number of different characteristics and really taking it by a name by name perspective, starting with bottom up due diligence. We don’t think there’s any substitute for examining a name where of course we’ll bring in outside perspectives, and we might look at third party research, but it’s really doing that fundamental due diligence on our own that helps us understand a company in a more holistic way.

And so depending on the sector, depending on the issuer, there might be more thematic risks and opportunities, but we think across the board, it’s important, no matter the need to look at issues like diversity and inclusion, issues like data privacy, issues like human capital management, as these really are all material factors that impact a company or an issuer’s ability to perform. And if we take that long term performance perspective, we know that companies with more diversity are more likely to have a higher innovation-related revenue source. We know that investing in your workforce might have upfront associated cost, but in the long run, it creates a better business model.

And we think about issues like data privacy and AI ethics as really being central to the entire investible universe. We know we have to get these issues right. And if we don’t, not only do we believe that, that company performance will suffer, but we’ll be in a really thorny situation. I think the UN recently came out and noted that data privacy is a basic human right. And who are the folks most impacted by insecure data? It’s going to be the most vulnerable populations, bringing that social issue upfront. And then to connect it back to your previous question, when you look at the values and the attitudes of Generation Z, they won’t stand for it. So, it’s putting on a lot of pressure for us to figure this out. I think we’re at an inflection point and I think it’s why our investment process at Brown Advisory – and I’m sure elsewhere – is taking a full picture approach. You can’t look at these issues in silo. They are too interconnected. What’s happening across the world is happening in our backyard. So I think it’s important that we understand that the environment, social issues and the governance of a company are all coming into play and working in concert with one another, and why we are doing our best to understand both the risks and opportunities that come with addressing them in a responsible manner.

And I’ll just add, I think engagement is an important tool that active managers have in their toolkit to push companies in some cases, or to work collaboratively, as we do at Brown Advisory, with environmental and social leaders, to really address these issues that we’re all grappling with. There’s no silver bullet, there’s no perfect answer, but investors and companies and stakeholders can come together and all be part of what we hope is a solution that provides a positive financial impact and a positive worldwide impact.

[9:56]

SS: You mentioned AI ethics briefly there, and not just that, but also a lot of the people who are actually in very high positions in companies and also government, are mainly white middle aged men, and they are making decisions for the rest of the world, but based on their own experiences. We’re sitting here together talking now, and we’re white middle class women, so diversity of getting both more females on company boards and in government, also people of different races, just to get that diversity and a proper representation of the world, is going to be vital to actually make sure these social changes happen. But from an investment perspective today, how on earth do you go about making sure that you’re including all of that in investment decisions?

KK: I think it’s such a good question. And it’s where the representation piece becomes very important. It’s just one of many factors that go into getting social issues right, and I think we can get very tripped up in ensuring that we have, for example, you know, X percent of women on board, it does make a difference. And we need to make sure, like I said earlier, that we’re centering those voices because otherwise, kind of like when you asked me about Gen Z, I’m taking a removed approach to the answer, but if we can get diverse experiences in the mix, we’re going to have better investments. We’re going to have better outcomes. And we’re just going to have a more holistic approach to these problems that are not small ones. So I definitely think representation is one piece of it.

I think the other piece is not only do we have a lack of diversity; we also have a lack of expertise on issues that are having just enormous impacts on all of us in ways that I certainly can’t even begin to understand. I’m opting into some of the data privacy prompts without fully understanding what those implications are. And so I’m making an assumption that the company knows what’s best for me, knows what’s best for society, but as we’ve seen, like in the case of Facebook, a little bit with Twitter, that doesn’t always happen. So a gap that we’re paying attention to at Brown Advisory is that expertise gap, in particularly when it comes to making products that are essentially using an algorithm to forecast a moral choice, you need to have ethics experts in the beginning and throughout the entire life cycle of product creation. So we need to think about something like facial recognition, for example, who are the people in the room that are governing what that process will look like and exploring the potential risks that misuse of it will have on people that don’t necessarily look like them, or act like them, or have the same income as them?

And this isn’t just a moral question. It certainly is. It’s a big one. But it’s a huge investment risk too. And so we just think, making sure we’re understanding all parts of the equation, be it representation, expertise, public reporting becomes really big, right? Who is accountable to who? We need to have that information in front of us in order to make sound investment decisions. But I agree with you. It’s, it’s a tough one.

SS: That was fascinating. Thank you very much.

KK: Of course.

SS: And if you’d like to listen to more of the Investing on the go podcast, please go and subscribe.