AB strategy invests in ESG improvers

Michelle Dunstan, AllianceBernstein’s global head of responsible investing and portfolio manager of its Global ESG Improvers Strategy, said the firm has incorporated ESG across all its actively managed products since joining the Principles for Responsible Investment in 2011.

AB has $16.5 billion on its “portfolios with purpose,” platform that includes sustainable strategies, low-carbon focused investments, and municipals with impact. Like many ESG-focused strategies, many of AB's tilt toward growth and quality. Not so with the fund she manages with Jeremy Taylor, a trained engineer who heads the firm’s commodities sector.

Their fund, seeded last year after running an internal portfolio since 2018, has a very different purpose. It will be launched this year for all private clients.  

Liz Skinner: Why create a fund that invests in companies you know need to improve?

Michelle Dunstan: About three or four years ago, AB started to think, could we do something more in the ESG realm? And what we noticed was most ESG funds tend to be very focused on the best of the best. They are very much aspirational, where we want the world to look in 10 or 20 years. And that’s great, we need people to invest in carbon capture and sequestration and hydrogen. But the fact is, they also ignore the way the world is today. And if you think about it, only 30% of the world’s oil actually goes into cars. So even if we moved into 100% electric cars tomorrow, you still need a lot of oil. Then what powers electric vehicles? It’s mined commodities, it’s lithium, cobalt, manganese.  So rather than ignoring these kinds of companies, let’s make them do better. We created Global ESG Improvers. The focus in on identifying those companies that have embarked on an ESG journey and are trying to improve. The tagline is Investing in tomorrow’s ESG leaders today. If the product and services are vital to the economy and what’s important in the coming years, let’s engage them today to make them do better.

LS: What’s the strategy with individual investments in the fund?

MD: We are trying to do two things. We are trying to generate alpha and drive improvement in companies that we think are necessary for the economy. On the fundamental side we can actually prove that companies that get ESG ratings’ upgrades outperform. That’s due to a couple of reasons. First, it’s rare for a company to just improve on one dimension, they are trying to get better on a lot of dimensions. So, if a company is enhancing its ESG performance, it’s improving other dimensions too, you are getting a fundamentally better company. But ESG also drives cashflows, we are increasingly seeing more dollars go this way so if you can move up in terms of your ratings and your perception, that opens you up to more investors and drives actual fundamental performance.

We also engage with these companies and encourage them to take decisions that are in the best interests of their long-term sustainable cashflows. It’s really trying to find those committed to improvement.

LS: Do you anticipate a time when ESG screens and policies are applied across all investing strategies?

MD: Ten years down the road, ESG integration — where you incorporate ESG factors into your investment decisions — won’t exist, it’s just going to be called good investment management.  If you are not thoroughly assessing the risk and opportunities of something like climate change, that would indicate that you are not producing the best financial decisions on behalf of your clients. So today where there are ESG integrated factors, that’s just going to be investment management.

I think what will still exist are the category of ESG funds that have ESG goals in addition to the integration of ESG. A climate solutions fund, for instance. or a municipal impact that goes to doing good in underserved communities will still exist.

LS: What are the key SRI themes you are seeing the most growth in right now?

MD: Climate by far is the one that’s getting the most attention. It’s a global issue, it’s not something that people can combat on their own. You need governments, companies, people, regulatory, and behavior all to change in order to adapt to or mitigate climate change. That’s one reason that people are so focused on that. It’s a problem that as a society we need to solve and it’s going to require capital spending and it’s going to create opportunities for some companies and it’s going to create risks for others. That’s one topic across the globe that investors are really looking at. And its very complex, and human action and reaction will also alter the path, so it’s very difficult to understand. There is a huge desire out there to learn more.

LS: How can financial advisers and investors be sure an ESG fund isn’t saying it’s more ESG than it really is?

MD: Like anything else, you need do ask the questions and do the in-depth research. Do you understand the objective of the fund? For my fund, I want companies that are going to improve. So truly understanding the objective of the fund, versus just saying it’s an ESG fund. The second question to ask is, how does that impact your investment process? What makes your investment process different? Is it screening? Are you narrowing your universe at the beginning? Is it through an analysis of assigning a carbon price and understanding that transition?

Then I would ask what resources are you using to do it? Are you just using third party data and tool sets? Are you doing your own analysis? Do you have just your analysts working on these things? The last thing I would ask is are you engaging with these companies? A lot of the data we have is insufficient and the data we do have is backward-looking, formulaic and based on disclosure. What you need to be measuring is a forward thinking point of view, what actions are the company taking? What’s the strategy? That’s what you get through actually engaging with the company.

An investment manager who is actually embedding this ESG philosophy at every stage of their investment process, is probably walking the walk.

LS: Let me turn your excellent suggestion on yourself. What is the engagement process that your fund managers go through with the companies?

MD: We engage for two reasons. We engage for insight, to really learn what that manager is doing and understand what they are doing. What you want to understand is what the directionality is. You want to think about how the company is going to look two, three, five and 10 years down the road on ESG factors. And we engage for action. This is where we try to encourage them to take decisions and strategies and actions that are in the long-term best interests of their sustainable cash flows.

We’ve done this for years on the fundamental side of things. We are generally long-term investors. They often ask us our opinions, or we say, hey, why wouldn’t you do this, or here’s what concerns me. We do the same thing on the engagement side with ESG issues. We think firms that are well versed in ESG are very forward looking. They are the ones that going to be prepared for the coming years in order to give clients the products and services they want and also attract employees who are increasingly making value-based decisions on the way they work.

LS: What are the realistic expectations of the Biden administration?

MD: I think as we’ve seen from stated policies and some of the initiatives that have already come into place, the Biden administration is approaching climate change in particular in a very different way than the Trump administration did. I think you will see continued evolution of policy in the direction whether in support for subsidies for or regulations to prepare the United States for climate change mitigation adaptation. We are proceeding down that path and that is going to create risks for some companies and opportunities for others. We as investors need to be aware of those risks, evaluate them and include that in our decision making. I think you will see continued progress down that path.

In any U.S. administration, the president doesn’t have unilateral say over certain things. There are regulations and Congress. I think you’ll see a gradual yet sustained move in that direction incorporating climate change concerns. I don’t think you’ll see sweeping changes immediately, but I think there will be continued pressure to move in a direction that’s incorporating climate change concerns throughout the U.S. regulatory framework and the economy.

[Webcast: What Biden means for ESG investing in 2021]