Green Shoots: ESG Investing and Innovation Stocks
Annika: Hi. I’m Annika Lombardi, a Portfolio Manager at Lord Abbett. And you’re listening to Green Shoots.
For this episode, I sat down with Matt DeCicco, a Partner at Lord Abbett and Director of our Equity business. We discuss the dynamics of incorporating environmental, social, and governance – or ESG – factors into a growth or value strategies; how his team incorporates research from ratings agencies; and how ratings may not provide the whole picture when it comes to newer, more innovative companies. This last bit is especially important because, while ESG investing has grown and evolved exponentially in recent years, Matt says there are still areas where in-depth research – and an active approach – make a big difference.
Thanks so much for being here, Matt
Matt: Hi Annika. Thanks very much for having me
Annika: One of the first things Matt and I discussed was his career – he actually joined Lord Abbett in 1999. And we also discussed how ESG is part of his investment process. Matt says his team’s investment process is made up of four key qualitative attributes.
Matt: It's the management team, our assessment of the management team, the industry conditions in which the company is operating in, as well as the company's competitive advantage.
And I'd say that a company's ability to sustain its competitive advantage has always led us to a conversation about sustainability. So sustainability is how long a company can maintain its revenue growth and earnings growth.
So for a long time, without really considering environmental factors, social factors, or governance factors, it was layered into some of the work we were already doing. Just for example, if you're paying close attention to management and their history and their credibility, you know, issues of governance would arise from time to time, and we were very quick to exit holdings where we did not have confidence in management's credibility.
And I think where I landed, and my thinking on this continues to change and improve as I learn more, is that, you know, a company's ability to maintain its position is dependent upon how it treats its ecosystem: its employees, its stakeholders, the society around it.
…I feel fortunate that the way I was raised as an investor, we considered some of these factors implicitly in our investment process, but as time has gone on we have weighed these factors more explicitly and greater than we did many years ago.
Annika: So Matt, you obviously oversee a number of different equity strategies, from value to dividend to growth strategies. Could you talk a little bit about how ESG integration might differ across different types of funds?
Matt: I'll start with kind of how they're the same, and then I think that will help sort of illustrate some of the differences as well. So regardless of whether an equity strategy is innovation, of which I'm a portfolio manager on, or value, all of our teams have integrated ESG risk factors into the investment decision making processes.
And so we ask our investors, no matter what strategy they're working on, to just think of how ESG risk will impact longer-term returns. So an ESG risk is considered in the context of an expected return for a security, the same way something like high inflation or another factor is considered into the risk of a securities performance.
Matt says while he and his team do pay attention to the main investment rating agencies, such as MSCI and Sustainalytics, they prefer to utilize their own internal research, and in-depth company knowledge, along with third party data providers
Matt: I would say, though, and this gets to the differences, I think that the ESG considerations impact different strategies in unique ways. For example, in a growth strategy or an innovation strategy, we might be viewing ESG tailwinds as a potential upside lever to returns.
Whereas in our values strategies, ESG risks might need to be understood so that they don't offset the return potential. I had described this as there's perhaps more ESG offense in some of the growth and innovation portfolios, and maybe some more ESG defense in some of our value strategies.
So what do I mean by that? In a growth environment, if you have changing consumer preferences that are driving desire for products that maybe are supportive of environmental change, or supportive of better governance, well, that could be a tailwind to revenue and earnings and therefore returns.
On the value side, you might be thinking about, "Well, what is a risk that's being highlighted that is perhaps impacting the security price?" But maybe your analysis as a value investor is that that risk is not nearly as material as reflected in the stock price.
And potentially if the company is doing something to address that risk, perhaps there's value that can be unlocked as that company, you know, lays out a plan for how to address that risk and mitigate that risk.
Annika: I want to highlight how Matt summarizes it here: That ESG factors can be used as more of an offense for growth strategies, whereas it can be a defense position for values strategies. I think that’s a useful anecdote for how to think about ESG in an equity portfolio.
I also think this would be a good stopping point for us to have Matt explain what we mean when we say “growth” or “value” strategies.
Matt: A growth investor generally focuses on revenue growth and earnings growth as the primary driver of whether or not to buy a security.
A value investor is… less focused on the revenue growth and the earning growth, but the price of the underlying security and where it's trading compared to its intrinsic value as a reason to buy or sell a security.
And a dividend investor could actually have some value attributes to it, or it could have some growth attributes to it. But they're primarily focused on the yield-- the dividend yield of the security that they're looking to buy.
…There's a few different ways to look at each of those strategies, but I think those would be the ways that I would concisely define it.
Annika: I asked Matt to elaborate for us a bit on his team’s investment process, what it looks like for analysts, what specific things they do to evaluate a stock’s ESG profile for a hypothetical growth company.
Matt: …There’s a few steps to our process, but I highlighted the qualitative aspect of looking at the model, the management, the industry conditions, and the competitive advantage
And I talked about how a lot of that has always led to a conversation around the sustainability of the business. I would just say that when you're evaluating a company's business model, when you're evaluating a company's management team, and the steps that the management team has taken before-- and when you're talking about the business model and sort of how they generate their revenues.
What is the profitability of the revenue that they generate? That can get you into some conversations that directly align, and analysis that directly aligns with social and governance factors. And also, when I described the industry conditions, a lot of times we're talking about regulatory changes.
…In some cases you have regulatory authorities that are supportive of industries, that align with certain environmental standards. Other times you have regulatory standards that penalize different environmental standards.
Oftentimes the discussion… that our team has around the industry conditions that a company is operating in will lead us to having a conversation around the environmental landscape, and also about the regulatory landscape.
Annika: Thanks, that's helpful. Matt, I'm gonna ask you a question about proxy voting… Could you talk about any trends you're seeing there, and how we at Lord Abbett, evaluate the proxies that we have to vote on from an ESG perspective?
Matt: …I am more and more involved with proxies that … are very focused on sort of board structures, the diversity on boards, the diversity … in management which is a high focus for Lord Abbett.
… I'd say just a lot more requests from our companies about, you know, not only concrete steps that they're making towards some of these environmental, social, and governance initiatives, but disclosure around policies and disclosure around statistics of what the company has done in the past, and what they plan to do in the future.
Annika: … It really does seem like ESG is something that's only going to become more of a focus in the proxy voting process. And I know we at Lord Abbett have done a lot in terms of forming our investment stewardship council to really address these votes when they come up. And… I'd expect if the rest of the industry hasn't already, they would definitely follow suit.
I’m going to take a moment here to define “proxy voting”. Proxy voting is one way shareholders, like Lord Abbett, can vote on issue decisions related to the companies that they own shares in. And it’s just one of the ways investors can engage with companies in which they have holdings.
Annika: …As I think about ESG investing, the engagement side of things is where an active manager can really shine and add a lot of value to the ESG debate because we're not just relying on external ratings or index weightings. We can really identify those companies before it's reflected in the broader marketplace that have a good ESG profile, or help companies or issuers actually improve their ESG profile, which will then hopefully be reflected in valuations. But just along those lines, I know you and your team do utilize some external ESG data. Could you talk about what data you use and what are some of the challenges that come along with using external data?
Matt: Yeah, so now you've-- now you've-- got me going here, 'cause this is something that-- I-- I-- I might-- get a little carried away on. So-- the-- the rating agencies do an excellent job, the primary ones are Sustainalytics and MSCI. And the reports that they put out are very comprehensive.
But, you know, there are some areas that, as an innovation investor-- I-- I-- I sometimes-- take issue with or-- disagree with the-- what the-- the rating agency might say. And I-- I typically see this with younger companies-- and-- and even-- some biotechnology companies-- that might have-- which by-- just for the audience, biotechnology is where I grew up, so I'm-- I am showing a little bit of my bias here.
But, you know, biotechnology companies, a small biotechnology company that might have a limited number of employees, a limited number of resources-- with-- a focus on a very specific objective, that is to get their drug approved as fast as possible for, you know, a severe medical-- condition that might be affecting children.
So a very-- I think a tremendous-- goal-- for-- and a tremendous societal impact, but they might not have a lotta the disclosures that a much larger company with more research-- more resources have about-- you know, a variety of different issues.
And at the same time, a company that's more mature, that perhaps has-- more ESG risk or ESG controversy, but has gone out of its way to spell out-- how it's gonna mitigate that risk or mitigate that controversy could-- could have a much lower score.
And so younger companies, I think-- tend to be-- tend to have lower ratings by-- the rating agencies than perhaps more mature companies. But again, that is-- an opportunity for us-- not only to engage, but also to d-- to determine if those risks are material or not material. And if they're not material, then it p-- potentially provides-- an upside opportunity-- in the stock price, if-- if those risks are potentially weighing on the stock.
Annika: Yeah, and it really goes back to the point of, you know, being able, or needing to balance external data, external ESG ratings with, you know, fundamental deep dive credit research… which something I think Lord Abbett really excels at.
Annika: That’s all for this episode of Green Shoots. Learn more about Lord Abbett’s commitment to sustainability by visiting our website, Lord-Abbett-dot-com, and be sure to like and subscribe to Green Shoots for more insights. See you next time.
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