The Intended and Unforeseen Opportunities of ESG

[00:00:00] Pierre Daillie: Hello. And thank you for tuning in to this episode of Insight is Capital. I’m your host Pierre Daillie, managing editor at advisoranalyst.com. ESG has gathered a lot of steam as an essential and strategic investment component for both returns with long term positive fundamentals and risk management. Around roughly 1400 studies have found a positive relationship between ESG scores on one hand and financial returns on the other, whether measured by equity returns or profitability or valuation multiples.

Another factor is the cost of capital. Evidence suggests that a better ESG score translates to about a 10% lower cost of capital as the risks that affect your business in terms of its ability to operate are reduced if you have a strong ESG proposition. For these reasons, publicly traded companies that are actively implementing ESG in their operations are expected to be granted evaluation and risk premium as a result of ESG goodwill, versus those companies doing less. Joining us to talk about how TD Asset Management approaches ESG are Samantha McDonald, vice president of ESG research and engagement at TD Asset Management and Jonathan Needham, vice president and director, lead of ETF distribution at TD Asset Management.

[00:01:13] Disclaimer / Announcement: This is the Insight is Capital Podcast.

The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of advisoranalyst.com or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

[00:01:32] Pierre Daillie: Samantha, Jonathan, welcome to the show. It’s great to have you.

Hi there.

[00:01:35] Jonathan Needham: Thanks Pierre, great to be here.

Thanks for having us.

[00:01:37] Pierre Daillie: To kick things off please tell us about the arcs of your careers and your roles at TD Asset Management.

[00:01:44] Samantha McDonald: I’m happy to go first. So I joined TDAM a- a little over a year ago and I’m a member, as you mentioned, Pierre of our growing ESG research and engagement team. My focus on the team is to lead our stewardship efforts, so engagement and proxy voting, and I’m happy to get into- to more of that in- in a bit more detail later. But prior to joining TDAM, I spent almost 12 years at a leading global ESG research and data analytics firm.

I wore a number of different hats over my time there as one does in a business that’s fast evolving. So I was an ESG analyst, I did business development, relationship manager, operations, you name it. I’ve been in the ESG space for quite some time. And it’s really been an exciting place to be over the past few years, especially as the ESG investment ecosystem has, exploded. From a personal perspective, it’s been great to see how far the industry has come and I’m- I’m really looking forward to where it’s yet to go.

[00:02:40] Jonathan Needham: Thanks Pierre, and again great to be here. So I- I lead up the ETF distribution efforts here at TD Asset Management. So I- I lead a team of ETF specialists work very closely with our national accounts team, so head offices across Canada in addition to our our- our wholesaling team across Canada that supports the advisor community.

So I joined TD just over two years ago. It- it’s been a great a great team and a- and a great firm and certainly a lot of growth on the ETF side of the business which I’m here to lead, so very thankful for that. Prior to that, been in the business for- for over a couple of decades. You can- you can tell by the gray hair through various roles and- and various asset management firms. So I’ve been on the fintech side of the equation.

I used to head up marketing as well as head up distribution for one of the largest asset managers globally. And, prior to that, have spent the majority of my career supporting and working with the advisor community across Canada. And I’m still a very strong believer in the value of advice. And I think even more so today with- with the type of volatility we’re seeing in the market. And I- I would say even more so as a result of- of investors looking to, vote alongside their values vote with their investment dollars and certainly need the guidance of an advisor to help them determine what are the appropriate solutions for them to help them reach their goals and still align with their values.

It’s great

[00:03:54] Pierre Daillie: to have you both, I’m really looking forward to our conversation. It’s- it’s fair to say that ESG and sustainable investing is at the top of investors’ minds. And a great place for us to start would be for you to share your perspective of what sustainable investing is within your firm’s mandate. Samantha, can you talk about TDAM’s engagement process and how that’s a part of defining your approach to the issues of ESG?

Maybe to take

[00:04:20] Samantha McDonald: a- a step back at the first part of your question gear around ESG investing and- and what that means, I think it actually can mean a number of different things to different people. It really depends on your investment objectives. And for us, we view it as a spectrum of different goals which are unique to each investor. So some investors may want to invest align with certain ethical or political beliefs, I don’t wanna invest in companies that produce controversial weapons or tobacco products, for example.

Some investors may be first focus on impact, wanting to invest with the explicit goal to address or solve environmental or social problems, which may also have a financial return. But at the- the TDAM at the firm level, our primary focus is what we call our ESG integration and this is probably the fastest growing space when it comes to ESG investing. And so this is the systematic incorporation of material or financially relevant environmental, social, or governance factors into the investment process.

So in- investment analysis and investment decision making. And here we do that across our asset classes. We have a dedicated ESG team as I’m- I’m part of and we ourselves are integrated in the investment group. We report into the CIO who ultimately has oversight over our ESG strategy. He’s part of our two decision making committees including our ESG committee and our- our proxy voting subcommittee.

And so I think that’s actually an important place to start an important point to make about our governance structure when it comes to ESG. We’re not siloed from the investment process, it’s- it’s quite the opposite. Now in terms of your… the second part of your question around ESG engagement and where that actually fits in an engagement and more broadly stewardship is a really key part of our overall ESG integration framework.

So on the one side of the framework, with supporting guidance from the ESG team, our analysts and our PMs are considering ESG issues in their investment process from acqui- active equity and fixed income teams to the quant teams, to our, the alternatives group. But our stewardship efforts really they’re equally as important. Perhaps I might even venture to say the core or the centralizing aspect of our ESG strategy.

So stewardship engagement and proxy voting is defined as investors using their influence over investees and other stakeholders to maximize overall long term value. And I think especially for our passive funds engagement and, proxy voting too for passive equity is how we’re able to express our ESG integration there. There isn’t an active process of stock picking for those mandates. And we engage our portfolio companies in many different ways and via, various channels.

From an- a direct engagement perspective we’ve developed an annual focus list approach. So this is where we’re targeting companies where performance may be lagging but there is opportunity for meaningful improvement over time. Our- our focus list approach has evolved from last year and will continue to evolve. But in 2022, we have four specific focus categories overall ESG, poor performance climate change human capital and human rights.

That doesn’t mean that we don’t engage on other topics. We definitely engage companies on other issues other relevant issues and of course, beyond our specific focus list companies. But, having this defined set of companies to do deep engagements engagements with, we believe that it’s best practice when it comes to achieving positive outcomes. And all of this compliments our, other collaborative engagement efforts with other major investors through organizations like CCGG or Canadian Coalition for Good Governance, sorry, a lot of acronyms, Climate Action 100+, Climate Engagement Canada and- and CDP.

[00:08:06] Pierre Daillie: Samantha, can you describe a good example or- or your favorite example of shareholder engagement and stewardship that- that really stuck with you?

I don’t think I could

[00:08:15] Samantha McDonald: pick just one. I think we’ve actually done quite of a- a bit of work over the past year in particular since I- I joined into enhancing our engagement program. In- in general, these engagements are- are not meant to be combative. They’re- they’re long term collaborative relationships, multi-year engagements. So we’ve built a lot of relationships with our portfolio companies.

There’s an ongoing feedback loop, where we share our principles and our expectations a- and, it’s a two way dialogue. I think a lot of… We’ve had a number of conversations with companies over the past year that have been I would say, we already can see some progress and I would say without naming names I think the companies that are actually starting out on their ESG journeys, we’ve seen already very quickly our own impact.

These are companies that have limited disclosures, they’re on the first stages of navigating the ESG reporting expectations the regulatory frameworks that- that are requiring a- all this different data. And I think it’s been really helpful for us or for them, sorry to speak to us as our, their- their shareholders and provide that feedback. And we’ve provided feedback on good ter- what are best practices when it comes to, setting diversity targets or environmental goals and so on, so forth.

So for me, those are- are low hanging fruit in terms of impact, and those have- have stuck. And I- I do feel like, those are gonna be relationships that we carry on for quite some time. I- I think the other ones that- that have really moved the needle are our investor collaborative engagements. So Climate Action 100+ for example, and there’s the new Climate Engagement Canada that we’re involved in. There’s really something about the collective voice, that raises the stakes and- and pressures, if you will, on companies.

And so we’ve had some success with a company, a number of companies there where, they may not have been maybe as responsive as we had hoped in the beginning, but over time and- and over multiple conversations, we’ve been able to see some impact. So I would say, those are the areas that I think have stuck with me at least over the past- past year as we’ve- we’ve built this program out.

[00:10:29] Pierre Daillie: Great to hear that it’s a very gradualistic approach as opposed to and if then else approach. It’s not- it’s not, it- it’s, so you’re- you’re taking, you’re allowing for a longer time span for companies to evolve into this- into this approach, to operations. Jonathan, in- in your experience, what is that key aha moment advisors are having in terms of realizing how they can integrate the ESG values of their clients into their model portfolios painlessly?

[00:10:59] Jonathan Needham: I- I think there’s a few aha moments if you will. But one that stands out for me in particular, it- it is really the, the- the return stream, right? So the aha moment for most advisors are, “Hey, I’m not voting alongside my values or my client’s values at the expense of returns.” And so for them, it’s a matter of can I, align my clients and my- my value system in the construct of a portfolio in order to help my clients achieve their goals while not sacrificing returns.

And I think that truly has been the aha moment when I can show my advisor community that, ESG is really putting on a risk lens and you are getting that kind of risk reduction and that premium valuation for cli- for companies that are doing the right things. And so as soon as advisors understand that they can use ESG strategies, particularly, the beta building blocks that we’ve launched here at TD Asset Management in the form of our ETFs that are index based that they can be beta replacement.

So they can still align their financial plans alongside their dispersion of return expectations vis-à-vis their capital markets model. And that truly has been the aha. So it’s a little bit of, yeah, it’s risk reduction. Yes, we’re seeing the trend and the premiums that investors and large investors like TD are putting on companies that are doing right by- by many standards. But really what really holds true to them is that they can hold these strategies, not sacrifice returns and still have reasonable expectations of those dispersion of returns for doing the financial planning.

And how

[00:12:27] Pierre Daillie: can investors think of this in terms of alignment with their personal values?

[00:12:31] Jonathan Needham: Samantha covered it really nicely earlier. And, that’s the role of the advisor, is to help that investor determine what solution is appropriate, depending on whether they’re, what type of values based or impact based strategy they’re looking for. Now in the case of that the five ETFs that I- that I support and help distribute here for TD Asset Management those are a little bit more broad based strategies.

So like I said previously when you can get Canadian, US and international equity exposure that looks and feels a lot like the return of the underlying benchmark or the broad based benchmark, I think that gives the- the comfort level from the advisor in terms of the predictability of returns. And of course, it gives the investor that comfort that they are screening for ESG companies, some controversial companies that are removed as a result of controversial scores if you will.

They’re getting access to a diversified basket of securities that have some of the lowest ESG scores. So lower is better in the case of the Morningstar Sustainalytics rankings. And so I think that’s really key for our advisor and our investor community that they know they’re- they’re getting rid of controversial companies. They’re- they’re removing certain controversials like tobacco firearms and gambling. So some of those negative screens.

But more, more importantly they’re waiting their portfolio and the underlying securities of that portfolio greater to companies that have a lower ESG score. And I think that’s been a sense of comfort in predictability of return streams, but also it doesn’t hurt that ESG is in the title. And then when they do a little bit of a due diligence on what the screening methodology is, they feel very comfortable with the outcome and the output of- of the portfolios.

[00:14:09] Pierre Daillie: So there’s this widespread notion among investors that investing on a ESG means having to make binary decisions about investing in things like energy, mining and commodities producers that are currently partaking in the inflation fueled bull that’s been unfolding,

[00:14:27] Jonathan Needham: but that’s just not true, is it?

We don’t think so. And Samantha can elaborate, but certainly, one of the benefits of the ETFs that we offer at TMEC, I like to talk in tickers for Canadian exposure TMU, for US exposure and TMEI for international equity exposure, and we’ll talk about the fixed income later really the- the benefit of these is they’re- they’re fairly sector neutral.

So plus or minus 2% relative to the broad base markets. And so what’s really important there, particularly in an environment like this where- where clients obviously are trying to hedge against inflation may not want necessarily fossil fuels, but if they didn’t have them, particularly this year, exposure to those energy companies their returns would be significantly lagging.

So this is the best of both worlds. If you will, you- you’re getting exposure relatively neutral relative to the benchmark but you’re only getting those companies that we’re engaging with. And in this case Morningstar Sustainalytics ranking based on a lot of in metrics that Samantha talk about that are included in the portfolio. Of course there are gonna be those individual investors that may not want the fossil fuel exposure.

And of course, we do have other solutions from- from TD Asset Management here to help solve for that as well that are also gonna give them exposure to companies that are best in breed from an ESG perspective and not in the fossil fuel space. And there’s- there’s multiple solutions and hence again why I think the value of advice and that guidance because in that case, in a- in a, market environment like we’re seeing today those strategies which have held up quite well would still be lagging somewhat relative to a strategy that does have some fossil fuel exposure in it.

[00:16:04] Pierre Daillie: What

are some of the recent trends and most unique meaningful opportunities that are happening in

[00:16:10] Jonathan Needham: ESG?

I like to look at industry trends from- from an assets and a- and an asset gathering perspective. I guess that’s truly indicative of how investors, institutional advisors and retail are feeling about their about their money and about their values. And certainly we- we’ve seen significant adoption of ESG strategies. We’ve seen, a proliferation of product in the marketplace to help solve for investors allow them to obviously solve for problems that they have, obviously help them achieve the financial goals but obviously to allow them to vote alongside their- their value system.

And so a significant amount of product growth, significant amount of asset growth. We’ve certainly seen, a massive adoption on the institutional side of the equation and that tends to then follow suit to the advisor and the end investor. And in many cases it’s been the end investor demanding and requesting it. In fact, as I mentioned, working with advisors for the last couple of decades I’m really encouraging them to broach, to have that conversation with their- with their investors, because most of the studies that we’ve done and third party studies that we’ve read have shown a significant amount of investors are looking to adopt and integrate ESG strategies but a significant number of advisors have not spoken to their clients about it. And so there’s a bit of a gap.

Yeah.

[00:17:23] Jonathan Needham: And that trend I’m seeing is- is starting to close particularly as investors start to, I’ll say, pay more attention to their portfolios and what they’re holding and why they’re holding it. And of course, they get pressure from their- their children and their grandchildren to do and certainly that’s a- a trend I’m seeing in addition to the significant transfer of wealth that’s happening right from the older generation to the younger generation.

And as a result of that advisors are having to, in some cases, listen to their clients’ goals and values of trying to integrate ESG. And so I think there’s gonna be a lot more of that pull from the end investor. But for the most part, I’m seeing advisors getting ahead of that as they always have done and- and be very educated on what exposure they can get for their clients that’s going to still align with their financial goals.

Absolutely.

[00:18:09] Pierre Daillie: I think- I think for advisors, the key is ha- having made the time to get to know exactly what- what ESG actually means. Very interesting Jonathan, Samantha, thank you. I- I I wanna change gears and talk about the three different strategies, the three different equity strategies within TD Asset Management. Let- let’s start with the Canadian strategy. You mentioned TMEC TMEC already, which tracks the TD Morningstar ESG Canada equity index. How are you addressing the Canadian market in TMEC which is rich in energy and commodities which are potentially seen as negative from an ESG perspective?

[00:18:48] Jonathan Needham: The- the strategies have been adopted and successful, particularly for those that are looking for broad based beta replacement. And so the way in which these strategies are designed is like I said earlier, is, they’re gonna be relatively sector neutral plus or minus 2%. And so you are gonna get that- that energy exposure. But of course you’re getting, the names that are best in breed in terms of what they’re doing and how they’re working with their communities and how they’re, their- their executive team is- is diverse in nature and how they’re addressing decarbonization and so on and so forth.

And a couple examples, yes, we own some Suncor and yes, we own TC Energy. And those have been great companies longer term. And as- as as Samantha mentioned, it’s really important I think, and- and we think here at TD Asset Management to be at the table to have investment dollars with firms like that to help them move along the path of- of doing good if you will, and continue to do better.

And so not only are you getting that exposure within TMEC, which obviously has- has helped clients significantly this year relative to a lot of other strategies but you’re making sure that you’re getting the energy names that are- are best in breed if- if you will, and are moving in the right direction. And so I think that’s- that’s really important for the advisor community. It allows them to understand what they’re getting. You get that more kind of predictable rate of return particularly relative to the- the benchmarks that clients track when they look at the paper, S&P/TSX Composite, S&P 500, so on and so forth.

And so I think that’s- that’s why we built that strategy the way in which we did. The other thing, I think that’s important to- to address is, and to highlight is, we did it in an extremely cost effective way, 10 basis points. And so a very low cost hurdle for investors to align their values with our investment strategy. We also happen to structure it in such a way where you’re getting two thirds of the market by market capitalization.

So it really is truly going to act a lot like the broad based benchmark, obviously differences as a result of the underlying holdings and over different periods of time. But, over a longer period of time you can expect very similar risk adjusted returns, slightly better, particularly from a risk lens and obviously we have, index data to support that. But that- that to me has been really important. These also, these ETFs, both the Canadian one you mentioned and our US and international exposure of ETFs have- have been ranked, five star globe ranking which only 10% of funds in ETFs in Canada can say that.

We also got recently awarded a Corporate Knights Award. Again, just reinforcing that these strategies have done what they’re meant to do in terms of getting the exposure that we know that Canadians want while also giving them exposure we know they need. And so I think that’s how- how we built that that- that complex, if you will, of- of ETFs and partnership with Morningstar Sustainalytics.

Tracking error is a big

[00:21:32] Pierre Daillie: deal when- when you’re building a portfolio. And if if you- if you advised your client to do something in- in lieu of their values and then it wasn’t working in terms of the line items in their portfolio then you know, you’d be faced with that dilemma. And that’s- that- that seems to be an issue that I think a lot of advisors typically are- are concerned about in any sort of forward looking investment planning exercise.

I- I would also add that the- the wide acceptance of ESG is also getting credit now with causing unintended consequences, notably the problem of demand for decarbonization outstripping the supply of decarbonization. Some- some folks would say this is ironic, this has led to a deeply under invested energy sector shortages, for example, over the last decade.

And so it’s- it’s great to find out that energy companies are, not only, were they caught on the back foot with its current inflationary environment that we’re in in terms of- of being able to bring supply forward but it’s great to see also that they are among some of the biggest reformers in the context of ESG as well, that they’re actually making significant efforts. And that is why they- they are included in these sustainability rankings. Samantha, what are some circumstances that would lead you to consider divesting a holding? What- what would it come to in order for you to make a decision like that?

[00:23:06] Samantha McDonald: Divestment is definitely a buzzword these days, I think particularly around, when it comes to the fossil fuel industry, there’s a lot of talk about divestment for TDAM in general, our emphasis really is on engagement over divestment. Divestment for us really is a last resort. I think, especially if you think about it when it comes to pursuing, real world’s outcomes I think, the key point is- is for us, is there are a lot of unintended consequences when it comes to- to divesting.

For example, if, we divest our investments or, we’re shifting assets into other other hands, I think there’s been trends of- of assets moving into private hands where there may be lower scrutiny of- of ESG performance or lower ESG standards. And, we as investors end up losing our influence or our seat at the table when it comes to these companies.

And so for us, it’s much more productive, I think, again, if you’re thinking about real world outcomes to- to maintain our ownership in these companies so that we can have those, that- that influence and we can have those discussions towards when it comes to fossil fuel industry and climate change towards a just transition to a lower our carbon economy. I think, that being said doesn’t mean that divestment doesn’t have a place.

I think in an active ownership strategy and a comprehensive stewardship strategy engagement isn’t a perfect science and so if engagement efforts are not productive and, we’re not seeing progress, I think there are some ex- escalation methods that we could explore which might include divesting. It might include reducing positions in companies. It could also mean, things like voting against board directors.

But I think any escalation process that, we employ that decision would require thoughtful and- and thorough consideration by TDAM and all relevant internal stakeholders. Again, engagement is the preference, divestment is the last resort. But- but, I- I think it- it could have a place in the conversation with thoughtful consideration taking place.

Thank you.

[00:25:17] Pierre Daillie: What do you see from your side of things are some of the unforeseen or unintended consequences and opportunities that ESG has been a catalyst for or provoked?

I think,

[00:25:29] Samantha McDonald: like I said, the- the unintended consequences and- and why, again, to- to be maybe a bit repetitive, but- but hit the nail on the head a little bit here is around the divestment, the slew of divestments that we’re seeing. Every headline these days seems to show an investment manager divesting out of energy companies or the fossil fuel industry.

And, for us, we don’t want to have that, that- that knee jerk reaction. And- and ’cause we have been seeing an… And apologies, I don’t have any the stats in front of me, but my colleague had just shared some, but how many assets have transferred into private hands where, again, we don’t have a seat at the table, a- a lot less scrutiny on ESG performance than ESG standard. So I think that’s a big concern.

I think the other opportunity, maybe, an opportunity angle here for us at least is, I talked about engagement and engagement with companies. But I think that’s, it can’t stop there because companies themselves can only, I think do so much, right? They have to operate in they have to have an an environment that is conducive or regulatory and policy environment that is conducive to- to a transition. And so for- for TDAM, one of the things that we have taken on more of and we plan to do more of this, is to actually engage the policy makers.

An issue like climate change, it’s a systemic one, it involves all stakeholders and needs all stakeholders at the table fossil fuel companies, investors civil society as well as, policy makers. And we’ve been doing some engagement with- with policy makers, with the regulatory bodies as well to push that- that regulate- regulatory environment forward and- and to progress.

And so not just about climate change, but things like, we talked a lot about, climate change, things like diversity diversity inclusion and expectations around the S I think that’s- that’s also really important to the ESG conversation. And I think there’s a- there is a lot of opportunity for investors to play a bigger role in engaging the policy side.

[00:27:33] Jonathan Needham: The only thing I think I would echo is that you’re hearing a lot about, engagement first divestment the importance of having a seat at the table. We’re- we’re here as fiduciaries to help influence the right actions, right? And so we wanna hold these companies accountable to doing the type of transitions that we know is important for the better good of society, if you will.

And I think that’s, the, I’ll say a lot of the times the missing link for that and- and client and end investor particularly when it comes to- to owning companies that are, in the fossil fuel business, is we need to be there in order to make sure we have that voice. And we can, engage them vis-à-vis our voting power, right?

Particularly at the size of the scale that a firm like TD Asset Management is with over 400 billion in AUM, right? And so I think that’s- that’s really important. And a lot of these fossil fuel companies are- are leading in terms of that energy transition. And I think some of them are gonna be some of the clean energy companies of the future because they have those they have the resources in terms of human capital. They, they have the scientists on staff. They’re very familiar with working with the type of technology. And I think that to me is really the importance of what we’re doing here at- at TD Asset Management taking a very active voice and an active role in how these companies embrace and transition over time.

Yeah. They’re definitely

[00:28:48] Samantha McDonald: some of the biggest allocators to low carbon solutions. And so there’s a lot of opportunity I think there as well. Like this is opportunities for them. And again, we wanna be part of that conversation.

And the

[00:29:00] Pierre Daillie: key- the key, I think, from what you both said is that it’s not a black and white approach. It’s very moderated, it’s a very… It’s taking a moderate stance and a gradual approach to ESG rather than- than some of the more extremist views that have maybe shaped perceptions out there of- of what ESG is. So a- a more gradual approach actually allows for more time, for more evolution of companies into this process.

I’m curious to know in your international ESG strategy I believe it’s similar to the other methodologies or rules that, that apply to TMEC and TMEU the- the US mandate, which we’ll get to in a second. But I’m curious to know, because in the international space, you have a- a, you have multinational companies that are- that are working in, let’s say as many as hundreds of countries. And- and then we have this geopolitical thing that’s happening right now with the war in the Ukraine and- and sanctions. How do you navigate… How does the sustainability rankings in the Morningstar index how does it- how does it navigate the geopolitical landscape and- and all the potential pitfalls that has created more recently?

[00:30:15] Jonathan Needham: The good news is I could tell you the approach and the strategy, ’cause this real space, like a back of the napkin type of approach. And I’ll do that very briefly. But the reality is behind the scenes, there’s a lot going on. The type of research and due diligence that Morningstar has done through their acquisition partnership/acquisition of Sustainalytics is there’s a lot going on.

There’s over 80,000 publications on a daily basis that they are reading, their robots are reading and screening in order to make sure, if- if some controversial event happens for a company, they’re catching it in real time and obviously reassessing the exposure within the portfolio when it gets reconstituted and rebalanced on a quarterly basis. But the back of the napkin kind of approach, if you will, is we take the entire universe of stocks call it the- the Morningstar broad index for the MSCI ETHI index, as an example.

We then essentially do some negative screens so any company that has a controversial score of- of four or five greater than three, if you will is removed from the port portfolio. We then screen to remove tobacco gambling and firearm companies. So there’s that negative screens. And then we’re scoring and ranking or Morningstar Sustainalytics is scoring and ranking the remaining companies and then waiting according to their their scores.

And so the lower the scores, the- the greater the waiting. And so long story short, the- the outputs, 360 plus holdings. A very large number of small bets, which is what you’re expecting to get when you’re growing a- a broad index based solution it is managed to track very tight tracking error relative to that index with the in-house expertise that we have at TD Asset Management, one of the few asset managers that have and can say that we do that here in the Canadian market.

For Canadians by Canadians, if you will. And so very tight tracking error multi-decade history of- of index expertise. And then, if I were to give you the, the ESG score for those who really track Morningstar Sustainalytics right now it’s running at like 19.43. And your outcome is essentially a very attractive ESG score a very diversified portfolio that is five globe sustainable rating and it’s medium risk because of its broad diversification.

I don’t know if it’s getting right to your question as to how we navigate this environment. I think the reality is more of our active strategies or active mutual funds that are active share would certainly be doing taking a different approach versus more of a rules based approach. But in the ETFs all three, both the Canadian all three of the Canadian, US and international equity strategies are designed in the same way in order to get about two thirds of the market cap by market capitalization.

What I was curious

[00:32:48] Pierre Daillie: about was companies, for example, that are caught in the crossfire between Russia, for example, and the west.

[00:32:55] Jonathan Needham: Yeah, I think, and that- that, again comes to the monitoring of- of the third party provider to look at-

What- what impacts have, this conflict had and- and how in real time are they, and- and what changes are we gonna make and reconstitute as a result of that? The- the beautiful thing for any end investor, that’s also curious about any specific company you can go right on to the Morningstar Sustainalytics webpage and type in a ticker anywhere in the globe, any stock ticker and you’re gonna get the- the rating and the ranking. And based on that ranking and rating, you’ll be able to determine whether it’s in the ETF. Of course the other beautiful thing about an ETF is it is fully transparent, right?

The- the basket of securities is published on a daily basis. And so the end investor and, or the advisor can essentially look in real time in what companies we hold and- and in what weight. So I’ll say it’s somewhat dynamic if you will. And obviously, events like these have an impact and a pretty fast impact. But in an index solution like this that’s, very transparent in this methodology and very broad base in terms of exposure you’re still getting fairly low turnover very much like you would in an index strategy, call it, 10, 10% annual turnover. So- so very minimal change on a quarter by quarter basis.

[00:34:08] Pierre Daillie: On the TMEU, the US ESG strategy, how does it differ from the Canadian strategy and the international strategy, aside from the obvious, aside from the fact that it’s US versus Canadian or international [laughs]. Are there any- are there any criteria that are added because the US is such a big market

[00:34:25] Jonathan Needham: aside from the [inaudible 00:34:27]?

No, the good news is the methodology is- is transparent across the board. Obviously the difference would be the output in terms of the number of securities, right? You’re getting 440 names versus 360 plus names in international and 78 call it core holdings in the Canadian strategy. The distributions are the same across the board quarterly. The fee structures slightly different as you would expect.

Yeah.

[00:34:47] Jonathan Needham: It’s 15 basis points to get US equity exposure. But no, that’s the- the great thing about those three strategies is if one all three and, from an advisor’s perspective, you know that they are anchors and building blocks to a portfolio.

And that’s really what we’re seeing today, is a transition from, traditionally holding, the S&P 500 or an ETF that tracks the S&P 500 advisors are starting to transition from that, well known broad based index strategy that doesn’t do ESG screens to a TMEU which is, very similar in terms of its cost structure, very similar in terms of its return stream profile. It’s truly a- a pure beta replacement.

And in market conditions like this where we’ve finally seen a fairly significant pullback investors are starting to lock in some cases, those losses depending on the time period of which they’ve held broad based strategies and- and moving away from broad base index strategies that track markets that they’re familiar with to getting familiar with ESG. And I think that’s one of the silver linings of- of a pullback in a market.

Nobody likes to- to live through- through this, don’t get me wrong. But I think that allows investors of all types to reassess what they own, why they own it obviously harvest some losses along the way while they can, and if they can realign their portfolio to vote alongside their values at the same time. I think that’s a- a win-win and obviously they can then have very similar return expectations going forward with a- with a better risk lens on their portfolio.

The- the role of fixed income in a portfolio particularly in this environment we, this has been the first time in- in multi decades where clients of experiences negative returns on both the equity and the fixed income market, so not- not ideal. But of course the silver lining there is clients are no longer being punished as savers, right?

You’re now getting fairly attractive coupons/yields by owning fixed income including high quality investment grade fixed income. And first and foremost, I should let our listeners know that we have two fixed income ESG ETFs TMCC and TMUC. So they track the TD Morningstar, ESG Canada corporate bond index and TMUC tracks the TD Morningstar ESG US corporate bond index.

[Laughs].

Long winded way of me saying these are high quality bonds meant to be a balance to equity volatility, very similar to the equity strategies, the lowest cost in the marketplace at 15 to 20 basis points. They’re also five globe sustainable rating they’re also rebalanced quarterly, the main difference being that they capture about 50% of the market by market capitalization. And we do that cause we wanna make sure we own the highest quality and the most liquid bonds because this is an ETF structure so you wanna make sure you’ve got extreme liquidity.

And so I- I think, A, I wanted to highlight that all investors should have at least most if not all, should have some fixed income as a balance to the equity and volatility. And particularly today where a TD Asset Management view is that you should likely be adding to bonds in this environment because you’re getting attractive coupons that the damage has been done, if you will and high quality bonds in particular. Thanks for allowing me to do that.

Excellent point.

[00:37:56] Pierre Daillie: So building blocks, maximum diversification, low tracking error, or none. Are there any specific rules that- that you can highlight within the Morningstar ESG industries that- that stick out for you that- that are

[00:38:08] Jonathan Needham: important?

From my perspective, it’s- it’s really what happens behind the scenes. And I won’t bore you with all the details.

No.

But it is quite fun when you start to look at, why is this company included and why is that one not included? And- and, if something happens, how long are those companies held accountable before they get reconstituted into the index? And, I can- I can tell you it’s a quite long period of time. Volkswagen comes to mind with their emission scandal. Obviously still not a part of- of those strategies. And so I think to me, I think the- the behind the scenes, the getting into the weeds is really what makes the difference of these type of strategies. What I can tell you too Pierre which I think is helpful probably for listeners is how we differ from our competitors.

In the equity side we track, what two thirds of the market by market capitalization where a lot of the other strategies are around 50%. So both are- both are sound, both are capturing broad markets. But when you can capture more of that broad market exposure obviously your dispersion of returns relative to benchmark are- are going to be tighter and more predictable. And I think that’s really what differentiates us relative to other index providers or other ETFs that track other index providers. It’s the depth and research and knowledge behind the scenes that Morningstar Sustainalytics brings to the table but obviously that exposure which is obviously gonna be tighter relative to even a broad benchmark.

So

[00:39:27] Pierre Daillie: with your betas in the being in the advisor seat with the betas, the attitude towards position sizing can be positioned for position basically is where- where you would take your- your pure S&P 500 beta, for example, and substitute some or part or all of it with the

[00:39:48] Jonathan Needham: ESG index.

Yeah. It’s gonna feel and look a whole lot like a- a market cap strategy.

Obviously with the variance being, it’s only gonna include those companies that are best in breed when it comes to their ESG rankings.

So that’s

[00:39:59] Pierre Daillie: very interesting having the ability to have these core building blocks at your disposal. What additional research are you and your team doing to support the integrity of these indices Samantha?

I

[00:40:11] Samantha McDonald: think with these particular ones, we don’t add a ton directly to- to them. But I think a lot of the work that we do is in, our due diligence process in the research providers and providing feedback to them in terms of the data that we’re ingesting or the- the groups that we choose to partner with and so our ESG team brings a lot of that expertise.

A couple of us come from- from the- the ESG rating space and so we know the data very well. And and I think that brings a level of expertise needed for, to- to build out TDAM’s ESG infrastructure here including, how we choose to partner with- with with- with various index providers.

[00:40:55] Jonathan Needham: Yeah. I think I’ll add to that Pierre. I think, Samantha talked earlier about how her team, reports right into the CIO, right? Our chief investment officer. And I think that- that makes us stand out relative to our competitors. And ’cause that means essentially that not only are you getting, that- that ESG lens, if you will, that integration on our index strategies, which are run by our- our expertise on our index team.

But you’re also getting that with our quantitative strategies, our- our quant strategies, our quant team. You’re getting that with our active strategies. You’re getting that with our our real asset strategies whether they’re in fund ETF or infrastructure format. And I think that’s on the broad level, I think that really differentiate us in the marketplace today.

And I can tell advisors and institutions and- and investors very comfortably that, sure, I’d love you to buy my ESG UTF and I think it’s gonna check a lot of boxes for you for the following reasons, but the reality is you can buy any one of our strategies and be confident and comfortable that Samantha and her team has been a part of the process in terms of the security selection and the the engagement that we have with those companies that are held within the portfolios.

And I think I think, probably, and- and maybe I’m talking outta- outta school here and Samantha will correct me if I’m wrong, but maybe 5, 10 years from now, we won’t really be talking about ESG and we won’t need to have ESG labeled strategies, they’re all going to be ESG. And I think that’s where the expertise and the depth of our team and I continue to see it growth grow. I- I think is- is really helping us stand out in the market and making sure that we’re- we have a voice and a voice that has influence.

Yeah.

[00:42:25] Samantha McDonald: I- I would agree with that. I think ESG investing with terms E- ESG investing may not exist, in five, 10, five years, maybe sooner, who knows? It just becomes, it just is investing.

Yeah.

[00:42:37] Pierre Daillie: It’ll just become part of our DNA. Another buzzword that’s getting a lot of attention, gotten a lot of attention, gets a lot of attention in this space is greenwashing. So please share your perspective on- on what it is to you and why should advisors be concerned or aware with the implications?

[00:42:54] Jonathan Needham: For- for me, gree- greenwashing is pretty simple. It’s- it’s pretending to care, but not really caring. And I think that’s really what- what we’re seeing in- in many cases, is, a marketing spin that’s unsubstantiated, that’s not accurate, that’s misleading. And so I think, that’s what it is to me. And obviously you can- you can hear that’s not happening here at- at TD Asset Management. But I’ll leave it to Samantha to see if she’s got a- a more complex way of saying it. But for me it says, hey, it’s saying you care, but you’re not.

[00:43:21] Samantha McDonald: Yeah. Yeah. I- that’s the probably, the- the simplest way to refer to it and, I could go on for- for quite some time in talking about the concerns there. And I don’t just think it’s around, greenwashing. I know there’s a lot of buzz ’cause we’re in the asset management or the investment management space. There’s a lot of buzz around greenwashing in this space from like a product perspective and, claims from investment managers around what they’re doing in ESG.

But I also think this is something to be highly cognizant of on the issuer side, right? Issuers in- in there, what they are- are putting out there in the reporting disclosure and it’s up to teams like ourselves, and we’re doing our- our research and our own due diligence as to how to sift through their own greenwashing as well and making sure that we understand the issues we understand, the- the things that are most material to the companies and then we’re pinpointing those things to have deeper conversations.

I think greenwashing spans the ecosystem. There’s, it’s a concern for the whole ecosystem. And- and here at- at TDAM, of course, working in the ESG team, I know that we are actually doing quite a bit in the the plumbing, if you will the- the infrastructure really that underpins our ESG strategy.

And so a lot of that work, might not see in our external reporting but- but it’s taking shape. And I think that’s important to highlight and- and understand, when you’re looking at an asset manager, you’re looking for an investment manager knowing that they’re- they’re doing the real work underneath, flashy reports. Also on reporting I think it’s great, when you see these commitments and, big numbers, but it’s also the substance of the reporting and that’s something that we focused on ourselves.

We look at things like our proxy voting, we issued our recently I guess it’s not so recent now, we’re midyear, I can’t believe how fast the year has gone by, at the beginning of this year, we- we published our updated proxy voting guidelines. I think that’s really best practice when it comes to transparency about our position on a number of- of, key governance in ENS issues, not just for the issuers that we are our shareholders in, but also for our clients as well.

They understand where we stand on things like diversity and inclusion, on, emerging climate issues human rights issues, indigenous rights and reconciliation issues. All of those things are pretty explicit in our proxy voting guidelines. So it’s really not about statements and it’s really about the substance of our reporting. And so that’s something that- that we’ve really focused on as we build out our- our library of- of, both content and reports for- for our clients.

[00:46:01] Pierre Daillie: Yeah. So in a nutshell, watching their feet, not their mouths.

[Laughs].

[Laughs]. Fascinating.

[00:46:07] Jonathan Needham: You’ve got all the sayings [

laughs].

[00:46:10] Pierre Daillie: Samantha, Jonathan, thank you so much for your time and your insight. And to those listening, thank you for tuning in.

Thank

[00:46:48] Jonathan Needham: you.

Thank you.