Lara Castleton: Hello, and thank you for joining this episode of Global Perspectives, a Janus Henderson podcast created to share insights from our investment professionals and the implications they have for investors. I’m your host for the day, Lara Castleton, and on this episode, we’re going to discuss the world of responsible investing.

ESG has emerged as a controversial topic for some, yet we find it surrounded by many misconceptions. So I’m excited to be joined by Michelle Dunstan, Chief Responsibility Officer, and Aaron Scully, Portfolio Manager on our Global Sustainable Equity team, to make sense of the current environment and how the space is shifting globally. Michelle and Aaron, thank you for both being here today.

Michelle Dunstan: Thanks for having us.

Aaron Scully: Thanks.

Castleton: So, Michelle, let’s go to you first. Is ESG dead?

Dunstan: Lara, that’s a really good question. And let me start with a quote from Mark Twain: “Reports of my death have been greatly exaggerated.” What you said is true, that I think a lot of the controversy surrounding ESG has derived from confusion. ESG – environmental, social, governance – what does that actually mean? It means many different things to many different people, and everyone interprets it in its own way.

What we think of when we talk about ESG is primarily we think of ESG integration. Where there is a financially material environmental, social or governance factor that could impact cash flows or valuation or cost of capital, we should be treating it the same way we do any other financially material factor, which is researching it, determining the impact on risk and return, and incorporating it in our investment process.

But a lot of people, when they hear the term ESG, think of different things. Some people make the leap to values-based investing; that’s a lot of exclusions. My values may not agree with your values, and if you have a lot of exclusion where you are eliminating, say, 30% or 40% of the potential investments in your portfolio, it’s really hard to deliver the risk-return characteristics that your clients want.

Others think of it as the opposite. It’s touchy-feely things, like does the company have a therapy koala? It’s cute and everything, you can cuddle it, but it doesn’t have a material impact on a company’s bottom line.

What many people talk about and how we talk about ESG is really that integration, financial materiality, things that do impact financial outcomes. Now, that viewpoint isn’t shared around the world. It is most controversial in the US, and I think there are the most misconceptions of it.

Globally, most people generally accept that environmental, social and governance factors can be very material, and there’s a trend to people wanting to do more with their money than just invest for risk and return. So, investing in ESG-oriented funds also.

Castleton: I think that’s such a great point, delineating how some people think about this space, particularly as you just pointed values. My values are different than yours. That’s why people sometimes have pushback to that. So, we have deep roots in this type of investing at Janus Henderson. How would you say that we approach the responsible investing universe?

Dunstan: Yes, we say we actually approach it from a three-pronged way. The first is actually our own corporate responsibility. If we are out there asking our portfolio holding companies to do things better or do things differently, our own practices need to reflect what we expect of the companies that we invest in.

The second, which is the foundation of what we do, is that ESG integration. Financially material factors, what’s the impact of those? And the way we think about that is the way we think about everything else. Research. That’s been the core of our DNA for decades.

Our investors, our analysts and portfolio managers, dig deep. We’re training that same research lens on financially material ESG issues. If we can understand the implications of those, that is a finer point on understanding risk and understanding opportunity.

So, whether that’s solutions and enablers to a lot of the world’s problems that are growing quicker than the rest of the stock market, or whether it’s improvers, companies that may not be the best of the best today but are offering vital products and services, you can show that they’re becoming better companies.

Castleton: Yes, that’s great. Again, pointing to financial results. And, Aaron, you are a portfolio manager. By the way, I think you should rally for having a koala, because that sounds awesome, as you’re making decisions in these markets today. But as a portfolio manager, what is your investment process in general? How do you incorporate this?

Scully: Yes, let’s address, I think, the narrative that’s been out there for a long time, and still is out there, the idea that you have to sacrifice performance to do sustainable investing. And I think that couldn’t be farther from the truth.

And I guess the first point I’d make is, Nassim Taleb references this concept called Lindy effect. And Lindy effect is this idea that the longer an idea, a technology, an investment fund has been around, the longer the life expectancy of that fund or idea or invention. And with our history, we’ve been around over 30 years, we came about in the first George Bush presidency a long time ago, and so we’ve seen a lot of different things.

We’ve seen the Asian crisis, we’ve seen the dotcom bubble, GFC, what we’re in right now, whatever you want to call that. I’m not sure. And fortunately, we’re weathering the storm. And so, I think that that’s important to emphasize. We’ve been doing this a long time. We’ve weathered a lot of different storms. And so, then that begs the question, why? Why have you been around so long? How have you been able to weather it?

And I would go right back to our sustainability lens. There’s a cognitive bias that we’re trying to take advantage of in the market, and that is this inability for humans to think exponentially. We still think linearly. And so, we’re trying to address that, both on the positive and the negative side.

Regarding the positive side, any time we’re looking at a new company, we’re saying, is this company’s product or service good for the world? And the way that we define good is we have ten sustainable themes, and if more than 50% of that company’s revenue is one of those themes, then it can fall into our investment universe.

And why is that important? Well, these are companies that generate a product or service that’s trying to address one of the great challenges of our time. And generally, when you’re trying to do that, there’s a large total addressable market. We also find that there’s a great deal of correlation between sustainability and innovation and flexibility of management.

But all of this sets up that company to be in a better position to compound, ultimately, free cash flow over time. And the market always gets that wrong. They look at the current valuation, and they don’t comprehend that this company could actually be really cheap in a few years, just through sheer growth alone. So, that’s on the positive side.

On the negative side is a concept that we incorporate called operational ESG. And operational ESG is this concept that we want to invest in companies that are treating all their constituents well, environment, suppliers, customers. If that company is abusing one of those constituents, while that risk appears small in the short term, it compounds over time. And the market always underappreciates that risk because they’re just looking at it short term and they can’t comprehend.

And how does that manifest? It can be legal, it can be regulatory, it can be customers who say, I don’t want to invest in a company that abuses one of its constituents.

So I think that our sustainability lens addresses both the positive and the negative, and I think really sets us up to outperform over the long term.

Castleton: And that’s something that should resonate with a lot of clients today, just finding those companies. Previously to now, a lot of high valuations across many companies, but what are the ones that will compound over time? Being able to provide the both positive and negative lens throughout your process can be very helpful.

Scully: That’s right.

Castleton: How have the conversations gone recently with clients around the strategy? And then also, where do you think the market’s heading from here?

Scully: Great question. So, I think one of the first things that we’ve really emphasized with our clients is we’re not deviating from our sustainability lens. As a firm, we’re not deviating from our commitment to sustainability. I think that some of our peers, competitors, have kind of started to pull back. And so, I think that’s one concern.

Obviously, with the new president in the US, there’s been concern that, will this have implications for the types of companies we invest in? And look, the reality is, we’ve been through Trump 1.0.

Ultimately, I don’t think you’re going to see a lot of deviation. People talk about renewables. Last year, as a total global commitment to low-energy investments, roughly $2 trillion was invested in low-energy renewables. That’s almost double what was invested in fossil fuels last year.

The reality is that renewables are some of the lowest cost forms of energy in the world, and I don’t think that’s going to change under a Trump presidency. So I think that we’re going to still see a ton of opportunity. We’ve been able to navigate Trump 1.0. Thus far we’re navigating Trump 2.0. And so, we’re excited about the future.

Castleton: And again, back to the initial discussions on what is ESG, a lot of people will label it something that it’s not. And you’re here saying, we’re finding opportunities and companies that are doing the right thing and compounding their growth amidst this backdrop. It doesn’t necessarily need to agree with what your specific values are. We’re looking for financial impact to grow returns over time.

Scully: Yes. Ultimately, these are great companies with durable, competitive moats, and they just happen to fall into what we view as sustainable businesses.

Castleton: Right. And so, Michelle, back to you. Let’s get into more of the current events of the responsibility or ESG world today. What’s shifting within the landscape? Are there any things that you’re seeing changing?

Dunstan: Yes. I think one of the things that is changing, which we as an asset manager have to deal with, but also some of our clients, particularly large asset owners, is the shifting regulatory environment. And it is shifting in response to a lot of the things that that Aaron just mentioned.

One is to clear up some of this confusion, what are you doing, how are you doing it, so that our end customers can understand what they’re getting from our different strategies. Another is disclosure. In order for Aaron to do what he is doing, he needs information. And historically, a lot of companies started with, here’s your financial statements.

Now more and more of them are publishing sustainability or responsibility reports, but those are very diverse and scattered. Two companies that do exactly the same thing may publish very different data, different statistics, portrayed in a different way, at different levels of detail.

So, we are seeing regulators around the world really focus on these two things. Particularly in Europe, but also elsewhere, we are seeing what I would call strategy labeling regimes, so that if you are using sustainability terms or ESG terms in your strategy, there are certain criteria you have to meet, certain levels of disclosures, so that a layperson reading through it will understand what types of companies you’re going to be investing in and how that strategy is being managed.

The other thing you’re seeing, and this includes in the US, is just corporate disclosure rules. So, there’s a California climate rule, for instance. CSRD is a big one coming out in the EU. These are all rules aimed at corporates, not just asset managers but any company, to standardize and report disclosure that investors like Aaron and us are leveraging in order to make better investment decisions on behalf of our clients.

This is all in migration. We’re continuing to see it move forward, but in some ways, we’ve seen that there are some rules, there’s are a bit of an overreach, that are asking for extensive data.

So, both in the US and Europe, we’ve seen them rethink some of these rules to make them more user friendly, to give people the ten or 20 pieces of data you need, rather than potentially 1,000 pieces of data that is very burdensome on the companies. And we’re never going to look at all 1,000 pieces of data. We don’t care about all 1,000. We care about those ten that really matter to that investment case.

Castleton: Yes, that sounds like there’s a lot of moving parts. And if you don’t really have a dedicated team that’s looking into this, understanding the regulations, this is a movement that’s happening across the board with every company, so you could be often left behind or not understanding the space in general. So, great that we have this team focusing on that. And how does that affect you, I guess, today, in current environments these changing regulations, labeling, how does that affect your investment process as a global strategy, right?

Scully: Yes. So, the simple answer, status quo. We have a history of dealing with different regulation. I think Michelle brought up a good point about legislation that would maybe limit some of the disclosure. To the extent that it doesn’t interfere with those ten or 20 things that we care about, it shouldn’t be a big deal. But for the most part, no impact whatsoever.

Castleton: And so, you’re a dedicated global, sustainable strategy. We have a responsibility team here at Janus Henderson headed up by you, Michelle. We have plenty of other strategies at the firm that aren’t labelled sustainable or ESG. I would imagine there’s a lot of integration with you and the rest of those teams on bringing this philosophy to what we do, broadly speaking, in certain aspects. Is that correct?

Scully: Yes, I think it’s symbiotic, and I think Michelle’s team’s done an incredible job of really integrating with all the strategies. There’s a lot of cross-collaboration, a lot of engagement on different ESG topics. The central research analysts here in Denver play a vital role in engagement as well. And I think I’ve got to give credit to the firm. Over the last eight years, it’s been a tremendous evolution. And we’ve put a lot of resources, including Michelle’s team.

Castleton: Great. And, Michelle, just maybe to wrap it, how do you see the landscape continuing to evolve going forward, and maybe what gets you really excited about it?

Dunstan: Yes. I think what we’re going through now is giving us a big opportunity for the future. It’s to clarify not only what ESG means to us, but why we think that integrating those financially material issues will bring about better financial results for our clients.

So, I am excited about that, and also the opportunities that are being brought about by the turmoil in the stock market. A lot of people look at that as, oh, it’s down. It is down, but that also differentiates between companies. There’s now ones that we can identify that we can pick up on that.

The other thing that I’m really excited about is, I do think the future of ESG is more thoughtful, which is the way we’ve been thinking about it. It’s not these widespread exclusions. It’s about leveraging your intellect, your research, your differentiated insight to drive alpha.

So, we’re doing that in a number of different ways, whether it is leveraging ESG Explore, our proprietary data platform that brings a lot of these both third-party but also proprietary information to our investors on the same system that they do their financial analysis on, that is really being used to derive those insights, or whether it’s the initiative we just launched with UC Berkeley, the Janus Henderson Berkeley Insights Collective.

So, this is really focused on equipping investors with the knowledge they need. Right now, we have about 400 people across the firm going through an eight- to ten-hour course with Berkeley on how to assess the financially material aspects of climate change and biodiversity, and how to incorporate that in their investing process.

And again, the emphasis is on the financially material impacts. If there aren’t any, we don’t care about it. But if there are, we want our investors to be able to investigate those with the same diligence that they can look at financial statements and everything else today.

Castleton: Well, thank you both for being here. There are a lot of moving parts, a lot of misconceptions. Clearly, a space that you need dedicated active managers who know it in and out, to be able to thrive and look forward in this space. It’s definitely not a market for passive allocations.

So, appreciate all of those insights. We hope that you all enjoyed the conversation, came away with some more clarity on the wide-ranging world of ESG and what it means to Janus Henderson, how it can maybe impact you going forward. For more insights from Janus Henderson, you can download other episodes of Global Perspectives wherever you get your podcasts, or check our website out at janushenderson.com. I’m Lara Castleton. Thank you. See you next time.