ESG investing has come under scrutiny this year as regulators have given the popular investment strategy a closer look and many funds have underperformed benchmarks such as the S&P 500 Index.
The Securities and Exchange Commission has proposed tighter rules regarding ESG labels on mutual funds and exchange traded funds. The watchdog also proposed that funds disclose how they incorporate rules around environmental, social and governance into their investment-selection process and strategies.
With underperformance, criticism of the strategy has also picked up, with some critics claiming it doesn’t work.
Sarah Bratton Hughes, the new head of ESG and sustainable investing for Kansas City, Missouri-based American Century, a $250 billion global investment manager, considers the greater regulatory interest good for the industry, which has seen a groundswell of investment products and dollars flowing to it.
“There was no regulation around it before, so I see it as a positive sign of the success of the industry,” she says. She added: “I also view some of the pushback is somewhat healthy.”
American Century is unique in the fund industry as 40% of its profits support the Stowers Institute for Medical Research, which owns American Century. Jim Stowers founded American Century in 1958, and in 1994, he and his wife, Virginia, used their personal fortune to found the institute, which included a controlling interest in American Century. Since 2000, when the institute’s laboratories opened, dividend payments have totaled $1.7 billion.
MarketWatch spoke to Hughes about her new role at American Century and how the firm views ESG investing. This is an edited transcript.
MarketWatch: What are some of your biggest ESG priorities in your new role at American Century?
Hughes: We’re going to deepen our stewardship program. We’ve now put in a thematic framework, with five megatrends we believe need to be focused on for a sustainable future economy: health care, the environment, empowerment, sustainable living and digitalization. I actually think digitalization is one that separates us from most. You can think about digital infrastructure from a risk perspective, like increasing cyber risk, but there’s really more on the opportunity side.
We’re going to need new and immersive technologies to help us get to where we need to be, whether it’s adapting to climate risks (or) … increased financial inclusion and giving more people access to banking. There’s a significant amount of infrastructure we’re going to need.
MarketWatch: American Century integrates ESG into its investment process. How do you do that, and what does that mean to American Century?
Hughes: Each one of our team members has a very close relationship with the different investment disciplines we have here. We have a deep understanding of their process from our side, and we provide them with specialty knowledge and research, and they’re incorporating that into their process. It’s a systematic process that ensures true embedding of ESG, rather than a bolt-on. We have a very strong growth franchise and very strong value franchise, so incorporating sustainability, or the companies that you would find, are very different. We use a framework we call BRITE framework, which stands for best-in-class, ESG risk, innovation, transition companies and engagement. So, for value companies, we would tend to see more companies that fit into that transition and engagement bucket, less so best-in-class. In the growth universe, you could see more companies fall into the innovation or best-in-class bucket.
MarketWatch: It’s been a rough year for ESG, performance-wise, considering its traditional overweight to tech and underweight to fossil-fuel energy. With rising interest rates dinging growth companies and long-duration assets, and a jump in fossil-fuel use, what does that mean for ESG investing?
Hughes: I’ve been in the ESG seat for more than one market cycle. I don’t think of it as any different than growth or value. There are going to be times where things are in favor in the market, and they are out of favor in the market. What I want to really highlight is, to me, ESG integration is process-oriented. It’s much more focused on your process. What people are talking about for underperformance are outcome-oriented strategies, strategies that have goals beyond just performance.
I’m a big fan of ESG and value. Think of an industry like aluminum. To meet our decarbonization goals, we’re going to need aluminum. We can’t just say [emissions] look terrible and eliminate companies, what we can do is say, who are the best players in this in industry, who is most poised to not only survive, but thrive in the future, because from an operating perspective, they understand the potential risks. And they are transitioning their operating model to use more renewable power sources.
Read: You can count value-oriented ESG funds on one hand. That’s painful for investors as tech melts down
MarketWatch: Fossil fuels have rebounded sharply because of the Russian war in Ukraine and lower supplies with a rebound in demand. Are fossils fuels going to stay around, or is this their last gasp?
Hughes: I think it is potentially the last gasp for some fossil-fuel companies that refuse to acknowledge that the [green energy] transition is coming. But I would caution that we still have a significant way to go. And the reality is, even if you look at the IPCC (Intergovernmental Panel on Climate Change) report, the world is still addicted to fossil fuels. Where we really are focused is on the financing of that transition. Big providers of capital really need to finance these new innovative technologies. I consider this a short-term price rise in fossil fuels [because of geopolitical crises], and what I think you’ll see is countries increasingly looking for energy independence. And the only way for many of them to get there is to invest in in renewables and clean energy. [For fossil-fuel companies refusing to transition] I think it’s going to be an escalator down [in value], not an elevator down.
Read: Russia’s invasion of Ukraine is changing ESG investing
MarketWatch: Can you talk about the type of research the Stowers Institute does? The way the institute is funded, through American Century’s profits, means scientists don’t need to write grants and can study problems for a longer time than most outside funders would allow.
Hughes: Our founders took their $2 billion and they built and endowed the Stowers Foundation. The institute does basic research into the causes, treatment and prevention of disease. [Most medical research] funding goes to flashy, innovative biotech. There’s a lack of funding for some of the nuts-and-bolts research that’s needed.
Finance, in general, is not really saving lives. We can talk about the progress we can make from our sustainable and impact investments. But many times, we are derivatives away from it. The research that’s happening here has the potential to really change lives and impact lives forever.