Episode 36 – New SRI fund for DCP, Plan 3 and JRA

Episode transcript:

[music intro]

Jenny

Welcome back to Fund Your Future with DRS. So, if you’re in Plan 3 or DCP, there are basically two types of funds for your investments. There’s the one step or the Build and Monitor. And all the funds are managed by the Washington State Investment Board, also known as WSIB. And WSIB is responsible for selecting the investment lineup for Plan 3 and DCP.

And part of their responsibility of managing these is that they periodically review the funds that are available. And last year, they decided to make a change with the Socially Responsible Investment option. That basically meant moving the fund from a balanced fund made up of stocks and bonds to a fund that will be stocks only. The new fund has a new thematic direction with investments that make up the fund being based on the United Nations Sustainable Development Goals.

So WSIB has a contract with a company called AB to manage this investment option that will be available to people in Plan 3 and DCP. And today our guest is Dan from AB. To talk more about what’s happening. Welcome, Dan.

Dan

Hi! Very happy to be here.

Seth

Thanks, Dan. So first, since this option is moving from a balanced fund which had a mix of stocks and bonds to a fund that is going to be all stocks, can you talk a little bit at a high level how that might change expected return and risk profile for the investment options for the customers who are invested in that option?

Dan

Yeah, sure. Well, in general, all stock portfolios offer potentially higher investment returns over time, but they can also be higher risk due to market volatility. So, equity markets are more volatile than bond markets. Balanced funds, in fact, invest in a mix of stocks and bonds. So, volatility and risk are usually a little lower than for pure stock funds. But they also offer potentially lower returns.

Seth

So generally, when somebody thinks about investing in a stock fund or an equity fund, you could divide that into two larger categories, kind of active and passive. Could you describe a little bit about what that means in terms of investment for somebody who’s investing in an employer offered fund?

Dan

Sure. So passive funds perfectly replicate the performance of some benchmark index like the S&P 500 or the MSCI all country world index. So, they simply own every company in the index in the same proportion as the index. So, there’s no attempt made to say: “Company A has much better prospects than Company B, so I’ll own more of Company A and none of Company B.” It just owns a little bit of every stock.

Active funds by contrast, only own some of the stocks in a benchmark index, so the managers of the fund are going to use their judgment. They’ll use research, they’ll use their analysis to select just a subset of stocks that they think are going to perform best over time from within that benchmark index. So active portfolios are very selective about what they own, and passive funds really just own everything.

Seth

That makes sense. In the intro, Jenny mentioned that this new fund is going to have a thematic approach, and so could you describe what that means in terms of active investing for your group – the manager of this fund.

Dan

Yeah, so, thematic portfolios are active strategies. I mentioned before that active strategies don’t own every stock in a benchmark. They only on a smaller subset of stocks. So, in thematic portfolios, that subset of stocks is united by some common thread, so usually some specific long term trend that’s shaping the economy or shaping society in some way. So, you know, examples of themes could be things like technological disruption.

So, stocks that are benefiting from artificial intelligence, let’s say. Or something that’s very relevant for us, at AB, maybe environmental change. So, stocks that are helping decarbonize heavy industry or improve resource efficiency or something like that. So thematic investors are only going to own companies that are connected to those very specific themes. And Seth I would say that I think there are a number of really important benefits that thematic portfolios can offer investors.

I’d say one is just better alignment with strong growth because these themes usually capture really big economic opportunities. Two, they can allow you to benefit from the power of compounding. Albert Einstein once called that the eighth wonder of the world. Because themes often take many, many years to play out and there can be a lot of advantages to thinking long term when a lot of people in the market are actually thinking very short term.

And then I’d say finally, thematic portfolios can be really helpful because they can help make sure that your investments are better aligned with issues that you believe are important. Again, maybe that’s something like fighting climate change or expanding access to health care.

Jenny

That’s really cool. So, Dan, it seems like there’s been a lot of news about ESG investing. It stands for environmental, social and governance. Could you provide a kind of a quick description of what ESG investing is and where this new fund might fit into this spectrum of ESG or sustainable impact investing?

Dan

Yeah, sure. So first, I’m glad that you use the word ‘spectrum’ because there are a few different flavors of ESG investing. It’s really not just one narrow approach. It really is more of a range of investing activities. Now that being said, I think there is a uniting element that ties all of those together. And I would say that that’s that ESG strategies they consider not only the financial aspects of the companies that they invest in, they’re also considering their environmental, social and governance aspects as well.

So, they’re thinking more comprehensively about the companies they invest in than just, let’s say, the immediate financial bottom line. Now, they all have that in common, but different funds are going to do that in some different ways. So, some funds are only going to invest in companies if they’re positively aligned with certain environmental or social themes, right? That’s what we do, for instance.

And that means that there are certain market sectors that we’re probably not going to invest in. So, funds like ours typically have little or sometimes no exposure to the energy sector, for instance, and strategies like that are typically called sustainable strategies. But then there are others that might invest in every sector, but they might try to maybe own just the best actors within each of those sectors.

So, maybe they do own energy stocks, but they’re trying to own the ones they believe are doing the least environmental damage or they’re actively transitioning away from fossil fuels. So, funds like that are sometimes called ESG integration or best of breed funds. And then finally, there might be some types of funds that own companies with the worst environmental or social behaviors. And they do that so that they can then mount more activist campaigns against them to try to get them to reform. And that might be one example of what we could call an impact fund. So not every ESG strategy is going to do exactly the same thing. It really is a spectrum. And I guess the bad news is that there are a lot of acronyms and that sometimes terms could be a little bit confusing.

But there is a flip side to that. I think the good news is that there are a lot of really good options out there. So, most investors can typically find an ESG portfolio to fill. Really whatever the investing need is that they have or kind of whatever view is that they have.

Seth

I really appreciate that context because I think sometimes we get questions from our customers about one topic that they’re really passionate about and they want to have some of their dollars invested in whatever that is that they’re passionate or they’re also maybe very passionate against something and they don’t want to have any of their dollars invested in that.

And I think it’s important to realize that these funds that the Washington State Investment Board works with, the Department Retirement Systems works with, we’re trying to serve a broad audience and work with a large population. And sometimes you have to go out on your own for an investment option that you’re really passionate about.

So in the intro, Jenny mentioned that this new fund that’s going to be available for folks in April and you mentioned thematic as well, it’s got the United Nations Sustainable Development Goals identified as the theme of the fund, hoping you can just explain a little bit more to us what that means for you as the fund manager.

Dan

Yeah, sure. Happy to share a little bit of insight to what we’re doing and maybe relating back to some of those earlier questions. I would say that, you know, first, this is an all equity strategy. It is an active strategy and it is thematic. We invest in only three main sustainable themes, and I’ll explain what those are in a minute.

It’s also a growth portfolio, meaning that the companies that we own tend to grow their earnings much faster than the average company over time. And then finally, it’s also a global portfolio so that the companies that we own, they’re not just U.S. based companies. They are domiciled in countries all around the world, both in developed markets and also developing markets.

So, at a really high level, those are some attributes of our portfolio. I would say that that probably the key concept underlying our strategy is that there’s a really important and I think an underappreciated role for the private sector in achieving global sustainability. You know, we have a range of very large, very complex challenges, everything from decarbonizing heavy industry and broadening access to health care, to ensuring food security and clean water.

It’s a long list, but we know that governments can’t solve those challenges on their own. They really need the partnership of the private sector to make progress against a lot of those issues. So, our strategy is really fundamentally designed to try to capture the really powerful growth synergies that exist between those massive social needs and private sector capabilities and resources.

You mentioned that we use something called the UN Sustainable Development Goals to help us build the strategy, and that that’s exactly right. So, the SDGs, as they’re often referred to, those are a list of objectives that were created a few years back by 193 countries around the world. And it’s really it’s a list of the biggest challenges these countries face and that they’re committed to addressing in some way over the next few decades.

And we actually think they’re a really useful tool for investors because one of the things they do is they provide us with a roadmap to almost $100 trillion in incremental capital investment opportunities for the private sector. And that’s obviously a massive number. So, we own companies that are providing the product solutions to these really big sustainability challenges that are called out in the SDGs.

So broadly speaking, those solutions are either climate solutions, so things like renewable energy or maybe it’s sanitation and recycling solutions. There are health solutions. So, that could be innovative drugs, that can be telemedicine. Or there are what we would call empowerment solutions. And that could include things like infrastructure development or education and employment resources. So that’s why we organize our portfolio into those three very specific sustainability themes that I was alluding to before.

Those three themes are climate, health and empowerment at a very high level. That’s what we do. And if I had to boil it down into one, if you will, and only given me 12 seconds to describe what the fund does: I think what we’re doing is generating strong financial returns over time by investing in companies that are helping make the world a better place.

Jenny

That’s beautiful. It sounds like you guys are really doing great work and this is obviously a good way to invest your money and help out other people.

Dan

We think so.

Seth

We’ll wrap up with the last question here. Is there an example or is there there’s something that you’re excited about that you could share with us that the fund is working on that might help maybe make this a little bit more real or tangible?

Dan

Yeah, sure. Maybe I’ll give you an example. I’ll give you an example. Then we’ll talk about something that we’re excited about. So, Apollo Hospitals is, I think, a great example of a company that’s finding that intersection between really big social needs and financial opportunity. So, Apollo provides a modern and affordable health care services in India, including in rural India, which is an area of really significant unmet medical needs.

So, we would connect it in SDG terms to SDG number three, which deals with good health and well-being. And this is a company that would be included in our health theme. So, India is home to about 16% of the world’s population, but 20% of the global disease burden and only 6% of global hospital beds. So, you can see that there’s clearly a massive unmet need in India and the need is especially big in rural India, where there have traditionally been very few health care options that are convenient or that are affordable.

So historically, a lot of people that are living in those areas just haven’t received modern health care services at all. So, Apollo Hospitals is a company that’s again, it’s helping fill that gap in a number of different ways. One of them is through telehealth, the broadening of communications infrastructure, things like cell phone ownership has really opened the door to telehealth services in India over the last decade or so.

Telehealth, it’s high quality, it’s cheaper, it’s more accessible. And I’m sure a lot of people listening to this have used telehealth services themselves. But Apollo is a clear leader there, and they were really the first to bring this to India at scale. They have a service they call Apollo 24/7. It makes a network of about 7,000 doctors available to people in a really low-cost way as long as they have a cell phone.

And it’s radically changed the way health care is delivered in a part of the world that desperately needs that. Again, it’s also a great example of a company that’s doing well socially, but they’re also doing really well financially. We’ve owned this company for almost a decade in our portfolios. Over that time, they’ve grown their revenues more than 20% a year.

The stock’s up more than 300% in US dollar terms, and that’s about two and a half times better than the broader market. So just one great example of a company that again, finds that intersection between massive social needs and private sector opportunities to add value and also profit.

Jenny

That’s really cool.

Dan

Yeah, it’s a great company. It’s been, you know, fantastic to own them for such a long time in the portfolio and see how they really are having a really big impact. In terms of things we’re excited about, thinking about themes that that we really like. It’s a… first, we like all of the themes in the portfolio, but infrastructure development is a really interesting one to highlight.

We would capture that within our broader empowerment theme. But really what we’re talking about here would be infrastructure development. The concept there is that across a lot of the developing world and the developed world as well, infrastructure just remains woefully inadequate. The OECD has estimated the global infrastructure investment needs were something like $6 trillion per year going out to 2030, just to support basic infrastructure development.

And that’s really without considering the impact of climate change. And when we consider the impact of climate change, that number goes up and it can go up dramatically. So, building resilient infrastructure and here you can think of things like transportation infrastructure, energy infrastructure, particularly clean energy infrastructure, water infrastructure. This is a clear sustainability goal. Drivers are: climate change, historic underinvestment, and even things like the relocation of our supply chains from overseas, you know, coming back to places like the US and into Mexico.

And all of that requires really massive investment into infrastructure. So spending… there are going to be a lot of spending tailwinds there that’s going to support, again, a lot of opportunity for private sector companies. There’s a lot of legislation here in the US that’s supportive of that. Things like the CHIPS Act, the IRA, the IIJA, but we know that there’s over a trillion dollars in committed capital that still has yet to be deployed relating to just those US focused pieces of legislation.

Dan

So, in our portfolio, lots of ways that we can benefit from that.

Seth

That’s wonderful. Thanks for sharing, Dan. I know we have a disclaimer at the end of our podcast is always to warn people that we’re not providing investment advice. I just make sure to say that as well here. But appreciate the opportunity to hear a little bit more about this new fund that’s going to be available for folks in April if they’re interested in finding more information about the fund, there’s a description on our website under the investment page where folks can find that under either Plan 3 or the Deferred Compensation Program.

Jenny

Yeah, well, thank you so much, Dan.

Dan

Great. All right, it was easy. Appreciate it, thanks. Bye.

[music outro]

Disclaimer

Thanks for listening. And now we’d love to hear from you. What topics would you like to hear about? What questions do you have for us? Send an email to drs.podcasts@drs.wa.gov that’s drs.podcasts@drs.wa.gov. The Department of Retirement Systems provides this podcast as a public service, but it’s neither a legal interpretation nor a statement of DRS policy.

References to any specific product or entity do not constitute an endorsement or recommendation. The views expressed by guests are their own, and their appearance on the program does not imply an endorsement of them or any entity they represent. Views and opinions expressed by DRS employees are those of the employees and do not necessarily reflect the view of DRS or any of its officials.

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