ESG investing has come under scrutiny this year as regulators have taken a closer look at popular investing strategy and many funds have underperformed benchmarks such as the S&P 500 Index.
The Securities and Exchange Commission has proposed tougher rules regarding ESG labels on mutual funds and exchange-traded funds. The watchdog also proposed that funds disclose how they integrate environmental, social and governance rules into their investment selection process and strategies.
Along with the underperformance, criticism of the strategy has also picked up, with some critics saying it doesn’t work.
Sarah Bratton Hughes, the new head of ESG and sustainable investing for Kansas City, Mo.-based American Century, a $250 billion global investment manager, sees the greatest regulatory interest as good for the industry, which has seen a flurry of investment products and dollars flow to that.
“Before, there was no regulation on this, so I see this as a positive sign of the industry’s success,” she says. She added, “I also consider some of the pushback to be somewhat healthy.”
American Century is unique in the fund industry in that 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 fortunes to found the institute, which included a majority stake in American Century. Since 2000, when the institute’s laboratories opened, dividend payments have totaled $1.7 billion.
MarketWatch spoke to Hughes about his new role at American Century and how the company 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 will deepen our stewardship program. We have now put together a thematic framework, with five megatrends that we believe must be focused on a sustainable future economy: healthcare, environment, empowerment, sustainable living and digitalisation. I actually think digitization is the one that separates us the most. You can think of digital infrastructure from a risk perspective, like increased 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)… increasing financial inclusion and giving more people access to banking services. We will need a lot of infrastructure.
MarketWatch: American Century incorporates ESG into its investment process. How do you do this, and what does it mean for American Century?
Hughes: Each of our team members has a very close relationship with the different investment disciplines that we have here. We have a deep understanding of their process on our end, and we provide them with expert knowledge and research, and they build that into their process. It is a systematic process that ensures true ESG integration, rather than brick and mortar. We have a very strong growth franchise and a very strong value franchise, so the integration of sustainability, or the businesses that you would find, are very different. We use a framework we call the BRITE Framework, which stands for Best in Class, ESG Risk, Innovation, Companies in Transition and Engagement. So for value companies, we would tend to see more companies fitting into this transition and engagement bucket, less best-in-class. In the world of growth, you might see more companies fall into the innovation or best-in-class bucket.
MarketWatch: It’s been a tough year for ESG, in terms of performance, given its traditional overweight in technology and underweight in fossil fuels. With rising interest rates weighing on growth companies and long-lived assets, and an increase in the use of fossil fuels, what does this mean for ESG investing?
Hughes: I have held the ESG seat for more than one market cycle. I don’t think it’s different from growth or value. There will be times when things are in favor in the market, and they are out of favor in the market. What I really want to emphasize is that, for me, ESG integration is process driven. It is much more focused on your process. What people talk about for underperforming are results-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 achieve our decarbonization goals, we will need aluminum. We can’t just say [emissions] look terrible and weed out the companies, what we can do is say, who are the best players in this industry, who are most poised to not just survive, but thrive in the future, because d From an operational perspective, they understand the potential risks. And they are transitioning their operating model to use more renewable energy sources.
Read: You can count single-share value-focused ESG funds. It’s painful for investors as tech crashes
MarketWatch: Fossil fuels rebounded strongly due to the Russian war in Ukraine and the drop in supply with a rebound in demand. Will fossil fuels stay, or is this their last breath?
Hughes: I think this is potentially the last gasp for some fossil fuel companies who refuse to acknowledge that the [green energy] the transition is coming. But I would like to warn that we still have a long 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 are really focusing is on financing this transition. The big providers of capital really need to fund these innovative new technologies. I see this as a short-term rise in fossil fuel prices [because of geopolitical crises], and what I think you’ll see are countries that are increasingly striving for energy independence. And the only way for many of them to get there is to invest in renewable and clean energy. [For fossil-fuel companies refusing to transition] I think it’s gonna be an escalator down [in value]not a lift down.
Read: Russia’s invasion of Ukraine changes ESG investing
MarketWatch: Can you tell us about the type of research that the Stowers Institute does? The way the institute is funded, through profits from American Century, means scientists don’t need to write grants and can study problems longer than most outside funders would allow.
Hughes: Our founders took their $2 billion and they built and endowed the Stowers Foundation. The institute conducts basic research into the causes, treatment and prevention of disease. [Most medical research] the funding goes to flashy and innovative biotechnology. There is a lack of funding for some of the basic research that is needed.
Finance, in general, does not really save lives. We can talk about the progress we can achieve through our sustainable and impact investments. But often, we are at derivatives. The research taking place here has the potential to truly change lives and impact lives forever.