Transcript of the podcast:
MARK RIEPE: When I lived in Chicago, my apartment was just a few blocks away from the hotel where NBA teams stayed when they were playing the Chicago Bulls.
Perhaps not so coincidentally, there was a unique business not far away. It was a shoe store, but not just any shoe store. They sold men's casual and dress shoes in large sizes and catered to pro basketball players.
If you're tall, really tall, shoes are a problem. Because while the average American man wears a 10½ size shoe,1 the average NBA player wears a size 13 or 14.2
And that's just the average. Among current players, Brook Lopez of the Milwaukee Bucks wears size 20. Among former players, Shaquille O'Neal wears a size 22.2
During the time I lived there, basketball shoes, as a fashion statement, started to take off. Pioneered, of course, by Michael Jordan and the Air Jordan.
Other NBA players—like current stars Steph Curry and LeBron James—followed Jordan's lead and have signature shoes bearing their names.
And ahead of the 2018-19 season, the NBA removed all color restrictions for shoes from the rules, so all players could freely express themselves on the court through custom shoes, often hand-painted just days before a game.3
It was a change that allowed the ultimate in customization because a player could wear a different shoe for every game.
I'm Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decisions and the cognitive and emotional biases that can cloud our judgment.
Basketball players aren't the only ones who customize their equipment. Since the Winter Olympics are about to end as I'm recording this, let me spend 90 seconds on hockey goalies. The goalies in the National Hockey League rely on a small group of goalie-mask painters to create their protective works of art.5
Some designs are merely variations on the team's colors and mascot, while others are highly personalized with images that reflect the goalie's interests and values.5
This personalizing seems to be a thing that goalies take very seriously, because creating a mask is no small feat. On average, it takes about 40 hours to design, prepare, and paint an NHL mask.
For example, when Connor Hellebuyck, current goalie of the Winnipeg Jets, was working with the designer to create one of his masks, he went back and forth with the artist a dozen times before finally approving the design.5
The oddest thing we learned about when looking into this is that not only can goalies specify images and colors, but they can enhance the design with materials like paint that change color depending on the temperature.
So, obviously, getting the mask just right is a high priority for some goalies. And I think it's fair to say that for these athletes, expressing themselves through the art on their equipment is important, or they wouldn't put so much time and effort into designing shoes and masks.
But in the grand scheme of things, with few exceptions, the customized equipment an athlete wears is a relatively trivial thing.
But this trend does tap into something that's far more important, and that is the fact that many of us yearn to express ourselves in a world that can feel increasingly cookie-cutter and standardized.
This applies to investing as well. For many investors, where we direct our money is a statement about who we are, what we value, and how we'd like to see the world change.
And while it's great to see extremely well-paid professional athletes performing their own form of self-expression by not being content with off-the-shelf shoes and masks, that isn't going to change the world in a meaningful way.
So, let's set aside athletes and get into the meat of this episode, which is about customization, self-expression, and how both apply to investing.
Investing in companies whose missions you believe in can have a more noble purpose. The goal, for some, is to influence, and perhaps even change, the direction of society.
"ESG" investing, which stands for environmental, social, and governance, means selecting investments based on how they align with your beliefs and values.
Investing has always been about customization to a certain extent. We all should be thinking about how we feel about the level of risk we're comfortable with as well as the amount of expected return we'd like to achieve.
In a sense, ESG is another layer of customization for investments, on top of risk and return.
You'll sometimes hear ESG used interchangeably with SRI, or socially responsible investing—a term and approach that's been around longer. And just as early goalie masks were plain white—think Jason from Friday the 13th—early SRI strategies were simpler, too. SRI was typically a way to screen out certain companies, such as those involved in tobacco, firearms, gambling, or alcohol.
But ESG has advanced, and instead of merely avoiding certain industries, people can specifically target investments that support the things they care about.
To find out more, I'll talk with my guest, Malik Sievers. Malik is head of ESG strategy for Schwab Asset Management. He is a Chartered Financial Analyst and is responsible for representing Schwab Asset Management's viewpoints on ESG to investors.
Malik, great to have you here.
MALIK SIEVERS: Great to be here, Mark.
MARK: Malik, I wanted to start out with just some basic concepts here. I think we've seen that, at least with Schwab clients, socially responsible investing is a popular term—it's well-understood—but it's not the same thing as ESG investing. So I wondered if you could kind of define the two and explain how they're different.
MALIK: Mark, I think that's a great place to start. At Schwab Asset Management, we use ESG as an umbrella term to describe strategies that emphasize environmental, social, or governance factors, in addition to traditional measures of risk and return. So it's really meant to include terms like SRI, or socially responsible investing, as you mentioned; values-based investing; sustainable investing; or even impact investing. We chose to use ESG versus SRI because, historically, SRI investing has been more associated with more of an exclusions-based approach. So, for example, you might be removing companies exposed to alcohol, or tobacco, firearms, or even fossil fuels. ESG, on the other hand, tends to be a bit more broad. So we've also seen industry participants starting to really coalesce around the ESG term. You know, Wayne Gretzky always used to talk about how he skated to where the puck was going versus where it currently was. So in the case of SRI, we really see it as more of a term that's a bit more dated, and ESG is becoming much more widely accepted as the industry term.
MARK: Thanks, Malik. One of the things that, obviously, has dominated kind of the headlines for a couple of years now has been the COVID-19 pandemic. It's affected a lot of things in society. What about sustainable investing? What about ESG investing? What sort of changes have you seen in the past couple of years?
MALIK: Well, there is no doubt that COVID-19 has had a material impact on ESG, or sustainable investing. If you think about at the corporate level, we've seen how COVID-19 has underscored the need for companies to focus on all of their stakeholders, not just shareholders, and especially focus on their employees. So we've seen companies have increased emphasis on their employees' health and even adding more workplace flexibility. And then at the individual level, we've seen people become much more aware of the preciousness of life. And I think that realization has made them much more focused on aligning their values and beliefs with not only their time, but also their investment dollars. And so I think all of these factors have really been a strong tailwind for ESG investing.
MARK: Do you detect any abatement of that? Do you see any of that kind of dropping off a little bit, or is the momentum still strong?
MALIK: So the data certainly the doesn't suggest any slowdown. I mean, if anything, I would say 2020, in particular, has been an accelerant for more growth. And it's not just about COVID-19, but we're also seeing increasing concerns with climate change. We're seeing heightened social, political, and economic unrest. I think really all of these factors have heightened people's awareness and made them want to engage on these issues.
And I will say this: Perhaps the most exciting thing for me is seeing the younger generation really start to engage earlier. I myself have two really beautiful daughters, and I love talking to them about these issues. So as a long-term investor, I'm constantly trying to teach them that it's more important to have time in the market than timing the market. So if you think about ESG, and if it can continue to be that catalyst to get young investors to invest earlier and then stay invested because they're so much more passionate about the issues, then I think that's a really great outcome.
MARK: Yeah, I completely agree with that. We're going to be talking … segueing here into a little bit talking about mutual funds and exchange-traded funds, which invest in these types of companies or this particular strategy. But one of the things about when you're investing in funds is, you know, labels get attached to these funds—you know, core funds, blend funds, you know, growth funds—but those definitions are a little bit squishy. And so I think the same thing applies to ESG funds. So are some ESG funds sort of more ESG than others? How do you separate the two?
MALIK: Yeah, I would definitely say that this is a subjective area in which reasonable people, my dad used to say, can often disagree. And I would say that the industry is still navigating questions on how to really define and measure ESG. I certainly would love to see improvements and more consistency, especially as it relates to how it's measured and how we determine what's most material, especially when it comes to ESG. Some of the top ESG rating firms can have correlations less than 30% for the very same company. In many cases, those companies aren't necessarily measuring different data, but they could just be assigning different weights to the factors. So, you know, if the rating companies or the experts can't agree on what a good ESG company is, it's a pretty tall order to ask our clients to make that assessment.
The bottom line really is that ESG means different things to different people, which also means it's important to understand individual objectives and always do the proper due diligence on investments.
And then the last thing I'd say is if you do have preferences or you're delegating your decisions to an advisor or some kind of fund manager, you really need to take the time to understand what those managers are doing and how they're investing the money.
MARK: Yeah, I think it all comes back to you really need to understand what you own, right?
MARK: Personalization, that's a hot topic in investing, as you just mentioned, and everyone I think for really good reasons, you know, prefers a more tailored approach, rather than kind of a one-size-fits-all to the things that they're investing in or the products that they're investing in. How can ESG investments kind of fit? What role does an ESG investment play in the investor's broader portfolio?
MALIK: So we do see ESG as another form of personalization. Some investors certainly want to invest in certain sectors, as you mentioned, or themes, but over the last several years we have seen, increasingly, more and more investors wanting to align their beliefs and values with their investment dollars. So when it comes to incorporating ESG into a diversified portfolio, we really see it as more of a dial and not a switch. So what I mean by that is it's very customizable. First, you try to assess the starting point and understand what the current ESG exposure is in your portfolio. There will be some investors who are maybe just starting to get their … dip their toe in the water. They may want to take more of an exploratory approach, where they might want to just add a few funds in an otherwise non-ESG portfolio. You have others that might want to take more of a middle of the road approach by picking ESG options in categories where there are readily available solutions. And maybe non-ESG options in other categories, like real estate or maybe international small cap, where maybe they're not as many good ESG alternatives. And then there are others who just say, "I want to be all in," and they want to build a portfolio from bottom up, security by security. I think this can allow for a lot more customization, but it also requires more assets in order to create a fully diversified portfolio. The point in all of this is that ESG exposure can really be tailored to each investor's preference.
MARK: Yeah, I think it comes down to … just to expand on what you said there, there's no one type of ESG investing—there's no one flavor that everyone follows—but there also doesn't need to be one method for building it into your portfolio. Everybody is different. You know, do what makes the most sense for your situation, right?
MALIK: Absolutely. There is definitely not a one-size-fits-all in this as it comes to ESG.
MARK: So ESG investing has been around for a while, and I've seen studies where people say it performs better than more traditional forms of investing. I've seen people say it actually performs worse because you're kind of concentrating your portfolio to an extent in a smaller set of companies. Is there that kind of tradeoff? What do you think?
MALIK: You know, Mark, that is probably one of the biggest questions, or, I should say, objections that I get from both clients and advisors alike. I hear from them all the time that ESG investing is going to hurt their performance, or the concern that it would. But, you know, if you look historically, the performance of ESG versus non-ESG funds have pretty much been in close alignment with each other. Typically, ESG funds have ranked right in the middle of their respective Morningstar categories. Now, of course, past performance is not a predictor of future performance, but we can definitely say, at least historically, ESG investing and good performance have not been mutually exclusive, and it's certainly been possible to do well while doing good.
MARK: Yeah, and always keep in mind that these are broad averages. Just like any strategy, there's going to be a distribution of performance, you know, some well above average, some well below average. But I think you're exactly right, on average, the strategies seem to track their non-ESG counterparts fairly well, again, at least historically.
What about this tradeoff between, kind of, risk and diversification? I think the argument typically is made, well, if you're investing … again, if you're investing in a smaller set of companies, you're going to be, by definition, less diversified. Therefore, there will be more risk, more volatility, because you aren't as diversified. What's your take on that?
MALIK: You hit on the second hot topic. I mean, that's another common conversation that I have with advisors and investors. A lot of them will believe ESG investing will either decrease or increase risk. You know, the supporters of ESG will argue that by removing undesirable industries, you are reducing the risk and increasing long-term sustainability, but then you have the opponents on the other side saying that by removing those industries, you're now decreasing diversification, which can increase risk.
So there, clearly, are many different ways to look at and measure risk. I mean, we looked at the standard deviations of returns for ESG funds versus non-ESG funds, again, by Morningstar category. And, again, we found that the standard deviation of returns were not materially different between ESG funds and non-ESG funds. So it's a very similar outcome to what we just discussed about performance.
But you … you know, you obviously can also have an investor that maybe has had a tobacco-related death in the family, or they may just be seeking to reduce or minimize exposure to tobacco-related companies, or maybe even proactively, they want to focus on investments that meet some sort of social good, like affordable housing. So there are tools that investors can use to analyze investments for these factors and understand those exposures or lack of exposures. The key really is to, again, look at the investment goals, the overall asset allocation, and make sure the risks are balanced in a diversified portfolio. You know, in other words, you really need to evaluate ESG investments, just like you would evaluate any other investment. You want to look at the investment merits of the strategy, who is managing the strategy, and then the specific approach that is being used to select the investments.
MARK: So when we talk about funds, typically, we're talking about mutual funds or exchange-traded funds, and one of the big divides in those universes is index funds versus actively managed funds. So I was hoping you could talk a little bit about how that difference plays out in the area of ESG investing.
MALIK: So an index ETF usually has some sort of benchmark like an S&P 500® that it is seeking to track. The holdings and the allocations within that index ETF will be purely driven by the benchmark. There are no decisions made by anyone managing that portfolio to intentionally deviate from that stated benchmark.
Now, with active ETFs, you have portfolio managers who are proactively choosing to hold more or less of an industry or a company. So if you think about it, this is exactly the type of decision that you might want an ESG manager to have so that they can try to identify factors that they believe are important from an ESG perspective.
Now, the one thing I do want to mention, though, is that with active ETFs, you, typically, will pay a little bit more because you're paying for that manager to do their own research and to try to select those firms that best have those ESG factors.
MARK: Thanks, Malik. I want to go … kind of circle back to something we said earlier about how it's important to know what you own and understand the strategy and understand the approach of the manager. So how can investors find out what holdings are in their particular fund? How can they see what those companies are to see if they really kind of line up with their values?
MALIK: Well, it's important to say that no matter whether you buy an exchange-traded fund or a mutual fund, whether it's at Schwab or if it's somewhere else, you can always get access to the holdings. I mean, whether these funds or ETFs send you electronically what those holdings are or via mail, they have to disclose those holdings. So index and active ETFs typically disclose their holdings each day, so an investor could literally look at individual names to determine if the holdings align with their values.
Now, there's a fairly new class of ETFs called non-transparent or semi-transparent ETFs that will disclose their holdings, too, but typically it's on a bit of a delay. So, for example, these ETFs, like mutual funds, will typically disclose their holdings at the end of each quarter, which is, again, very similar to the frequency used by mutual funds. This is really done to protect the fund manager's strategy so that the manager has the flexibility to buy or sell securities without other institutional investors trading in those same securities before they have had a chance to.
So at the end of the day, it really just comes down to the timing and the frequency of when the actual holdings are disclosed. And that's what you really have to consider when you're choosing between, say, a more indexed or active strategy versus this new form of ETF called the semi-transparent or non-transparent ETF.
MARK: As we were talking about earlier, Malik, many of the people who are interested in ESG investing, they've got interests that go beyond just, you know, the rate of return on the fund or the amount of risks they're taking on. They really want to use investing as a way of kind of making a difference in the world or kind of shaping the future in a positive way. So can you give me an example of how ESG funds, or maybe just ESG investing, in general, has actually made a difference?
MALIK: Yeah, I really think ESG investing can make a real difference because it helps to bring clarity and alignment around a specific goal. And I can give a few examples of this. You could think about at the industry level we've recently seen a number of companies commit to net zero targets, which, essentially, is a commitment for these companies to follow policies targeting net zero greenhouse gas emissions. You know, and we've also seen at the company level, General Motors saying that they will stop selling gas-powered cars and go all electric by 2035. Then at the individual level you can, obviously, design portfolios that exclude certain companies, or industries, or even countries that they want to avoid or look for investments that are seeking to have a specific social or environmental impact. So I think all of this can become even more powerful in the future. Getting back to something I said earlier, when there is more consistent data and standards of measurement that people can really rely on, I think that will even help to make this have even more powerful impact on change in the broader environment.
MARK: So last question. I mean, what you just said is just fantastic. It shows that there really is … you know, this form of investing does, in fact, result in change, but it really all starts with, you know, investors being heard. So what are some other ways for investors to kind of make their preferences known and to make sure that people who are working on their behalf are aware of those preferences?
MALIK: You know, Mark, I think that is such a really important point to make, and I'm glad you asked that as the last question. Individual investors should absolutely proactively seek to talk with their financial consultants or advisors about some of these preferences. They could start by making sure their values and beliefs are incorporated in the planning process or part of the very early conversations that they have. You can also, as an investor, choose to engage in some of the proxy voting from the securities that you own.
I mean, one of the reasons that I'm so excited about my role at Schwab Asset Management is I get to work with clients to help them to better understand what resources, what guidance, and even what investment choices they can make, or they have access to, in order to express their preferences and ensure that their voices are being heard.
MARK: Malik Sievers is the head of ESG strategy for Schwab Asset Management. Malik, thanks for dropping by today.
MALIK: Thank you, Mark, for hosting me today and allowing me to add my voice to the conversation.
MARK: It is a fact that we buy things, including equities, to express who we are, what we value, and how we see the world.
By and large, in all areas of life, there's more and more variety available, which makes more personal expression possible. In fact, I would say that we expect it these days.
Henry Ford once said, "The customer can have a car painted any color that he wants so long as it's black." He was true to his word, as the Model T was only available in black from 1914 to 1925.6
That's an old story, but what you may not have known was that in the beginning, the Model T was available in a variety of colors, but black paint dried fastest. And since Ford valued efficiency over customization,7 the other colors were eliminated.
Fast-forward to 2021 and the best-selling vehicle in America is also a Ford—the Ford F-Series pickup.8 And in 2022, you can get one in no less than eight colors, including "Agate Black."
This show is about decision-making and the cognitive and emotional biases that can trip us up when making decisions. A downside of personalization is that it can lead to decision paralysis in the form of choice overload.
We've covered this concept a few times on past episodes, and it's been dealt with as well on the Choiceology podcast.
But there's another pernicious aspect of personalization besides choice overload that you should be aware of. It's a decision bias that's captured in the phrase "Don't let the perfect be the enemy of the good." Personalization is great, and this revolution of expression through customization has made its way to investing. ESG is an example of that.
If you go down this path of investing and have highly specific preferences, you may not find a mutual fund or ETF that is a perfect match for your world view.
Now, if you're a wealthy investor, you can work with an advisor to craft a more custom strategy, but those strategies and advisors often high minimum investment amounts that are greater than what the average investor can afford. In that case, you must use funds that are meant for a more mass-market investor or go the do-it-yourself route and build and manage your own portfolio.
The DIY approach is great if and only if you have sufficient time and expertise.
If you don't, then consider ESG-oriented mutual funds and exchange-traded funds. They may not be a perfect match, but if ESG is your thing, then they're probably closer to what you want than what you're doing today. The point to keep in mind is that sometimes the best decision to make is to go with a choice that's good and better than what you're doing today rather than pursuing perfection, which may not be realistic.
If this episode has piqued your interest in ESG, Schwab can help. Check out our resources for ESG and SRI at Schwab.com/SRI.
On that page you can learn more about how to invest in ways that reflect your own personal values.
Thanks for listening. To hear more from me, you can follow me on Twitter @MarkRiepe. M-A-R-K-R-I-E-P-E. If you've enjoyed the show, please leave us a rating or review on Apple Podcasts.
For important disclosures, see the show notes and Schwab.com/FinancialDecoder.
1 Whelan, Corey, "What Is the Average Shoe Size for Men?" healthline.com, August 7, 2019
2 Drake-Flam, Danielle, "These Basketball Players Have the Biggest Feet in the NBA," FootwearNews.com, December 30, 2021
3 DePaula, Nick, "NBA Players Get Green Light to Wear Sneaker Color of Choice Throughout 2018-19," espn.com, August 28, 2018
4 Skyes, II, Mike D., "A Complete List of Every NBA Player with a Signature Shoe," usatoday.com, January 29, 2022
5 "Inside the Colourful World of Goalie-Mask art," Day 6, CBC Radio, cbc.ca, October 15, 2021
6 "The Model T," ford.com, accessed February 2, 2022
7 Kurylko, Diana T., "Model T Had Many Shades; Black Dried Fastest," autonews.com, June 16, 2003
8 Henry, Jim, "The Best-Selling Cars, SUVs and Pickups of 2021," forbes.com, January 6, 2022
Is it possible for your portfolio to reflect your beliefs? ESG could be one way to help. ESG is an umbrella term to describe investing strategies that emphasize environmental, social, or governance factors, in addition to traditional measures of risk and return. Within this umbrella framework are strategies like SRI, or socially responsible investing; values-based investing; sustainable investing; and impact investing.
In this episode, Mark talks with Malik Sievers, head of ESG strategy for Schwab Asset Management. They discuss how to personalize your portfolio, the average performance of ESG funds, and how ESG funds may help make a difference in the world.
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Financial Decoder is an original podcast from Charles Schwab. For more on the series, visit Schwab.com/FinancialDecoder.
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