Wendy Cromwell, head of sustainable investing at Wellington Management, began her career at the firm 25 years ago. Previously, she led the company’s multi-asset group, and over the past decade she has helmed Wellington’s venture into impact investing and sustainability. Cromwell is also a board director at Principles for Responsible Investment.
Here she speaks to ESG Clarity about why some parts of the firm are more ESG integrated than others, talking to clients about physical climate risk, the issues with ESG data and ratings and why she doesn’t like the term ‘divestment’.
How does Wellington integrate ESG?
Wellington is a community of boutiques, all organic. We haven’t done buyouts or mergers or anything like that. But we have 50-plus investment teams, and each of those has their own investment philosophy and process. The investment philosophy answers three questions: What inefficiency do you see? Why does it exist? And how are you taking advantage of it? You should be able to express how you envisage ESG or incorporate ESG in that answer. What’s your genuine, incredible way of integrating ESG considerations into your investment philosophy and process?
The level of integration is on a continuum, and that’s generally determined by the availability of frameworks and methodologies and data for various asset classes. Our equity portfolios and our corporate portfolios are much more integrated, because they are meeting and engaging with companies on these topics, and the data is available. And they can look to see if there’s a plan with regard to the low-carbon transition, etc.
You get to structured product, and it’s a little less so, because there’s not that data available, or there’s not a framework as readily available. However, wherever across the spectrum we uncover an impediment to adoption, we try to figure out, how can we either contribute to the ecosystem to improve it, or how can we develop our own data just to improve our own processes.
An example of that would be in sovereigns analysis, particularly in emerging markets. Physical climate risk is particularly important. Back in 2018, we launched a physical climate risk research partnership with Woodwell Climate Research Center … to really figure out where we’re going to see more heat, drought, wildfire, hurricanes, floods, access-to-water issues and how they would impact the securities that we own and how we should be thinking about that with regard to our muni book of business.
We’ve also made a net-zero commitment. When we made the commitment, 1,400 companies had science-based targets or commitments to science-based targets. And now it’s more than 2,200. And that’s before the initiative hits its full stride.
What do clients want to know about sustainability and ESG issues?
Physical climate risk. No matter what we do on mitigation, we’re still going to face physical climate impairments. We need to understand those, and we need to encourage companies, society, economies to adapt to the new climate regime that we face, no matter what we do on emissions. Most forecasts suggest we’ll pass [an increase of 1.5 degrees Celcius by] mid 2030s.
For companies that are distributors, does that mean just not carrying products that are made with petroleum? Does that mean not carrying meats? Or is it mostly using carbon offsets?
Yes and no. Science-based targets initiative doesn’t really allow for carbon offsets except for hard-to-remediate emissions. But it’s only meant to complement your core business operations.
We’re trying to get as many companies in our portfolios as possible … to decarbonize their own business operations so that we decarbonize our portfolios from the bottom up and we meet our net zero-commitment and in a way that’s going to help our clients be less impacted by climate risk. Because if we just sold out of security … that doesn’t really work. Some parts of the market can do that, but it doesn’t truly affect the real-world emissions profile.
They’re still going to exist.
They’re still going exist and they’re still going to emit, so to really change the real-world emissions profile – and to really try to help your clients navigate climate risks – you actually need to get the companies to decarbonize themselves. That’s the more meaningful impact we think we can have.
How do you get an oil company to decarbonize?
You see meaningful differentiation in the approaches of different oil companies that define themselves now as energy companies. Many of them understand there is this transition happening, and they don’t want to be caught with stranded assets. They need to be investing in new technologies and they need to be shifting their capital allocation to other forms of energy.
Not all of them have that same approach … It’s a better long-term strategy to have a plan for the future than to not have a plan for the future. Some will just say, “We’re going to take advantage of the oil beta right now for as long as we can. And others are getting out, so we’re going to make a bunch in the short term.” That might be a good short-term strategy. It’s not a good long-term strategy, if you accept that the low-carbon transition is happening. It’s one of the greatest economic transformations we’ve ever seen.
How does Wellington handle divestment?
Instead of using the word “divestment,” we use the words “sell discipline.” Divestment conjures up this idea that you’re going to sell something because you’re mad at the company or based on your own values.
We’re choosing to sell a position because we no longer think it meets our investment criteria, because it doesn’t have a plan for the low carbon transition, and that’s an important economic transformation.
In working with the companies that Wellington holds, what are some of the challenges they have with incorporating ESG? And how do you address that?
One of the challenges we hear throughout the whole system is that the data’s not good. There’s not enough data. And we hear that from asset owners, asset managers and the companies themselves.
Through time, company disclosures and company accounting practices have evolved. When financial accounting standards were originally introduced, the economy as we know it was very different, much more manufacturing intensive. And therefore, we were counting physical assets. Now we have evolved globally as an economy. We should be thinking about things beyond physical assets in terms of those accounting rules. You’re starting to see pretty major initiatives throughout the system to help build that, starting with climate. We’ve been very involved with the SEC and their questions about whether there should be mandatory climate disclosures for issuers.
There are a lot of different companies offering some types of sustainability ratings or ESG ratings. Does Wellington rely on any of those? And do you have any concerns about them?
There are, at last count, 14 different vendors providing ESG ratings, but there are two dominant ones: MSCI and Sustainalytics. The work those two companies and the broader group of vendors is doing is good and is additive to the ecosystem. It’s the interpretation that can be problematic – and the use case of those ratings. For example, a lot of people like to think of those ratings as being like credit ratings.
Instead of thinking of those ratings as credit ratings, we suggest that people think of them as sell-side recommendations. Would you expect Goldman Sachs and Credit Suisse to have the exact same recommendation, price target or earnings per share estimate for a company? No. Would you expect them to converge over time, to think the same way about companies? No. Would you work with them and take on their research reports to inform your own mosaic and help you think through how you would want to think about them and what questions you should ask those companies? Yes.
That’s the major issue. Some people think they will converge. I don’t think they will. The way they’re applying different methodologies, they’re using different data. They have a different emphasis. But they can both contribute to a greater understanding of a company and using the underlying data in a way that’s effective.
In a perfect world, should every investment include an ESG component?
I’m going to say something that’s going to sound kind of crazy. If you think of ESG as a research discipline, I think to a certain extent, every investment already has an ESG component. Because if you break ESG down into its subcategories, you’re thinking about culture, you’re thinking about governance. You’re thinking about capital allocation.
Do we need to build more frameworks and practices around deeper adoption of those concepts? Yes. So both things are true. And a lot of that does have to do with overcoming the data gap apps, having more out in the public record.