ValueWalk’s Raul Panganiban interviews George Mussalli, Chief Investment Officer and Head of Equity Research at PanAgora Asset Management. In this part, George discusses how he quantifies for intangible assets, opportunities in acquiring beneficial alternative datasets, and his thoughts on ESG funds following a best in class approach.
The following is a computer generated transcript and may contain some errors.
Q3 2020 hedge fund letters, conferences and more
ESG Funds Following A Best In Class Approach
well, that Disney versus Netflix is a great example, I think everyone can see how operating Splash Mountain takes a lot more carbon than streaming Breaking Bad from your laptop.
So, you are so going back to the idea of intangible assets, while some ESG factors can be easily calculated, such as a woman and minority representation in the workforce, other factors can so how do you quantify for intangible assets such as employee morale, brand equity and DNI think, partnerships.
This gets back to one of our panagora what something we've been doing for 20 years but now focusing more on ESG.
So these are different ways in quant investing, you know, the most important thing is
coming up with new ideas, right? That's the lifeblood of the Alfa engine. Right if we don't continue to come up with new ideas, the you know, anything we have in the model today will be, you know, useless. Five years. This is constant decay in our models. It's very important you structure and create a culture and the investment team to create to come up with unique interesting, different ideas.
So the way we do it is again, going back to basics, back to fundamentals. You know, we interview a CEO, we listen to earnings call, we read a research report, and we sit around and we say, like, you know, what are the most important traits of companies? In First we put that down on paper? And second is we look for data, right? A lot of the pitfalls, other quants, I think,
come out come upon, is they flipped that in the opposite way. They come up with a fine data, and then they come up with a story later to justify why that data is important.
So we go back to how we do it. You know, this is these are the conversations we have we say, for example, employee morale, when the things you mentioned. Yeah. Is it important? Yeah, it's important for especially for these types of companies that I mentioned. How do you measure it? Right? Well, you know, a lot of times, you know, we had a conversation in 2006. And we would have this discussion, and we say, yeah, employee morale is important.
And then it would end there, because there was no way to measure employee morale. So we put it on the shelf, and we let it sit there. But then, you know, 10 years later, you have websites, like glass door in the US, you have chat rooms, you have social media, and equivalents across the world, where employees are actually talking about what it's like to work at a company have LinkedIn discussions, things like that, right.
So now we have a channel to, to see this, right. So you know, we're very adept at it, which is one month, you need to have to do ESG. Well, today is the collection of these alternative data sources. Unlike balance sheet income statements that are very easy to collect data. ESP data is in the McLeod's like, what is it really? Right, it's hard to put your finger on it, but everywhere is everything. Right?
So, you know, for this, we can scrape, no comments, rankings, discussion, conversations between employees from all these different sources. Collect them, you know, you have, we'll have terabytes of data, we'll use natural language processing to on top of it, to analyse it. And we'll get to ranking. You know, so, you know, give you a good example today. And one of the best
ranked companies on employee morale, which would probably surprise you is Alaska here, right? Some, I'm sure, is not very fun working on an airline today, right.
You know, you probably have half or more of your colleagues furloughed.
It's very dangerous to you know, COVID you get to airport be on airline, you know, aeroplane all day long, to must be stressful, but somehow, Alaska is working with their employees and keeping the morale up. Now, compare that right with other airlines that I have the opposite problem, right. And now we look at 2021.
You know, there'll be, you know, you'll you'll have a kink in demand, sometime in the middle of the year. And I'm, I don't know about you, but I'm itching to get on a plane and fly somewhere, right.
So once we have vaccine, and caseload goes down, there'll be this huge demand, right? In Alaska, yours.
Employees are motivated and excited to go to work, they'll be you know, more than willing to keep up with that demand come back to work when more flights are added. And that'll help the company a lot versus other airlines that have the opposite problem that maybe maybe the furloughed baggage handler I know works at Amazon, you know, distribution centre or something of that, then I can come back then I like working there anyway.
So that's the type of thing we're looking at, you know, with you mentioned, brand equity. And that's a very important thing, right? That's another piece of the social component is how do you treat employees but how you treat your customers.
You know, another example in the airline space when united had that VIDEO leaked of a mother dragged the traveller out of their his seat ultimate passion, that wasn't a very good example of a company treat your customers well, and it hurt the brand. And now with social media, you know, that might have been word of mouth or a couple 100 people before internet today, that only takes a couple of minutes and hundreds of millions or billions of people.
So, you know, we monitor social media search activity, for, you know, you can see the good brands, right? If you probably know yourself, when you love a brand, you interact with a lot, you follow it on social media, when they post a ad or a new comment, you'll, you'll like it, or you'll share it or retweet it.
And you're very ignore brands you don't like, right?
So we can get a sense of that. Right. And, you know, for example, one trend we saw this year and identified was in homebuilders, right. So, you know, think about it that home is one of the biggest purchases, the biggest purchase you make in your life, right? So you're gonna do a lot of research before you do it. And you see
a home, home housing sites go through the roof this year, home purchases skyrocket, house demand is very strong this year. And we can we could see it happening because, you know, what do you do before you buy a house? It's not a
purchase you make? Quickly, right? So, way before a purchase happens, you're going to start researching, following the homebuilder online, maybe liking the different models that you see things like that. So
that's a way to get an insight into future demand. Right. And, like, companies that spend time invest in that customer relationship are the ones that are gonna win.
Thank you. And so aside from chat rooms and social media, what, over the next five years? What specific opportunities does panagora see to acquire beneficial alternative datasets?
Yeah, I think we, we've, we've done a lot of research in the environmental space, but I think there's there's tonnes more to do.
You know, the data just starting to come out. You know, we're leaders, and I think that data,
but there's a lot of different facets and things we don't know. And also, you know, we believe as regulations increase, it'll be more and more important for companies to address this. So for example, one
facet of this we're working on is, you know, right now, you know, when you think of environmental issues with a company, you're looking at first degree, you're saying, here's a chemical company, as these plants all over the world and emits this, this, this many tonnes of carbon right now, but what about, you know, versus a, you know, say, apparel manufacturer, and they're very clean, right? They have all this, you know, these scrubbers, and they have offsets, and they care about the environment. But what about the secondary effects? Right? Who are the suppliers of the apparel company? Maybe there's a buy fabric from a
company developing world that pollutes the water that where the factory is, right.
That's an important aspect.
And we've seen some instances where kind of in greenwashing, a company divest a certain division that pollutes a lot and then just create a contract to purchase all the companies the spin off companies to buy it, there's a way around, you know, hiding the fact even electronic vehicles which are, you know, the hype today. Green, typically, they're very, you know, those companies like Tesla are ranked very highly in ESG metrics. However, you know, when you plug in your car at night, you're demanding or electricity, right if you're a local power plant, uses coal to produce electricity, you know, you're you're, you're you're doing the environment that makes good you have to offset here. Less
Carbon coming from your car with more carbon coming from the power plant.
This takes a lot of data and a lot of research, we're chipping away at it. But I think when you look in the next five years, five years from now, we'll have will be much more advanced than today and measuring these efforts.
Ray, and I'm curious regarding the fashion example you gave, would you also then have to consider the lifespan of the goods, your ability, because as we know, fast fashion is something that's been in the news a lot for, you know, even if a fashion company, let's say were to offset all the carbon emissions from the process, what if their clients just end up throwing all their clothes and products into a landfill after a few months? Yeah, exactly. That's it, that's another aspect of it. The other that's the, as we get deeper and deeper into this,
you know, we you really have to add to the lifecycle of the product. If it's recyclable goods, then that's a better aspect. And, you know, you might think, you know, you know, if you're really if you have the lens of, you know, that was the question, you started with the kind of financial statement analysis of it, who cares, right? You know, you sell if you if you can, if the, you're buying the fabric from a company that pollutes more, maybe it's cheaper, right, and your margins are fatter. Right? So,
you know, and if you don't work on using recycle level goods to produce your product, you got another boost to today's profitability, right?
And that's the thing, right? If you're just looking at financial statements, you buy that company, right? However, you know, it's not just, you know, a feel good
aspect, right, I, I'm gonna buy the company that has lower margin.
Because I feel better about, you know,
the stock won't do as well. And I'll feel better about it. It's not that we believe that the company with lower margins, that spends more time thinking about the environment will get more customer retention, right, they'll,
you know, the, they'll have
over time, if, you know, if we go through a recession, and, you know, Cust, customers need to decide what they're going to give up, they won't give up that, that brand, because they love it. Right.
The other part is regulation, as we, you know, we delve more into it, we, we think that there'll be some kind of issue with these externalities that that companies will have
addressed these types of things, and at the end of the day, are a long term investor, you have to incorporate these things to find the best company.
So we've been talking a little bit about this. And I'd like to focus a bit on some of the criticisms and potential shortcomings of ESG.
I think we mentioned this, we talked about this a little bit earlier, when you were mentioning how different ESG factors are very, are very important for depending on the industry of a company. So some ESG funds follow a best in class approach. This approach has drawn criticism because it means funds can include companies like Exxon Mobil, as long as they're outperforming their peers. What are your thoughts on this?
Yeah, I think we look at a very nuanced, complex question. In any not as simple as those were the way others I think about it, right. And I go back to the example of the kind of third party ranking companies vs. What we're doing right, so again, you know, what, those third party companies that, you know, slap a ranking on every company, triple A double A, right?
Again, it's like a, it's like a credit rating of a bond. Right. And, you know, if I was if you were,
you know, a fixed income investor, you're not gonna give any, you know, you're not gonna pay active manage fees for manager just not to own below investment grade bonds, right. There's just a very, very big and it's not alpha producing, right. If you want that, just go by
ETF that has only I rank bonds in it. So equivalently, you know, you shouldn't pay anegada or any other active manager any more fees just to say I'm not going to buy low ranked ESG score, right?
What I think what we were trying to do is the equivalent of, you know, what have you go back to the other analogy is to look at, you know, you know, what, what a great bond manager does is tell him the bond before get downgraded, or by the fallen angel. And, and before it goes back to investment grade, right. And that's the real insight. And that's what we're trying to do. So part of the process of our bores, it's very
forward looking, right. Whereas the third party metrics are very backward looking, slow moving, even sale, right?
We're trying to look at what the company is going to be like in the future, right.
So actually, if you're looking at our scores, they you know, that ESG alpha scores of using our portfolios, they actually can predict the third party scores, right, so that there's a lot of benefits in doing that. One is, as you as I get
ESG flow data every month from from the brokers I we use, it's huge, right? billions of dollars coming into ESG funds every month. Now, if you can, you know, that if you can, if you're in that flow, you're you're you're susceptible to getting a front run. But if if you can, if you know, which companies will score will be the high ranking ESU companies six months from now, do you have a leg up? Right? So that's on the technical version, that's, that's one thing we can do better.
But the other thing is, again, back to fundamentals, right, you don't want you know, you don't want the triple A company that might fall down fall below, right? We're looking for companies that are improving, right,
that are doing things and committed to acting better as a member of the community, or an environmental or governance stance, doing things to improve themselves. And you know, that that's the whole thing, right? You want to, you know, if I if our models can identify, you know, a company that just went through a scandal that will, you know, see the light and change their ways and become a symbol of, you know, good ESG practices, three years from now, that's what I want to do. Right?
So that's shows, there might be a company, that there might be companies in our portfolio, they don't look good today. ESG, I thought, you know, our hope is not just window dressing or something, but but look to the future. And Tina, these companies will be ESG leaders going forward.
