In this interview, Shannon O’Leary, the chief investment
officer of the Saint Paul and Minnesota Foundation, discussed with Markets
Group’s Iain Bell, best practices on building a socially conscious portfolio. O’Leary explored how asset owners can create the metrics required
to measure social investments and, crucially, how they must engage with their
managers and holding companies alike if they are to strengthen their social
investing credentials. 

Since joining the Foundation in
2019, O’Leary has implemented an approach that both quantifies and promotes Diversity, Equity, and Inclusion (DEI) as well as environmental, social and
governance (ESG) investing strategies that align with the Foundation’s work to
inspire generosity, advocate for equity, and invest in community-led solutions.
Long-term performance remains very strong, and the fund has seen material
outperformance in the one-year and three-year periods relative to its policy
index, as well as significant outperformance relative to its 70% equity/30%
fixed income public market benchmark.

Markets Group: You’ve built a name for yourself as a socially
conscious CIO. When you joined the Saint Paul & Minnesota Foundation in
2019, you took a strong look at your managers and their internal diversity
records. Why was that important and what was the result of the review?

Shannon O’Leary: Investment team diversity continues to be a key
factor in achieving superior portfolio outcomes for both return generation and
risk management. Reporting from the Knight Foundation and others shows that
diverse asset management teams are consistently over-represented in the top
quartile of performers, despite attracting far less attention from investors.
My experience working with managers over the last few decades has also been
instructive. I am most interested in diversity at the investment
decision-making level of a firm because investment professionals are not immune
to the perils of information silos. I have seen a number of firms significantly
damage their investors via rampant group-think. Having a diverse team helps
mitigate that risk.

When I stepped into the role at
the Saint Paul & Minnesota Foundation, I didn’t expect all of our fund
managers to have diverse management teams – this industry is still
overwhelmingly white and male. I prefer to meet folks where they are, help fund
managers understand the importance of diverse teams, and get them committed to
diversifying their teams over time. My team and I developed an assessment tool
that gives us a baseline metric for each fund manager, and tracks their
progress over time. Critically, we share our results with each manager and have
frank conversations about our goals for them, what we can do to support their
efforts and how their efforts can contribute to diversity of the overall asset
class or the industry more broadly.

The result has been overwhelmingly
positive. Many of our managers were already putting in the work to improve
their diversity efforts and we’ve been able to work together to identify areas
where they can continue to improve. It also turns out that telling someone they
got an “F” is a uniquely motivating tool in an industry populated by
high-achievers, straight-A students hustle to bump up that grade. We have
exited from firms that lack interest or motivation to improve, and since there
is no shortage of high-quality fund managers who take DEI seriously, we simply
do not have to work with those that do not. Another fun result has been inbound
calls from managers who want to work with us – they have heard about our DEI
process from their peers or the UN PRI folks, and want to partner with us to
improve their process.

MG: It’s fair to say that since you joined the Foundation, you’ve
overhauled its portfolio to focus on ESG, and in particular, social investing.
Would you be able to explain the process of this review, and the implementation
of social investing in the portfolio?

SO: As a baseline, I believe a core tenet of my job is to do my best
to ensure that we’re not investing in entities that are causing problems that
our nonprofit and community partners are trying to solve. Approaching asset
management from that socially responsible lens was something we codified in our
policies during 2019 and 2020. Beginning in 2019, my team developed a process
that allows us to assess how values-aligned our underlying managers and
holdings are with our responsible investing policies. We partnered with
Sustainalytics to review ESG metrics on our public market holdings as an
initial step. The team at Sustainalytics provided us detailed insight into
their methodology, which helped us develop a proprietary process to review all
of our private market holdings as well. Presently, we are able to assess values
alignment across the full portfolio and we provide reporting to our board and
investment committee.  

In addition to transitioning our
portfolio to be more fully socially responsible, the Foundation leadership
wanted to make a public commitment to this work. In early 2022, we became the
first U.S. community foundation UN PRI signatory. Being a part of the UN PRI
community connects my team with like-minded institutional investors who are
also trailblazers in this field. I’ve found the time-sharing ideas and
learnings with peer organizations to be invaluable, and we have worked closely
with the UN PRI team on several efforts that further support responsible
investing efforts across the industry.

MG: Social investing is notoriously subjective. What framework
have you developed when looking at manager performance but also holdings when
ensuring that your mandates are followed?

SO: As I mentioned, we created a proprietary values-alignment
framework to assess individual managers and our full portfolio. The most
important component of this process is engagement with each manager on
responsible investing practices at every single meeting with every individual
we encounter at the firm. There are real limits on what can be assessed via a
survey filled out by an investor relations professional, or reading through
policies and procedure manuals. We’re interested in how investment
professionals interact with our responsible investing questions. Are they
comfortable with the discussion itself? Are they providing clear examples of
how they have integrated responsible investing on a deal-by-deal basis? What
concrete steps have they taken to enhance team diversity? 

I recently had an on-site visit
with one of our managers that we felt had room for improvement from a
responsible investing standpoint. During my discussion with the CIO and a
number of members of the team, it became clear that the firm was deeply engaged
in diversity and ESG related efforts in a manner that absolutely did not come
through in past interactions. In this case, the senior investment folks we
typically speak to were not as fluent as they needed to be in the responsible
investing discussion, and I provided that feedback to them directly.

MG: Where do you stand on the engagement vs. divestment debate
when it comes to social investing? And to what degree do you think engagement
can work, given your public holdings will be minorities?

SO: Our whole framework is centered on engagement, as my previous
example illustrates, and this clearly extends to public market holdings as
well. We want to see our fund managers fully engaged in the values-alignment
conversation, and we expect them to demonstrate further integration of
responsible investing practices over the course of our relationship. I believe
that tying your responsible investing program to specific ESG scores, for
example, is problematic and can lead to poor decisions. First, the scores can
vary widely, and the methodology of some of these scoring tools can be murky.
Second, there are tons of investable opportunities where helping a company
improve a poor score results in significant financial and social benefits for
the investor. Engagement fosters these opportunities for double impact while
divestment ignores them at best, and at worst, can reinforce the negative
social outcomes.

MG: There seems to be a politicization of ESG in America today. Gov.
DeSantis’s elimination of ESG as a consideration in Florida’s state pension
funds is the most obvious example, but there is an increasing backlash against
ESG in general. Where do you think the industry has failed? And how might ESG
and social investing in particular regain some of the credibility it may have
lost?

SO: The U.S seems to be suffering from a collective desire to reduce
anything requiring more than three brain cells to an internet meme or a
click-bait headline. ESG and socially responsible investing more broadly are
complicated, nuanced processes that do not neatly fit into a box to check. Much
of what is now called ESG analysis has been ingrained in investor’s diligence
for years. For example, every credit manager assesses governance and environmental
factors prior to making an investment. Why? Governance is often the crucial
factor in how credit shops get their money back and environmental issues are a
key bankruptcy risk. Strong governance tends to improve social outcomes, and
we’ve hit the ESG trifecta, so I guess Florida won’t be wanting any credit
managers in its pension funds? The politicization of ESG investing seems to me
to be a lot of hand-waving that has the potential to hurt investors, which is a
clear violation of fiduciary duty.

Greenwashing certainly occurs and
I also think divestment has been really damaging for the ESG brand. The
Securities and Exchange Commission is working through how to assess ESG claims
by funds and companies, which can help address greenwashing concerns. The SEC
is proposing additional rules for ESG reporting, which may help create an
industry baseline that investors can use when making investment decisions.
Damage from divestment is especially evident in the energy crisis in Europe.
Eliminating your homegrown source of hydrocarbons is not ESG-friendly when you
fail to reduce the demand side of the equation and have to pay a much dirtier
producer to come up with the shortfall. My hope is that this experience allows
nuance to come back into the ESG conversation and helps us move on from purity
tests.

Critically, we continue to see
that the data reflects favorably on the results of ESG and responsible
investing. A number of studies have found that positive changes in portfolio
ESG metrics leads to stronger financial performance over time. At the end of the
day, investors are judged on returns, and this steady stream of data suggests
that investing in a socially responsible manner is a key component driving
those returns.

 By Iain Bell