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
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
By Iain Bell