Episode #514: Liz Simmie, Honeytree – A Quantamental Approach to ESG

Guest: Liz Simmie is the co-founder of Honeytree Investment Management, an asset management firm based in Toronto, Canada.

Recorded: 12/13/2023  |  Run-Time: 52:11

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Summary:  In today’s episode, Liz dives into the strategy of BEEZ, which focuses on responsibly growing companies that are stakeholder governed, purpose driven, and make a net positive impact on the world. Then she shares some hot takes on the state of both ESG and active management. As we wind down, Liz talks about the process of launching an ETF with our friends at Alpha Architect and shares advice for anyone thinking about launching one themselves.

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Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

• 1:15 – Welcome Liz to the show
• 1:46 – Launching BEEZ
• 7:11 – Finding responsible growth and being ‘quantamental’
• 10:19 – Active management and index hugging
• 15:14 – Main factors that filter out sectors and companies
• 21:30 – Overview of stakeholder governance
• 25:16 – How power balances inform Liz’s investment philosophy
• 34:56 – Position sizing
• 38:44 – What it’s like to start an ETF
• 44:24 – Episode #318: Perth Tolle, Life + Liberty Indexes
• 46:23 – Beliefs Liz holds her that her peers would disagree with
• 49:11 – Liz’s most memorable investment
• Learn more about Liz: Honey Tree Invest; X

 

Transcript:

Welcome Message:

Welcome to The Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer:

Med Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb:

Hey, hey everybody. A fun show again today. Our guest is Liz Simmie, co-founder of Honeytree Investment Management, which recently launched an actively managed ESG-focused ETF ticker BEEZ. In today’s episode, Liz dives into the strategy of BEEZ, which focuses on responsibly growing companies that are stakeholder-governed, purpose-driven and make a net positive impact on the world. And she shares some hot takes on the state of both ESG and active management. As we wind down, Liz talks about the process of launching an ETF with our friends at Alpha Architect, and shares advice for anyone thinking about launching one themselves.

Please enjoy this episode with Liz Simmie.

Liz, welcome to the show.

Liz:

Thank you for having me.

Meb:

Where do we find you today?

Liz:

Toronto, the great white north up here.

Meb:

I heard an A in your diction earlier. Are you originally a Canadian?

Liz:

Yep, born and raised in Toronto my whole life. I’ve never gone anywhere else. Actually I went to Montreal for school and then came back and will never leave this great city and country.

Meb:

Awesome. I love it up there. We’re going to talk about a lot today. One of the topics listeners, which you probably really want to stick around for is this concept of starting ETFs. I get a lot of questions. Every day people want to start an ETF, they got an idea for an ETF. We’re going to talk about someone who’s done it very recently, putting out their first fund in November with our crazy friend, Wes Gray and crew. So we’ll definitely get into a little bit of that later. But I want to talk a little bit about you, your ideas, your process. Give us a little background.

Liz:

I have an economics degree, economics and history degree, and I wanted nothing to do with this great industry of ours because I wanted to make the world a better place and do cool stuff. So I ended up in market research, so consumer insights, so testing brand strategy for PNG and big bank, new account, all these cool research projects, quantitative and qualitative.

And then my dad started an emerging manager. So my dad’s a bootstrapped US equity manager based in Toronto, and they had this third guy who was American and he got divorced. So when you get divorced and you’re here on a spousal visa, you get sent back to the US, which it is what it is. So my dad needed a third person to come in. I begrudgingly said, “Sure, it sounds like an interesting idea,” having literally no concept of the investment industry beyond a little bit of exposure here and there.

And I was lucky. I joined a bootstrapped dividend growth equity manager at about 10 million AUM and was there until about 1.5 billion AUM and then left to start Honeytree. And to be super clear, it’s ’cause my dad was a founder. There’s a whole pile of privilege in there, but if I had gone the traditional route to be a portfolio manager at a bigger shop or a pension or whatever, it’d be a very different experience that wouldn’t necessarily set you up to going to bootstrap your own emerging manager.

The firm’s called Bristol Gate for folks who want to google things. We launched ETFs in 2018, and I had met my co-founder at the same time, and we thought all these folks are trying to launch ESG strategies and they’re all missing what we think the end client for these ESG products want. And this, to be super clear, is long only equity universe, not alter hedge funds or anything like that.

And so in 2018, we set out, which is the same year we launched the ETFs up here. 2018, we set out to found Honeytree. We were registered in 2019. It takes a lot longer up here to get approved by the regulators. We started our track records in 2019 for our global equity strategy. We did that so that we did not need to launch a vehicle off the bat because vehicles cost a lot of money and they take a lot of effort to distribute. They take a lot of awareness and all this stuff.

Anyways, we had always intended to launch a retail vehicle. We did not ever want a private fund. Long-only boring strategies definitely don’t make sense in private funds in Canada or the US and we thought we’d have a Canadian vehicle first. So we went around. There’s not as many white label options up here, and the ones that they have are, we’ll call it not as good, but we thought we would launch a subadvised Canadian vehicle up here.

And then we met Wes. And Wes decided that we needed to get ourselves into a US ETF. And then we realized, wait a second, US, the US market’s bigger, there’s just as much if not more demand for ESG products. One major distribution difference between Canada and the US is in Canada, nobody cares that we’re woman owned. We’re the fifth or sixth public markets asset manager owned by woman in Canada. That’s how many there are up here. So there’s no manager diversity initiatives up here institutionally or from advisors, whereas everybody knows in the US, lots of states have diverse manager initiatives at their pensions and things like that.

So we thought, if we’re going to do this vehicle, let’s do it in the US, let’s do it as an ETF and let’s do it with Wes. And boom, November 7th, we launched our first ETF and the ticker is BEEZ, B-E-E-Z, ’cause branding matters and it’s a US large cap and it’s focused on responsible growth.

So it’s the same investment thesis we’ve been working on our entire firm history, which is responsibly growing companies, stakeholder-governed, purpose-driven companies who take care of their stakeholders outperform in the long run.

What’s really interesting is we did not like any of the existing ESG frameworks. We thought, and I could talk about for 10 years about the problems with existing ESG and investment frameworks, but we threw out a lot of the ratings and existing models and existing assumptions about ESG. And we took what my dad had built, a quantum mental model for Bristol Gate and we brought in ESG data on equal footing with the financial data throughout the entire process.

What we’re known on is ESG integration. So full ESG integration, which means we treat ESG data as fundamental company data in security selection, not here’s our financial model over here on one side and here’s our ESG model and reviews over here on other side. We treat the ESG data that we use as fundamental company data when picking these companies for the portfolio.

Meb:

So let’s dig in on the process because a number of the phrases you used could mean a lot of different things. ESG means a lot of different things to a lot of different people. So let’s hear a little bit about y’all’s process. You have a nice deck. If we can include it in the show notes, listeners, we certainly will on the process, which I think is very helpful. But why don’t you walk us through it. How do you guys find responsible growth? What does that mean? And when we hit some of these terms, let’s try to give y’all’s interpretation of what you think it means to you as well.

Liz:

So quantum mental means we are not purely fundamental and we are not purely quant. We use both processes. And for folks out there who are not deeply steeped in equity, fundamental equity land, fundamental is considered deep dive qualitative research and quantitative research into a company versus quant processes tend to be more quantitative, less deep dive into a company type measures. And there’s many different managers who do both. We do both.

And what that looks like in our process is we start with the whole index, whatever index that might be. In this case for the ETF, it’s the US. And we run 25 qualification criteria. And most of those are quantitative data points. We don’t do a fancy-schmancy predictive complex quant like some of other folks might think quants are. But we have 25 qualification criteria that’s trying to get us down to a consideration set about 50 companies.

And what that qualification criteria looks like is there’s some functional stuff. Can we buy it in custody in North America 5 billion minimum market cap? Some financial. If we have a dividend, it has to be growing investment above investment grade credit rating. Then there’s a lot of traditional ESG exclusions. So traditional ESG exclusions are kind like the original religious investor exclusion because ESG has its roots in religious investing. So no weapons, no guns, no gambling. We don’t exclude pot, but no pot companies make our screen. We exclude fossil fuel production.

Meb:

That’s sacrilege up there in Toronto. Man, no wonder you’re launching this in the US. There’s all the classic Canadians, man, the mining and energy, they’re probably just like, “Liz, what are you talking about?”

Liz:

Well, it makes it very interesting up here because we have all the major pensions are deeply committed to ESG and deeply committed to energy funding. And I like to point out to people that the energy companies are really good at DEI and reporting much more so than tech companies and asset managers, but that’s a different story. But we exclude fossil fuel.

There’s a couple of reasons we exclude fossil fuel. We never held an energy company at Bristol Gate because energy companies are a little too cyclical to have high consistent dividend growth. So from fitting in into qualifying and getting into the portfolio, they’re likely to fail anyway. So it’s kind of just a bit easier to screen them out ’cause you know they’re not going to make it. We also don’t have any renewable energy companies in our portfolio.

Meb:

Well also, I mean when you move from a universe of thousands down to 50, you’re invariably going to kick out all sorts of things and areas and sectors and industries, whether it’s from the broad criteria, whether it’s from the secondary sort of criteria as well. So that’s the whole point of active management. You want a concentrated portfolio because if you’re charging more than zero, you want it to look at weird and different.

Liz:

Yeah. And it’s funny ’cause I’ve never understood why folks don’t want it to look weird and different. It’s one of my big issues with active management index hugging.

Meb:

It’s very simple. They want it to look weird and different when it’s going up. They want it to look weird and different if it’s going down and you’re not going down. But mainly it creates a weird principle agent problem because a lot of the large asset managers, once they get to scale, once you have 10, 50, 100 billion, 500 billion, you don’t want to look that different because there’s only downside risk. The money is already captive. And we know that money once it’s sitting somewhere, doesn’t like to go anywhere unless it gets abused or does very poorly. If you look at a lot of the old school hedge funds too, their early years where they did 150% or these massive returns and now they all do 7% with 10% volatility.

Liz:

And they’re all chasing FANG stocks and it’s like, what are you doing? But the index hugging thing, people like to pick on ESG for index hugging. Active is index hugging all the way. I mean, I’m a big believer that a lot of active underperformance comes from not taking risks and not having high active share and index hugging and making a bunch of stupid decisions as part of that.

But you’re right, our qualification process kicks out whole sectors. When we run our global, we exclude dictatorships in our global equity strategy. So we’re okay not having exposures to a bunch of things, whether they be sectors or countries or type of companies.

In our non-traditional ESG qualification criteria, we look at board diversity beyond gender. So we include racial diversity of board members, 33% or more. So we won’t look at a company who has not figured out how to put a couple token diversity hires on their board yet, mostly because if you haven’t figured out how to do that from a governance perspective, you’re not very competent.

Meb:

I mean, does that screen alone kick out half of the universe it feels like?

Liz:

No, people are much … In the US, especially the US boards are pretty diverse. Canada’s pretty bad, but obviously we’ve got none of those in the ETF. But even when we started, if we had a 40% bar, it would kick out lots of folks. It’s funny ’cause really it ends up kicking out cool tech renewable energy boards that you … not typical stuff that we hold in our portfolio like boring industrials and boring retailers and semiconductors because they’ve all been working on this stuff for a while. So it doesn’t kick any of those out.

Investment grade credit rating might kick out more companies. If you look at the last cohort of our qualification process, there’s probably more boards that fail or more companies that fail on investment grade credit rating or fraud issues and things like that, lawsuits, than on the board diversity. Why? ‘Cause everybody’s slowly figuring it out. And to be super clear, we’ve increased that 33% from 30, so eventually it’ll be 35 and we have to deal with the universe as it is. ‘Cause our goal is to get from the universe down to a manageable consideration set that we can cover from a fundamental deep dive perspective in the most efficient way possible.

And we run that consideration set once annually. So we’ve done it five times now. So did 2018 till now and it evolves, but it doesn’t change that much. It absolutely spits out overweight IT, overweight industrials materials. We never have any banks. We have some financial stuff. We generally don’t have real estate, and we’re okay with that.

And one thing you’ll notice, if you look at our portfolio, there’s a lot of manufacturing involved companies. And that’s where the semis kind of pop in. It’s ’cause these companies who have had to manage labor, manage manufacturing facilities, manage employee safety, you can imagine there may be a little few steps ahead of a West Coast tech company in terms of thinking about their employees and reporting ESG stuff and worker safety and things. So it’s interesting how it nets out.

Meb:

Yeah, I’m saying this from a podcast whose listeners are probably 90% male. I mean, I remember giving a speech in New York to Quantopian crew and they did a live audience and it was like 95% male. But the venture capital has to me, the most outsized. I mean, I think women get 2% of venture capital dollars. It’s some incredibly low number that’s nowhere near 50. But anyway. Okay, so we’re getting a little off-topic.

All right, so we’re starting with a number of these factors. You got a lot of them. What do you think are the main drivers of the ones that sort of filter out the most things? Are there any of the 25 or so that are particularly more prominent?

Liz:

Looked at it year-over-year and they tend to be, I mean obviously participation exclusions. You know what I would say? There’s a whole bunch and they’re all pretty equal. And that need for dividend growth, the investment grade credit rating, the diversity, the industry participation, the typical ESG exclusions, even glass door rating, it’s kind of just an equal. You would think it was bigger in some of the areas. Other than losing whole industries, it’s a very interesting kind of balanced process.

When we did it at Bristol Gate, it was the S&P 500, got rid of all the non-dividend payers, got rid of everybody below investment grade credit rating, and based on next year’s predicted dividend, we chose the top 50 and did the fundamental deep dive on those. And what we’re getting with the same but a different process ’cause remember, what we’re cutting out is not, we can’t just have the highest dividend growers because if we just looked at the highest dividend growers to get the ESG growers too, or the responsible growers too, we’d have to kind of go a little bit further than the top 50 high dividend growers.

And that’s why we altered or optimized this process that my dad built because we wanted the same factor exposure. So these high consistent dividend growers who are well-managed and well-governed and focused on the long-term, we wanted them, but with slightly higher level of ESG. And to be super clear, if you look at the Bristol Gate ETF, it has a higher ESG rating than most ESG managers and strategies out there because boring, high, consistent sustainable dividend growers generally have high ESG ratings ’cause they generally don’t do a whole bunch of stupid stuff that gets you pushed down in the ranking with controversies or behind on the times in terms of board diversity, all these things that make up ESG ratings.

And you’ll notice I didn’t mention we use ESG ratings because we don’t use ESG ratings at any part in our process. And ESG ratings, just ’cause I know people hate ESG and ratings, ESG ratings are the same as buy/sell ratings, right? So it’s just external sourced research that a portfolio manager can buy or not.

And so we run that qualification once annually. That gets us to about 50-ish companies. And then we do our fundamental deep dive. And what we do is we take all the financials we did at Bristol Gate, which skews looking at debt capacity, how conservatively they’re managing their debt, earnings growth, dividend growth, competitive market share, and we bring in ESG data and put it equally beside that financial fundamental data. And we purposely organize it under pillars so that they’re equally weighted. So it’s not like, “Hey, the financial part gets 66% weighting and the ESG part gets … ” We don’t divide it like that and nor do we just to be super confusing, do we think of measures as E, S and G. Every ESG input that we use, we consider fundamental to the company. And I’ll give you some examples.

So turnover. Turnover costs you money. It’s an ESG measure, but the higher turnover you have, the more it costs to hire new people. Water use, if you can save the cost that you spend on water, it’s a financial thing. It’s definitely an ESG thing, but it’s tied to the operations and the costs of a company. It’s not a separate consideration. Waste is a great example. It costs lots of money to dispose of waste.

And then you get into the stuff that’s a little more confusing to understand how it’s tied to the bottom line, like gender and leadership year-over-year, racial diversity and leadership year-over-year. So at first glance, oh, that’s just a feel good measure. Well, companies that we’re looking for and that we own understand that the more women you have in leadership roles, the bigger your pool of candidates you have to recruit from. So it actually increases the many positive benefits to the company of doing this basic stuff that some would say is stupid DEI stuff. But the companies that we’re holding are doing it for operational and business reasons, not because it makes them look good on a questionnaire.

We look at science-based targets, which are net-zero related. We look at parental leave. We look at what data we can find that’s relatively systematizable across the consideration set of companies.

So if you think about it, we’re looking at probably, of the 50 companies we’re doing this deep dive on, we’re looking at some of the top ESG reporters and scoring things. So we actually can run relatively custom data sets across this 50-ish group of companies like racial diversity and leadership year-over-year, three-year change in that, three-year change in water intensity, three-year change in water use. Because you can’t get it for the whole S&P 500 for example because a whole bunch of those companies aren’t reporting that level of data yet. But because we’re looking at this kind of more advanced ESG-esque pool of companies, we’re getting all these data points that we would not be able to buy from an index provider who’s selling ESG data across their index.

Ultimately, we’re building a high active share, 25 positions, super concentrated ETF of the most boring, sustainably growing, responsibly growing companies. And in a nutshell, these companies that we’re holding understand that the positive impacts that they make on all of their stakeholders, so their employees, their customers, the local community, their shareholders, they understand that the positive impacts they make on those groups drives their bottom line. So it’s not separate from their bottom line. Doing good by their employees or their customers is core to their mission and core to their purpose.

And these companies are founded on that and it doesn’t matter what their political beliefs are. Well-managed, long-term focused companies that are stakeholder-governed and purpose-driven will outperform in the long run. And that’s our investment thesis and I should probably define some of those terms.

Meb:

Sure, let’s hear it.

Liz:

So stakeholder governance. So anybody steeped in investing has been generally trained that shareholder primacy and shareholder governance is the role of a corporation. So a corporation’s job is to govern on behalf of their shareholders and make their shareholders money. The problem with that is employees and customers and a whole bunch of other factors influence a company’s ability to make money.

So stakeholder governance, which is not something I invented, I would argue original governance was stakeholder governance, but that’s a more complex topic. Stakeholder governance is just a company that says, “You know what? Our employees and our customers and all these things need to be considered in our governance and our management processes. Why? Because they impact and they’re impacted by our decisions. And we’ll do better if we’re engaging all of our stakeholders and helping and supporting and not screwing over essentially all of our stakeholders.”

So there’s tons of companies out there that believe in a stakeholder governance framework. So instead of being our only goal is to return returns to shareholders. That becomes just one of the roles of the board. And so we’re looking for those companies where there’s evidence in their metrics, whatever those metrics might be, that they’re considering their stakeholders. ‘Cause you can’t just say you or your stakeholders are governed and you care about all this stuff just like you can’t say you care about diversity. Saying you care about diversity or the environment is great, but what you actually do in your business and the changes that you make and the outputs that you can see in the business tell you whether something’s caring about any of this stuff.

So stakeholder governance is, I think it’s something corporations do more naturally. I think it’s in the investment industry I think a lot of our traditional finance theory assumes that stakeholders don’t matter. And so what you see in ESG is you see traditional financial models over here and you see people trying to fit all this climate and diversity into those models and they don’t match because the traditional models assume shareholder primacy and shareholder governance. The only way ESG works in a corporation is when its core to their operations and core to their purpose, not as a separate activity on the side.

Our companies are not doing ESG stuff to feel good or to look good. They’re doing it because it’s part of their purpose and their core, and it’s how they were always founded and how they’ve always operated. And purpose-driven is really complex because it’s something I learned a lot about in governance training and in marketing, which is it’s really difficult to communicate consistently to people.

And so these companies that we’re looking for know that it’s really hard and know that sharing, having a shared purpose, getting a whole thousands of employees to work together towards the same goal consistently and communicating that goal is a difficult activity that they as a board and a management team need to work on. And that shared purpose is not only having a clear purpose for the organization, but helping all your employees, all of your stakeholders, all of your customers understand why you’re there and what you’re doing makes for a more efficient ship if one might want to say. When you have disparate goals and disparate ideas in an organization about where one should go, it’s less efficient, and folks get confused and don’t understand as clearly what they’re supposed to be doing.

This is all leadership and governance science that is just in the early stages of academia in terms of quantifying and analyzing all this stuff. But I think everybody can agree that if everybody’s running around with their head cut off and nobody knows what they’re doing at a company, it’s decreasing productivity. And the more everybody can be on the same page in terms of long-term goals, the more efficiency that you can achieve.

Meb:

As you think about governance, there’s areas that you may or may not be involved, but you can speak to it. I’m thinking of things like in the US, particularly with some of the tech companies this past cycle who have been very sort of me-focused, meaning like stock-based compensation that’s just outrageous, a ton of dilution to shareholders, maybe dual shared classes, all these sort voting things that have gone on.

Do those play any role at all in your various screens and how do you think about this push-pull story as old as time with the balance of power between boards and C-suite and compensation? How does that play into what y’all do?

Liz:

There’s like a hundred topics there and they’re all super fascinating. I’m going to start with a story. So Google back, must’ve been 2018, 2019 when we started, had two senior dudes sexually harassing a whole bunch of their employees and the board found this out. And then the board spent 12 or 14 months debating what they should do with them. And the one woman on Google’s board said, “Probably we should tell people and fire them, probably we should do that.” And they all just sat there and twiddled their thumbs.

And this is all highly qualified group of people who are CEOs and on a whole bunch of boards and they’re professionals at this, yet one of the largest companies in the world sat there and twiddled their thumbs. And then eventually they gave the guys 50 million each and paid them off and caused a big controversy with all their employees, all stuff that they could have been avoided. It’s not their fault they got a bunch of sexually harassing dudes. The board’s job is to hire and fire the CEO. And when the CEO’s not hiring and firing the dude sexually harassing folks, that’s a governance issue.

The first time we built the portfolio, our global equity strategy, two of the boards had recently fired their CEOs for sleeping with their secretaries and various other things. And that shows functional governance.

The answer to your question is what is functional governance? Is it a whole bunch of independent board members? Well, that’s what the ESG ratings would tell you is good governance. The problem is 10 independent highly qualified folks don’t create good governance. Good governance is created by a governance culture, by a shared purpose, by people actually working together on governance issues.

So you can have good governance with weird compensation and all this kind of stuff at the same time, absolutely. But I would argue a lot of that big tech is poorly governed. We don’t have any bank stocks in our portfolio for a reason. And it’s not ’cause they get excluded for producing fossil fuel. But there is a strong belief that non-independent directors are not ESG. We don’t necessarily share that belief. While we’d prefer … Obviously we look for audit committee independence for example. That’s one of our requirements. We won’t invest in a company. But that ship’s sailed. Everybody knows how to make their audit committee independent at this point and there’s no magic bullet on compensation.

And just going back to CEO compensation, people hear a lot about CEO compensation, and there certainly are a lot of highly paid CEOs. The problem is we don’t have any good measures right now to truly assess CEO pay. And what I mean is what we’re generally using right now is average worker pay to CEO pay. So it really depends on what industry and which set of data that you’re using. And what matters more is, to me, who cares about the CEO pay. What matters more is the baseline employee pay. What matters more is pay equity. So if you’ve got a man and a woman in senior leadership roles and the woman just because she’s had lower incomes throughout her career is getting paid less, and this is stuff that companies can fix.

What matters is Walmart’s base pay versus another retailers base pay, not necessarily the ratio of what their executives make versus what that pay is. Because a company paying a low amount to executives doesn’t naturally mean it’s doing better for the world. And executives cost lots of money. So it’s a really interesting, messy topic, but the future of ESG is us being able to get this data at the right granularity.

We already have exec comp. So exec comp obviously was already always there. It’s just a little more standardized in ESG reporting now. What we’re soon going to have is leadership comp divided by group, right? So we’re going to have woman in leadership’s comp, men in leadership’s comp even broken down by racial diversity because the future of ESG reporting is the Department of Labor diversity data being put in financial statements as required disclosure, and that includes gender and race by level, and that’s going to end up including turnover. It’s going to end up including pay and pay equity, including bonuses. It’s very interesting because salary versus bonuses gets very messy in terms of pay equity. It’s going to be a shock to everybody and everybody’s going to hate it except for the companies that have been reporting this already.

Meb:

How do you guys deal with shifting sands over time? Not on things that are as obvious maybe as diversity on boards, but things like, hey, we’re going to exclude, you mentioned cannabis, alcohol, like opioids. I don’t know, a decade ago people were like, “These are the best thing ever.” And now they’re like, “Oh my god, these are responsible for a lot of misuse and things like …” I mean we wrote an investing paper a while back on the investing pyramid, but the example we gave was the food pyramid from my youth, which is like you really should just be eating pasta and frosted flakes and muffins. Your base of food should be carbs and the last thing you want is fats or protein, whatever it was, and today it’s inverted.

So as knowledge change and shifts, how do you guys deal with that? I know you said it’s an annual process, but do you sort of update these criteria and ideas as they become more accepted? How do you think about some of these topics?

Liz:

I like to point out almost everything we do kills people and folks in the ESG side of the stuff give specific sectors a pass, like pharmaceuticals for example. We have no pharma companies in our portfolio. We have a lot of health tech though, like medical equipment and things like that. One of the reasons we have no pharma companies is ’cause they all have price fixing scandals. And so regardless of their ability to kill folks with their product or whatever, which is obviously don’t even get me started on the opioids and the Sacklers because that could be a whole other podcast, the price fixing, which is they just, I don’t know, they all just decided to do that in the past five years, all the executives just running for prices or whatever and then the big congress thing.

But here’s what happens in ESG and impact, and I say ESG and impact because impact ratings happen in public markets too. Sometimes people when they talk about impact investing, it’s just private markets, but for the most part we have impact ratings on these companies. The problem with impact ratings is they generally are based on the SDGs, so the sustainable development goals which are developed for countries by the UN.

So a company to be impactful according to this framework, and I’ve got a whole bunch of air quotes here for people who are not watching my attempt to framing the sarcasm, to be impactful a company needs to address an SDG. And so what happens is all the pharmaceutical companies get 100% impact rating because they make a drug that’s helping people. They don’t get any negative rating for price fixing.

And so we would not be only concerned about the opioid crisis. We’d be concerned with the whole Sackler governance shit show disaster that was them creating the opioid crisis. For anybody who has not read the long, I think it’s the Atlantic piece on the entire history of the marketing behind that, ’cause again, the food pyramid that you talked about, do you know who paid for that? It was not the FDA. It was the cereal companies just to be super clear. There’s a whole bunch of research that corporate interests … This is one of my passionate areas. Tariq Fancy was the former CIO of BlackRock, ESG at BlackRock, and he quit and he went on a big, big speaking tour of the world to say, “Companies don’t make an impact. Only governments and nonprofits can make an impact.”

But the Sackler family in a corporation through a whole bunch of marketing decisions and a need to make more money started and created a giant negative impact far beyond their product, right? With all the lies and the paying off doctors and continued issues, they created a negative impact that no government or nonprofit could stop.

And so the answer is companies make giant, giant impacts, positive and negative. What we’re trying to aim for in this portfolio is companies making a net positive impact. So companies who are reducing their negative externalities because they cost money, they hurt people, they look bad from a PR perspective, a whole bunch of reasons why you would reduce your negative impact on the world while increasing your positive impact. So whether that’s better decent pay, safer work conditions, better quality products, more innovative that solve things, reduction in packaging so it costs less, all these negative and positive impacts.

Meb:

So as far as portfolio construction, you get down to these small group of names, 25 whatnot. Do you have some sort of sector composition screen so it’s not all 25 in MedTech for example, or how do you guys do any sort of position sizing on this final portfolio?

Liz:

Yeah, so they are equal weighted, so we remove the position size decision-making. My dad always said it was so you didn’t have a bunch of PMs fighting over position size. We run a correlation analysis, but it’s sector agnostic. We used to own McDonald’s and KFC in my dad’s strategy. And people would say, “Aren’t they the same company?” And when you look at the geographic revenue of them, they were completely opposite. And same thing, there’s lots of companies that look very similar and seem very similar in this large cap space that aren’t necessarily.

So when you look at our portfolio, we got a whole bunch of similar stuff in there. And that’s the nature of one, we’re being really selective. Two, we’re kicking out a whole bunch of stuff, but we definitely don’t care about what the weights of the index are at any point in our decision making.

And we know we’re going to be overweight tech and industrials and usually materials and both consumer things depending on. But we’re agnostic to that. And these are equal weight bets, so we’re putting the same weight on a mega cap as we would be on a small cap in the portfolio.

And then that’s part of the active share. We’re okay not holding the top 30 something percent of the index. We have none of the fake stocks. You can’t have high active share if you’re holding a bunch of those companies. And everybody else, I mean everybody’s going to have those in their portfolio anyways. But it is really, we’re looking for the 25 most responsibly growing companies out of that 50-ish set of companies that we have. It becomes our bench too. So the next set of ranked companies in there are who will use when we need to fire a company, whether it’s for quarterly earnings or doing something stupid on the ESG side or the non-ESG side.

But again, a lot of our stuff is annual data. While annual reporting and reports come out midyear and things like that, a lot of our board diversity changes when they change somebody on a board, and we have fired a company for going below our threshold, but you can imagine the companies that we’re holding are very cognizant of not, if you’ve got 76% board diversity, of course you can put a whole bunch of white dudes on your board, but if you got 31 and every investor that shows up is engaging with you on your board diversity or something, you’re going to be cognizant of it.

And that’s what’s so funny about ESG. The whole world tries to blame BlackRock and the investment industry on ESG. They’re the laggards in this. The pensions for the most part do a lot of the engagement around and lots of managers to be super clear, ESG managers do a lot of pushing on diversity and environmental stuff and governance and all these kinds of things, but it’s the companies themselves who realize that it’s a marketing benefit, it’s a recruiting benefit. It’s their big four accountants saying that they can audit this data and helping them organize it. It’s the corporations driving ESG. It’s not BlackRock driving ESG. It’s not … definitely not Vanguard driving ESG stuff. Literally Vanguard is just being called into congress for pushing climate change narrative, which is the funniest thing in the entire world for a passive shop.

The oil sands companies up here in Canada are working, doing a lot more work than most asset managers on diversity and reducing their emissions. Why? Because they have a whole bunch of investors who care and they could be foundations, pensions, individuals who care about progress on this stuff and employees who care about progress on this stuff.

Meb:

Give us a behind-the-scenes look at what it’s like to start an ETF. We get this question a lot. A lot of people see the pot of gold at the end of the rainbow. There’s obviously a lot of work that goes into it and you guys are relatively new launch, so congratulations. But tell us a little bit about the experience, how it’s been, have you made it down to Puerto Rico yet? What’s the overall agony and ecstasy of being not only a founder but a money manager and now a ETF issuer as well?

Liz:

And a wholesaler and a marketer and all that kind of stuff. I think it’s fascinating that people think ETFs are like ideas. I think there’s so much room for innovation in this industry. I think it’s going to look completely-ish different in 20 years, but I think there’s some stuff that is not going to change.

I think there’s always going to be public markets investors and private markets investors and folks who do both. I think people are always going to think geographically in terms of allocation in certain things. I think there’s certainly a place for thematics. When you launch a product, it doesn’t matter what it is, this SMA model, ETF fund index ’cause that’s a whole interesting side of the business, you have to know who’s going to buy it no matter how cool the idea is, and you have to know how it’s going to get distributed.

The good thing with an ETF vehicle is people can buy it, regular people can buy it, and advisors can buy it in a bunch of places, but there’s a whole bunch of restrictions and things. They make things more complicated than just launching an ETF. Like the crypto ones, for example, you probably are friends with all Eric Balchunas and all the crypto-obsessed ETF folks, and they’re going to whatever the spot Bitcoin ETF is going to launch. Well, most of the warehouse shelves are locked in the US.

Interestingly up in Canada, none of the warehouses locked their shelves to Canadian or US listed ETFs. So any advisor in Canada can buy any ETFs except the crypto ones. The big banks up here has put a special ruling on crypto ETFs, and they basically said to advisors, you cannot buy them. You can only buy them if your client signs a big waiver and it gets a high risk rating in their portfolio.

So even though these are possibly the coolest, most talked about ETFs in the entire, entire world, a whole bunch of Merrill Lynch and UBS and Citi folks are not going to be able to buy them in their accounts anytime soon because they’re going to have to get approved, they’ll probably create internal ones so that they can, ’cause there’s a pay to play aspect there too, that folks need to understand. You can get your ETF on Schwab or whatever for free-ish. Getting your ETF on US platforms requires money and time and a bunch of random stuff.

So this crypto one’s really interesting ’cause these should be, there’s going to be like, I don’t know, how many are there? 18 now, all the big asset managers, and they’re going to watch and some of them are going to get on some platforms, but a whole bunch of them are going to get locked off a bunch of platforms. So even though it seems like an ETF is a magic bullet in terms of wrapper for these products, there’s a whole bunch of other considerations.

So that’s just my rant to tell everybody that your product idea is great. Who’s going to buy your product and how they access it is probably more than 50% of the consideration that you should make before spending a whole bunch of money to launch an ETF.

For retail platforms, when I say retail platforms, I mean advisors using platforms to manage their models, an ETF is becoming an increasingly better option than a mutual fund because one, you’re usually going to price it lower. Two, they’re changing all the fees and cost structures of how ETFs and funds and trade costs and things like that. And so you see a big move towards arguably simpler ETF models, and that’s why we didn’t go with Wes ’cause we love Wes. We went with Wes because we definitely weren’t going to do a mutual fund, and he has a great white label ETF platform and has demonstrated. I mean, I met Perth first and that’s how we met Wes. Perth is my hero.

Meb:

I know. Well, I noticed your dictator’s comment earlier, and so I said that sounds like somebody we know.

Liz:

And I just think it’s so fascinating. Perth’s probably one of my favorite examples obviously, of building a successful product. She knew there was a lack of emerging market systematic products that she knew there was none that excluded dictatorships and that there would be a whole host of advisors across the US who would be totally fine with their emerging market slice of the pie to not include Chinese holdings or Russian holdings or Qatari holdings or whatever because there’s enough emerging markets companies out there to get the exposure. And yeah, you’re not going to look like the index. But who cares? Lots of folks are looking for systematic or active options, not the whole index. We’re never going to convince a bunch of passive folks to use this as a core option, even if we’re the best in the world. You can’t change the consumer behavior.

So Perth really built a product to solve the end user’s needs. And I mean, she got an amazing timing with the Russian invasion, but she was already doing the work of finding the market fit and getting teams to build her into the model long before that happened. And so everybody should just go learn everything about Perth because if you want to launch an ETF, literally just go watch all Perth’s videos.

Meb:

Perth has been on the show. She’s an alum. She, listeners, runs the Freedom ETF, FRDM, which is closing in on a billion dollars in assets. So go Perth. That’s rad.

Liz:

Perth is amazing. She’s just the perfect example of you need to find who’s going to buy your great idea before going and figuring out how to make your great idea. And maybe you were an advisor, maybe you worked as a wholesaler, maybe you worked somewhere in the distribution of the industry, but especially if you’re a pure portfolio manager or you’re outside of the industry, do some work on who and why and who’s buying this product and where are they going to put it, because you need some of those basic answers before you make a bunch of decisions that are going to cost you money that you’re going to need to go change.

The way to launch an ETF is to have a whole bunch of money and be willing to spend it, I think is the best way. Launching a vehicle, whether you are BlackRock or a startup, is a bit of a coin toss.

I was talking to my buddy who works at a pretty large asset manager, and he was like, “Yeah, any new fund we have, we spend the whole time worrying about who’s going to be the first 20 million in.” So you got to go find kind of where that first 20 million is, and then it’s never going to come as fast as you want it to come, and that’s why you need to have money. But it really is, you look at the list of … any list of ETFs and you go to the bottom ones. And it’s not just like 30 little startup companies you’ve never heard of. It’s literally 90% giant asset managers who’ve got vehicles from 2 to $10 million.

I love telling folks, Cathie Wood launched an ESG ETF in, I don’t know, 2000 and then closed it 18 months later ’cause she couldn’t raise money in ESG ETFs. So literally you could be the most famous human being on earth. You still need to find the distribution connection between the product that you’re wrapping and the need, and then you need to not screw up the performance and all that kind of stuff.

Meb:

When it comes to, you’ve got a lot of different takes on this space, but one of the questions we’ve been asking most of the guests is, if you sit down to coffee or lunch with a bunch of advisors that are sort of in your world, what’s a belief you hold that say if you sat at the table, 75% of the attendees would shake their head and say, “Liz, I disagree with you,” on investment related, portfolio related, ESG, DEI related, anything come to mind?

Liz:

Yeah, a lot. I could go two directions here, so …

Meb:

Name them both. Do both of them. We got time.

Liz:

So I don’t believe you can predict the market. As somebody who was raised in a very evidence-based quantum mental shop where we did no predicting of the market, it’s fascinating to see this whole ecosystem of folks yelling about stocks all day, every day and guessing where macro is going to go and all these things. I don’t think it’s 75% of folks don’t believe in market. And to be super good it’s predicting the timing of the market too.

I think there’s risk in timing. I think all the studies suggest that the timing risk of active security selection is one of the biggest things. That’s why we’re macro agnostic. We’re everything other than responsibly growing agnostics despite the constant barrage on Twitter or CNBC or wherever. This idea that people just sit on TV yelling about future numbers and what they’re going to predict pushes cool, qualified math experience people away from the industry. So that’s my general take.

My ESG take, and I hear this a lot, is ESG data is not standardized and can’t be standardized. And when you look at the companies that we hold in the portfolio, more than half the portfolio has externally assured environmental data. And so not only is it standardized, not only are they reporting through the same framework. They’re getting external auditors to review their emissions data and a bunch of their environmental data. And the Department of Labor is reviewing their diversity data.

While five years ago for sure, it definitely looked like stuff was not standardized in terms of ESG data, all the companies we’re looking at have moved towards this. It’s called the GRI template. There’s like a billion different frameworks in ESG, but if you go into any large cap sustainability report, except for a Tesla or all the folks who refuse to report basic ESG stuff, which is a very small group now, the vast majority, probably like 400 of the S&P 500 companies are reporting this framework. Are they reporting year-over-year? No. You can go back to their previous report and some are laggards and some are ahead, but we’re able to look at three year data for most of these metrics for most of our companies.

Meb:

As you look back on your career, what’s been the most memorable investment? Good, bad, in between?

Liz:

Probably starting the firm, but I’m going to say this ETF mostly because it’s public. I mean, when you’re operating in separate accounts, we could share stuff with what we’re doing, but now it’s like, hey, we’re out there. Performance has been pretty good since we started, which is a coin toss to be super clear. We just like the product. We like the branding. We like Wes. We like the US market. It’s great. There’s so many opportunities. I mean, Canada’s great too, to be super clear, but we love how many of you there are, 10 times as many of us. There’s random 4 billion RIAs in the middle of states that nobody’s ever heard of, which would be the 12th largest RIA or asset wealth shop in Canada.

And so I got to say, our ETF BEEZ is my favorite investment. We don’t love our companies one by one. We think of them as a team. We’re fielding a team of players. I mean, we don’t play favorites. We just want to pick a good team. So it’s, I’ll never answer a single security as being a good investment or my favorite ’cause again, that’s just not how we approach portfolio construction.

Meb:

Right on. Where do people find out more information? Where do they go? Follow you, follow the firm, the fund, all that.

Liz:

So we have an ETF website, which is honeytreeinvestetfs, which is all that formal one. And then we have honeytreeinvest.com, which is our regular one that has tons of blogs. If you just google Honeytree Investment or Honeytree ETF, you’ll see lots of articles and podcasts and things like that.

I, despite Twitter or whatever folks want to call it current shit show, I’m still on there. I’ll be on there until it goes down for a variety of different reasons. ‘Cause I love the community and there’s lots of great folks there, and it’s how we met Wes and all these things. So Liz Simmie on Twitter, if you want obnoxious, occasional ESG takes. I mostly just rant about how BlackRock is not woke and people should not be convinced that any asset manager is woke. That’s us in a nutshell.

And of course you can go by B-E-E-Z on select custody platforms in the US. If you’re a retail investor, it’s probably even easier to access than an advisor, but of course, we’re mainly focused on advisors in this. So if you’re an advisor interested in ESG and knows nothing about it or you’re a deep ESG practitioner, please feel free to reach out to us on our website ’cause that’s who we’re looking to connect with.

Meb:

Liz, thanks so much for joining us today.

Liz:

Thank you for having me.

Meb:

Podcast listeners we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at feedback@themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.