The State of Sustainability in Illinois State

Jon Hale: Hi, I'm Jon Hale, head of sustainable investing research at Morningstar. And I'm joined today by Michael Frerichs, Illinois State Treasurer, who has embraced sustainable investing in a big way in the Illinois State Treasurer's Office. Thank you for being here.

Michael Frerichs: Jon, happy to be here today.

Hale: Let's talk a little bit about your sustainable investing initiative that you call Raising the Bar. Tell us how you came to embrace sustainability and ESG integration and, you know, what it means to raise the bar?

Michael Frerichs: Well, we talk an awful lot about ESG, but really, it comes from sustainability. When we invest or invest pension funds or retirement funds, we're looking at a 20- to 30-year horizon. When we're helping families to save for college--a lot of families start saving when their kid's born or in kindergarten, so you're looking at a 13- to 18-year time horizon. I think a lot of companies have established incentives for their CEOs that are perverse incentives to take steps right now to lift stock price in the next quarterly report--but not looking at long-term things. As a long-term investor, we want to make sure these companies, these corporations, are sustainable.

Hale: So, part of Raising The Bar involves what we call active ownership--the idea that shareholders should engage with the companies they own, vote proxies, and even speak out on ESG issues of broader concern. So, you've been quite active in that area, for instance, just this past year, working on the opioid crisis through shareholder engagement. Can you tell us a little bit about how that's gone and how it aligns with your fiduciary responsibility as state treasurer?

Michael Frerichs: Yeah, I think if you're a fiduciary, you have obligation to help get the best return possible for your customers, for your retirees. And I think one of the ways to do that is to make sure that companies are acting in ways that ensure long-term viability. So, I think with a company like that's involved in the opioid crisis--and there clearly is a lot of attention around this issue... We think that selling a product that's addictive is great in the short run, people will continue to buy, and they'll come back and they'll buy, but eventually you expose yourself to legal risk, much like the tobacco industry did in the 1990s: It ultimately cost them $200 billion. You expose yourself to legislative risk: Congress might come in and change your business model, which would reduce your profitability. You expose yourself to reputational risk: People may not want to buy or work with a company that has been accused of contributing to tens of thousands of deaths of Americans.

And so we don't believe in divestiture. We do our typical analysis. We do qualitative and quantitative analysis, but ESG or sustainable factors, we overlay on top of those to make sure it'll be a good long-term investment. And then we actively engage with companies as well. And we try direct involvement, but we also vote our proxies, we file shareholder resolutions, trying to get change that would make sure these companies are sustainable for the long term.

Hale: So, you mentioned divestment. The University of California System, I noticed, just last week announced that they are going to divest from their fossil-fuel investments. What are your views, a little more generally on divestment versus engagement? No divestment under any circumstance?

Michael Frerichs: I wouldn't say under no circumstances. Occasional legislature will force you to divest. We have no control over that. But in general, we don't choose that path unless it is clear that the company is in imminent danger of losing great value. In that case, we'll divest, but we'll do it because of loss of value in the company, not because of our personal values. We think a much greater or much better way is to engage the corporations. We did this with other investors with Exxon and said, "Look, you are profitable right now we like your underlying metrics. However, are you going to be able to sustain this in long term? Do you have an approach for dealing with climate change? Do you have a plan to maybe change all fossil fuels towards renewables?" We think that's direction things are going. And so we asked them to engage. We engaged with other shareholders. About over 60% voted on a resolution, and Exxon put together a report. And so we think that kind of direct engagement is much better than just divesting. You lose any sort of say you have when you divest.

Hale: And you back up the engagement with being willing to vote on proxies in favor of shareholder resolutions as well?

Michael Frerichs: Yeah. We make sure we're serious. We don't run to hold press conferences and shame people. We reach out--we reach out with letters, we reach out with phone calls. We put together coalitions. We will file shareholder resolutions if we're not getting an adequate response. And we vote our proxies, and in some cases we let them know we're going to vote "no" on your board of directors unless we see some sort of change.

Hale: So, looking ahead to the next proxy season, 2020, it's already basically begun. What are some of the major issues that your office is going to be engaging on?

Michael Frerichs: A lot of the issues we have been engaging on the past are the ones that will have our attention going forward. We'll continue to look at the opioid crisis. We focus an awful lot on corporate-board diversity, corporate-governance issues--make sure we have a separation of CEOs and chairman of the board. We look at how shares are voted, different classes of stock. These are things that we think are just general, good-governance issues that will make for a stronger board, will make for stronger company, and return greater shareholder value.

Hale: So, how could your constituents find out a little more about the Raising The Bar initiative?

Michael Frerichs: Well, we have a lot of information on that at our website, illinoistreasurer.gov. We encourage people to go there and encourage your viewers also go and check our unclaimed property and see if we have money that belongs to them. We love putting more money back into the economy. We think it does a lot more good when we put it into Illinois citizens' pockets than it does when it sits in a bank account in Springfield.

Hale: Well, as far as the Raising The Bar information on your website is concerned, I think it's really an excellent report. And you do about as good a job as I've seen explaining the rationale for ESG integration as well as just what you're actually doing.

Michael Frerichs: We feel we have to do that because we believe in transparency ourselves. If we're going to ask corporate boards to be more transparent, we have to be transparent, providing information about our investments, about our rationale. Because I go out and I talk to a lot of talk radio stations, when people hear that you're pushing ESG they hear that word environmentalist, they say, "Well, stop pushing your values on corporations." It is not about values, it is about value. We're trying to make sure that companies maintain their value, that they maximize their value. When we talk about corporate-board diversity, it's not about quotas. It's making sure you have people with different perspectives sitting around the table. Because when you have people from different backgrounds, you're less prone--the board is less prone--to groupthink. You're less likely to miss out on opportunities because different people see different opportunities out there. And that is one of the ways we're trying to maximize shareholder value.

Hale: Great. Well, it's been a pleasure to talk with you Treasurer Michael Frerichs.

Michael Frerichs: You, too. Happy to come back any time.

Hale: OK, we'll do it. For Morningstar, I'm Jon Hale.

In 2020, Morningstar checked back in with Michael Frerichs. Learn more about his perspective on sustainable investing.