Tom Lauricella: Hi and welcome. I'm Tom Lauricella, editor for Professional Audiences at Morningstar. And I'm here today speaking with Jackie Cook, who is director of Investment Stewardship Research at Morningstar.
Jackie, thanks for being here today.
Jackie Cook: Hi, Tom. Thanks for having me.
Lauricella: So, we are here today to chat about a very serious topic, and that's deforestation, which is probably one of the greatest threats that the world is facing. And it's a key part of the climate risk that so many folks, in particular investors as well, are concerned about. We recently had an article in which we discussed the hidden risks of deforestation in portfolios and we just want to talk through some of the aspects of this that a lot of investors may not realize, and understand about how deforestation actually plays out, where it shows up in their portfolios and what, as an investor, should they be thinking about in regards to deforestation.
So, the first question here is--so, we see deforestation. We see the pictures of the jungles being burnt down and bulldozed. But why is it an investment risk? Why should investors be concerned about deforestation?
Cook: Thinking about deforestation as an investment risk, I think of it on two levels. One is, as you say, deforestation is a global crisis and it's driving climate change, it's driving biodiversity loss, it's driving species extinction. It's also driving people off their land. So, it's a human rights crisis. A lot of indigenous peoples are affected by deforestation. So, in that sense, it affects everybody, and it affects investors, creating financial risk across the system. So, it's a market-wide risk, and that transcends portfolios. But of course, some portfolios are going to be more exposed to deforestation risk because the companies in the supply chain that are part of the global commodities chain that contributes to deforestation are at an increased risk, especially now that international attention is being trained increasingly on this global crisis. So, deforestation risk in portfolios would come down to your exposure to consumer brands, companies that source from the supply chain that ultimately leads to the forests, tropical forests, or real forests from which agricultural commodities are extracted.
Lauricella: Right. Many investors might look at their portfolio and say, I don't think I have any companies in here that are actually bulldozing rainforests. I don't see that in my portfolio. So, when you talk about supply chain, what do we really mean here? So, what types of companies, what types of industries on a more specific level are we looking at? And how does deforestation make its way through that food chain, as it were?
Cook: If you look at your portfolio and you have consumer goods companies in there, you might have food brands like Kroger KR or Domino's Pizza DPZ. You might have companies like Procter & Gamble PG, Unilever UL. These companies are all sourcing raw materials for their products that come from--that ultimately come from forests. Now, they would be sourcing them from trading companies, trading companies like Archer Daniels Midland ADM, from Cargill, Bunge BG, you know, those are some of the trading companies that sit--they are in the U.S., but then you actually have trading companies that sit in the exporting country as well. Wilmar WLMIY, probably the largest supplier of palm oil globally, sits in Indonesia. So, there's this international trade in these global commodities, and these global commodities look pretty much--I mean, it's a commodity. So, once it enters the supply chain and it's mixed with the same commodity from different sources, it's the same thing. Now, these trading companies source from producers. And sometimes there is some vertical integration. You've got the producers, you've got the--so, on the producer side, you might have the plantations, the growers, the logging companies with forest licenses, and then you've got the processors, the mills, and those that prepare the raw material for the supply chain. So, you might think of the supply chain in four groups. You've got the producers; you've got the processors; you've got the trading companies; you've got the consumer brands. But of course, there can be vertical integration between these.
Lauricella: Right. And there's also meat producers, right? I mean, this is a prime source of deforestation as we discovered in our story. I mean, a lot of the destruction of rainforests is to make room for cattle grazing, right?
Cook: That's right. That's especially a problem in Brazil, in the Amazon. And in Brazil, you've got JBS JBSAY. That's perhaps the biggest trader of beef in Brazil.
Lauricella: So, from an investment perspective, so folks might look at their portfolio, they might have mutual funds that own these particular stocks. Particularly, if they own a broad-based index fund, they're probably going to have some of these names in there. What's being done in the asset-management industry to address some of these problems with deforestation? Are the big asset managers doing anything to say, Hey, you need to make sure that the way you run your business is trying to avoid being connected with deforestation? Are they taking a stand anywhere?
Cook: In 2019, asset managers--er, investors got together to sign the investor statement on deforestation and forest fires in the Amazon. There's an example of investors getting together to come together with a single voice. Because one of the problems throughout the supply chain and even amongst investors is this collective action problem. So, in the short term, you are better off sourcing your product from clear-cut lands or lands that are being illegally burnt. It could be cheaper, and it could be--and the product is indistinguishable. It's very difficult to trace. So, the really important approach to solving this problem is solving the collective action problem at each stage of the supply chain. And so, investors coming together to sign these agreements and commitments is very important.
Friends of the Earth did a review of the investors who signed the investor statement on deforestation and forest fires in the Amazon in 2019, called “Doubling Down,” and found that the big three were not using their heft.
Lauricella: The big three are…
Cook: BlackRock, Vanguard, and State Street, the big three asset managers. They were not using their heft to pressure consumer goods companies that they held in their portfolios to, in turn, pressure the rest of the supply chain to do more in avoiding deforestation, particularly deforestation that was leading to forest fires in the Amazon.
So, once you've got these agreements in place, you also need these agreements to be monitored and you need some a level of transparency throughout the supply chain that allows civil society, advocacy groups, other investors to be able to see who is reaching their commitments and who is reneging on their commitments. A similar agreement exists across consumer brands companies. It was signed in 2010 called the Consumer Goods Forum Net Zero Deforestation Commitment. Unfortunately, it turns out in 2020 that consumer goods companies, very few of them had met the commitments under this agreement.
Lauricella: So, are we starting to see signs though that the big three and other asset managers are starting to change their tune on this? I mean, there was a history where they were standing by and not doing very much. Obviously, climate change has really become much more of a front-burner issue. We're seeing BlackRock's chief executive, Larry Fink, talking about climate. Are we starting to finally see any evidence anywhere that investors who care about deforestation can at least feel like maybe they are starting to turn a corner when it comes to doing something about this problem?
Cook: I think we are. And there's a few things I'd point to. One is, some emerging investor groups that are getting together to renew pledges and not only to make pledges, but to think through how you effect change within your portfolios and, in so doing, throughout the supply chain. So, the Finance for Biodiversity pledge was signed in 2020. So, it's a small group of investors, but that has the potential to grow and become very influential because one of the areas that they commit to is engaging on deforestation. Likewise, the Natural Capital Finance Alliance, another investor group getting together to think through the tools and data that investors need to be able to effect change in their portfolios.
But perhaps the most recent and obvious piece of evidence that we have that even the largest asset managers are getting very serious about addressing deforestation is Procter & Gamble's vote last October. And that's of course the vote that caught our attention, and it led to the article that we wrote, which was: 68% of shareholders that voted on that resolution, which was put forward by Green Century, asking the company to create more transparency into how it is sourcing its agricultural commodities, and what sort of pressure it's bringing to bear on its supply chain to ensure that its supply chain is deforestation-free. BlackRock, Vanguard, and State Street all supported this resolution. And this was against the recommended vote of Procter & Gamble's board. So, I mean, that's really significant. Sixty-eight percent of shareholders opposed Procter & Gamble's board in voting for that resolution. And that resolution actually was quite powerful. It went further than previous deforestation resolutions did.
Lauricella: So, from an investor standpoint, who is looking at this issue and looking for their portfolio, what sorts of things should they be looking for? Is it how these fund companies are pressuring companies in the supply chain to do more work on the fund disclosure? Is it evaluating the actual companies that are in their portfolios--going to other resources? What would be just a couple steps for the average investor to take here who cares about deforestation?
Cook: Right. I mean, for the average investor, there are some options to look--you can look at the portfolio itself and evaluate. And there are--I pointed to like deforestation-free funds' websites where you can go, and you can look and see what is the deforestation exposure of a portfolio. So, there are some tools. Forests & Finance, they are tracking banks' and investors' exposure to deforestation. So, there are some online tools that you can use to investigate exposure to deforestation at the portfolio level. But I would actually go further and say, it's really powerful when asset managers use the holdings that they do have to effect change. And so, there what I would do is look at the proxy-voting guidelines of the asset managers offering the funds in which you're invested. Do their proxy-voting guidelines provide a position on deforestation? Look at their engagement reports and their engagement policies to see whether deforestation has been identified as one of the key themes. And look at the kinds of materials that asset managers put out. Increasingly, asset managers are putting out educational materials on their websites for investors to deepen their understanding of key ESG issues. I have personally seen materials on deforestation, and I think that goes a long way to educating the end investor and explaining the kinds of actions that the asset manager may take to effect change through their investments.
Lauricella: Great. Jackie, thank you so much for being here today and talking about this really important story that affects basically the entire globe. Jackie Cook, director of Investment Stewardship Research at Morningstar, thanks for being here today.
Cook: Thank you.