#FA Success Ep 279: Expanding The Impact Of Sustainable Investing For Ultra-HNW Families, With Erika Karp

Resources Featured In This Episode:

• Erika Karp
• Pathstone
• Morningstar Sustainalytics
• MSCI
• SASB (Sustainability Accounting Standards Board)
• 17 UN Sustainable Development Goals

Looking for sample client service calendars, marketing plans, and more? Check out our FAS resource page!

Full Transcript:

Michael: Welcome, Erika Karp, to the "Financial Advisor Success" podcast.

Erika: It's a pleasure to be here, Michael.

How Erika Defines ESG Analysis And Impact Investing [02:52]

Michael: I'm really looking forward to today's discussion and a little bit about just the world of ESG and impact investing. And I feel like there's been a lot of just buzz and hubbub in the industry over the last couple of years around the rise of ESG. And, yeah, we're seeing it from regulators, we're seeing it in the media more now, we're seeing it within the industry, we're seeing industry studies that talk about segments of consumers and more and more consumers that are interested. And I know you've both lived this journey for many years now of building portfolios on ESG, building whole frameworks around how to design ESG portfolios, you do it in what I think of as a little bit of a unique environment now in a family office environment where you get to do this with some folks who have very, very large amounts of dollars, which I know puts a couple of additional sort of tools and options on the table about how you do this. But I think to kick-off, I'd love to just hear from your perspective how do you think about and define this space of ESG and impact investing? Because we had so many advisors talk about it from different perspectives that we're not always even quite talking about the same thing. So, when we say ESG and impact investing, how do you define that space? What is that exactly?

Erika: Well, we probably do or I do bring a different perspective because I was a director of investment research, right? And so, the way I define...first of all, I don't think there's any such thing as ESG investing, right? ESG, environmental, social, and governance analysis, that's a thing and it's a discipline. And if you engage in ESG analysis, you can do any kind of investing you want. So, to use the terms, ESG analysis, a discipline, sustainable investing, the systematic analysis of ESG factors in any investment process, right? And then impact investing I would define as intentional and then additional, meaning, "But for your money, something societally would not happen," and then measurable, we want to be able to measure the impact.

And then there's loads of other terms, socially responsible investing, and double bottom line and triple bottom line and values-based investing. In the final analysis, it's all just investing and ESG analysis is a lens, again, it's a tool. And I personally think it needs to be done in all investing contexts, by the way, including on the corporate side, the investment of treasury dollars from corporations, their CAPEX plans. So, it's an analytical tool, and then you can go from there and look at a client's aspirations.

Michael: So, it's a really interesting way to frame it. So, it's not ESG investing, it's ESG analysis, so incorporating environmental, social, governance, factors into the analysis. That just like the fact that you're doing that, that is the ESG component of the analysis. The implementation of the portfolios as you frame it as sustainable investing, which means an investment process that has incorporated the ESG factors into the portfolios that are ultimately being constructed.

Erika: Right. And as it relates to ESG analysis in the financial return context. Now, I'm not talking about the societal return but in financial returns, we want to understand what are the material ESG factors, meaning which of those factors are going to affect financial outcomes, profitability, and economic outcomes? So, material, i.e. what matters to revenues, to cause, to risk? And by the way, those are...we think about them in a longer-term context, but in that longer-term context, ESG factors very often do determine big financial outcomes. Like I said, it's revenues and costs and risk.

And by the way, that kind of analysis is what matters to the SEC and all the financial regulators but again, it is long term. I would argue, actually, that ESG analysis and sustainability from a corporate perspective and from an investment perspective is a proxy for quality, it's a proxy for innovation and growth and resilience. And that's why ESG analysis is critical, frankly, for every investor. And for those investors and those advisors that really don't look at these factors, you're going to miss stuff, both risk and opportunity. That's just a fact.

Michael: So, I find that an interesting framing because certainly, there has been a lot of debate in the industry over the years of just do you get better returns with an ESG framework and I guess from SRI's sort of predecessor discussion around it? So, I feel like there's been two camps, one side says, "This is a path to better long-term returns," and the other says, "This isn't about returns, this is about clients aligning their capital with their values and what's important to them and maybe it will also happen to get better returns but if you just don't want to invest in a certain type of company that engages in certain practices because it's where you don't want your capital to be, that's a preference unto itself and it's not even about the returns anymore." So, how do you think about that spectrum between are we doing this for the returns or are we doing this because clients have certain preferences about where their capital goes and we're just trying to express those preferences in a portfolio?

Erika: So, the answer is yes, right? It's about both and it's about both simultaneously. And the preponderance of empirical research shows that you need to sacrifice nothing to invest for both sustainability and financial returns. You have to be skilled to do that, right? Because there is a lot of so-called greenwashing and there's a lot of kind of...

Michael: And what's greenwashing for those who aren't familiar?

Erika: Greenwashing means since sustainable investing is kind of a thing today, it's kind of cool, there are companies, there are advisors, there are managers that are trying to put a spin on their businesses like, "Oh, I'm helping environmental and social factors," and you got to put that label out there. So, greenwashing is an effort to make it look like we're doing sustainable finance. So, there's a lot of that now because it's kind of a cool subject, right?

Michael: So, this is the manager that says, "Oh, yeah, we build ESG portfolios," and then you get in there and it's like you have a 1% allocation to an ESG fund, the other 99% is you just doing what you were going to do in the first place. But you got an ESG thing so you said you're an ESG manager but you're not really.

Erika: Yeah, or you're a company and you do some advertising saying how energy efficient you are. And by the way, let's say your business is in finance or some service sector and the energy efficiency is not the point for you, the point for you is governance and human capital management and diversity or whatever else. And by the way, this goes to that issue of materiality, what matters? If you are a mining company, the social interactions with your labor force, that's what matters most. If you are a beverage company or even a semiconductor company, your water efficiency actually matters a lot.

And that's not intuitive, by the way, the semiconductor company puts a $10 billion fabrication plant somewhere where there's no water in Southern California and if they lose water, they lose their license to operate effectively because it takes so much water to produce high-end chips, right? So, what matters, what is material by sector and by company, right? If you're a hotel or travel or tourism company, you want to make sure that you're looking at issues of, frankly, modern-day slavery and human trafficking because that happens more frequently in those industries.

So, by industry, what matters and that's ESG analysis. With regard to, again, performance, so the answer really is it depends. Some clients are totally into impact, they will go way out on the kind of thematic impact, direct deals, private equity, they'll go way out on the scale to make sure they're getting the social impact. They may or may not care about loss of capital, right? And then there's the other end, there's people who are totally focused on financial returns and are not looking at ESG factors. Now, again, I think it's a mistake because ultimately, in the long term, I do think there is excess exposure to risk if you don't look at the relevant ESG factors.

How Values-Based Factors (Intentionality, Additionality, And Measurability) Determine Impact [12:41]

Michael: So, for those clients that, I guess, reframing like they're doing it for the values, not necessarily the returns, do you think of that as just another version of sustainable investing and incorporating ESG analysis? Would you put those folks in the domain of impact investing because they're saying their investment is based on impact and not necessarily driven by financial return? How do you describe that values-based, values preference-driven investor that's also incorporating some types of ESG analysis?

Erika: Again, we could say impact investing but remember, we talked about intentionality, additionality, and measurability, those are the three kind of things that what we would call an impact investor is looking for, right?

Michael: Can you define those three? Just what are those mean in practice?

Erika: Sure. Intentional, right? So, my issue is the ocean, right? So, I really, really want to put my money to work to help create a healthy ocean, right? So, that's the intention for me. Or pick anything else, pick water, pick racial equity, social justice, pick just pure climate issues, right? So, that's one, the intentionality. Second, additionality, let's say your investment, again, let's say is the oceans. Remember that the ocean supports about 12% of the jobs of the human race, right? So, making your living off the ocean is a really big deal, all right? About 50% or 60% of the human race gets its protein from the oceans, right? So, the ocean matters.

So, when we're talking about additionality, when you make an investment, we would not have, call it more jobs, more proteins, we would not have the establishment of ocean research facilities. Right now, there's this really cool facility called Proteus which is the space station of the ocean and it's being driven by Fabien Cousteau, right? It's going to be impact investors that get involved with this. So, that's the additionality part. And then, again, there's the measurability. So, back to that intentionality, "How many jobs can I create, can my dollars help create around ocean health?" Right?

"How can we start to see this huge mass of plastics that's invading our oceans, how can I help affect that?" That's a big one, by the way, we need huge efforts to do that. But again, you can start to have metrics in place to say what your money is doing. And I personally...the ocean is a big one for me and if you look at the ocean in 2050, you're going to see more plastics in the ocean than fish, right? It's really, really bad. So, that's an example of impact investing. And, again, by the way, I'm using this because it's a hard one. There's more clear ways to invest in racial equity and climate impact and health impact, the ocean is a tough one.

Michael: So, I've heard at least some circles define impact investing as something that is non-traditional assets, non-traditional portfolios, often very locally based or small business based as sort of like a defining characteristic. And I feel like your definition of how you're framing impact investing here is different. It's larger and broader in some ways, it may or may not still include some traditional investments or portfolio assets, it's primarily defined around, first, just the client's intentionality in building the portfolio, right? Just when they're saying, "I'm not building the portfolio for returns, first and foremost, I'm building for impact into whatever my impact thing is."

It needs to be measurable or it's probably a good practice to be able to say like, "Here's the impact you're having when you put your dollars towards the impact." And that as your framing it, it does need to be something...it does need to be some additionality, we have to be creating something new and different because that's what causes the impact, which may lead you in the direction of some new or different or non-traditional investments. It's not defined by direct deals or private equity and the like, that just happens to be one of the ways that it gets expressed by the time you meet the factors of intentionality, additionality, and measurability. Am I framing that well in what impact is and how you define it?

Erika: You're right, I do define it much more broadly. In fact, I believe that every investment, every investment has an impact. The question is, do you know what it is? And is it good or bad? Right? But every investment has an impact. And I believe we have to move the whole capital markets, infrastructure, and all the dollars towards impact in some way, all right? So, I'm going to give you an example just for context, all right? In the last couple of years, about $500 billion a year was put into alternative energies. You know, $500 billion, that's pretty good. If we wanted to get anywhere near the goals of the Paris Agreement, all right, for carbon emission reductions, we would have to invest about 1.5 trillion a year, all right?

So, we're spending like a third of what we need to spend to really get climate action, to really start bringing down emissions, or growing them less rapidly, all right? So, we need to move...it's not millions and it's not billions, we need to move trillions towards all kinds of impact. And so, if we think that it's going to be kind of one subgroup of investors like impact investors that are going to get that done, we're wrong, right? We need to move the quantum of capital. And so, the reality is if we can get everyone and everything moving towards investing in renewables and investing in protecting the ocean and the water and, frankly, society, we need to move at all. And so, yes, I define it very broadly because...actually, let me give you an example.

I use that word, quantum, which is, really, it's a cool word because people think of it as very large, like a quantum leap. But the reality is quantum is also very small, right? It's the infinite divisibility of something. Quantum computing, right? And so, I will take quantum computing, which is a huge theme, trend, technological kind of shift, that you wouldn't think impact investors should have anything to do with but we do. Because when you think of what quantum computing does...because knowing what it is really hard, Einstein had trouble with it, but knowing what quantum computing can do, which is again, infinitely fast simultaneous processing, think about what that is going to...how that is going to affect the logistics of airlines and trains and city traffic.

It's a huge amount of processing power allowing us to analyze stuff simultaneously and it's going to be incredible for carbon emission reduction when we optimize routing, right? So, that's just one example. So, quantum computing has a huge impact on climate because it has a huge impact on emissions. So, I don't think most investors think about that but it's true, go ahead and invest in quantum computing. It's tricky but it's doable. And that is a big thing that I don't think is perceived as being an ESG analyzable thing, it is.

Michael: Well, I'm struck by your point and comment overall that every investment has an impact, the question is do you know what that impact is and whether it's influencing your investment decision in the first place? I've been fascinated with the rise of some of the ESG tools and...well, I guess, in this context, impact investing tools that have started trying to help quantify this a little bit more, "If you make this investment versus that investment, here's the jobs created or the amount of carbon emissions that are reduced or the amount of plastics in the ocean that are reduced." And it starts to put numbers to investment decisions beyond just the return numbers or it puts different numbers on the table and I suppose, to some extent, we all weigh the additional numbers differently, right?

Some people, I guess, would be...I don't know, I'll call them investment purists, the only number that matters is the return number, if you want to do good in the world, take your returns and donate them or be charitable or whatever you're going to do with it but I'm here to maximize your returns. And then you get clients at the other end of the spectrum that say, "No, no, no, the other numbers are actually so much more important than the return numbers that I actually want to invest for the other numbers first and foremost." So, we're calling those impact investing folks. But the fundamental change to me is for most of investment history, I feel like we didn't have any other numbers to measure by.

The only one was returns or the derivative numbers we have tied to returns like risk, standard deviation, semi-deviation, and all the different metrics around returns. But just one of the things that strikes me from the whole discussion is we've brought different measuring sticks to the table over just the past couple of years, I think aided in part by technology that's figuring out how to harness these numbers and pull large data sources to get these numbers and put them in front of us. And just the fact that we get to look and measure more things than we did before seems to me to be the fundamental thing that's starting to change this.

Erika: Yes, definitely. So, there are loads of tools out there but you're actually starting to see a consolidation of those tools a bit. But let me go back to a basic issue, which has to do with the quality of data, right? So, a lot of the ESG analysis that's done relies on data that is quite flawed and that's because it has to do with corporate data disclosure of material ESG factors. Thankfully now, this is after kind of 20 and 10 years, we are starting to see some standards for disclosure, for corporate disclosure of ESG data that is material, but there has not been any standards. So, companies can put out data as they define it, as they need and wanted, and it is not comparable and you can't base a projection on it and there's no governance or auditing of it. And it's challenging, those data standards.

Now, there's some companies that are kind of leading the way, which is great. They try really hard to disclose what matters to them in terms of ESG and materiality, but there haven't been standards for disclosure. It's coming now, which is exciting. Ten years ago, I was on the founding board of something called the SASB. For those of you that don't know, that's the Sustainability Accounting Standards Board. And the idea was very much to have standard sector-based disclosures by companies, right, that, again, are decision-useful for investors. So, finally, we're starting to see that happen.

Still very slowly because it's complicated and you're seeing a consolidation between the SASB and some of the European standards and now global standards. So, we will have...we're getting closer to having these standards for disclosure. But in the meantime, you have this data out there and then you have these ratings and rankings organizations that look at the data and put their own kind of spin into it. And then you have indices that are based off ratings and rankings and then you have these ETFs and other funds that are rated off the indices, so you have multiple flawed data systemically going through the system. And so, that's really a problem. But again, we're making progress on this, it just takes time. And so, until we have some standard data from corporates, it's tricky to put these kind of corporate ratings and rankings and products in place.

Michael: So, just for those of us who aren't familiar, can you give us an example or two of just what does flawed data look like? Just like what's out there that is data that we might have thought is data that you would characterize as flawed data that maybe we shouldn't have been using or relying on?

Erika: Well, I'll give you a macro piece. So, everyone wants to talk about anything related to the climate, right? So, whether it's carbon emissions or ocean waste or whatever it is. So, people would ask, "Okay, do you as a company report to the CDP, the Carbon Disclosure Project?" And one company could answer with all kinds of details on their emissions and their progress and all their standards for how they're using energy. And so, yeah, they report to the CDP. And another company can look at the CDP questionnaire and the first question is, "Do you report to CDP?" And their answer is, "Yes," and that's it, right? And meanwhile, both those companies report to CDP. And so, that could be just that yes, it could be in a great...

Michael: So, if someone's built an ESG ETF that determines carbon responsibility has determined that the people who report to the CDP are...you'll get a check in that box for being higher weighted on their ESG carbon factor, it's like, okay, the general index looked at, "Do they just disclose?" If the answer is yes, they get a point. But the drill-down is like, yeah, but these are drastically different disclosures because one company is actually really doing the hustle work on it and the other one is basically just said yes and isn't really doing much beyond that.

Erika: Exactly. So, you see, this is a big difference, right? And so, we're not yet at a place where, again, companies report in a way that is standardized and comparable and projectable and decision-useful, so we're not there yet.

Michael: And so, what do you...I guess, given that dynamic, I guess I'm just wondering what do you look at to set these factors in the first place? Does this mean you have to decide for yourself which ESG factors you think are actually useful and valid and reliable in the first place and that becomes part of the exercise?

Erika: Yes. So, at Pathstone, we are analyzing managers all day long, so that's what we do and part of our analysis of every manager relates to how they incorporate material ESG factors, we want to understand their thought process, all right? So, we do a lot more than just look at their ratings or rankings for sustainability for Sustainalytics and MSCI. We are asking questions of these asset managers to really understand how they think and are they doing what they say they're going to do. And by the way, that's why we do the kind of thematic research that we do on whether it's quantum computing or circular economy or social justice. Because when we ask them questions, like I mentioned, with human trafficking for an airline company, quantum computing actually also for an airline company.

When we ask them questions for food companies, restaurant companies, we want to ask them questions about safety, right? And then we want to see how they answer those questions. And if they don't kind of get it or they can't respond in such a way that shows that they are really thinking about materially ESG factors, well, that's problematic, that might be the manager that we're not going to use. So, it really is a matter of going deeper. Also, at Pathstone, we have a proprietary Impact Access Framework, right? So, we look at our clients' portfolios to try to get a sense of where their tilts are in the various kind of sustainable development goal frameworks. So, is your portfolio tilted towards water? Is your portfolio tilted towards gender equity? We can look at the asset managers and the strategies that they own and start to understand and then we can kind of construct portfolios to get to where they want to be in terms of their focus.

Michael: So, can you explain that process to us more? Is that an analysis with a tool and piece of software to X-ray their portfolio on an ESG factor basis? What exactly are you guys doing? And how do you actually get there to do it?

Erika: So, we think of kind of the best way to have impact, we kind of looked for a single common denominator among these 17 UN Sustainable Development Goals, right? So, the SDGs, which, if you don't know, it's a big framework that the UN put in place for both investors and corporates that's aspirational, right? Like no hunger, no poverty, clean air. And so, it's aspirational. But in any case, these 17 goals are a really interesting starting point and we were looking at these 17 goals and we're like, "Okay, what is the single common denominator to achieve these goals?" And we argue that it really is access, right?

And so, for example, one of the goals, number five is women's economic empowerment effectively. So, how do we offer that to a client who really wants to invest for that? Well, access is, in our view, just pivotal, right? We need to get women access to education, to water, to broadband, to capital, to healthcare, you need access to a bunch of other sustainable development goals to get to number five. So, we created...basically, it's a matrix to say, "Okay, your portfolio is skewed towards gender equity, which is what you want, which is great. But we created these access indicators, for each one of the goals, what do you need to get to that, which other ones?" So, we have this Access Framework, and then we take that down to the level of managers, we take that down to the level of stocks, and we can see what a client is leaning towards in terms of the portfolio.

And so, that access impact framework is our kind of...it's built on some of the ESG data, but it goes a lot further to understand managers and then to understand client portfolios, so we created a heatmap to show visually where our clients are kind of leaning. So, again, everyone has to have their own way. I happen to think ours is really unique and really powerful and, again, you really have to understand impact to be able to do it. By the way, the SEC is now looking at RIAs, right? To see are you just kind of saying, "Oh, yeah, we do sustainability," or are you really doing it? And most importantly, as with the SEC, are you doing what you say you're doing? Right? And so, we kind of go above and beyond, I think.

How Pathstone Implements ESG Investment Analysis [33:56]

Michael: So, talk to us a little bit more about just how all of this is actually done and expressed in Pathstone, in your advisory firm? Because I've been...I'm struck just hearing the discussion overall that relative to, we'll just call it traditional advisor investing, I do hear kind of more analysis, more work, probably requires more scale, there's more effort involved, right? Just kind of by its nature, if you're going to look at more factors and evaluate on more measurability outcomes, it's going to take more to do this analysis and work in the first place. So, how is this actually done and implemented at Pathstone? What is your ESG offering to clients and how do you actually implement that?

Erika: Well, it's things that we've talked about, it is an understanding of manager selection, right? So, ESG analysis is included in every one of our manager diligence discussions. That's one. Two, we do this thematic research that allows us to push managers harder and allows us to better align our clients' values and objectives.

Michael: Can you give me an example of what one of your thematic research projects would be?

Erika: Well, sure, the quantum computing is an example, right? That's one example. We've done pieces on racial equity and how do you invest for racial equity, and we think a lot about understanding the genesis, the structural issues around how we got to where we are. So, we know that African Americans from the beginning of the U.S. did not have access to education, did not have access to capital, did not have access to housing, the ability to build wealth in a family, generational wealth just wasn't there, right? So, you need to invest in kind of the infrastructure that makes up for that, right? So, CDFIs and understanding banks that do community lending, and there's ways to invest in writing historical wrongs, right? And so, we've done pieces on that. We've done pieces on LGBTQ rights and equality, we've done pieces on circular economy on the intersection between health and climate, a hugely important one. So, we do that.

Michael: So, the idea of these is like you do a deep dive on one of these, I guess, to understand the issues and factors yourselves at an even greater level. And then that turns into questions that you're then bringing back to managers when you're doing due diligence evaluation of managers to say like, "We've been doing our research and finding these factors are really drivers for quantum computing, so talk to us about how you're incorporating the long-term impact of quantum computing into your portfolios?"

Erika: Yep, how do you see that? And so, yeah, for us, again, it's the deeper ESG analysis, adjustments to the ratings and rankings and such that are out there, incorporating our thematic research, proprietary measurement framework, and field building and education, we do a lot of that. All of our research, we put out there into the public domain. That's purposeful, we are building the field. Again, with our clients, we're doing education all the time, we bring experts to help understand issues, everything from Ukraine to water scarcity. So, yes, to answer your question, it's a lot of work but we think it's a unique offering and it helps us win business.

Michael: So, in practice, do all clients that invest with the firm get invested through an ESG framework? Is it synonymous to say, "If I'm a Pathstone client, I'm investing under this ESG framework?" Or is that simply one of the investment options that you've got and clients that want to go out their direction have other portfolios or models available?

Erika: Well, again, we have everything. We're quite large, so we manage $35 billion in client assets, and so we're going to have everything out there, we're going to serve everyone. So, no, not every client is intentional about having a sustainable portfolio as we say. But what I will tell you is, probably, if you look at it, about 90-plus percent of our clients do happen to have some strategies in there that are considered sustainable simply because those strategies have outperformed dramatically. They're good strategies and great managers. So, no, I definitely would not say that we're all sustainable. That said, again, if it's a great strategy, does it matter if it's sustainable or not if someone cares?

Michael: So, how does this get invested within the firm? So, I guess what I'm wondering, at the end of the day, are you actually going all the way down to the point of building the entire portfolio stock by stock along the different factors that you're evaluating after going through your ESG analysis? Or, ultimately, are you focused on finding managers that do this and your primary focus is the manager search and selection and due diligence process?

Erika: We have plenty of clients that own individual stocks but, really, it's not as much of our remit. We have a very large research department that focuses on diligence all day long, right? So, it really is manager strategies that we are focused on.

Michael: I guess I'm just wondering, given the size and the resource that the firm has, why? Why manager search and diligence as opposed to being the manager, hiring the manager, bringing the managers in trying to do that in-house? Just for a firm at your size of 35 billion, how do you think about using third-party managers versus trying to be the managers internally yourself?

Erika: Yeah, it's a different skill set, it's a different function. Again, coming from the sell-side investment bank, we had about 600 publishing analysts at my former firm, right? So, getting stock-specific...I love it, I'm still a stockbroker by heritage, but it really is a different function, a different analysis. So, that's just how the business evolved. And, again, it actually is...arguably, it's a good way to consolidate kind of expertise, right? So, our expertise is analyzing the managers and then thinking about how they do stock selection. So, again, it's a resourcing issue and it's a skillset issue. So, this is, I think, not unusual for how wealth advisors are doing it. And what I would say is, again, coming from a really big firm with a giant research staff, it would be really hard on a single stock basis for even what is a large IRA to compete with the abilities of the research staff of an investment bank.

Michael: And when you talk about finding managers, I guess what kind of managers are we talking about? I think for a lot of advisors, a manager is essentially like a manager of a mutual fund for the most common way that we apply it. But there's managers in mutual funds, there's managers in separately managed accounts, there's managers in more private and alternative investment structures. What kinds of vehicles does Pathstone use when you start implementing this? What are the managers managering?

Erika: So, really, when we go to meet a client, let's say it's a new client, we're going to talk about high-level investment policy statement, their IPS, right? What do they want to accomplish? What is their risk appetite? What are their liquidity needs? What's an appropriate long-term view? So, this is an investment policy statement, what do they definitely not want to invest in? What is their profitability goal? What are their social impact goals? So, the high level is the IPS. Then we come into an asset allocation discussion like what's done kind of standard, right? So, where should we be in the different types of asset classes, depending on liquidity and risk outcome?

And then we start talking about the managers but in terms of those managers, we can go anywhere from a standard straight equity, large-cap mutual fund, right, to a much more esoteric, private, long/short distressed credit hedge fund, right? You can go anywhere. And by the way, you can go anywhere when it comes to ESG analysis too, that's part of all of it. But, yeah, all the different classes from private equity and venture, real assets, real estate, we can go where it's appropriate for the specific client.

Michael: I guess I'm just wondering, in practice, where does it tend to go? Are you heavily in mutual funds in practice? Are you heavily in private equity and venture in practice? It's just where do the dollars usually end out getting expressed when you go through this process with different clients?

Erika: Well, when it comes to a standard asset allocation, that's not going to be that different, right? So, 60% equities, whatever, it's pretty standard. When there's more wealth...and again, our clients on average are about $50 million or so. So, when there's more wealth, you can go further out on the risk curve and you're probably going to see more private deals in there, so some private equity and some alternative, some hedge funds, some venture, so there's going to be more there. When it comes to privates, so standard portfolio of wealthy people, it might be 5%, it could go up to 10%, something like that. But, again, it's always specific. You all know, if you've met one family, you've met one family and it's all over the map.

Michael: And you had said, typical client is $50 million, so you guys are very much working in that ultra-high net worth family office space in the first place.

Erika: Yes.

Michael: How challenging is it when clients with that level of dollars come in and you're trying to implement them to these kinds of strategies and models in the first place? I'm going to guess not a lot of people are coming in like, "I have $50 million in solid cash in a bank account, you guys can just invest it from scratch."

Erika: So fun when that happens. It's rare, but it does happen occasionally.

Michael: Yeah, I guess someone had a little liquidity event and the check just cleared but...

Erika: Yeah, it happens sometimes and it's awesome because we really do. I mean, tabula rasa, yeah, but it's great. Typically what happens, though, is they're coming in with a portfolio and we're analyzing the portfolio and matching it up to what's most appropriate for them and you transition a portfolio over time, the tax implications are so critical. But sometimes, there are clients who don't care about that also, "Let's just get it done," right? "Let's decarbonize our portfolio, let's get fossil fuel-free right now, get it done." That's typically not how it is, it's typically more a client wants that strategy of moving towards fossil fuel-free, and it could take two or three years or even more to get that done in a tax-efficient way. Again, once again, I will tell you, it's all over the map.

Michael: So, what's the actual investment team structure to do this within Pathstone? Just how many people are on this investment team or ESG investment team to make this happen?

Erika: Well, first of all, I should say that it's not really an ESG investment team, there are pockets of particular expertise. My group, that heritage Cornerstone group has particular expertise because Cornerstone was purpose-built for impact, right? But our team is spread around the whole firm and we do education and teachings all the time because we need everyone to be versed in ESG analysis and sustainable investing. So, we are kind of a resource for the whole firm, as well as being our own advisory team just like any other region, right? So, we're the New York/Colorado team. And then there's obviously an LA team and a DC team and Boston team and such, but everyone in the firm is learning more and more about sustainability and then they bring us in if they need deeper expertise with a client.

Michael: So, from the Pathstone perspective, you had your own firm in the past that did this, you got merged into Pathstone as the larger firm, and so now you get to operate as kind of the ESG team in the ESG knowledge base within a larger firm environment that's got other advisors, other clientele across the firm that may want to leverage and tap into that.

Erika: Yeah, but it's not just our team, there really was some heritage expertise. So, we have for the firm a fairly large Impact Committee, which I chair, and in that Impact Committee, we have people from advisory, from research, from across the firm. And so, it's really the Impact Committee that's tasked with working for the whole firm. And again, there's maybe some more expertise, there's more expertise, some of the staff that came from the heritage Cornerstone, the research, the framework for impact, all that, came to this much larger platform. And this deal, this merger, just made all kinds of sense for those who want to really scale impact because having this platform, it's just so much more powerful and broad than having a boutique.

Michael: So, describe for us a little bit more of this Impact Committee, what do they do? You have a big firm, so there's a lot of people and a lot of stuff going on, just what is the actual impact committee? What do they do?

Erika: So, the committee itself, again, it's made up from people around the firm in different functions and we have various subcommittees, including Investment Solutions, Marketing and Education, Research and Analysis, and Governance, whether it's family governance or corporate governance. So, these committees, each are tasked with various things. Research Committee obviously works on the thematic, the Investment Solutions team is mostly about, "When we do a thematic," as an example, "which managers make sense? What do we need from Research?"

The Marketing Committee, it's obvious, it relates to field building and education. And then, of course, the Governance Committee, we do a lot of discussions with multi-generational families and that's a family governance issue. So, that's what that committee works on. So, it's pretty straightforward, actually, but it engages everyone. And at Pathstone, we have a number of committees and if you are engaged in one of our committees, if you are involved in it, whether it's impact or diversity, equity, and inclusion, it's a big deal. We take this really seriously.

Michael: So, how many people are on this committee in the first place?

Erika: The Impact Committee has about 16 people.

Michael: Okay. And so, are you...I guess I'm just trying to understand there, is the committee literally picking investment allocations and managers? Is that where the ultimate decisions get made about where dollars are going to go and how they're allocated or the committee is providing support work on that but the decision is happening somewhere else?

Erika: Yeah, it's Research that focuses on manager selection, the committee is going to work with Research to figure out what we might need. For instance, let's say, from advisory, it turns out we need more private equity solutions, the committee is going to see that because they are advisors on the Research Committee, and then the committee reports back to the research organization, right? The thematic research committee or subcommittee is going to say, "Okay, we're going to do this piece on health care, whatever, do we have solutions? What's the piece going to look like? And can we find solutions on the platform or maybe we can't and we need to do some more searching and analysis?" Yeah, by the way, this is a relatively new structure, I have to admit, that I'm working on, so this is how it's supposed to work and it's exciting.

Erika’s Journey Into Sustainable Investing [51:38]

Michael: So, talk to us about your path personally in coming to this. When did you get started in this direction of ESG investing in the first place? Does this has been something you were interested in from the very start or you came to it later? What was your pathway into ESG investing?

Erika: So, ESG analysis, again, it's just research, it's just great research, right? It's going down different avenues of inquiry that are ultimately going to be fundamentally important, right, financially. So, I actually came to sustainable investing very organically. So, I've been in the equity markets for years and it's probably about 20 years ago that I observed that this SRI thing seemed really ideological and divisive and political and I was like, "Well, that's not really how it should be." Now, again, as a director of research and investment research, I'm thinking, "Well, this stuff needs to be treated as an enhanced analytical approach and as pragmatism because it's real." And so as I more and more learn how material ESG factors were, I started realizing that I, myself, am a sustainable investor, I just didn't know it, I didn't have the language.

So, anyway, what I needed to do is, as I was the chair of this investment review committee, when analysts and strategists would come to the committee to get approval for an upgrade or downgrade or whatever, I would start to ask different questions, questions along the lines of sustainability, around issues of governance, around risks in societal impact, around costs of, let's say, energy consumption, right? So, I started asking these different questions and again, I became more and more certain, really certain that ESG factor analysis was critical to understanding outcomes for stocks.

And so, I had to be kind of subversive because, again, that heritage of socially responsible investing as being really ideological and not financially grounded, I had to avoid that, right? So, I just spoke in terms of governance. And among the E and the S and the G, that governance is first among equals, it really is. If you don't analyze environmental and social issues as a company, well, you're not well-governed, period. Anyway, again, pragmatically, I came to a place where this analysis is a must-have, it's just investing, I don't have to use the word sustainability, I'm not going to be perceived as a tree hugger, and I'm just going to do this kind of work in the world...at that time, in the world of what was called social responsible investing.

And by the way, I say what was called and what still is called. The word responsible just troubles me because it implies that any other kind of investing is irresponsible and I don't believe that, right? So, I didn't want it to be ideological and judgmental and stuff. But anyway, I became more and more certain that this is how it needs to be for Wall Street, for capitalism. And so, I started going outside UBS a little bit more and I started working with the UN and the Clinton Global Initiative and the World Economic Forum. And so, I went out there as a mainstream Wall Street executive and I think that there was a differentiation between me and a lot of the heritage SRI people.

And so, I became more and more convinced that I have this right, I became more and more convinced that this was, frankly, a huge market opportunity, I'm a business person, right? And so, that's when I decided to found my own firm that was, again, a purpose-built impact investment advisor. So, we managed about $1.5 billion, and then last year, after about seven years in business, I got to know Pathstone and it made so much sense from a sensibilities standpoint and a fit too from a financial standpoint. If my whole thing was to scale impact, at $1.5 billion, I did some good work, but at $35 billion, our voice is dramatically larger. So, that's kind of the story, very pragmatic, I happened to believe and my values happened to believe and it happened to be what we are doing. So, that's kind of the story.

Michael: So, I'd love to hear more about the transition from spending a lot of years in the large Wall Street firm. I think you said you were building at UBS to making the switch to going out on your own and hanging your own shingle. Having spent time so directly on Wall Street, that's a really big leap.

Erika: It is scary as hell, you know? No net, no net. But also, the freedom to do exactly what I wanted to do. Granted, at UBS, I did pretty much what I wanted to do but...so I did have a lot of latitudes but not like you do when you have your own company. But it is really scary, being an entrepreneur, a lot of people here know, is like jumping out of a plane and building the parachute on the way down, it is really scary. And you're betting kind of everything, right? But when you are as certain as you can be that you've got this right, yeah, you go do it. And so, yeah, it was really scary but really exciting and happily, I got to go in the direction I wanted to go. And happily, also the good thing is like with UBS, I am very, very proud of the legacy that I left there. And so, again, back to the idea of field-building for sustainable and impact investing, I feel really, really good about what we've done and I feel really, really good about where we're going here with Pathstone. But yes, scary as hell.

Michael: So, was there a moment where you just realized like, "I can't stay at UBS, I'm going to have to go do this scary thing on my own?"

Erika: No, there's not a particular moment. I guess you kind of lose patience for not moving as quickly as you want to move. That's probably, I think, the genesis of a lot of entrepreneurs, you kind of lose patience because you know what has to get done. But no, it wasn't a particular inflection point.

Michael: And so, how did you take the leap and get started?

Erika: Well, I was fortunate in that UBS was comfortable with my founding the firm from my office there, which was very nice. So, there was a feeling like, "Yeah, Erika is doing what she needs to do," and so it was positive and so the relationships were very good.

Michael: I feel like that's a little unusual, that that tends to be harder for people transitioning out of a firm. I guess the distinction, correct me if I'm wrong, but at UBS, you weren't necessarily in the going out and getting clients side of the business, you are in the research side of the business. So, you are kind of crossing the divide from research to advisory as opposed to being an advisor and trying to leave and start your own advisory outside which...

Erika: Yeah, or an executive at the investment bank where they escort you out the door. It was even more of a transition. So, not only was I transitioning from research to an advisory business, I was transferring from the investment banking research part to the wealth management advisory part. So, it was a whole different kind of business model, it was a system-based business model that I was taking, right? Yeah, so UBS was very gracious about it. That doesn't mean it wasn't scary as hell because it was my capital that I started the company with.

Michael: So, what did you do when you got started? Was it you hanging a shingle solo out of the gate? Did you have initial team? Were there any clients that I guess...I was going to say came with, but you didn't really have clients directly there. Were there launch clients? Just how do you...coming on day one and it's like, "Oh, I don't work at UBS anymore."

Erika: Yeah, my money, my mother's money. Let me tell you something, the first 90 days out of the gate when we got SEC approval, I had to get $25 million in the door in 90 days to make sure that it was good with that SEC approval was the worst 90 days. It was horrible.

Michael: Right, so this was before SEC had lifted the limits up to $100 million. So, $25 million was SEC registration but if you were starting from scratch, they give you a brief window to get over the threshold.

Erika: Right, and we had no initial investors, right? So, it was really...

Michael: So, just how do you find $25 million in 90 days? There are advisors who spent 10 years trying to get to 25 million of AUM.

Erika: I had some good relationships and we managed to get it done. My mom was nervous at first because she thought I was going to put her money in my desk drawer and I explained this big firm called Pershing that's going to be...the money is going to be in that vault. But, again, it was really scary, no question. So, I had about four people, none from my former firm, none from UBS that were going to be starting off with me. And we started...it takes a while to do what you need to do to start an advisory firm, obviously. So, we started by publishing research and that was my heritage, so we put out a monthly research report. And we also did some corporate consulting because, again, I had that investment bank background, so I had some corporate relationships. And so, the corporate and the research helped finance the company along with my capital until we were able to start the advisory business.

Michael: So, publishing research wasn't just like, "We're putting out research white papers as a way to prospect for business," you were literally selling research to institutional buyers that were buying research on ESG?

Erika: Yep, so we had a newsletter, the "Cornerstone Journal of Sustainable Finance and Banking," and we put our newsletter out every month, which we charged for. We did some, again, bespoke research for some institutions on a few different themes and we did some corporate consulting. And so, that was helping us continue until we got the advisory license.

Michael: And so, I guess the good news was because you were leading research where you'd been previously, there were also people that were familiar with your research work. So, when you said, "I'm going out on my own and we're starting up a new research offering," there were people that knew you and trusted your work and said, "Okay, we'll pay for Erika's new thing."

Erika: Yeah, yeah. It's kind of crazy, we actually got some checks for the "Journal of Sustainable Finance and Banking" before we had ever published it. And my very first client, she's still a good friend, she was on the corporate side, now she's an asset manager but I said, "Paula, I don't even have anything to show you," she's like, "I don't care if it's coming from you, it's going to be good." So, she was the very first client.

Michael: So, what do you charge for that kind of research?

Erika: It depends. So, we had regular a couple of $1,000 for the newsletter a year but more importantly, some of the bespoke research, it depends, it was by project.

Michael: Okay, so like, multi-$1,000 a year research paper times a bunch of people who sign up, was this actually a material financial driver for you early on?

Erika: Yeah, it absolutely was and it was very few projects but larger tickets.

Michael: Okay.

Erika: And we also did, again, some corporate consulting because of the corporate relationships I had and that was large tickets.

Michael: Interesting. So, kind of getting paid as an independent, I guess, research publisher and independent research consultant was part of the revenue bridge for you until or as you got clients to get the actual AUM side of the advisory business going?

Erika: Yup, exactly.

The Surprises And Low Points Erika Encountered On Her Journey [1:04:46]

Michael: So, what surprised you the most about going out and trying to build your own advisory business?

Erika: Oh, just how hard it is. And it's so hard because, on the one hand, you want to be a trusted advisor, that's the key, right? But on the other hand, you do have to be selling, and especially with wealthy and very wealthy families, selling, per se, they'll run in the other direction, it's not appealing.

Michael: Because they have so much money, people are coming at them so continuously, they tend to be more sensitive to it and they tend to run more quickly.

Erika: Yes, yes. Another thing that I found difficult is that I was kind of always in a rush because...a rush to get clients, a rush to drive revenues. And being in a rush is bad, it's bad for trust, it's bad for your physical health, it's bad for business. And so, you can actually move kind of more quickly in terms of your business and your objectives if you actually move more slowly. I know that sounds like an oxymoron there but I mean it. Like now, I just feel I am so much more confident and certain of the value that we add and the job that we do. And with confidence, you start rushing less and with knowing that you really have a unique selling proposition, you can sell less, and I think those things are more appealing and sustainable.

Michael: And was that something...were you able to get to the point of moving more slowly at the time, or is that like, "Now looking back, I see that might have been helpful but I was still caught in the rush at the time?"

Erika: Yes, yes, this is newer and I feel like I can move more quickly if I move more slowly.

Michael: So, what was the low point for you on this journey?

Erika: Oh, God. Well, I don't know if you count that 90 days when I have to find $25 million. That was pretty low. But when I doing a capital raise in the beginning of the pandemic, I was doing a raise to finance the company's growth and you just looking around and you're like, "Oh, my God, we're in the middle of a pandemic." So, we're in that health crisis, we're in a crisis of confidence with our government, we're in a climate crisis, we're in a gun crisis, we're in a racial crisis, and I'm trying to raise money. So, that's kind of a bummer. But we got through it, it takes a lot of heart and soul to be able to do it.

Michael: So, what were you raising capital for in 2020?

Erika: That was basically to grow, to hire, to make sure that we could have the flexibility to do the vision that we wanted to do, you know? And ultimately, that's what led to my meeting Pathstone and it's as if it was meant to be.

Michael: Interesting. So, I guess just relative to advisory firms, we don't see a lot of firms that raise capital for their, internal growth, we see some that raise capital because they want to get dollars to acquire other firms. So, I guess what was the focus of raising capital for you? What was going on that it felt necessary and what were you actually looking to do with the dollars?

Erika: Well, you have to remember, we were not...we're an advisory firm but not just an advisory firm, right? So, we were in the midst of publishing research, creating our unique framework, building the field. So, we had big aspirations...we have big aspirations but that's expensive, especially publishing research. And again, in growing the field, we wanted to really finance the Access Impact Framework to tech-enabled it, that was really, really important and we still are going to do that here with much more capability. So, it's multiple reasons.

The Advice Erika Would Give Her Former Self [1:09:04]

Michael: So, as you look back, what do you know now you wish you could go back and tell you from 10 years ago when you were still at UBS but gaining some momentum and interest in going further in this direction?

Erika: I guess the time, the time it would take to do everything. Everything takes two or three times as long as you might like, everything costs two or three times as much as you might think. But it's the time probably, I wish I knew more about how long stuff takes. That's probably the biggest thing.

Michael: And would you have done something differently with that? What would it change if you'd known?

Erika: I'm not actually sure. I am very fortunate generally in my life, I have very few regrets because when it comes to making decisions, all day long, what we do is make decisions with imperfect information, right? And I am good at saying, "Okay, I know as much as I can know, so I might as well go and make that decision." Right? So, given that that's the case, I don't typically have regrets. And so, in terms of what I would have done differently, I'm not sure.

The Advice Erika Would Give Younger, Newer Advisors [1:10:21]

Michael: So, what advice would you give younger, newer advisors looking to come into the industry today?

Erika: I guess the advice that I would give is make sure you know when you had a great day, why was it a great day? What were you doing? And then over the course of your career, aspire to do more of that. Whatever you were doing when you had a great day, do more of that. And that's the advice that I would give, you want to...frankly, I'm at a place I know and I wish I got there earlier where I'm going to be damned if I don't have some fun, especially now. So, yeah, I know what I'm really good at, I know what I don't love, and I want to do more of the former.

Michael: And so, how do you define that for yourself? What is your "I had a great day" and why?

Erika: Well, again, what I like to do, I love doing presentations, so I love speaking and talking and interviewing like this. I enjoy real conversations and I believe you can do real conversations in a room of 1,000 people, I happen to enjoy it. And I think that one of the keys to that is to make it kind of intimate, right? And so, I'm very transparent on stuff. So, if I've had a day where let's say, I have a prospective client meeting in the morning with a client that is semi well-versed on sustainability, I love that prospect meeting. And if I had a client meeting or prospect meeting and then I did some kind of presentation and then I worked on some research that we're working on so I could learn about whether it's quantum computing or the climate determinants of health, whatever it is, learning. And so, to me, that's a great day, especially if we win the client, but that's a great day.

Erika’s Plans For The Future [1:12:17]

Michael: So, what comes next for you? What are you working on next?

Erika: You know, I'm very fortunate. I'm in a place right now where I have the best job, I have a great job at a great firm and I am having more and more of the best days. And again, I love that I can really make a big impact move fast and still move slow, and so I feel very fortunate. Honestly, the work-life balance thing, I still want to do a better job with that. I have a wife and three children and...not young children anymore, but work-life balance would be...I'm getting there, I'm getting there.

Michael: So, what throws you off from work-life balance when you're otherwise feeling pretty good about where the business and career are?

Erika: When there's a lot of what I love, it's just...there are days where we've got a bunch of clients and advisory work and the pitches and the speeches, it can get like too much and so that that loses the work-life balance a little bit. But that's a high-class problem and we thought we can resolve it. When I look at my calendar and I see no breaks in between 12 meetings, that's not cool. And so, I stop and I remind myself, "Let me at least build some breaks in here so I can get back to it."

What Success Means To Erika [1:13:45]

Michael: So, as we wrap up, this is a podcast about success and just one of the themes that always comes up is even the word success means different things to different people, sometimes different things to us as we go through the stages of our own lives. So, as someone who is objectively built a very successful business and career around this, how do you define success for yourself at this point?

Erika: You know, at this point, what's cool is I kind of...a lot of us are insecure and we want to show how great we are and successful and everything else. I kind of did that, I feel like at this point, I don't have anything to prove to anyone. And so, to me, I think finally I feel successful, I got nothing to prove, I really want to be part of building a great enterprise and helping people and helping the environment. And so, I guess I define success as maybe contentment, you know? I don't strive to happiness, right? Happy is a moment in time and I've got plenty of those and sadness too moments, but overall, being content, to me, that is a success.

Michael: I love it, I love it. Well, thank you so much, Erika, for joining us on the "Financial Advisor Success" podcast.

Erika: It's truly a pleasure, Michael.

Michael: Likewise, thank you.