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Q&A: Illinois Raises the Bar on Sustainable Investing

Michael Frerichs, the state treasurer of Illinois, weighs ESG risks in his assessment of long-term value.

Editor’s note: This is one in a series of Q&As with financial professionals about how they’re incorporating environmental, social, and governance factors into their investing approaches and their views on ESG risk.

As Illinois’ chief investment officer, state treasurer Michael Frerichs oversees $31 billion, mostly in pension and college savings assets. The state’s direct-sold Bright Start 529 Plan has a Morningstar Analyst Rating of Gold. The long-term nature of these funds requires him to look decades into the future. Therefore, he says, he has an obligation to weigh the ESG risks companies face and ensure they are taking sustainable steps.

Illinois has embraced sustainable investing through an initiative called Raise the Bar. What does it mean to raise the bar?
When we invest for pension funds or retirement funds, we're looking at a 20- to 30-year horizon. When we're helping families to save for college, we're looking at a 13- to 18-year time horizon. A lot of companies have established perverse incentives for their CEOs to take steps right now to lift stock prices in the next quarterly report--but not look at long-term things. As long-term investors, we want to make sure these companies are sustainable.

Part of Raise the Bar involves 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. You've been working, for example, on the opioid crisis through shareholder engagement. How does this align with your fiduciary responsibility as state treasurer?
If you're a fiduciary, you have an obligation to help get the best return possible for your customers, for your retirees. One of the ways to do that is to make sure that companies are acting in ways that ensure long-term viability. 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.

You do about as good a job as we've seen explaining to investors your rationale for ESG integration as well as just what you're actually doing.
If we're going to ask corporate boards to be more transparent, we have to be transparent. I talk to a lot of talk-radio stations, [because] when people hear that you're pushing ESG they hear that word “environmentalist,” and 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 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, the board is less prone to groupthink. You're less likely to miss out on opportunities.

This article is based on an October 2019 interview and appeared in the first-quarter 2020 issue of Morningstar magazine. Learn how financial professionals can subscribe for free.

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