Morningstar - Q1 2020 - 33

ESG PERSPECTIVE

Illinois Treasurer Raises Investing Bar
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 is rated Gold
by Morningstar. 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.
Morningstar: Illinois has embraced sustainable

investing through an initiative called Raise the Bar.
What does it mean to raise the bar?
Michael Frerichs is the state
treasurer of Illinois.

Frerichs: 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

Convincing Clients

For years, we educated our clients on keeping
fund expenses low. ESG funds, by nature, are
active funds that require a deeper, more
specialized bench of analysts. This makes these
funds more expensive.
After concluding that ESG funds were the
way to go, we created our four model portfolios
in Morningstar Direct and realized that they
had expense ratios that were about 13 basis points
greater than our old models. For our 60%/40%
stock/bond portfolio (which is our most used), the
expense ratio jumped from 0.44% to 0.57%.
In the end, our investment committee agreed that
the damped volatility in these portfolios more
than made up for the fee increase.

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

Now, all we had to do was explain this to our
clients. We approached clients with complete
transparency. We included the proposed
changes and increased expense ratio in our
quarterly letter and hosted a webinar to
explain everything in more detail. Of our roughly
330 households, only a handful questioned
our proposed changes-and all but a few
(the number was a single digit) signed on once
their concerns were addressed.
We started the transition with just qualified
accounts. We are going through taxable accounts
one at a time. If there are large unrealized
gains, we will keep our old funds until the opportunity to sell out of them arises. After that, the
transition happens over a period of 10 or so days.

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.

Today, new clients automatically are invested
in a portfolio featuring ESG funds. From
day one, they'll get both the benefit of knowing
that their portfolio is better aligned with
meeting their financial goals while aiming for
greater good in the world. K
Sheryl Rowling, CPA, is head of rebalancing solutions with
Morningstar and principal of Rowling & Associates,
an investment advisory firm. She is a part-time columnist
and consultant on advisor-focused products for
Morningstar, and she continues to actively run her advisory
business, from which Morningstar acquired the Total
Rebalance Expert software platform in 2015. The opinions
expressed in her work are her own and do not necessarily
reflect the views of Morningstar.
Lorenzo Sanchez, CFP, is director of wealth management
with Rowling & Associates.

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Morningstar - Q1 2020

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