🌐 Sustainable Investing with Franklin Templeton

And we are live. Welcome, Jonathan, to Cloudflare TV. We chose a very appropriate topic for today, sustainable investing at Franklin Templeton.

And just for the audience, for background, so at Cloudflare, we kicked off Impact Week today.

It's the first time that we have an event like this where we try to highlight the things that the company is doing around environment, social, governance, ESG.

But it wouldn't be Cloudflare if that turned also into products and features and partnerships.

So it's going to be a really exciting week for us. And over the course of the week, we are going to talk a lot about what we do from an ESG perspective, but also how we always tend to take a broader perspective and a lot about it will also be around innovation.

So we thought, Jason Nolan, who heads IR, and his team, in preparation of this week, we talked to our large shareholders, how important ESG is from their perspective, what lens they have.

And it was highly educational for us as a team.

And we thought we wanted to share that. So we asked Jonathan Curtis to join us today.

You've been with us, accompanying us, so to speak, for a while, have deep insight into this vertical in the company and the technology.

And why don't we get started by you telling us a little bit about yourself, but also about Franklin Templeton, because I'm sure a lot of folks listening today might recognize the name from their 401k statement.

But, you know, would appreciate a broader perspective, Jonathan.

So welcome again. And yeah, and over to you.

Great. Well, thank you for inviting me. Happy to be here. Just a little bit about me.

So I work at Franklin Templeton. I've been here for about 13 years now.

Prior to joining Franklin, I spent some time on the sell side, which are the Franklin, we buy securities, we hold them, we seek to generate or get a return on those for on behalf of our clients.

So we're called sort of the buy side.

But I prior to joining Franklin, I was on the sell side. And those are the folks who are pitching ideas to clients, explaining stock stories to clients and the like, but doing it in a much more public way.

In Franklin, I am doing that for the purposes of managing actual funds and assets.

So at Franklin, I manage a fund called the Franklin Technology Fund.

It's about a $10 billion fund focused on this big idea of digital transformation.

And these 10 themes that are in support of that AI and machine learning, cloud computing, digital customer engagement, long list of themes.

I also as an analyst, I'm responsible for covering the infrastructure software and IT hardware sector.

So I cover names like Cloudflare. I do Microsoft, ServiceNow, Akamai.

I do also Apple and Cisco. And I used to do all the firewall vendors.

And then I'm also the lead of our technology research team here in the Franklin Equity Group.

So Franklin is a large asset manager, I think one of the top five or six asset managers around the world.

We manage about $1.5 trillion of assets.

I'm in a part of Franklin called the Franklin Equity Group. We manage about $150 billion of that $1.5 trillion.

And most of that is focused on growth companies, companies that have really tremendous growth prospects ahead.

So think of an Amazon or a Microsoft or ServiceNow, but also a Cloudflare in that mix.

So in the fund I manage, Cloudflare is definitely one of our top 15 positions, a company that we have a really positive view on and think has just a tremendous future ahead of it.

So and then prior to doing time on the buy side or here on the buy side, and on the sell side, I was an engineer.

I built software for networking infrastructure.

I moved to the Valley in the beginning of 2000 to get rich building routers for a company called Caspian Networks.

That didn't work out. Prior to that, I was at a company called Nortel building software for telephone systems.

So I know the networking space well, been covering a long time, and I've written networking infrastructure software.

I think it's fair to say before we dive into the topic, you're probably one of the most technology and technology minded analysts that is covering us.

So you've been covering us for a while. We already started to talk before we went public and always appreciate it and so appreciate your input and your perspective because you're not just looking at the numbers, you're looking at the products and the features and the technology behind the services we offer.

So yeah. And to that point, yeah, you're right. I am a nerd at my core.

My weekends are spent oftentimes pulling Cat5 cable around the house or Cat6 cable around the house, playing with our network infrastructure.

So I am an engineer at heart.

And so I bring those insights to things like investing in Cloudflare.

Good. So a lot of money, interesting companies that you cover, and now comes this ESG perspective and lens that has to be put on top of everything you do.

Help us get our arms around this. How do you look at that? You mentioned in one of the discussions we had earlier, you're also, you have customers, you need to sell your ideas and your portfolios, and those customers are all over the world.

They have a perspective on what they want to see. So how does this all come together?

Great question. So the fund I manage is sold in Europe and in Asia, and increasingly, particularly in Europe, there's real interest in our clients knowing that we are investing in high quality companies that are taking into account the costs they're imposing on the environment, the costs they're imposing on society, and they want to make certain that the businesses that we own are well governed.

Now, when we look for ideas to put into the portfolio, we look at them through three big lenses.

One, does the company have a big growth opportunity will allow the company to compound and grow and grow and grow for many years?

Is it a high quality business?

Is the management team good? Does the company have some sustainable unfair competitive advantage that they can continue to exploit?

And are the financials of the business good?

Are the unit economics of the business good? But over the past few years, we've also added in the ESG framework to help us deepen our understanding of the quality of the business.

And then finally, we look at valuation, are we paying a good price for the security and will it generate a good return for us?

So let's take this apart. You mentioned E, you mentioned S, you mentioned G.

When you look at environment, when you look at social, when you look at governance, what are the things that you're looking for in terms of metrics?

And how do you get a framework into place that allows you to see if companies perform or not perform or live up to your expectations?

Yeah, so first off, we're always doing these analyses of ESG in the context of improving shareholder risk -adjusted returns.

We want to make certain that we are delivering good outcomes for our clients with a reasonable amount of risk.

So when we're looking at a company's impact on the environment, impact on society, and whether they're well governed or not, really we're trying to answer the question, is a company's environmental practices, will they expose the company, for instance, to a regulator coming in and surprisingly changing the cost structure of the business?

Or perhaps will customers not want to do business with a firm like Cloudflare because they aren't taking into account the costs they're imposing on the environment?

We're always looking at through the lens of improving risk -adjusted returns for the shareholder.

Now across these three pillars, we've had to come up with sort of a framework.

What matters across ESG that we're going to consider when we're evaluating a company?

So in the case of environmental, we're looking at, is a company looking at their carbon footprint?

And are they making investments to minimize that to understand and minimize that carbon footprint?

Are they considering their usage of water? And if you were a hardware company, we'd also want to know, are you managing your e -waste appropriately?

We weight that in our score for ESG at about 15 or so percent.

On the social side of things, we're looking at whether a company is a good steward of their customers' data.

Are they securing that data? And are they using that data and the insights they're getting from that data in manners that are transparent and that their customers have signed up for?

We're also looking into whether a company has good relations with their employees.

One of the biggest costs for a firm like Cloudflare is recruiting and retaining top talent to build your products and sell your products.

And it's very expensive to replace engineers with deep insights into how the products need to operate.

I jump in here because this is something that I think is really important.

It's important for us in how we differentiate ourselves moving forward, how we stay competitive.

We always believed in a diverse workforce.

But if you look at current reporting standards, even at SASB, that part of employee retention, employee development is not even a big part of the official ESG frameworks today.

So you are looking deeper than what third parties or standard setting organizations are doing from that perspective.

Yeah, no, that's exactly right. And we get those insights by not only engaging directly with management, engaging with members of the board, looking at Glassdoor surveys, talking with former employees of the company, all of that comes together to help us develop our sense of whether a company has good relations with their employees.

Governance, I stopped you before you move to the third point.

Sure. And on governance, ultimately, we want to make certain that a business is well governed.

And we define a well, at least in the Franklin Equity Group and a part of the group that I work in in technology, we define a well governed business across a variety of parameters.

One, does the company look like its customer base?

Yeah. Right. You know, Cloudflare is a global company, we want to make certain that they have insights into all of the end markets that they want to sell their products and services to.

So I want to make sure and increase, you know, I want to make certain that the people who are going to make those decisions on buying Cloudflare's products look like, Cloudflare looks like their customers.

So, you know, we're looking in diversity and inclusion on whether there is good representation at the board level, in the executive ranks, and in the employee ranks.

And so literally, I will go on, you know, in your case, Cloudflare's website and look at, you know, who makes up your executive team, who's on the board, I will go into Glassdoor and look at metrics around diversity and inclusion.

You know, so I'm trying to get at that a number of different ways.

We're also seeking to understand whether the board is independent of management.

You know, we also pay very close attention to whether companies, you know, have dual class share structures, and whether the boards are staggered.

But ultimately, all of that is aimed to understand whether the business is well governed and whether investors have a seat at the table and are able to influence the direction of a company.

When you look at your factors, are you differentiating companies in what verticals they are, whether this is tech or industrial or healthcare?

How important is that for your evaluation? So it's very critical that we have materiality matrices that help us evaluate industries and companies on relevant terms.

So you would look at, you know, maybe a technology company that has lots and lots of customers data on the social front, you might weight the social element much higher than you might weight the social element in an oil and gas company.

In an oil and gas company, you might consider environmental considerations at a much greater level.

So yes, it depends on the industry and the business model of the company we're looking at.

If you can say that, if you look at our space, you know, and you look at who's really good at this from a disclosure perspective, what names would come to mind?

Yeah, so this is a great question.

And we've noticed in our analysis, there's a bias towards big. The bigger the company is, the more they can invest in understanding even what their environmental, social, and even governance practices are.

So Microsoft does a very good job of disclosing key things for us.

Apple does a very good job. Oracle does a very good job of disclosing this stuff.

But then we've noticed sort of smaller and mid-cap companies who are still scaling their businesses, struggle to report the level of metrics that we might want.

So the onus is then more on us to go do our own digging and get our own insights.

But regardless of the company size, we are always advocating for the companies to make this a priority, because ultimately we want to make certain that they're managing the potential risks in the business.

Well said. I think at Glockfair, we always punch above our weight. This was part of our DNA.

And Impact Week is a way for us to get us. There's so much happening in the company that we have not talked about in a cohesive manner.

So this is our path now, take a big step forward in that direction.

So you talked about your customers, just out of curiosity, selling into your products, into Asia, into Europe.

Is there a difference in terms of what clients want to see? Is Europe more looking for environment and Asia is looking more for social or is there no differentiations across your customer portfolio?

I think that the Europeans are much more organized on this topic broadly.

I haven't really done an analysis on which of the three pillars are most important in market versus Asia.

But if I had to sort of rank Europe, Asia, and even the US where I do have some engagement, not so much directly on the fund, certainly as an analyst, I engage with funds that have that.

I think that Europe seems most tuned into this, followed by Asia, followed by the US.

The US is catching up in terms of this being a priority, but they're still pretty far behind Europe.

If I look at the work that we have done over the last couple of weeks, looking into the standard setting authorities, the third parties that are out there, talking to various stakeholders in terms of what they require, it has become a really complex field.

Where do you get your data from?

Where does it get audited? Who should you listen to? And it's hard to just follow a pure KPI quantitative path in terms of disclosure.

And it feels like there is also a story still that needs to be told.

How important is that from your perspective, this quantitative analytics and disclosure review and doing your own due diligence, and then the story part that still goes with it?

How do you weigh those? And especially in these early phases where everybody tries to just get oriented.

Yeah, I think you've described it well. It's a very complex landscape with differing disclosures across companies and industries.

I think in the fullness of time, we're going to have something like GAP accounting or IFRS accounting, where companies will have things to report.

They will be comparable across one another, and that will facilitate investors like us making better decisions.

So in the absence of that right now, we rely on company disclosures.

We rely on third party assessments. We rely a lot on our own work, and we're trying to put it together.

We have been doing some interesting experiments around using artificial intelligence and machine learning, for instance, to go through this massive corpus of data.

And I mean, not just quantifiable disclosures, but also the narratives that companies are putting out, describing what they're doing.

In all of that, there is signal. Even in looking across the profiles of employees, you can get insights into whether companies are investing in this category or not.

So right now, we are still not at a point where there is consistency and standardization, if you will.

But I think in the next 10 years, we'll get there.

In the interim, we're having to do a lot of our own work on this one.

So you mentioned you have a framework, you have probably a grading system that you apply against the portfolio of your companies.

So how do you deal with the companies that you would want to invest that might not be there from a rating or from your grading perspective?

Is there engagement then trying to help them along the way?

Or does it come down to a hard capital allocation decision?

Well, listen, we are active investors. And so we are active in all things we do, and we're certainly active on managing risk.

And so we put this in that context, and we reach out to the companies, and we have a discussion about things we would like to be improved upon.

I've disclosed to Cloudflare my own rating for the company, how I came up with that rating, areas where I think there's opportunities for improvement.

So there's engagement.

And the best companies then take that input, and they take input from other investors, and they adjust.

And if we don't see those adjustments, and we don't think the risk is appropriately being dealt with, then we either hold less of a company or we don't hold the company.

And one of the, in fact, in Europe, we have to have binding ESG consideration.

So if a company scores in our rating system B or lower, we simply can't hold it.

So there are real implications for the cost of capital for firms like Cloudflare if they aren't being responsive to investors' interests.

I have a couple of questions that follow up. First of all, I mean, do you do most of the work yourself as the portfolio manager, or is there an infrastructure that supports you?

Because you're absolutely right. The amount of data that gets disclosed is just enormous, and finding your way through it is hard.

So how much is you, how much is happening in the background?

And then I think what we should also cover, you brought up something very interesting, which makes you also very unique, is the engagement you have with your portfolio companies.

That might be interesting to whoever is listening to this live or later in the recording, how that started with us and how you bring companies, so to speak, along on the way from private to public companies.

So we do engage actively. The work is done by our analyst team.

The Franklin Equity Group has made very significant investments in our research.

It's core to our ability to differentiate ourselves.

And so in this case, in the case of you guys, for instance, I did the analysis myself, but I used data that the company disclosed, data that I was able to gather from third parties about the company.

But ultimately, I'm doing the analysis.

Our journey with Cloudflare started in 2015, 2016, because I was the analyst responsible for, at that time, the network firewall space.

I covered names like F5.

I still covered names like Cisco. And I had a thesis that we were in the early days of those vendors, those services, those solutions being moved into and as a service model.

And I was curious to know the companies that might lead that transition.

And I thought Cloudflare might be one of those. And sure enough, I think that that's exactly how it's playing out.

Matthew reached out to us. Your CEO reached out to us in late part of 2018 and said, we're doing one final round before we go public.

Would you be interested in participating? I jumped at the opportunity because I thought there was such a big opportunity for the company.

At the time, I think we put in $20 million.

And then the company, that next year, I spent a lot of time engaging with yourself, Matthew, your head of IR, Michelle, and really learned the company in an even deeper way.

It only increased my conviction. And then when the IPO came, we bought more stock and we bought more stock subsequent to that.

And of course, it's been a very good investment for us. And of course, I think there's still a long runway for growth ahead.

And that's why we continue to hold it in the portfolio.

But that engagement really helped us, prior to you becoming public, build that confidence that would have allowed us to remain good shareholders after you went public.

Yeah. Michelle always says we're just getting started.

So that's literally true. I think you brought up an important point. It takes a lot of work to go through all the disclosures.

So for us, that was one of the key lessons I learned, no matter what standard we follow, and no matter what third parties we use for our data, how we disclose it, and that we make it easily digestible by people like you is as important as what we disclose.

And we learn, we launch products, and then we reiterate fast and hopefully learn fast.

And you need to wear it on your sleeve.

Disclosing the stuff is one thing, but it needs to come out in every engagement that you're having with your customers, with your employees, and with your investors.

It needs to be obvious that this is who the business is.

And in my engagements with Michelle and with Matthew and yourself, that is what I've gotten confidence in is that in fact, these things that you're talking about this week, but ultimately your values are core to who you are, which has made it easier and easier for us to be good shareholders.

Yeah, so we're a mission-driven company.

And it's, you know, the European and their standards call it whitewashing.

We don't need to do whitewashing in order to get to good disclosure, we hope, because what we do is so core in our DNA.

So hopefully, we are on a good path.

And hopefully, we not only keep our good ratings with you, but improve upon them.

And, you know, as we said before, we are deeply thankful that you are an investor, not only investor, but also a true partner over the years.

So we are almost coming to the end of our time here.

I want to thank you for making time for this.

You're a busy individual, and help us understand what sustainability and sustainable investment means from a Franklin Templeton perspective.

But any parting thoughts on our journey here that you would like to leave with us?

Yeah, well, I'm excited to see what you have to reveal this week.

I've already looked at a couple of the announcements, very exciting.

So I just I think that you guys have a enormous future ahead of you.

And so we're excited to see what comes but but make certain that you're always thinking in terms of delivering better risk adjusted returns for your investors.

And that will ultimately create great I think outcomes for your other stakeholders, your communities, your employees, and your customers.

Thank you, Jonathan. We're in quiet period, but we'll see you on the other side of the period.

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