Explore the Thinking behind our investment approach

New York University School of Law recently conducted an expert survey on the economics of climate change. Out of 738 PhD-level economists responding, 74% agreed that “immediate and drastic action is necessary.” Respondents estimated that “economic damages from climate change will reach $1.7 trillion per year by 2025, and roughly $30 trillion per year (5% of projected GDP) by 2075 if the current warming trend continues.”1 Mitigating and adapting to climate change requires multiple interventions across multiple sectors, which is why the $2 trillion infrastructure plan announced last week by President Biden is an interesting read. The White House release states that “domestic investment as a share of the economy has fallen by more than 40 percent since the 1960s” leaving the U.S. 13th in the world when it comes to the “overall quality of our infrastructure.”2 Even with rapid decarbonization, near-term physical climate risk will further challenge crumbling infrastructure. The White House notes that, in 2020, “the United States faced 22 extreme weather and climate-related disaster events with losses exceeding $1 billion each – a cumulative price tag of nearly $100 billion.”2 In addition to fixing and improving transportation systems, among many other measures, the plan seeks investment to increase the resilience of low-income communities likely to be impacted by physical climate risks, improve access to high-speed broadband, and upgrade and retrofit buildings, including schools, for energy efficiency and air quality, alongside various measures that seek to address “long-standing and persistent racial injustice.”2 The plan also calls for funding to “establish the United States as a leader in climate science, innovation, and R&D,” listing key priorities as “utility-scale energy storage, carbon capture and storage, hydrogen, advanced nuclear, rare earth element separations, floating offshore wind, biofuel/bioproducts, quantum computing, and electric vehicles, as well as strengthening U.S. technological leadership in these areas in global markets.” Funding for innovation is critical if we are to achieve the “immediate and drastic action” expert economists recommend.2

The replay can now be seen on demand by clicking here The ESG and sustainable investing landscape has greatly evolved over the last decade. From the evolution and increased adoption of standards and protocols, to the propagation of new data sets, there are now more ways than ever to create an ESG portfolio. This growth is unlikely to slow down, and so knowing how to diligence the ESG universe is a big task in and of itself. Kicking off on March 3rd, 2021, we’ll be co-hosting the ESG Practice Playbook education series with MSCI, RIA Channel, and Paul Ellis Consulting. Created to educate advisors on how to integrate ESG into their practices, the ESG Practice Playbook will hold weekly, 90-minute online educational sessions for financial professionals. Each session will provide 1.5 CFP / IWI / CFA CE credits. Replays of all sessions will also be available on demand. Sessions Include: Identifying ESG Products and Performance Integrating ESG into your Client Service Model Integrating ESG into your Marketing Model Building your Brand with Media and Marketing Tools

In last week’s ESG Practice Playbook, Jeff talked about the cascade of recent physical climate events and the legal and regulatory trends that are increasingly putting climate change considerations at the center of business and investment decisions. With climate data growing in volume, availability, and sophistication, pricing climate risk is becoming easier. The stakes are getting higher across asset classes and sectors, as well as at the level of national governments. For example, earlier this year, a French court determined that the French state is not meeting its commitments in relation to reducing greenhouse gas (GHG) emissions, and can be held responsible. “Activists also hope the ruling will set a legal precedent for victims of climate change.”1 In the U.S., the SEC, which is stepping up overall activity in relation to ESG, is reviewing its “disclosure rules with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change.”2 The agency laid out a number of questions for stakeholder consideration and encouraged the public to respond. This effort is in addition to the launching of a taskforce that will “initially focus on identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.”3 If you would like to learn more about climate investing, please don’t hesitate to reach out to us. Last week Tariq Fancy, former CIO of Sustainable Investing at BlackRock, catalyzed conversation when he published an op-ed accusing the industry of “duping the American public with its pro-environment, sustainable investing practices.”4 Certainly, greenwashing is a problem, and Wall Street is not going to rid the world of all its social and environmental challenges! Criticism is important in keeping the industry honest, but so is recognition and encouragement where it’s due. One of the reasons we favor active over passive managers, especially with respect to climate investing, is because ESG topics are dynamic, complex, and often interactive. A future that will not resemble a past that lives inside financial models necessitates the deep research and analysis associated with active management. Moreover, when in-depth analysis is supported by direct engagement with companies, it can lead to real change, as evidenced by our partners at Green Century, Federated Hermes, and Promethos, among others. We hope that the recent moves by the Biden administration and the SEC to create more structure and clarity with respect to climate change and ESG will lead to greater trust and transparency in sustainable investing.

“When you need water, water is the only thing that will do.” ~Matt Diserio, President, Water Asset Management Climate change is increasingly disrupting the hydrological cycle, manifesting in increased flooding and droughts. Alongside this, multiple other human activities are leading to water shortages, the spreading of disease, and pollution. While we all know that water is critical to life, we don’t always act in a way that aligns with its value. The poor and those living in rural areas are generally most affected, but urban residents are also at risk. A UN progress report recently noted that “even before COVID-19 struck, the world was off track to meet Sustainable Development Goal 6 (SDG 6) – the goal of ensuring water and sanitation for all by 2030.”1 Water is a key investment theme for Gitterman Asset Management: our SMART Climate UMA includes an allocation to Water Asset Management’s Global Water Equities strategy and our mutual fund models include the Virtus AllianzGI Water Fund. As global financial markets embrace ESG and climate change risks and opportunities, water’s role in company value chains is becoming more transparent. This is leading to a greater focus on water conservation and treatment, and an awareness of the need for infrastructure improvements. Innovations in the water space include “smart meters” to manage water use, advanced treatment technologies, and redesigning consumer packaging to reduce water requirements in manufacturing processes. From an investor perspective, water is an opportunity for positive impact, both directly with regard to water systems, and also in relation to improvements in energy efficiency related to water services. Water has also “historically acted as an effective hedge against inflation” and demonstrates “relatively low levels of risk and volatility.”2 For more information, check out this interview with Matt Diserio on TheIMPACT TV and then connect with us for a deeper dive on how our SMART Climate UMA incorporates the water theme.

Sustainable investing industry jargon can be challenging. Certain terms may seem straightforward but are more complex if you look deeper. Over the past three weeks, our ESG Practice Playbook has been covering some fundamentals, which we would like to briefly revisit here. The concept of financial materiality in the U.S. is connected to a 1976 Supreme Court case. Publicly listed companies must disclose material information when there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”1 In the ESG world, financial materiality topics differ from industry to industry. For example, what’s most relevant to a company like Amazon is not necessarily what’s most relevant to Tesla, Nike, or Exxon. Enter the Sustainability Accounting Standards Board. SASB provides guidance on ESG disclosures not covered in traditional accounting, and also a framework for determining which data points are material across industries. The U.S. Supreme Court definition remains the foundation for SASB standards, but as SASB expanded internationally, their definition of materiality was updated: “Information is financially material if omitting, misstating, or obscuring it could reasonably be expected to influence investment or lending decisions that users make on the basis of their assessments of short, medium, and long term financial performance and enterprise value.”2 Asset Managers may leverage SASB standards as a base, and add their own research to arrive at a proprietary financial materiality matrix. Other notions of materiality can also go beyond the investor perspective. The Global Reporting Initiative (GRI), for example, takes a broader stakeholder approach in its standards. In addition, there is a growing understanding that topics that are of material importance to stakeholders may become financially material to companies over time. This concept has become known as “dynamic materiality.” ESG ratings agencies which use materiality to define and weight the importance of ESG topics in arriving at scores and ratings are continually evolving. As MSCI states in its ESG Industry Materiality Map, “We recalibrate the model, including identifying industry Key Issues and setting weights, every year based on the latest data and research as well as input from our regular client consultations. As a result, you should expect to see changes in this ESG Industry Materiality Map over time.”3 Research has shown that “firms with good performance on material issues and concurrently poor performance on immaterial issues perform the best.”4 For a deeper dive on material sustainability topics and corporate performance, check out this milestone paper, Corporate Sustainability: First Evidence on Materiality, by Khan, Serafeim, and Yoon.

While the EU and other jurisdictions have been pressing ahead with ESG policy and regulations aimed at creating market clarity, the SEC has been way behind. However, recent developments demonstrate that a U.S. catch up is underway. On March 4th, the SEC issued a press release announcing its “Climate and ESG Task Force,” which will “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules…[and] analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”[1] Additionally, in its 2021 priorities for examinations, the SEC stated it will include physical climate risks in its assessment of business continuity plans. “As climate-related events become more frequent and more intense, we will review whether systemically important registrants are considering effective practices to help improve responses to large-scale events.”[2] As US SIF CEO Lisa Woll notes in Barron’s, “It is extraordinary that it took until 2021 to have a position focused on these matters, but it is a clear signal that the SEC understands the critical role that the climate crisis and a range of ESG issues play in the investment process.”[3] Last week we kicked off our ESG Practice Playbook, in partnership with RIA Channel, and held our second session yesterday. Don’t worry if you missed them – you can still register and access the playbacks. Several of the questions we received from the event related to definitions, how to know if an investment product is truly ESG, and how to compare different ESG strategies. These are foundational challenges for anyone embarking upon their ESG journey, which is increasingly challenging given the product expansion in recent years! There are a multitude of ways a fund can include ESG in the investment process. It’s therefore critical to go beyond the fund name and marketing headlines and dig into the detail to understand the philosophy, use of data, alignment with shareholder engagement, and proxy voting policies, among other factors. We’re encouraged to see the SEC taking a stronger educational role alongside integrating ESG into its enforcement procedures. Check out this SEC Investor Bulletin that defines an ESG fund and provides several considerations for performing ESG due diligence.