Explore the Thinking behind our investment approach

More and more countries and individual businesses are making Net Zero commitments, moving beyond carbon neutrality to removing human-induced CO² emissions from the atmosphere. Carbon neutrality and net zero emissions are often used interchangeably, but there is one key difference. Carbon neutrality can be achieved by balancing greenhouse gas (GHG) emissions with offsets via buying carbon credits. This means carbon neutrality can be achieved without reducing emissions. Essentially, net zero carbon challenges “business as usual,” while carbon neutrality allows emissions to remain the same. These commitments necessitate understanding terminology, emissions baselines, setting targets, and managing progress. The classification system for greenhouse gas (GHG) accounting, created by the Greenhouse Gas Protocol, measure carbon footprint using three categories of emissions: SCOPE 1 – Direct GHG emissions attributable to operations owned and/or controlled by a company, including vehicle fleets and facilities. SCOPE 2 – Indirect GHG emissions from purchased or acquired electricity, heating, and cooling. SCOPE 3 – Indirect GHG emissions not covered above, such as supply chain emissions, business travel via non-owned vehicles, and emissions associated with the “use phase” of products. Reporting and disclosure related to Scopes 1 and 2 is more mature. However, the deepening scrutiny associated with net zero targets means that “Scope 3 investment risks are mounting. These risks may come from new regulation of a company’s high-emission products and shift in end-product market demand driven by climate concerns.”¹ Investors have traditionally focused on Scope 1 and 2 emissions, but as the state of Scope 3 reporting improves, investors like Gitterman are looking to manage Scope 3 risks. Scope 3 is the biggest area for innovation in carbon reduction, especially because for some companies and industries, Scope 3 emissions dominate their overall carbon footprint. Seeking Low-Carbon Solutions? Our SMART Fossil Fuel Free Models were launched in 2016. They are a family of global climate aware investment allocation strategies that screen for fossil fuel and utilize carbon foot-printing tools to guide investment decisions. On the equity side of the portfolio, we use Morningstar’s Global Equity Classification Structure to identify key industries partaking in direct fossil fuel investment. The SMART Fossil Fuel Free models divest from these industries, with the exception of specific diversified water utilities. This is due to our belief that water investments have a strong sustainability thesis, specifically as it relates to UN Sustainable Development Goal #6: Clean Water and Sanitation. On the fixed income side, we carry out divestment from fossil fuel on a best effort basis, depending primarily on direct dialogues with fund managers and a quarterly analysis of bonds with fossil fuel involvement. We go beyond simple divestment of energy sector companies to understand the carbon footprint of the portfolio using Scopes 1, 2, and 3.

The U.S. is now officially back in the Paris Agreement. Messages coming from the government on climate change are strongly worded, but it’s still early days in terms of tangible actions. As The New York Times noted, “There are two immediate signals to watch for. First, how ambitious will the Biden administration be in its emissions reductions targets?” and, “…how much money will the United States provide to help poor countries adapt to the calamities of global warming and shift their economies away from fossil fuels?”1 On April 22nd, Earth Day, President Biden will hold a “Climate Summit,” which should give some insights into these questions. In the meantime, domestic climate adviser, Gina McCarthy “has pledged “the most aggressive” carbon cut the U.S. can make.”2 The White House is also working to determine the “social cost of carbon,” or SCC, which “would be considered in every rule, regulation and policy enacted as part of President Joe Biden’s “whole-of-government” approach to tackling climate change.”3 Carbon costs in other countries are running between $20-$100 per ton. Following the same method as the Obama administration could result in a cost of $125 per ton, the same value New York State recently announced as its carbon value.

We are featured in Refinitiv’s latest publication of ESG trends. In it, Jeff reiterates his view that we are facing a significant repricing driven by climate change that will impact multiple asset classes. As always, we encourage advisors and investors to assess their portfolios for climate impact. Featured insights and takeaways from other contributors include: Circular economy practices are expected to gain more traction in 2021, which “represents a systemic shift in our current conceptualization of wealth generation and well-being.” Corporate incentives will increasingly be linked to ESG metrics, or at least shareholder resolutions will increasingly make that ask. Addressing racial inequality requires multiple solutions e.g., removing lending biases, improving board diversity, investing in managers of color, and venture capital funding. Social indicators, in general, will gain more focus as “the pandemic continues to reveal the weak points of our societies.” The full report is available here, but a shorter overview can be found here. Finally, as Jeff states in the piece, “[we] have a tough road ahead, but we believe there are amazing feats along the way. Human potential is always in abundance.”

While interest in sustainability and ESG is on the rise within the financial services and broader investor community, corporate boards are lagging. In a Harvard Business Review article, Tensie Whelan, Clinical Professor for Business and Society at NYU Stern School of Business, shared the findings of research showing “that many boards have little ESG-related expertise and many do not even recognize the need to pay attention to material sustainability issues.”1 In fact, fewer than one-third of 1,188 board directors studied had ESG expertise and very few have experience in the most material issues for their sector.1 Current boards “have a preponderance of former CEOs on their boards. Those CEOs were in charge 10-20 years ago when ESG issues were not specifically identified as financially material and may burden boardrooms with an out-of-touch mentality.”1 However, in research conducted by PWC, female board members were found to be “more likely to say that material ESG issues like climate change and human rights should be part of business strategy.”1 On a positive note, board training on ESG topics is now available. Helle Bank Jørgensen, CEO and Founder at Competent Boards, has created the ESG Competent Boards Certificate Program and says, “I would look at the proxy statement and in the governance section on websites. In the coming months, you should be able to spot board of directors who have achieved the ESG Competent Boards Certificate and Designation (GCB.D).”2 Jeff also recently interviewed Caroline Abramo, Chief Investment Officer at Pana LCE (Low Carbon Economy) Investments, on TheIMPACT TV show. Caroline talks about the “Green premium” emerging with respect to company valuation, how fossil fuel companies are investing in technologies to help lower carbon, including sequestration, and the potential opportunities and jobs that could manifest from enacting sustainable infrastructure legislation.

As one year closes and another starts, financial services firms memorialize their economic and market expectations for the upcoming year. Over the last few weeks, we’ve reviewed several papers and news items, and talked to experts in order to summarize some key ESG themes for 2021. 2020 saw record flows into ESG mutual funds, and ETFs continue at a record pace. As 2021 unfolds, MSCI sees market maturation with “both hype and skepticism giving way to a more nuanced understanding of when and how ESG has shown pecuniary benefits — and when it hasn’t.”[1] They go on to say that “investors no longer need to “believe” in ESG, or not. A sharper understanding is emerging as to which ESG approaches are financially relevant and which are more focused on social objectives, allowing investors to more precisely build their own strategies based on a track record.”[1] All of this should further support overall growth in sustainable investing. MSCI also highlights the following trends: Climate: Several companies have made ambitious targets, but a broader failure to adequately decarbonize could leave investors “with a dwindling investment universe of companies that meet the 2°C or 1.5°C targets.”[1] This could mean increasingly concentrated portfolios over time. Biodiversity: With many plants and animals at risk of extinction, biodiversity is seeing greater focus from regulators and investors. As with climate change, the impacts both on companies and those effected by companies vary based on sector and region, with the food industry especially vulnerable from both angles. “ESG Data Deluge”: In unwelcome news for many companies, pressure to enhance ESG disclosure will only grow as new regulations are implemented and stakeholders become more educated. MSCI notes TCFD becoming mandatory in certain countries, potentially including the U.S., in the not-too-distant future. Social Inequalities: Income inequality and racial justice concerns became more prominent in 2020, along with “S” topics in general. Noting that, “action is important, but there are limits to what individual firms can do to address the underlying root causes,” in 2021, MSCI sees “investors venture into new approaches, including financing vehicles like social bonds, to address a challenge that extends beyond the neat boundaries of individual companies.”[1] With respect to climate change, which is core to our investment philosophy, we’re already seeing new data initiatives from firms such as BlackRock as well as from companies driving innovations to support their net zero targets. And, as expected, the Biden administration has already moved to rejoin the Paris Agreement as well as moving to cancel the Keystone XL pipeline, among other measures. Climate-related subthemes such as water and sustainable infrastructure will be in focus, alongside continued pushes towards electrification in energy and transportation. These are themes and topics that are covered by the managers with whom we partner for our SMART Climate Unified Managed Account (UMA). In addition, given the political climate in the U.S., two particular ESG topics are already front-and-center for 2021: Political Spending: Company reactions to the insurrection and riots at the Capitol were swift. Numerous companies halted political donations to Republicans who supported overturning the election results, and some companies stopped all donations while they undertake reviews. The long-term impact may be “more symbolic than consequential”[2] given that corporate political giving is relatively small compared to other channels. However, this may catalyze a broader conversation about money in politics. Social Media Responsibility: Already under criticism for their roles in fomenting political polarization, several social media companies moved to de-platform President Trump this month. In their recent brief, Democracy Disrupted & ESG Risk, Truvalue Labs restated their earlier observation that “it is hard to imagine a business with more significant tail risks than social media.”[3]

Jeff recently chatted with Julie Cooling, CEO of RIA Channel, about our SMART Climate UMA and why there is more alpha potential available in a UMA (Unified Managed Account) comprised of SMAs (Separately Managed Accounts), as opposed to mutual fund models, including tax alpha from the overlay capabilities.