Explore the Thinking behind our investment approach

At the Earth Day summit, President Biden announced that, by 2030, the U.S. will cut greenhouse gas emissions by at least 50% from 2005 levels and will double climate-related financial aid to developing countries by 2024. Both proclamations bring the U.S. back onto the road towards meeting the ambitions of the Paris Agreement. However, lofty goals bring challenges and trade-offs, one being profound changes to the mix of energy sources in the U.S., and another being how we use land. Taking data from Princeton University’s Net-Zero America Project, a Bloomberg article stated that, “no matter how you slice it, the U.S. will need to rethink land use for an emissions-free future.”1 The current energy footprint of the U.S. is “about the size of Iowa and Missouri combined, covering roughly 4% of the contiguous U.S. states”.1 A low-carbon transition would require significantly more land to house solar and wind, even when considering offshore wind farms and rooftop solar. Additional land-use challenges will come from building the transmission infrastructure needed to connect renewable energy with end-users. The Net-Zero America Project has created pathways to illustrate what the transition to a carbon-free U.S. could look like from now to 2050. The pathway that uses the least amount of land increases dependence on nuclear energy and natural gas plants that use carbon capture technology. Neither of these options come without controversy. The same Bloomberg article notes that, “expanding nuclear power will present serious land-use challenges. While no one wants a power plant in their backyard, many people don’t want nuclear power on their planet.”1 Wind power, the pathway with the greatest additional land-use, would quadruple the current energy footprint, with the potential for wind farms to cover an additional 250 million acres. Land-use challenges aside, some stakeholders question whether the U.S. goals are realizable without a carbon price in place to provide a key market incentive. Last September, the Commodity Futures Trading Commission (CFTC) became the first U.S. regulator to call for a carbon price, describing it as the “single most important step to manage climate risk and drive the appropriate allocation of capital.2 More recently, the American Petroleum Institute professed its support for such a mechanism in its newly published Climate Action Framework. John Kerry, Special Presidential Envoy for Climate, stated in a briefing in India that, “President Biden believes that at some point in time we need to find out a way to have a price on carbon that’s effective. He hasn’t decided or made an announcement about it, but we all know that one of the most effective ways to reduce emissions is putting a price on carbon.”3 In the meantime, other jurisdictions are ramping up their carbon trading activities. The EU will expand its Emissions Trading Scheme and China will establish a national one for the first time. Global commodities traders and financial institutions are predicting carbon prices could rise to $100 per ton in the nearer term, a price that would be highly disruptive to multiple sectors and regions. As you would expect, new carbon-related investment instruments and strategies are coming to market as we are now “entering a period of expected future scarcity.”4 NET ZERO ASSET MANAGERS Climate commitments are proliferating across the financial services industry. The Net Zero Asset Managers Initiative, launched last December, has already attracted 87 signatories representing $37 trillion in assets under management. Managers signing up commit to “help deliver the goals of the Paris Agreement and ensure a just transition.”5 We are proud to work with several of the managers listed: Allianz Global Investors, Boston Common, Calvert, DWS, Sage, Vert Asset Management, and Wellington Management. Check out the full list and the commitments here.

Our March RIA Channel ESG Practice Playbook catalyzed several audience questions related to ESG engagement and divestment. Below are a couple of (slightly edited) questions we received: How can investors influence companies to be even better in ESG performance? How can advisors get more information on the proactive efforts of ESG funds that try to drive positive change? Great questions! One major way of influencing company behavior is via engagement, which encompasses everything from direct dialogue with a company to the filing of shareholder proposals to voting proxies. In our SMART Investing Solutions, we favor asset managers that incorporate strong engagement practices into their overall approach. For example, Green Century Funds, a manager in our mutual fund models, puts engagement central to its strategy. It states that the companies themselves “may also gain from strong relationships with their stakeholders.”1 The firm has deep experience in efforts to reduce deforestation, especially with respect to palm oil, which has led to tangible shifts in corporate behavior. In session one of our ESG Practice Playbook (video playback still available!), Martin Jarzebowski, CFA of Federated Hermes, a manager in our Climate UMA, said his definition of engagement is “a collaborative dialogue with the board of directors and with the senior leadership…to really better understand their ESG risks and opportunities, but also very importantly to be able to have a seat at the table to advocate for positive change.” Engagement enables an investment team to see the progress on the ground and potential “ESG momentum.” Engagement is a powerful tool, but there may be good reasons to consider divestment, especially when the issues go way beyond a single holding, or if an entire sector is in question for ethical reasons. In the 1980s, divestment was a contributor to the end of apartheid and, more recently, divestment movements are influencing change with respect to the use of the fossil fuels and the private prison sector. The choice to divest, engage, or both may depend on various considerations including firm values, investment thesis, and theory of change, along with the circumstances of a specific situation. Circling back to engagement, when dialogue fails, an issuer may be subject to a shareholder resolution and votes that go against the preferences of company management. According to US SIF, The Forum for Sustainable and Responsible Investment, “such resolutions are a meaningful way for shareholders to encourage corporate responsibility and discourage company practices that are unsustainable or unethical. A shareholder resolution need not win a majority of the shares voted to succeed in persuading management to adopt some or all of the requested changes.”2 Sometimes, simply filing a resolution brings a company back to the table for discussion and the filer may withdraw the resolution in response. We are now in the 2021 proxy season, which according to Barron’s, “looks unusually active.”3 The resolutions currently on the table show that several large companies are getting requests to conduct racial-equity audits, with others facing political spending and “Say on Climate” proposals. State Street Global Advisors will vote against “nominating and governance committee chairs at S&P 500 companies that don’t disclose the racial and ethnic makeup of their boards this year.”4 And, unsurprisingly, given the increasing focus on climate change, there are a number of resolutions in play asking for climate disclosures and ambitious emissions reductions. For those of you looking to follow how the season unfolds and more generally understand how managers engage and vote, there are several places to check: Managers with strong ESG integration and engagement practices often publish information on their websites regarding proxy voting policies, votes, engagement outcomes, and resolutions filed. For example, Federated Hermes, Calvert Investments, and AllianceBernstein. The Principles for Responsible Investment (PRI) has a shareholder resolution database where you can see which companies have received filings from which managers. Proxy voting service providers such as Glass Lewis collate the trends of the past season and the previews for the current season.

This Earth Day we’re encouraged by the proliferating commitments from financial services firms, regulators, policy makers, and corporations, in support of protecting and valuing the climate and natural ecosystems. Although there is much to be done, including greenwashing to discern, an increasingly bright spotlight is shining on climate, which illuminates interrelated environmental and social issues. One of those issues is the management and protection of natural capital resources, which is the focus of this email and a key theme in our upcoming RIA Channel ESG Playbook iSummit on May 12th from 12:00 – 2:00 PM US ET CORPORATE NATURAL CAPITAL MANAGEMENT In March, BlackRock released Our Approach to Engagement on Natural Capital, noting the connectivity between natural capital and climate, with a particular focus on biodiversity, deforestation, and freshwater and oceans. The report stated that “heightened awareness of the economic and social impacts of unsustainable natural capital depletion could accelerate policy actions that either introduce or increase taxes on the externalities from which companies currently benefit. This has the potential to significantly impact the economic viability of some business models.”1 BlackRock underlines the need to appreciate critical social aspects. Beyond supporting food systems and livelihoods, biodiversity, for example, is “an integral part of religious, cultural, and national identities throughout society, and provide[s] sources of recreation, knowledge, and inspiration.”1 Companies should therefore see natural capital within this broader lens and focus on their impact on communities in addition to disclosing their reliance on natural capital. These topics are gaining more priority from a standards and frameworks perspective. The Taskforce on Nature-Related Financial Disclosures (TNFD), which emerged from discussions at the January 2019 World Economic Forum (WEF), aims to leverage the structure of the Taskforce on Climate-related Financial Disclosure (TCFD) and emulate its rapid path to industry acceptance. TNFD expects to deliver a reporting framework in 2023 which will guide “corporates and financial institutions to assess, manage, and report on their dependencies and impacts on nature, aiding in the appraisal of nature-related risk and the redirection of global financial flows away from nature-negative outcomes and towards nature-positive outcomes.” As with TCFD, “[i]t is expected that complying with the recommendations of the TNFD will initially be voluntary for financial institutions and corporates. Over time, mandatory disclosure requirements are expected.”2

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.