Explore the Thinking behind our investment approach

The story surrounding California Public Utility Pacific Gas and Electric (NYSE: PCG) is a case study of the nuanced implications of different sustainable investing strategies. PG&E filed for bankruptcy after estimating a $30 billion liability from two years of wildfires, becoming one of the largest utility bankruptcies in history, and one of the first to be tied directly to climate change. 1 Despite investigators having already determined PG&E’s equipment to be liable for at least 17 major wildfires in 2017, and disclosing climate related risks at length in the financial disclosures and annual reports, the traditional rating agencies, S&P, Moody’s, and Fitch all rated PCG as an investment grade company through the first half of 2018. 2,3 Why didn’t markets price in these risks? To some degree they did, by demanding higher premiums for greater risk in lending, and through tools like insurance and credit-default swaps; however, markets don’t always price every kind of risk correctly, and research suggests that this is often the case with issues related to climate change. A recent Bloomberg article by Nir Kaissar titled “PG&E Exposes the Pitfalls in Virtuous Investing” builds a case against ESG investing’s efficacy to mitigate risk when relying on overall scores from ESG databases. Kaissar cites that PG&E’s environmental, social, and governance scores from several major data providers, such as RobecoSAM and Sustainalytics, were above average in 2018.1 In reality, Sustainalytics rated PG&E 71 out of 100, designating it as an average performer, but if you looked deeper than their top line ESG score, the data told a different story. 4 Did ESG Funds Hold PG&E? The stringency of ESG criteria varies widely among fund managers. Some funds only buy stocks with overall ESG scores in the top 20% of their industry, while others will buy a stock as long as the overall ESG score is above the industry average. In the case of PG&E, Sustainalytics’ score of average overall performance may have been enough to trigger some passive ESG funds to buy the stock. Out of 2,008 ESG strategies globally, analysis from Morningstar Direct shows that only 75 funds held PG&E. Meaning that only 3.7% of ESG funds held PG&E. 4 While this is a low percentage, Kaissar’s article does propose an interesting question: if ESG investing is supposed to mitigate event-based risk, then why were any ESG funds invested in PG&E? The answer is materiality. Investors focus on different ESG data points as material at the sector and industry level. Staying with the example of Sustainalytics data, under their newer risk rating framework, PG&E scored dead last out of its entire universe of 2,952 companies when it comes to product governance, a category that encompasses quality and safety events. This led Sustainalytics to mark PG&E as “severely risky” as this was a data point that it had deemed very important to its business model. The current state of ESG data is far from perfect, but the data made it clear to investors that PG&E was not operating safely.4 What types of ESG funds held PG&E? This can be answered by investigating the diversity of ESG fund strategies, such as passive ESG ETFs, ESG-integrated funds, and/or thematic funds, commonly based on the United Nations Sustainable Development Goals (SDGs). Let’s start by defining passive ESG ETFs and index fund strategies, as these made up 52% of the ESG funds in the sample that were holding PG&E stock. Passive ESG funds embody the concept Kaissar described, they often buy stocks based on the overall ESG score that their chosen database provider assigns to each company. 4 Funds that looked through a more thematic lens for impact picked up PG&E for other reasons. In contrast to ESG ETFs, index funds, and ESG-integrated funds, thematic funds designate a target theme that takes precedence over ESG data. Therefore, a thematic fund can hold stock in a company that drives revenue through promoting a theme, such as one of the United Nations Sustainable Development Goals, even if the ESG score for that company is low. In terms of thematic funds, PG&E is an interesting company, because while its safety score is low, it plays a large role in facilitating California’s transition to a low carbon economy. California’s Renewable Portfolio Standard Law requires utilities such as PG&E to supply 60% of power from renewable sources by 2030. Given PG&E’s vast domain, serving roughly 6 million Northern California residents, it is one of the country’s most renewable utilities. Thus, a fund that is mandated to focus on United Nations Sustainable Development Goal #7, “Affordable and Clean Energy,” may hold stock in a utility company such as PG&E due to its role in the renewable energy sector, and regardless of its low ESG safety score. 2 “Additionally, PG&E’s recently-published 187-page 2018 Corporate Responsibility and Sustainability Report. Sustainability is explicitly called out in the company’s mission, vision, and values. Board committees are in place; ESG materiality assessment has been done, ESG is incorporated in the company’s financial incentive plan, and the organization has a dedicated Chief Sustainability Officer, along with an outside advisory group. They also have $34.5B worth of renewable energy contracts, which is more than the average utility.” 3 Conclusion In our view, thorough ESG-integration goes much deeper than selecting stocks based on their overall average ESG ratings. A more active strategy merges financial analysis with granular aspects of ESG data to identify specific areas of risk within a firm. Gitterman Wealth Management tends to stay away from passive ESG investing, instead opting for human analysis and active management through ESG-integrated investing. This is because many of the ETFs that have come to market do not have an institutional quality construction methodology for all the reasons discussed above. While the jury is still out on which ESG analysis type is best, the ESG-integrated investing approach we utilize certainly helps to build a case for its validity, as our investors were relieved not to be holding PG&E. If you have any questions about our ESG analysis or how we can help you manage your sustainable investments, please feel free to contact us for more information.

The current market downturn and volatility we are experiencing is obviously a big change from the behavior of the market over the past 10 years. In my 28 years of experience as a financial advisor, I’ve found that the most important thing to do during a down market cycle is to call my clients before they call me. The reality is that more clients leave their advisor due to lack of communication and service, as opposed to market performance and return. Calling your clients first lets them know that you are not hiding or panicking. There are 5 things that I have highly recommended to all of the advisors in my firm as we navigate the ups and downs of the current market cycle: Take a deep breath. It is vital that you do not panic during challenging market cycles. Fear is contagious, but so is confidence, and whatever you portray to your clients is going to have a great effect on them. Pick up the phone and call your clients before they call you. Assure them that market cycles are normal. While every client might hope the market never drops, every advisor knows that that the market does not continually go up forever, but over the long term, the trajectory of the market is upward. Review your client’s risk tolerance in light of the current volatility. For many clients, risk tolerance in a bull market differs greatly to risk tolerance in a bear market. Rebalance their portfolios when appropriate. Hopefully, the portfolios that you’ve designed were appropriate for your client’s risk tolerance when the markets were going up, and are still appropriate now given the market volatility that is currently taking place. If you would like to learn more about our ESG (Environmental, Social, and Governance) focused portfolio strategies, and/or would like a complimentary analysis of your current strategies, please feel free to contact Penelope Jackson at pjackson@GittermanWealth.com or 828-707-2079.

We are very proud to announce that Gitterman Wealth Management co-founding partner Jeff Gitterman has been named RIA “Thought Leader of the Year” at the 2018 WealthManagement.com awards. The award was given on Thursday, September 13th, at a black tie gala event at the Ziegfeld Theater in NYC. Now in its fourth year, WealthManagement.com hosts the only awards program to honor outstanding achievements by companies and organizations that support financial advisor success. This year, judges presented 67 awards to 59 companies from a pool of 156 finalists. A record number of nominations were submitted this year—nearly 600 entries were received from 156 companies. Jeff was recognized for his innovative work in the Sustainable, Impact, and ESG Investing arena, which has included the creation of the firm’s SMART (Sustainability Metrics Applied to Risk Tolerance)® Investing Services for Individuals and Financial Professionals, as well as for his role as the lead host of the 2016 and 2017 NYC Sustainable Investing Conferences, and the 2018 Sustainable Investing Conference at the United Nations. For more information about our work in the ESG / Impact arena, please feel free to take a look at this recent interview with Asset TV, and/or this recent interview with well.org.

On Tuesday, September 11th, Gitterman Wealth Management hosted the 2018 Sustainable Investing Conference at the United Nations. The first conference of its kind for financial advisors at the UN brought together over 500 financial professionals to discuss the business case for Sustainable, Impact, and ESG Investing, and its relevance to the United Nations Sustainable Development Goals (SDGs). This was the third annual Sustainable Investing Conference that Gitterman Wealth Management has hosted in New York City, and the increase in attendance clearly demonstrates the rapidly growing interest in Sustainable, Impact, and ESG Investing. The 2016 Conference brought together approximately 140 financial professionals, while the 2017 Conference brought together approximately 250. This year’s conference brought together over 570 people in total with about 170 wait listed.

With the unfortunate proliferation of mass shootings around the county, both in schools and elsewhere, several of our clients have begun to ask about their portfolio exposure to small arms and controversial weapons. Gitterman Wealth Management’s SMART (Sustainability Metrics Applied to Risk Tolerance)® Investing Services utilize multiple ESG (Environmental, Social, and Governance) data providers, including Morningstar’s Product Involvement data set, which helps us to better understand the practical implications of our investments. With this particular tool, Morningstar provides information related to numerous environmental, social, and governance issues, including thermal coal, alcohol, nuclear power, gambling, GMOs, palm oil, animal testing, small arms, and controversial weapons, among many others. Within each of these categories, direct and indirect involvement is taken into account. With regard to small arms, direct involvement relates to whether a company manufactures or sells small arms, or key components of small arms, to civilian customers, the military, or law enforcement. Indirect Involvement relates to whether a company is involved in retail / distribution of small arms or their key components. Morningstar’s list of controversial weapons includes anti-personnel mines, biological and chemical weapons, cluster weapons, depleted uranium ammunition, nuclear weapons, and white phosphorus weapons. Direct involvement refers to a company that is involved in core weapon systems, or components of the core weapons systems that are considered tailor-made or essential for the lethal use of the weapon. Indirect involvement refers to a company that provides components for core weapons systems that may not be considered tailor-made or essential to the lethal use of the weapon. Within our current SMART Investing models, our revenue exposure to small arms is zero, both directly and indirectly. With regard to controversial weapons, our revenue exposure is zero in 15 of the 18 funds we are currently working with, with minimal exposure ranging from .03% – 2.31% in the other three funds. The fund we hold with the most controversial weapons exposure (2.31%), was cited by Morningstar because it works with a company that offers services in resource management, infrastructure, and communications. The company was cited for “indirect involvement of non-essential and non-tailor made” weapons, as they work for the US Army Corp of Engineers, but the company is not responsible for any direct weapons production. The second of our funds that was cited (0.69% controversial weapons exposure) was due to a company within the fund that provides engineering, maintenance, and repair services to a number of systems aboard U.S. Navy vessels. We also consider this exposure to be indirect in nature, and estimate that it too accounts for a very small percentage of the company’s overall annual revenue. The third fund that Morningstar cited (0.03% exposure) was due to an aviation company within the fund that designs and produces cabin interiors, communications, and other products for commercial and military customers. We also feel this to be minimal and indirect exposure to anything controversial. As you can see, the exposure in our SMART Investing models to small arms and controversial weapons is extremely small. In many respects, this is a natural by-product of using ESG data sets and investing in sustainable funds, as weapons exposure is rarely a component of these types of products. ESG tools such as Morningstar’s Product Involvement data set are showing to be invaluable in this regard, as they give advisors the ability to easily understand and explain to clients their portfolio exposure to individual sectors in the environmental, social, and governance arenas. These tools bring transparency and accountability to investing in a way that we have never seen before. It is part of an evolutionary leap, helping people to better understand the deeper implications of risk management and the non-financial, intangible information that accounts for much of a company’s value in today’s increasingly transparent world. If you would like to have your portfolio reviewed for weapons exposure by Gitterman Wealth Management for weapons exposure please contact Adam Bernstein at abernstein@GittermanWealth.com For more information about Gitterman Wealth Management’s SMART (Sustainability Metrics Applied to Risk Tolerance)® Investing Services for individuals and financial professionals, please visit www.GittermanWealth.com. Related to this piece, please also see the MarketWatch article, Are You a Proponent of Gun Control? Take a Very Close Look at Your 401(k), which includes commentary from Gitterman Wealth Management ESG/Impact Analyst Adam Bernstein.