WhatisESG? October2022
MiltonFriedmanonbeingsociallyresponsible
Source:StocksfortheLongRun,6th edition, JeremySiegelandJeremySchwartz
NewGoals:GreedisNotGood
+ 2019BusinessRoundtable:firmsshouldmakeafundamentalcommitmentto allstakeholders,notonlyshareholders.
–
Newgoalsincludedcompensatingemployeesfairly,fosteringdiversity,and protectingtheenvironmentbyembracingsustainableproductionpractices.
+ The New York Times 50yearsanniversarypiece: Almostallweresharply criticalofFriedman’soriginalessay.
+ MarcBenioff,CEOofSalesforce,claimedthatFriedmanbrainwasheda generationofCEOs.
+ DoesFriedmandoctrineencourageexcessive“short-termism,”theerosionof employeeandenvironmentalprotections,andotherevils?
+ WhatifFriedmanhadsaidthatthepurposeofmanagementwastopursue policiesthatmaximizeshareholderreturninsteadofcorporateprofits?
+ Pursuingabroadersetofgoals,corporationsmayactuallyincreasetheir profits;eveniftheydonot,theseactionsmightboostsharevalue.
Source:StocksfortheLongRun,6th edition, JeremySiegelandJeremySchwartz
EarningsandESGRatings
+ ESGpoliciesmayenhancecorporateprofits:betterworkingconditions improvemoraleandproductivity;encouragingdiversityrecruitsbettertalent andbringsawiderperspectivetotheboardroom.
+ Goodcorporatepractices,suchasanindependentboardofdirectorsorthe establishmentofacompensationcommittee,mayalsodirectlyincrease earnings.
+ CustomersmaybewillingtopurchasegoodsfromfirmsthatfollowESG practices,eveniftheproductstheymakecostmorethanthosefromfirmsthat donotpursuesuchpractices.
+ Alargenumberofautomobilebuyersdemandelectricvehicles,evenif purchasingstandardcombustionengineswouldbemorecost-efficient.
+ AchievingESGobjectivesmayalsoenhancethevaluationinvestorsplaceon corporateearnings,particularlybypursuingbestpracticesinthegovernance category.Firmsthatestablishtightauditingstandardsorincreasethe transparencyofthedecision-makingprocessmaysellatahigherearnings multiplethanthosethatdonot.
WhatisESGInvesting?
+ Conventionalsecurityanalysisemploysfundamentalratiosandfactorstohelpidentifycompaniestoeitherinvestin oravoid.
ESGintegrationdoesthataswellbutaddsenvironmental,social,andgovernancefactorsintotheanalysiswith thegoalofcreatingamorein-depthframeworkbybetterunderstatingoverallrisk–bothfinancialand nonfinancial.
+ ThegoalofmanyESGmanagersistoimproverisk-adjustedreturnsbyfocusingonESGfactorswhichmanyhavea materialeffectonacompany'sfinancialperformance.
Environmental Conservationofthe naturalworld
emissions
Airandwaterpollution
Biodiversity
Energyefficiency
Wastemanagement
Waterscarcity
Social Considerationof people&relationships
satisfaction
protection
Genderanddiversity
Employeeengagement
Communityrelations
Humanrights
standards
Governance Standardsforrunning acompany
composition
Auditcommittee structure
Briberyandcorruption
Executive compensation
Lobbying
contributions
CommonMethodsofSustainableInvesting
+ MethodologiesmaybeappliedinESG,SRI,andImpactStrategies
+ ESGinvestorswilloftenemploymorethanoneformsimultaneously
– Forexample,anESGintegrationstrategymayalsouseexclusionaryscreens
+ Manyinvestorsexpecttheirmanagerstoemploysomelevelofcorporateengagementregardlessofmethodology
Exclusionary Screening Positive Screening
• Excluding companies basedon specific criteria
• Large percentageof sustainable strategies applynegative screens
• Socially Responsible Investingwas basedonthe principleof values-based exclusions
• Including companies basedon specific criteria
• Best in Class approachis common application whereby companies thatscore betteronESG criteria v. peersare includedina portfolio
Norms based Screening ESG Integration
• Using principlesset byathird party organization todefinewhat companies shouldbe includedor excludedfrom aportfolio
• The10UN Global Compact Principlesis onepopular approach(i.e., humanrights, labor, environment, anti corruption)
• Incorporation ofESGmetrics intosecurity evaluation alongwith otherfactors
• Wide spectrumin termsofhow ESG practically gets integrated
• ESGand conventional analysisoften mergewhen climateriskis analyzed (transitionand physicalrisk)
Corporate Engagement Impact Investing Sustainable Themes
• Investingin themesor assetsrelated tosustainable productsor processes
• Forexample, renewable energy, sustainable agriculture, electric vehicles
• Primary objective isto addressa socialor environmental problem
• Oftendifficult toinvestin andmostare availableonly toinstitutions, foundations, andHNW
• Most investments areinprivate companies andarehighly illiquidwith510Ylock-up periods
• Using shareholder powerto influence corporate behavior
• Investorsand investment managerscan exert influence through shareholder resolutions, proxyvoting, direct engagement
WhatisSustainableInvesting
TheEvolutionofESGInvesting
SociallyresponsibleinvestinglaiddownthefoundationforESGinvesting
In2004,theEnvironmentalProgramFinanceInitiativeReportpublishedbyUnitedNationsfirsttouse phrase“environmental,social,andcorporategovernanceanalysis”;followedbyPrinciplesfor ResponsibleInvestment(PRI)
ResearchfirmscollectESGdatafromcompaniesandpublishheadlineratings,dominatingESGsecurity selectionandportfolioconstruction
ShortcomingsofESGratingsbecomeapparentandmaterialitybecomessignificantfocushighlighting conceptthattheimportanceofESGissuesvariesbyindustry
ThefutureofESGliesinstandardizedESGdata;allcompaniesreportingonESGperformancelikethey doonfinancialperformance
GlobalGrowthofSustainableInvesting
Morgan
Some
SustainableFinanceDisclosureRegulation(SFDR)ETFProduct Classifications
• EUSFDRcametoeffectfromMarch2021.
• SFDRhasthreeclassificationsforfinancialproducts.
• Thebelowclassificationsmandatethedisclosuresandreportingrequiredforthe applicablefinancialproduct.
ALLPRODUCTS Article8 GENERALESG
Article6
Article9
SUSTAINABLE
Afinancialproductmay integratesustainability risksintoinvestment decisionsbutarenot promotedashavingESG objectives.
Afinancialproductwhich promotesenvironmental orsocialcharacteristics,or acombinationofthose characteristicsandhas goodgovernance practices.
Afinancialproductthathas sustainableinvestmentas itsobjectivewhichis measuredbyKPIs
Source:WisdomTree,September2022.
Recentlegislationandpolicyinitiativesarecreatingstrongtailwinds fordecarbonisation
TheUNFrameworkConventiononClimateChange(UNFCCC)anditsParisagreementsigned by196 Partiesat COP21setsoutaglobalframeworktoaddressthethreats ofclimatechangeandlimitglobalwarmingtowellbelow2°C abovepre industrial levels
The convention’s supreme decision making body, the Conference of the Parties (COP), meets annually and reviews the implementation of the Convention, the progress on achieving its ultimate objective and measures taken by the Parties
Sustainable Development Goals that focus on sustainable consumption and production, clean energy and urgent action on climate change aim to accelerate the energy transition as well as the transition to circular economyGlobal
Europe
TheEuropeanGreenDeal andthegoalofclimateneutrality by2050 CircularEconomyActionPlanaimstohelpwithachieving climateneutrality by2050 through decouplingeconomic growthfromresource useandwastegeneration Fit for 55 package under the European Green Deal contains legislative proposals to revise the entire EU 2030 climate and energy framework and meet the updated emissions reduction target of net 55% compared to 1990 levels.
U.S.ClimateStrategy under theBiden Administration andthegoalofnet zero emissions bynolaterthan2050 EPA’sNationalRecyclingStrategy andU.S.NationalRecyclingGoal toincrease thenationalrecyclingrateto50% by2030
United States
The US National Climate Strategy details how the United States will deliver U.S. NDC for 20301 reduce emissions by 50 52% below 2005 levels. The Long-Term Strategy of the United States aims to achieve net zero emissions by 2050.
Source:Global UnitedNations,UnitedNationsFrameworkConvention onClimateChange;UN2030AgendaforSustainableDevelopment. Europe theEuropeanUnion;theEuropean GreenDeal;NewCircularEconomyActionPlan;Fitfor55PackageundertheEuropeanGreenDeal. UnitedStates “TheLong TermStrategyoftheUnitedStates,PathwaystoNet Zero GreenhouseGasEmissionsby2050”publishedNovember2021;UnitesStatesEnvironmentalProtectionAgency(EPA).
1.NDCsarenationallydeterminedcontributions(NDCs)undertheParisagreement.
Decarbonisationishappening-butnotfastenough
84%
Primary energy consumptionbysource1
Renewables Nuclear Coal Oil Gas
Theworldiscontinuing toproduce energy fromfossilfuels in 2020 almosta combined84% of primaryenergy consumption wasfrom coal,oilandgas.
12%
Consumption ofrenewableenergy didnotincreasefastenough inthe lastdecade in2020 thefigure stood ataround12%.
Theworldneedsmuchfasterrateof displacingfossilfuelsinthe energy mixanddecouplingeconomicgrowth fromthe increase inGHGemissions.
Source:OurWorldinDatabasedonBPStatisticalReview ofWorldEnergy.
1.Primaryenergyisshownbasedonthe‘substitution’ methodwhichtakesaccountofinefficiencies inenergyproduction from fossilfuels.Renewablesincludewind,solar,hydropower aswellasbiofuels andgeobiomass.
The
Transitionalargedriverofmetalsdemand
Decarbonizationcreatingopportunitiesfornewtechnologiesand loweremissionsproductsandsolutions
Fossilfuelsubstitution
fuelalternatives
Transitiontoacirculareconomyisoneofthekeyprerequisitesin achievingnetzeroclimatetarget
+ Weliveinsocieties whereeconomies aredrivenby consumer demandforgoodsandservices.The traditional linearmodeltakesnaturalresources, makestheminto consumer productsthatareoftendisposed.
+ Thecyclecontinues,requiring morenaturalresourcesto makemoreconsumer productsastheglobalpopulation grows. The resultis risingcarbonemissionsthatare highlycorrelatedwithrisingpopulations.
+ By2050duetotheprojectedrise inpopulation, the equivalentofalmostthreeplanetscouldberequired to providethe naturalresourcesneeded tosustain current lifestyles.1
+ By2050,theglobalannualwastegeneration issetto increase to3.40billion tons, uparound70%fromtoday’s figure.2
+ EllenMacArthur Foundation highlights that current endeavoursincombatingclimatechange focusedon renewableenergy andenergy efficiency measures, addresses only55%ofemissions.
+ 45%ofemissionsareassociatedwithmanufacturing of productsmakingthe transition toacirculareconomya keyprerequisite forachieving netzero.
Source:TortoiseEcofin;EllenMacArthurFoundation,“Completingthepicture:Howthecirculareconomytacklesclimatechange”,2021Reprint.
1.UnitedNations,“Goal12:Ensuresustainableconsumptionandproduction patterns”availableat https://www.un.org/sustainabledevelopment/sustainable consumption production/ 2.WorldBank,“WhataWaste2.0:AGlobalSnapshotofSolidWasteManagementto2050”published on20th September2018. Forecastsarenot anindicator offutureperformanceandanyinvestmentsaresubjecttorisksanduncertainties.
Renewablenaturalgas(RNG)–decarbonisationpotential
+ TheIPCC6th assessmentreporthighlightstherisksof GHGotherthanCO2
+ Areductioninmethane(CH4)emissions,highlypotent atwarming,canrapidlyslowthetemperatureriseand canbekeyinachieving1.5°Ctarget.
Wastetypes
DairyCow/ Pigmanure
Sewagesludge
Animalmanure
Yardandcrop wastes
+ Historically,methanefromlivestock wasteisreleasedintothe atmospherecausingsignificantdamagetotheenvironment.
+ Renewablenaturalgas(RNG)capturesharmfulmethanefromwaste andturnsitintoenergythroughaprocessincluding:
• capturingmethanefromsupplysourceprimarilyfromdairycattle andpigwaste;
• processinganimalwastethroughananaerobicdigester;
• producingrenewablenaturalgasthatreplacesfossilfuelsourced naturalgasusedasatransportationfuel,togenerateelectricity, and/orforhomeheating/cooking
+ AccordingtoBloombergNEF:
• TheU.S.RNGshoweda35%CAGRfrom2017 to2021.
• ThelandfillRNGsawa48%increasefrom2020 to2021 andremains alargermarket.However,thegreatestincreasefrom2020to2021 wasinmanure-basedproductioncapacitythatwasup77%.
• Transportationmarketisestimatedtobethekeyconsumerofthe RNG 82%oftheproductioncapacityinUS.
• ProducerscapturingRFSandLCFStransportationcreditscan achievesignificantprofitmargins.
Intensity
Foodandfood processingwaste
Anaerobic digesters (AD)
Biogasmadefrom organicsourcesis treatedtoremove moisture, particulates, contaminantsand othergases.This increasesthe methanecontent to90%orgreater.
ADOutput
Carbon Intensity
Theresulting productis renewablenatural gas(RNG)
RNGcanbeused asavehiclefuel, togenerate electricityorin thermal applications
Gasoline/Diesel
Landfills RNG Dairy/Swine Manure
Source:WisdomTree,TortoiseEcofin; BloombergNEF,“RenewableNaturalGasDatabase LiveSheet(1.1)”published on22nd March2022;EPA,“Anoverview of renewablenaturalgasfrom biogas”published inJuly2020.CAGRiscompoundannualgrowthrate.RFSisrenewablefuelstandard.LCFSis thelowcarbonfuelstandard.Chart:CaliforniaAirResourcesBoard,28 February2022,dataavailableathttps://ww2.arb.ca.gov/resources/documents/lcfs pathway certified carbon intensities.CarbonIntensity(CI)Scorefigures representtheaverageofallCI scoresfortheselectedfacilitiescoveredinthe“CurrentFuel Pathways”spreadsheet. Forecastsarenot anindicator offutureperformanceandanyinvestmentsaresubjecttorisksanduncertainties.
Howbigistherenewablenaturalgasopportunity?
+ In2021therewere174RNGproducingfacilitiesintheU.S. (97animalwastefromfarmsand77 landfillgas).
ProductionVolumesRelative toU.S.NaturalGasConsumption
+ Over8,000potentialdairyandhogfarms intheU.S.andover2,500landfills intheU.S. althoughnotallwillbecandidatestoproduceRNG.
+ IntheU.S.,thereare317operationalanaerobicdigestersin2021reducingmethaneemissions bycollectingbiogasfromanimalwastecomparedtoover4,000livestock manuredigesters operatinginGermanyin2018.
+ RNGproductionintheU.S.in2021wasaround300millioncubicfeetperdayrepresenting less than1%ofU.S.naturalgasconsumption.
+ EstimatesareforRNGtogrow40xto12bcf/dby2040thatwouldrepresentapproximately14% of2020U.S.naturalgasconsumption.
LandfillandAgricultureRNGProjectsintheUnitedStates
AgricultureRNGProjects LandfillRNGProjects
Source:TortoiseEcofin;EPA;WorldBiogasAssociation;BBI International.Chart“RNGProductionVolumesRelativetoU.S.NaturalGasConsumption”: theRNGCoalitionandtheArgonne NationalLaboratory(ANL);AmericanGasFoundation,“RenewableSourcesofNaturalGas”published December2019;U.S.EnergyInformationAdministration,dataavailableat https://www.eia.gov/dnav/ng/ng_cons_sum_dcu_nus_a.htm;Bcf/disbillioncubicfeetperday.Chart“LandfillandAgricultureRNGProjectsintheUnitedStates:EPA,dataavailableat https://www.epa.gov/lmop/renewable natural gas
arenot anindicator offutureperformanceandanyinvestmentsaresubjecttorisksanduncertainties.
Recycling–decarbonisationpotentialandopportunity
+ Recyclingisacriticalcomponentinglobal decarbonisationmegatrendincludingrecyclingwaste andplastics.
+ Increasingrecyclingispartofthetransitiontoacircular economy.
Thelinearplasticsystemandtheopportunity forplasticrecycling
+ Recyclingfocusesonthetypesofwastewhichcanbereturnedintothe economiccycleaspartofthevaluecreation.
+ By2050,theglobalannualwastegenerationissettoincreaseto3.40 billiontons,uparound70%fromtoday’sfigure.
+ Recyclingplastic(OECD(2022)):
• Only9%ofplasticiscurrentlyrecycledglobally
• Theamountofplasticwastegloballyhasdoubledincomparisonto twodecadesago
• Mostplasticsinusetodayarevirginplastics,madefromcrudeoilor gas.
Recyclinglithium:
+ Thegloballithium-ionbatterymarketisforecastedtogrowataCAGR of23.3%through2021 2028 perioddrivenbythedemandfrom automotiveandconsumerelectronicssectors
+ Lithium-ionbatteriescontainmanyscarcematerialsincluding lithium,cobalt,nickel,graphite,aluminium,andcopper
circulareconomyforplastic
Source:WisdomTree,TortoiseEcofin; WorldBank,“WhataWaste2.0:AGlobalSnapshotofSolidWasteManagementto2050”published on20th September2018;Organisationfor EconomicCooperation andDevelopment(OECD),“GlobalPlasticsOutlook:EconomicDrivers,EnvironmentalImpactsandPolicyOptions”published 2022;FortuneBusiness Insights, https://www.fortunebusinessinsights.com/industry reports/lithium ion battery market 100123.
Thelinearplasticsystemandacirculareconomy forplasticillustration:WorldEconomicForum,EllenMacArthurFoundation, McKinsey&Company,“Anewplasticseconomy: rethinkingthefuture ofplastics(2016)”. Closedlooprecyclingis recyclingofplasticsintothesameorsimilarqualityapplication. Cascadedrecycling recyclingofplasticsintoother, lowervalueapplications.
Forecastsarenot anindicator offutureperformanceandanyinvestmentsaresubjecttorisksanduncertainties.
Ethanol–decarbonisationpotentialandopportunity
+ Ethanolisacolourlessliquidwhichisproducedbythe naturalfermentationofsugarprimarilyfromcornand sugarcane
+ Ethanolisusedinmanyconsumerproductsandisan additivetogasoline
Rawmaterials
+ Corn,sugarcane,andcropresiduearetheprimaryrawmaterialusedto produceethanol.
+ In2020,83%ofglobalethanolproductioncamefromtheU.S.(53%) andBrazil(30%).1
+ Ethanolproductioniscircular anddecarbonisingasethanolproduced fromcorn/sugarcaneisusedasatransportationfuelincarsthatemitCO2. CO2isabsorbedbycorn/sugarcanecropsthatproduceethanol.
+ Corn basedethanolcutsgreenhousegasemissionsby39%compared togasoline.2
+ Sugarcane-basedethanolproducesonaverage89%lessemissions thanBraziliangasoline.3
+ Secondgenerationethanolusingbagasse(sugarcaneresidue)inBrazil produces97%lessGHGemissionsthangasoline.3
+ Ethanolproducersarelookingtocuttheircarbonfootprintby investing,forexample,incarboncaptureandstorageprojects.
Carsconsume ethanol producingCO2
GrowCorn/Sugarcane
Production and distribution ofethanol
Source:WisdomTree,TortoiseEcofin.
1.RenewableFuels Association(RFA),worksheet “GlobalEthanolProductionbyCountryorRegion”availableat https://afdc.energy.gov/data/
2.USDA,“Building theEvidenceonCornEthanol’sGreenhouseGasProfile”published on29th July,2021.
3.https://www.raizen.com.br/en/our business/renewables
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