Strategic Investors: Profiles of investors with strategies to consider.

Finance is a humming factory of confusing terminology, as anyone old enough to remember the damage done by SIVs and RMBSs did to the global economy in 2008-2009 can attest. While “special investment vehicles” and “residential mortgage-backed securities” no longer pervert the market (we hope), the various ways people describe investment strategies meant to bring about social good – or at least avoid doing harm – are generating plenty of confusion today.

Is “impact investing” different from “socially responsible investment” (SRI)? Do ESG (environmental, social, governance) strategies automatically qualify as SRIs? Can an oil company be part of an ESG strategy?

Purists and ideologues have their own opinions. Jeffrey Gitterman, co-founding partner of Gitterman Wealth Management, is a recognized expert in the field. He explains the differences and much more to Karma Network’s Contributing Editor Michael Moran.

Michael Moran: How do you define ESG, impact and sustainable strategies?

Jeffrey Gitterman: We call ESG the “GPS of investing,” and the reason that we use that metaphor is simple. Twenty-five years ago, when you wanted to take a road trip, you had this one-dimensional view, a backward-looking view, of the trip that you were about to take in the form of a map. It didn’t tell you anything current, it told you nothing about traffic or road closures or detours or potholes or cops hiding in the bushes. So, you had all these obstacles in your path that you weren’t aware of, things that we can adjust for today as you get in your car and you have a GPS working for you. It makes that road a lot smoother and that’s how we look at ESG data. Twenty-five years ago, 80-85% of the S&P 500 in market value was based on tangible assets on the balance sheet and financial disclosure items. As of 2015, 85% percent of the S&P 500 market value is now based on intangible, non-financial disclosure items. So that one-dimensional view – the K1 or your quarterly reports about stock prices and the S&P 500 – [is] the same as that old roadmap.

By comparison, ESG data is this huge data set which is growing every day, and as Big Data gets more robust, ESG will grow more influential. [ESG data] gives you a lot of live, current data, news sources, feeds, Glassdoor-style intel about all these non-financial disclosure items having to do with employer-employee retention, customer loyalty, brand identity. These are all things that are critical to, for instance, Amazon and Google and Netflix and Tesla. Just because Wall Street can’t find justification for those stock prices in the financial disclosures of these companies right now doesn’t mean they are wrong. This also has to do with the coming of age of millennials and the fact that they are the largest percent of the workforce. Millennials work and invest and spend differently. They punish perceived misdeeds, and we’re starting to see material impact on stock prices based on non-financial disclosure items – whether that’s Facebook or Equifax or Wells Fargo or any of these companies. To be a fiduciary in today’s world, you have to be looking at that data.

Michael Moran: So ESG is the biggest, and least constrained, of the three buckets?

Gitterman: Yes, that’s right. Now in the GPS after you put it in your address in the search bar, you are given choices of route preferences. You could take a route that has no toll roads or take the shortest route or fastest route. That’s what we look at as “values” or “SRI investing.” In SRI strategies, you are excluding things very deliberately for reasons not contained in financial statements. ESG is something completely new because we didn’t have these data sets before. And if you want to do SRI investing, you know that taking a different route might have an effect on your trip, and that’s true of SRI investing too.

The third category, impact investing, is more constrained still. You have both the route and the destination in mind from the start – everything is very intentional. The impact should be intentional and measurable, and in many ways this is comparable to the United Nations Sustainable Development Goals (SDGs), which are a framework for human survival and development that many people are starting to adopt today around impact investing.

Michael Moran: So how do you draw the line on various industries? For instance, you could make an ESG case for frackers who are turning out the natural gas that is greener than many alternatives and seen as a transitional fuel to a future renewable system. You could probably make a similar case for nuclear power. Where do you draw those lines?

Gitterman: For us, we only make exclusions in impact and SRI strategies, and we allow at a certain level – over $1 million dollars of investable assets, for instance – for the client to define those exclusions. To us, that’s not ESG. If I’m investing in oil companies, there’s still a huge difference between the various oil companies as to how they’re working, especially in developing countries, in regards to how they’re treating the population, the environment, the governance issues, how many lawsuits they’re facing, whether they have women on their boards and all of these other ESG data sets. This makes one company comparable with another within each industry, whether it’s nuclear or oil and gas or tobacco. If I’m owning for a client that is just a massive, affluent client and needs exposure to all markets, I still want to own the best in class of each industry. So, I want to screen my stocks through ESG data and try to avoid companies that have big risks that I can see through those data sets.

A perfect example of this is Pacific Gas and Electric. It was the darling of a lot of ESG investors, especially passive index companies, because PG&E was on track to convert the greatest number of people to alternative energy in the fastest amount of time based on California regulations. But they were also publicly disclosing on the governance side that they had huge risk of losses to wildfire and that, in a worse-case scenario, it could even lead to bankruptcy. They were off the chart compared to all other energy companies on that risk. So, for us, PG&E has to be a “no” because its climate risk was accelerating off the chart. So, from an ESG perspective, I can’t own that, even though on the energy side they are converting and moving to clean energy faster than everyone else. I believe, unfortunately, that we have to move toward climate adaptation in our portfolio models and away from trying to stop climate change, which, you know, is a terrible thing to have to say, but it’s the truth because we’re not moving fast enough. So, there’s conflict between fiduciary duty and what we’d like to see happen in the wider world.

Michael Moran: When you founded Gitterman Wealth Management in 2010, ESG and impact investing were little-known concepts and you pursued a more traditional portfolio allocation approach. Yet you’ve quickly developed a reputation for ESG. At what point did the ESG model really become what you wanted to emphasize in your investment advice?

Gitterman: In 2009, I published a book called Beyond Success: Redefining The Meaning of Prosperity. I started thinking about our cultural definitions of success and prosperity in a different way. Then in early 2014, I got involved as a producer in a film project called Planetary with executive producer Guy Reid, a film based on conversations with astronauts who have witnessed the fragility and beauty of the Earth from space, and also with environmentalists and spiritual thinkers like Bill McKibben and others. The idea was to redefine our relationship with the Earth. There’s a line in the film which had a profound impact on me: “We’re not on this planet, we’re of this planet.” And I realized that if people started asking me what I was doing about all these problems, I knew that my business life really wasn’t affecting change in the way that I could be. I also saw that unless the capital markets really shifted in a big way with regard to where we’re investing, we were not in any way going to achieve what the SDGs are aiming for or ultimately have (a) sustainable, survivable planet.

So, I made a commitment before the film came out, which was Earth Day in 2015. Beginning in 2016, I began the process of converting 100% of my personal practice to ESG investing. Then last year, I presented at the United Nations Sustainable Investment Conference. Some 588 advisors and multiple asset managers attended [the conference] and we will be doing it again this year. I’m doing that because I realize that there’s only so much I can do with my direct client base, and advisors are really the stumbling block to more widespread adoption of ESG and sustainable strategies. All of this is heavily driven by millennials and women, but even baby boomer men are coming around now. There’s a proliferation of ESG and SDI production coming from all the big investment houses because they realize that unless they engage with this, they’re going to lose the millennials. The millennials are going to inherit all the money of their clients, so they’re panicking. But there’s still this bottleneck in the middle, which is getting advisors to really adopt it. So, I decided I would do both: We would focus on our client base but we also focus on educating advisors, and the more we’ve done that, the more press and PR [we received]. As of this year, we now work with Fidelity and Schwab and TD Ameritrade and others just trying to help support advisors who don’t have the depth of knowledge or the bandwidth.

Michael Moran: You mentioned that millennials and women are driving much of this trend. Can you expand on that?

Gitterman: Things are definitely changing. I don’t want to say it’s changing Wall Street because I don’t think fundamentally it’s changing anything there yet. There’s still a belief on Wall Street that people are product driven. But what they’re not understanding is that millennials, and women as well, but millennials particularly, they’re really identifying with the purpose and the brand behind the product. They’re leapfrogging the product – right into its purpose, and it’s going to take some time for Wall Street to figure out that they can’t just name a product “ESG” or “impact” and win over the millennial generation. This is a generation that will change jobs if they don’t feel that their work has purpose. They will spend money differently based on brand and purpose identification. And certainly, as they inherit the bulk of the wealth from the baby boomers over the next 15 years, millennials will also invest differently. I think some of the big banks and investment companies are starting to see those outflows driven by millennials and they’re getting panicky about it. But I don’t think they bridge the gap that they actually need to yet.

Michael Moran: How do you detect greenwashing and how do you define it?

Gitterman: It really is a hard thing to completely identify because once we get into values-based investing beyond ESG, it’s really down to personal preference. Your personal preference about what your values are and how my company can match your values with investments depends on product and what stands behind that product. That’s a complicated situation. Most impact has to be done in private companies because it’s one company addressing one issue that’s important to you and that’s their function and their measurable, and they can report back to you what their impact has been. Goldman Sachs and JP Morgan and Morgan Stanley – they’ll never be able to achieve that in a way that will satisfy the desire many people want for impact. But in ESG, there’s also greenwashing. It’s what are you doing with the data. Are you just using one data provider and screening out the bottom scores and overweighting the top scores? In the stock market, that’s not having any real material impact on the companies because if you don’t own my stock, someone else will own my stock. It’s a passive approach, and the more it’s done the less there’s any additional impact. At least with an active manager who is looking through the scores at the data from multiple data providers, he’s hopefully avoiding landmines that the traditional metrics might not tell you.