Market Commentary – ESG Investing. Also Brazil.

ESG (Environmental, Social and Governance) investing is getting hotter (pun intended). We are watching organizations change their institutional asset allocation to increase their exposure to environmental, social, and/or governance standards that are acceptable to the trustees or boards or donors. Those incoming flows into the ESG space mean higher stock prices for the companies and securities that meet the target objectives. That also means an allocation away from the bad actors who fail to qualify with high ESG scores.

At Cumberland, three ETFs that we include in our US-focused ETF portfolio are focused on water, solar, and wind power. It is important to note that there are a number of choices in the ETF space and diligent research is needed to dig into the underlying securities. One example of a rejection we made is a so-called environmental fund that purports to hold a heavy weight in electric utilities. When we dug deeply, we found indirect exposure to coal-fired power plants as a generation source. Who’s kidding whom? The same care is needed in the electric vehicle space, where a company’s policy around charging stations may create a favorable location developed by a coal-fired power source. That may make the car owner “feel good” about ESG, but the seriousness of the environmental issue is violated if the electricity is furnished by a polluting generator.

The country governance test can be even more difficult. Cumberland looks at various metrics in determining where we take on exposure. Of course, a lot of this research is necessarily subjective, and that is particularly true in the emerging markets. A new ETF was recently launched that tries to quantify governance risk in the portfolio. The symbol is FRDM, and the full name is Alpha Architect Freedom 100 Emerging Market ETF. FRDM describes itself as follows:

“FRDM follows the theme of ‘life and liberty.’ The fund examines emerging markets stocks for factors by which its index measures this theme. In measuring the right to life, the listed factors include absence of terrorism, human trafficking, torture, and political detentions. For measuring liberty, the fund uses the following factors: rule of law, due process, freedom of the press, freedom of religion, and freedom of assembly. Lastly, to gauge property, the factors are marginal tax rates, access to international trade, business regulations, established monetary and fiscal institutions, and size of government. Based on the above factors, FRDM selects 100 securities for inclusion.”

We do not currently hold FRDM in managed accounts because we have certain seasoning rules and liquidity requirements and the ETF is too new for us to take on a position. However, our managed ETF international accounts own some of the same countries and I own some personally.

Now let’s get to a bad actor and the ongoing saga of poor governance.

We continue to monitor reporting on the destruction of the Brazilian rainforest and the political and scientific response to it in Brazil, the US, and elsewhere in the world.

Let’s start with a newly published study by Thomas Lovejoy of George Mason University and Carlos Nobre of the University of Sao Paulo, as reported in the Washington Post on Dec. 20, 2019. Their decades-long research now strongly indicates that the Amazon has come to a tipping point, beyond which deforestation and other rapid changes in the Amazon threaten to turn large areas of the rainforest into savanna, devastating indigenous cultures and wildlife and releasing additional billions of tons carbon into the atmosphere.

“The precious Amazon is teetering on the edge of functional destruction and, with it, so are we. Today, we stand exactly in a moment of destiny: The tipping point is here, it is now,” the scientists wrote in an editorial in the journal Science Advances. (“Top scientists warn of an Amazon ‘tipping point,").

An article from NASA’s Earth Observatory gives us a deeper, more detailed picture of the progression of the devastation of the Amazon, drawing on Landsat satellite data. The article explains, “Landsat has taken a snapshot of every part of the Amazon rainforest every two weeks for 47 years, creating the world’s longest, most consistent record of change in the region.” In the 2000s NASA also conducted the Large-Scale Biosphere-Atmosphere Experiment in Amazonia (LBA), which studied how Amazon ecosystems are interconnected and how they react to rapid deforestation, climate change, and drought cycles. (“Making Sense of Amazon Deforestation Patterns,” – hat tip to reader David Kruschwitz)

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Disclaimer: The preceding was provided by Cumberland Advisors, Home Office: One Sarasota Tower, 2 N. Tamiami Trail, Suite 303, Sarasota, FL 34236; New Jersey Office: 614 Landis Ave, Vineland, NJ ...

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