© 2021 Buckingham Wealth Partners. All rights reserved. IRN-21-2672

Larry SwedroeChief Research Officer

Sustainable Investing: Economic Theory & Evidence

Samuel AdamsCEO & Co-Founder

Agenda

Understanding Sustainable Investing — Sam

Theory and Evidence — Larry

2

What is Sustainable Investing?

3

Financial first

(social outcomes are secondary)

Impact first

(financial outcomes are secondary)

Source: Vert Asset Management.

4

ESG Metrics

Source: . https://www.cfainstitute.org/en/research/esg-investing

5

SRI Issues

Values Based Exclusions

• Alcohol• Gambling• Tobacco• Weapons• Nuclear Power• Adult Entertainment• Genetically Modified Organisms

Thematic Strategies

• Gender Equality• Veganism• LGBTQ• Community Investment• Water• Sustainable Agriculture• Social Justice

Who’s Doing ESG: World’s Largest Pension Funds

6

Fund Market Total Assets ( USD Millions)

1. Government Pension Investment Japan $1,237,6362. Government Pension Fund Norway $893,0884. National Pension South Korea $462,1615. ABP Netherlands $404,3107. California Public Employees U.S. $306,6338. Canada Pension Canada $235,79010. PFZW Netherlands $196,461

For illustrative purposes only.Source: https://www.willistowerswatson.com/en/press/2017/09/Assets-at-worlds-largest-pension-funds-return-to-growthSource: https://www.businesstimes.com.sg/hub/whos-who-in-private-banking-2018/the-rise-of-esg-investing-in-asia

Who’s Interested in Sustainable Investing?

7

0

20

40

60

80

100

Millennials Female Overall Male Little or NoInterest

SomewhatInterested

Highly Interested

Investors Advisors

Investors Are Interested Advisors Are Not

Source: Morgan Stanley Institute for Sustainable Investing (2017). “Sustainable Signals: New Data from the Individual Investor.”

8

20168.72 Trillion

Sustainable Investing in the US is Growing Rapidly

Source: Morningstar 12/31/2020

Sustainable Investing in the US is Reaching Scale

9

20168.7 Trillion

*20%

20146.5 Trillion

20123.7 Trillion

201812 Trillion

*25%

Source: Report on US Sustainable, Responsible and Impact Investing Trends 2020, US SIF

202017 Trillion

*33%*Percentage of all

professionally managed assets

How To Offer It: Who Gets What

10Customization

Complexity

ESG in ALL Portfolios

Conventional &ESG Models

CustomValues-Based

Portfolios

Emerging Markets

Real Estate

Other

Fixed Income

Equities

How to Build ESG Portfolios

11

Conventional Asset Allocation

Note: The asset allocations represent a generic model portfolio that captures diverse asset classes. Asset class weights are for illustrative purposes only and are not based on securities or actual investments. Investors should re-evaluate their portfolios as circumstances change.Source: Vert Asset Management.

Sustainable Asset Allocation

ESG Emerging Markets

ESG Real Estate

ESGOther

ESG Fixed

Income

ESG Equities

The Sustainability Tracking Error Trade-off

Percent of Benchmark Held

Sust

aina

bilit

y Sc

ore

Tracking Error

Lead

ers

Lagg

ards

12For illustrative purposes only. The chart does not represent any specific investment. Source: Vert Asset Management.

Strategies that hold only the companies leading on sustainability tend to have higher tracking error to the index.

Low Medium High

>75% ±50% <25%

Strategies targeting low tracking error tend to include companies of varying commitment to sustainability.

Why do Investors Want to Invest for Sustainability ?

13

How is the Performance?Financial Return

Does it have any Impact?Societal Return

Will it make me feel different?Personal Return

14

Being Part of

the Solution

Peace of

Mind

Security Vote My Capital

Align My

Values

Free Up My

Time

ClarityLeave

It Better

Personal Return

Understanding Your Clients’ Motivations

15

World Economic Forum ESG Ecosystem Map.https://widgets.weforum.org/esgecosystemmap/#/

Signal+

Support

Societal Return Personal

Return

16

Vert Asset Management LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Vert Asset Management LLC Form ADV can be found at https://adviserinfo.sec.gov.

Neither the information nor any opinion expressed in this webinar presentation constitutes an offer, or an invitation to make an offer, to buy or sell any securities. The information provided in this webinar presentation does not constitute a complete description of our investment services or performance. The expressed views and opinions presented during this webinar presentation are subject to change without notice. Although information contained herein this webinar presentation has been obtained from sources believed to be reliable and are accurate to the best of our knowledge, Vert Asset Management LLC cannot and does not guarantee the accuracy, validity, timeliness, or completeness of such information made available to you for any particular purpose. Material presented should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Past performance is not indicative of future results. We do not take responsibility for third party content.

Disclosure

© 2021 Buckingham Wealth Partners. All rights reserved. IRN-21-2672

Larry SwedroeChief Research Officer

Sustainable Investing: Economic Theory

• In equilibrium, screening out assets based on investors’ taste should lead to a return premium on the screened assets.

• Favored companies will have a lower cost of capital because of a higher P/E ratio. • Flip side of a lower cost of capital is lower expected return to shareholders.

• “Sin” companies have a higher cost of capital because of lower P/E ratio.• Flip side of a higher cost of capital is a higher expected return to capital providers.

• Hypothesis: Premium return is compensation for the emotional cost of exposure to offensive companies. • Investors in companies with higher sustainable ratings are willing to accept lower returns as the “cost” of

expressing their values.

Behavioral-Based (Taste-Based) HypothesisSustainable Investing: Economic Theory

• Companies neglecting to manage ESG exposures could be subject to greater risks.

• Companies with high sustainable scores have better risk management and better compliance standards, leading to fewer extreme events such as environmental disasters, fraud, corruption and litigation.

• High-scoring firms have reduced tail risk, creating the “sin” premium.

Risk-Based HypothesisSustainable Investing: Economic Theory

Sustainable Investing: Economic TheoryDiversification

• Sustainable investors sacrifice some of the benefits of diversification because their investments are limited to the universe of stocks that meet a sustainable investing screening process.

• In theory, less diversified portfolios are less efficient ones.

“Many investors want to own ethical companies in a saintly effort to promote good corporate behavior, while hoping to

do so in a guiltless way that does not sacrifice returns.”

— Lasse Heje Pedersen, Shaun Fitzgibbons and Lukasz Pomorski, “Responsible Investing: The ESG-Efficient Frontier”

What Investors Want

ESG Raters

• There are seven main providers of ratings: CDP, Trucost, MSCI, Sustainalytics, Thomson Reuters, Bloomberg and ISS.

• Correlations of ratings between the rating providers averaged just 0.61 and ranged from 0.42 to 0.73—the information is noisy.1

• Divergence of ratings poses a challenge for empirical research.• Using one rater versus another may alter a study’s results and conclusions.

The Evidence: Divergences in Ratings Sustainable Investing

1Florian Berg, Julian F Kölbel, and Roberto Rigobon, “Aggregate Confusion,” May 2020.

2019MSCI versus Sustainalytics Rankings at Start

Source: Data from MSCI and Sustainalytics for 878 U.S. companies.

• There is a variety and inconsistency of metrics purporting to measure the same things.

• The diversity of measures gives rise to considerable dissimilarity in ratings, reflecting firm-specific attributes, differing terminologies, metrics and units of measurement.

• There are differences in how raters define the benchmark for comparisons.• Versus the market or versus industry peers.

The Evidence: Divergences in RatingsWhy There Are Divergences in Ratings

2017 Study on Norway’s $1 Trillion Government Pension Fund1

• Exclusion of stocks on ethical grounds reduced fund returns by 1.1 % over the prior 11 years.• Divesting from tobacco manufacturers reduced the portfolio return by 1.2 percentage

points.• Avoiding weapons makers decreased the return by 0.8 percentage points.

SRI: The Evidence Consistent with TheorySustainable Investing

1Pension&Investments, “Norway wealth fund misses out on returns due to divestment, Norges says.” March 22, 2017.

A Five-Factor Investigation of Vice Stocks (2017)1

• October 1996-October 2016, S&P 500 Index returned 7.8%, the “Vice Fund” (screened stocks, primarily tobacco, alcohol and gambling) returned 11.5%.

• The vice portfolio exhibited less volatility than the S&P 500 Index: lower betas against one-, three-, four- and five-factor models.

• Annual alphas on the CAPM, three-factor and four-factor models were statistically significant 2.9%, 2.8% and 2.5%, respectively.

• Five-factor alpha virtually disappears—the higher returns to vice stocks is because they are more profitable and less wasteful with investments than the average corporation.

SRI: The Evidence Consistent with TheorySustainable Investing

1Greg Richey, “Fewer Reasons to Sin: A Five-Factor Investigation of Vice Stocks,” July 2017.

• Investors seek compensation for holding the stocks of disproportionately high CO2 emitters and the associated higher carbon risk.

• The carbon premium is economically significant; returns increase as emissions increase.• There is also a significant carbon premium associated with the year-to-year growth in emissions.

• Companies that succeed in reducing their emissions can afford to offer lower stock returns.• Companies that keep on burning more and more fossil fuel must resign themselves to offering higher

returns.

Do Investors Care About Carbon Risk?Sustainable Investing

Patrick Bolton and Marcin Kacperczyk, “Do Investors Care about Carbon Risk?” April 2020.

Screening out countries based on their degree of corruption (quality of governance measure).

• 2015 study by Elroy Dimson, Paul Marsh and Mike Staunton:• Examined post-2000 returns of 49 countries with poor (14), acceptable (12), good (12) and excellent (11)

governance scores.• Returns to the poor countries averaged 11%.• Returns to the other three categories averaged 5.3%-7.7%. • Risk and reward were related.

Evidence Consistent with Theory: Governance Sustainable Investing

Elroy Dimson, Paul Marsh, and Mike Staunton, 2015 Credit Suisse Global Investment Handbook.

Sustainable InvestingEvidence Consistent with Theory

Risk Effect

Responsible assets exhibit financial risk characteristics that appeal to investors—reduced exposure to stakeholder risk, such as potential consumer boycotts, fraud, human rights scandals or environmental scandals.

Taste Effect:

Investors do not want to facilitate “irresponsible” corporate conduct and construct their portfolios accordingly.

The Price of Taste: Two Sources

Both generate premiums for “sin” investments.

• Firms with lower ESG scores exhibit higher expected returns.

• Investors recognize increased ESG risks and demand a premium for accepting it. • Companies pay a price in the form of a higher cost of capital.

• Investors are only willing to hold firms that score low on ESG items if they are compensated with higher returns.

The Evidence: ReturnsSustainable Investing

Rocco Ciciretti, Ambrogio Dalò, and Lammertjan Dam, “The Contributions of Betas versus Characteristics to the ESG Premium,” 2019.Lubos Pastor, Robert Stambaugh, and Lucian Taylor, “Sustainable Investing in Equilibrium,” December 2019.

• The exclusionary issue leads to a reduction in returns.1• Factor exposures are negative to size and value,

but positive for profitability.

• The sustainability issue also leads to a reduction in risks.1• Higher ESG rated stocks have lower crash risk and

are less likely to hoard bad information.2

• Higher ESG rated stocks have better risk controls—less stock-specific downside (tail) risk in the company’s stock price, leading to higher valuation.3

• Any benefit from incorporating ESG credentials into a portfolio is already captured by other well-defined and known equity factors.1

• An ESG-tilted process doesn’t deliver lower risk-adjusted returns—investors can express social views through investments without penalty, at least in terms of risk-adjusted returns.4

Conflicting Forces: Both Risk and Return Reduced

1André Breedt, Stefano Ciliberti, Stanislao Gualdi and Philip Seager, “Is ESG an Equity Factor or Just an Investment Guide?” The Journal of Investing, ESG Special Issue 2019, 28 (2) 32-42.2Bei Cui and Paul Docherty, “Stock Price Overreaction to ESG Controversies,” April 20203Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltán Nagy, and Laura Nishikawa, “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance,” The Journal of Portfolio Management (July 2019).4Fabio Alessandrini and Eric Jondeau, ESG Investing: From Sin Stocks to Smart Beta,” The Journal of Portfolio Management, Ethical Investing, 2020, 46 (3).

Sustainable Investing

• Companies seeking lower costs of capital will strive to improve ESG score.

• Improvement in ESG scores (ESG momentum) results in improved valuation (lower costs of capital).1

• Companies that show a positive ESG rating trend significantly outperform both the benchmark and a comparable strategy that tilts portfolio weights toward companies with high ESG ratings.• A combined strategy that selects stocks with the highest ESG scores while maximizing momentum at the

same time results in a more profitable ESG portfolio.1,2,3

Sustainable Investing Is Making Companies BetterThe Impact of Sustainable Investing

1Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltán Nagy, and Laura Nishikawa, “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance,” The Journal of Portfolio Management (July 2019).2Madelyn Antoncic, Geert Bekaert, Richard Rothenberg, and Miquel Noguer, “Sustainable Investment—Exploring the Linkage Between Alpha, ESG, and SDG’s,” July 2020.3Matúš Padyšák. “ESG Scores and Price Momentum Are More Than Compatible,” August 2020.

• Firm engagement in ESG instills a sense of purpose to employees, motivating them.1

• Motivated employees are more productive, enhancing firm value.1

• ESG coupled with employee satisfaction enhances firm value over and beyond the effect from employee satisfaction.1

• Firms with high ESG ratings and high ratings on employee satisfaction significantly outperform

those with low ratings on both and with high employee satisfaction alone.

• By pushing green asset prices up and brown ones down, investors’ tastes induce more (less) investment by green (brown) firms.2

• Companies seeking lower costs of capital seek higher ESG ratings.2

Sustainable Investing Is Making Companies BetterThe Impact of Sustainable Investing

1Kyle Welch and Aaron Yoon, “Corporate Sustainability and Stock Returns: Evidence from Employee Satisfaction,” June 2020.2Lubos Pastor, Robert Stambaugh, and Lucian Taylor, “Sustainable Investing in Equilibrium,” December 2019

Summary

• By expressing their values, sustainable investors are having an impact, both on companies and the environment.

• Investor cash flows, which lower (raise) the cost of capital for companies with high (low) sustainable ratings, causes companies to focus on sustainability in order to gain a competitive advantage.

• Those actions, in turn, lead to improvements in sustainability for us all.

• The increased demand toward ESG funds has shifted the equilibrium.

• Firms with high ESG scores have rising portfolio weights, leading to short-term capital gains for their stocks—realized returns rise temporarily.

• Long-term effect is that higher valuations reduce expected long-term returns.• Discount rate effect

Short Term versus Long Term: Conflicting Forces

The Impact of Sustainable Investment on Stock Returns

Summary

• Sustainable investment strategies that do not take into account factor exposures should expect lower returns.

• Sustainable strategies also reduce risk—thus, there may not be a sacrifice in risk-adjusted returns.

• In the short-term, the increased demand from sustainable investors might even be sufficient to offset the ex-ante lower expected return as valuations of green stocks relative to brown stocks increase.

• Once a new equilibrium is reached, lower returns to sustainable strategies, along with lower risk, should be the expectation—unless you adjust for factor exposures.

Disclosure

The information and opinions contained in this presentation are for informational purposes. While reasonablecare has been taken to ensure that the information contained herein is factually correct, there are norepresentations or guarantees as its accuracy or completeness. Certain information has been provided by third-party sources and it has not been independently verified and its accuracy/completeness cannot be guaranteed.

The information contained herein is not intended to be a substitute for specific individualized tax or legal advicewe suggest that you discuss your specific situation with a qualified tax or legal adviser. Investing involves risk,including loss of principle.

No strategy assures success or protects against loss.

Thank You