One Corporate Center Rye, NY t GABELLI.COM ESG INVESTING

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1 ESG INVESTING Q Water There is no substitute for water and there is no creation of new water on our planet. Improved management of water leads to better economic outcomes.

2 ESG Investing WA T E R In investing, the continual search for information mispriced by or altogether missing from the market is an unending quest that differentiates successful active investment managers. Many investors today would agree that a company s externalities are increasingly important. At GAMCO Asset Management, we view Environmental, Social and Governance (ESG) investing as a framework that encompasses a more holistic approach, to include and consider additional material information that can have long-term implications on a company s economic viability. It is important that such risks are considered because in most cases, it provides insight into how resource constraints are managed by a company. Evaluating ESG issues help identify both risk and opportunities within an industry. For some traditional investors, it may still be difficult to see beyond the feel-good investing trend ESG is often equated with to the more comprehensive analysis with potential profitability consequence. We believe that some of these important issues are being overlooked in most investment analysis, which may, in fact, be partly attributable to the industry s short-term-ism and increasing focus on passive investing. However, as fundamental, long-term investors who perform deep industry research and examine company fundamentals to understand both long and short-term business dynamics, ESG issues support active examination of additional factors material to a company s business. Some factors are harder to evaluate than others. But just as our global world has shifted in a myriad of ways, it makes sense that the world of investing evolves along with it, to actively include such sustainable issues in investment analysis. Let s start with a look at one environmental factor, water. The Looming Water Crisis One does not have to look far to see the looming global water crisis. Given worldwide population growth estimates against the backdrop of already persistent droughts caused by climate change, both water scarcity and water stewardship have become a major concern. Currently, more than half of the world s 37 largest aquifers have been depleted to the point where regional water availability is threatened, according to research. In the US, California, which is the 8 th largest economy in the world and a major agricultural producer, is entering its sixth year of drought. In Asia, it has been estimated that two thirds of China s groundwater and one third of its surface water is unfit for human contact. Consequently, it is not surprising that 1

3 water crises are considered to be a top five long term risk considered by global leaders of the World Economic Forum (2016 Risk Report). Top 5 Global Risk of the Highest Concern, according to an annual survey of global political and business leaders at the World Economic Forum, 2016 While companies dependence on water varies by industry, the need for careful management of water usage and water related risks is becoming more pronounced. In 2013, San Luis Obispo County, California established a moratorium on installing any new irrigated crops to restrict water from being pulled from a low groundwater basin in a largely agricultural area. This had an immediate effect on many local farmers in this agriculturally intensive state. On the other side of the world in 2016, Coca Cola announced that it was suspending bottling operations at three units in India amid severe water shortages. This event similarly was caused by local water tables falling too low. Despite local Indian farmers who celebrated the benefit of increased availability of water to their own crops, the loss of jobs and economic impact of this closure had other, less desirable effects. So we can see the impact of reduced water supply to local economies being increasingly felt around the world. 2

4 In addition to water supply, the element of water delivery is also critically important and further impacts water access and economic growth. Perhaps in the US, it was not until the Flint, Michigan water crisis that many everyday citizens and politicians became acutely aware of the collective urgency around the nation s water infrastructure. When there is no water available, everyone takes notice. In September 2016, the Senate passed the Water Resources Development Act, which provided funding for Flint, Michigan and sets a course for necessary maintenance and water investments, but at the same time does little to add incremental investment. The House also created its own version of a similar bill. The State of the Water Industry Perhaps the most important thing to know about water is that water is not as abundant as people assume. Water is a finite resource. There is no substitute for water and there is no possibility to create new water on our planet. The available amount of water is continuously and naturally recycled between the earth and the atmosphere. Below are some highlights on the water industry: - The global water industry is roughly $550 billion in revenues, growing 3-5% annually. This can be broken down into growth of 4-7% in developing markets and 1-3% growth in developed markets. - While water makes up over 70% of the earth s surface, the actual usable amount of water is < 1% of the world s total supply. Visible water represents only a tiny amount of global freshwater sources, most of which are stored in 37 aquifers around the world. Currently, 13 of the world s 37 largest aquifers have been depleted to the point where the regional water availability is threatened. Freshwater availability around the world is becoming more vulnerable (Exhibit 1). - Water is an intensely local issue. Regional levels of water stress are due usually to population growth and increased use of water from economic development and growth. - Agriculture disproportionately uses fresh water, but the efficiency of such use varies between developed and developing countries, with developed nations typically allocating more of their water resources to industrial production means. For instance, the US utilizes nearly half of its water for industrial purposed, mainly in the form of power generation (Exhibit 2). Advancements in water efficient farming has had positive impact on water stressed areas. - Developing countries especially will require new water infrastructure. Overall economic growth tends to drive increasing water withdrawals which in turn place increasing strains on reliable water sources. 3

5 - The cost of water is highly subsidized and the majority of people believe water to be an inherent entitlement. In reality however, this subsidy creates a lack of much needed resources to improve infrastructure. - New, large scale water projects are financed mainly by government entities, but with current budget constraints post the 2008 financial crises, a lack of financing continues to limit much needed investments. - Within the US, municipal spending, which accounts for more than 80% of the water system, continues to trend positively, with manufacturers and engineering firms seeing positive demand nearly across the board. Municipal issuances and tax receipts have slightly increased year over year, which bodes well for the continuation of investment. Exhibit 1 4

6 Exhibit 2 Fresh Water Usage 80% 60% 70% 49% 65% 40% 32% 20% 10% 20% 19% 12% 23% 0% Global United States China Residential Industrial Agricultural Source: US Geological Survey, Worldwater.org Growth Drivers The demand on the global water supply is expected to continue far into the future for several reasons which include, but are not limited to: - Global population is expected to grow by 34% from 7.3 billion people today to 9.8 billion people by 2050 while water use is expected to be 40% higher by Global warming is expected to continue which will contribute to imbalances in water supply and water demand. - Urban migration continues around the world which places stress on urban water systems. - Water and wastewater related equipment is used beyond its intended operating life and maintenance expenses are outpacing new equipment spend. Water related Infrastructure both sanitation and distribution is considered to be very old. - The OECD estimates that by 2025 water will make up the largest share of global infrastructure investment. Russia, China, India and Brazil water infrastructure spending will top $1 trillion by

7 - To maintain and improve quality in the US alone, estimates are that over the next 10 years, US municipalities will need over $500 billion in capital improvements to address deteriorating piping networks, combined sewer overflows and rising population. (EXHIBIT 3) Exhibit 3 Investment Opportunity Source: Bluefield Research In addition to paying attention to the risks related to water constraints, there are also significant investment opportunities for companies directly involved in the infrastructure that addresses our global water crises. The long term demand for water, delivery and treatment was initially addressed in Water: The Wave of Future Investment Opportunities, Gabelli & Company, Inc. Globally, 3-4 million people die annually from waterborne disease. Freshwater usage grows approximately 2% per year but is a finite resource. This provides a strong incentive for governments around the world to focus on water quality and availability. We have been investing in water-focused companies already for several years. These include companies involved in: Pumps Pipes Testing Irrigation Valves Metering Filtration Desalination 6

8 In summary, water is an integral element when considering ESG investing as it is not only a material issue to many industries and businesses, but also critical to sustainable economic growth. Without more of it and careful management of water, the world s long-term economic growth could be threatened. Investing in companies that help solve the large water challenge through better management of water related risks (efficient usage, recycling, sourcing, etc.) or product opportunities related to expanding water infrastructure is key. ESG investing can broaden an investor s framework to better understand long-term economic implications related to both the reliance on and management of water. Connecting the Dots - Water and ESG Investing Environmental, Social and Governance (ESG) investing is about recognizing the impact of environmental, social and governance related factors as constraints and risks in a company s business. Water and wastewater is just one of many aspects within environmental issues to consider. Investors benefit by carefully understanding which industries and companies have the most direct financial impact from water and wastewater issues as well as which are better at managing it as a resource within their business operations. According to the Sustainability Accounting Standards Board (SASB) which guides investors on materiality of ESG issues, industries most financially impacted by water are: Consumption Renewable Resources Resource Transformation Agricultural Producers Biofuels Containers, Packaging Meat, Poultry, Dairy Solar Energy Chemicals Processed Foods Paper and Pulp Non-Alchoholic Beverages Alcoholic Beverages Infrastructure Services Household Personal Products Electric Utilities Hotels & Lodging E-Commerce Waste Management Restaurants Non Renewables HealthCare Technology & Communications Oil & Gas Exploration& Production Medical & Equipment Suppliers Electronic Mftg Services Oil & Gas Exploration Services Biotech Software & IT Services Oil & Gas Refining and Marketing Pharmaceutical Semiconductors Coal Operations Internet Media & Services Iron & Steel Production Metals & Mining Construction Materials Source: Sustainability Accounting Standards Board, Materiality Map TM 7

9 Long term investors are better informed by including water reliance and management as we consider the external factors of these industries. We have seen some global companies recognize water as a critical element and set targets to track, manage and then reduce their overall water usage. Some are able to replenish water used back into nature and communities. Others do not recognize water as an inherently important input to their process nor make any attempt to curb water use in production. Curbing water use is not easy but it can contribute to future water availability long term and potentially higher profit and sustainability of the underlying businesses that rely on it. Responsive companies restructure their operations so that water intensive parts of their businesses are mapped to regions where water is more plentiful. Decades ago, this did not matter to investors. Even today, while this may seem obvious to some, company management at many companies have not established formal processes to consider such sustainable issues when developing business operational plans. But as long term investors, we believe sensitivity to water constraints in industries where it is material is an externality that investors should understand. Connecting the dots between environmental, social and governance issues in investing helps evaluate risks. We further believe it differentiates businesses which consider relevant factors to their industries. Why Gabelli and ESG? GAMCO has been involved in responsible investing since As a fundamental investor focused on investing in industries where we have accumulated compound knowledge, incorporating material ESG issues certainly provides us with additional insight. However, we believe there is a lot of information in these areas which is still evolving. This necessitates both experience and active investment judgment to best consider these issues. For more information on ESG investing: Christina L. Alfandary (914) , ESG & Sustainable Investments 8

10 Sources: 1) Water: The Wave of Future Investment Opportunities, Gabelli & Company, Inc., ) United Nations: The World Water Quality Assessment, March ) United Nations: An Overview of the State of the World s Fresh and Marine Waters- 2 nd Edition ) World Water Council and OECD: Water: Fit to Finance? April ) World Bank Water Partnership Program: Investing in Water Infrastructure: Capital Operations & Maintenance, Nov ) Bluefield Research: U.S. Municipal Water Infrastructure Utility Strategies & CAPEX Forecasts, ) 2030 Water Resources Group ( 8) USGS.gov 9) Worldwater.org 10) Waterworld.com IMPORTANT DISCLOSURES GAMCO ASSET MANAGEMENT INC. ONE CORPORATE CENTER RYE, NY TEL (914) FAX (914) We prepared this report as a matter of general information. We do not intend for this report to be a complete description of any security or company and it is not an offer or solicitation to buy or sell any security. All facts and statistics are from sources we believe to be reliable, but we do not guarantee their accuracy. We do not undertake to advise you of changes in our opinion or information. We refer to private market value or PMV, which is the price that we believe an informed buyer would pay to acquire 100% of a company. There is no assurance that there are any willing buyers of a company at this price and we do not intend to suggest that any acquisition is likely. Additional information is available on request. Investors should carefully consider the investment objectives, risks, charges, and expenses of any Fund before investing. The prospectus, which contains more complete information about this and other matters, should be read carefully before investing. To obtain a prospectus, please call 800-GABELLI or visit Stocks are subject to market, economic and business risks that cause their prices to fluctuate. When you sell Fund shares, they may be worth less than what you paid for them. Consequently, you can lose money by investing in the Fund. The Gabelli Mutual Funds are distributed by G.Distributors, LLC., a registered broker-dealer and member of FINRA. 9