Investing in a Changing World

Impact Reflection

Strategies that include environmental, social, and governance (ESG) considerations continue to gain attention as investors weigh the long-term impact of corporate activities on people’s lives. Much of that attention has been positive, with investor demands driving greater corporate accountability and climate-focused investments being heralded as high-impact solutions. The attention has also created negative reactions, including companies greenwashing their activities and politicians dragging ESG into political culture wars. The reality, as is often the case, exists somewhere in the middle.

ESG is not a cure-all for the environmental or social challenges we collectively face. It can, however, serve as a valuable tool for investors to reduce specific portfolio risks and align their investments with a changing world. Increasing investor demand, more corporate engagement, and a significant improvement in data collection should all support continued economic growth and innovation.

We have no shortage of evidence that the climate is changing – an unfortunate fact that has moved beyond scientific consensus and into the front pages of our news outlets. California is currently being pummeled with snow and rain. Cyclone Freddy just set the record for longest tropical storm in history. These and countless other weather events have gotten more extreme in recent years.¹ Companies still operating in an old climate paradigm are facing an increasingly significant risk, while those firms seeking to proactively understand their exposure and address shifting energy costs are better positioned to mitigate that risk.

Even conservative predictions suggest that fossil fuel usage for power generation will peak soon if it hasn’t already.² Companies providing wind and solar energy are currently adding more capacity to the grid annually than natural gas has in any previous year, and renewables are projected to pass coal as the largest electricity source globally by 2025.³ This rapid change is paired with dramatic progress toward electric vehicles, with almost every major auto producer having announced intentions to fully stop production of internal combustion engines within 10 to 20 years. This transformation will benefit sectors including battery storage and energy efficiency technology as well as the commodities and infrastructure needed to scale up production. The global energy transition will continue to influence markets, and change will depend on a combination of investment, supportive public policy, and innovation.

Change is already underway, including in less obvious sectors. Walmart, the world’s largest retailer, has implemented more than 550 renewable energy projects and aims to be powered by 100% renewable energy by 2035 – and estimates it’s already at 36% as of 2022.⁴ Target has added solar panels to the top of more than 500 stores, and plans to source 100% of its energy from renewable options by 2030. These large-scale changes from existing companies represent an important complement to the more ambitious projects like fusion and carbon capture that grab headlines.

While many investors seek ESG to align with their own values, this investment style can also be an essential tool for risk management. Businesses are increasingly being asked to be part of the solution to a shifting climate. Companies that proactively include this as part of their corporate strategy will be better positioned for future growth opportunities and cost savings, and also avoid the reputational risk that may come from declining to make the effort.

The “E” in ESG has historically gotten the most attention, but expanded focus on the “S” has allowed investors to look more intentionally at social factors including diversity on corporate leadership teams and within workforces. This is another area where ESG can help assess future risks when vetting companies for long-term investment. Firms that shun DEI efforts introduce the risk of reduced employee retention, while companies that proactively address these issues are better positioned to attract the high-quality talent that helps fuel future growth.

The data backs up this theory. According to a recent McKinsey study, companies in the top quartile for racial and ethnic diversity are 35% more likely to have financial returns above their respective national industry medians.⁵ Diverse companies have also been more successful in capturing new markets through innovation. A global study shows that above-average workforce diversity was correlated with companies having +19% higher innovation revenue (from products launched within the last three years) and +9% higher profit margins compared with below-average diversity companies.⁶In an increasingly dynamic business environment, this means that these companies are better able to quickly adapt to changes in customer demand.

Despite this data, progress is often slow. Efforts to improve gender parity on corporate boards saw less progress in 2022 than prior years, despite continued engagement from ESG-oriented investors. Still, women ended the year at a record 32% of S&P 500 corporate board seats and are on pace to exceed one-third of board seats this year for the first time.⁷ With International Women’s Day celebrated earlier this week, we recognize the progress that has been achieved as well as the distance still to go.

There are irreversible macro trends underway that should broadly support portfolios aligned with a changing environmental and social landscape. In the short term, the financial materiality of these trends is less certain. The conversation about regulation and implementation is still evolving, and ongoing debates about the merits of ESG will likely persist with presidential elections coming up next year. While it can be frustrating to see alarmist headlines and slow progress, new policies and active dialogue around these issues can ultimately move the conversation toward more sustainable outcomes.⁸

For investors, taking the long view has been a far more reliable way to reduce risk and achieve portfolio growth than attempting to time short-term gyrations. At North Berkeley, we take comfort in a view that extends beyond election cycles and near-term uncertainty, and we maintain the perspective that renewable energy and diverse workforces will be key drivers of economic growth – and portfolio performance – in coming decades.

Risk Considerations: There is no assurance that strategies incorporating ESG factors will result in more favorable investment performance over any particular time period. Strategies that incorporate impact investing and/or Environmental, Social, and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. 

Resources
¹ Extreme weather, fueled by climate change, cost the U.S. $165 billion in 2022 NPR.org 
² Even Conservative Estimates See Fossil Fuel Use Peaking Soon Bloomberg  
³ Renewables to overtake coal as world’s top energy source by 2025, IEA says Washington Post  
⁴ Target looks to massive solar panels in California CNBC  
⁵ Why diversity matters McKinsey & Co  
⁶ How Diverse Leadership Teams Boost Innovation Boston Consulting Group  
⁷ Women’s Gains on S&P 500 Boards Slow, Delaying Parity Progress Bloomberg Law  
⁸ Clean Energy Is Suddenly Less Polarizing Than You Think New York Times