ESG and Inflation: Short-Term Pain, Long-Term Gain
Is ESG investing fueling inflation?
As counterintuitive as it seems, the well-intentioned allocation of capital may come at a cost to investors. That’s particularly true in the energy sector. Environmental, social and governance, or ESG, investing has grown very quickly into a mainstream and increasingly dominant force in portfolios, reflecting growing concerns among investors across a range of issues from boardroom diversity to carbon footprint.
Let’s back up. This style of investing is designed to combine capital growth with long-term business and environmental sustainability. Estimates vary widely, but it seems fair to say that the 40%-plus growth over the last few years that has led to $17 trillion1 in sustainably invested assets is poised to continue apace.
Countries and corporations are paying attention. At present, 90% of S&P 500 corporations publish a sustainability report, up from 20% in 2011, indicative of both investor and management focus.2 Among the topics addressed are direct impacts like energy companies transitioning from reliance on fossil fuels, in response to investor and regulatory pressures, as well as corporate commitments to sustainability.
As a result, traditional energy production is becoming more difficult and more expensive. Oil production growth rates are falling and coal use is dwindling.
So far, so great for ESG investors. But energy transitions take time. Coal, oil and natural gas all took decades to move to peak usage. While some renewables, notably solar and wind, are now within striking distances of rivaling traditional energy sources in cost effectiveness at scale, there are still some big issues to be resolved, such as those around storage and transmission. Overall, the use of modern renewables is barely a decade along in its growth. At the same time, global demand for energy is rising. The International Energy Agency projects global energy demand to increase by more than 2% per year for the coming decade and, in the recovery from the pandemic shutdowns, almost double that rate in 2021.
As Bill Gates describes in his book How to Avoid a Climate Crisis, the move to modern renewables is, at this time, based on environmental interests and often in the face of economic interests. A possible result is inflation and the economic pressures that go along with it. As a case in point, rising prices across most of the energy sector are contributing to increases in gasoline prices to multiyear highs, putting pressure on consumers, as illustrated by the chart below. While these price hikes may indeed prove transitory, they also serve as a reminder of the importance of considering longer-term supply-demand dynamics.
What would be the offset to this inflation? As with so many other aspects of the economy, we look to technology-driven productivity gains and the companies leading that charge. The 2020 pledge by Google parent Alphabet to carbon-free targets by 2030 was big news. Two other examples from the current Evercore Wealth Management core equity portfolio also serve as good examples of corporate change: BorgWarner, a traditional auto parts supplier, is evolving into an electric vehicle/hybrid supplier; and Microsoft’s Azure cloud segment has built a suite of software designed to drive efficiencies and safety throughout the energy industry.
Investors will be wise to monitor the extent of this green premium. Future inflationary trends and the transition to a greener future are important considerations in building portfolios meant to last.
Michael Kirkbride is a Managing Director and Portfolio Manager at Evercore Wealth Management. He can be contacted at michael.kirkbride@evercore.com.
Evercore Wealth Management, LLC ("EWM") is an investment adviser registered with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. EWM prepared this material for informational purposes only and should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. It is not our intention to state or imply in any manner that past results are an indication of future performance. Future results cannot be guaranteed and a loss of principal may occur. This material does not constitute financial, investment, accounting, tax or legal advice. It does not constitute an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Specific needs of a client must be reviewed and assessed before determining the proper investment objective and asset allocation which may be adjusted to market circumstances. EWM may make investment decisions for its clients that are different from or inconsistent with the analysis in this report. EWM clients may invest in categories of securities or other instruments not covered in this report. Descriptions provided in this material are not substitutes for disclosure in offering documents for particular investment products. Any specific holdings discussed do not represent all of the securities purchased, sold or recommended by EWM, and the reader should not assume that investments in the companies identified and discussed were or will be profitable. Upon request, we will furnish a list of all securities recommended to clients during the past year. Performance results for individual accounts may vary due to the timing of investments, additions/withdrawals, length of relationship, and size of positions, among other reasons. Prospective investors should perform their own investigation and evaluation of investment options, should ask EWM for additional information if needed, and should consult their own attorney and other advisors. Indices are unmanaged and do not reflect fees or transaction expenses. You cannot invest directly in an index. References to benchmarks or indices are provided for information only. The securities discussed herein were holdings during the quarter. They will not always be the highest performing securities in the portfolio, but rather will have some characteristic of significance relevant to the article (e.g., reported news or event, a new contract, acquisition/divestiture, financing/refinancing, revenue or earnings, changes to management, change in relative valuation, plant strike, product recall, court ruling). EWM obtained this information from multiple sources believed to be reliable as of the date of publication; EWM, however, makes no representations as to the accuracy or completeness of such third party information. Unless otherwise noted, any recommendations, opinions and analysis herein reflect our judgment at the date of this report and are subject to change. EWM has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete. EWM’s Privacy Policy is available upon request. EWM is compensated for the investment advisory services it provides, generally based on a percentage of assets under management. In addition to the investment management fees charged, clients may be responsible for additional expenses, such as brokerage fees, custody fees, and fees and expenses charged by third-party mutual funds, pooled investment vehicles, and third-party managers that may be recommended to clients. A complete description of EWM’s advisory fees is available in Part 2A of EWM’s Form ADV. Trust services are provided by Evercore Trust Company, N.A., a national trust bank regulated by the Office of the Comptroller of the Currency and/or Evercore Trust Company of Delaware, a limited purpose trust company regulated by the Delaware State Bank Commissioner, both affiliates of EWM. Custody services are provided by Evercore Trust Company, N.A. The use of any word or phrase contained herein that could be considered superlative is not intended to imply that EWM is the only firm capable of providing adequate advisory services. This material does not purport to be a complete description of our investment services. This document is prepared for the use of EWM clients and prospective clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of EWM. Any unauthorized use or disclosure is prohibited. The Chartered Financial Analyst and CFA trademarks are the property of CFA Institute. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and CFP® in the U.S.
IRS Circular 230 Disclosure:
Pursuant to IRS Regulations, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for (i) the purpose of avoiding IRS imposed penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This information is provided for information purposes only and does not constitute financial, investment, tax or legal advice.
©2016 Evercore Wealth Management LLC. All rights reserved.
