ESG Politicization and Backlash – a Return to Sustainability?
I listened to an ESG (environmental, social, and governance) webinar last year in which the head of ESG at a major European bank noted that the ESG industry had “matured” – meaning the industry had concluded that, for example, a wholesale exit from investing in carbon-producing entities would have unintended and negative consequences, such as the selling of carbon assets to bad actors, thus not really helping to reduce carbon emissions. Now the focus is more on engaging companies and municipalities to be part of the energy transition, without negativism or the boycotting of stocks and bonds. But damage has been done, and now there is pushback, much of it political.
In Texas, a big movement to wind and solar for diversification and because there were subsidies, combined with extreme weather, may have exacerbated the disruptions caused by storm Uri and contributed to the deaths of residents. The fixation on wind and solar may have directed resources into alternatives that could have been applied to preparing for extreme weather, in particular the resilience of oil and gas assets in extreme cold weather.
The conversation seems to be changing. Municipal and corporate providers are concerned about carbon emissions and are keenly aware of the myriad risks affecting the long-term viability or sustainability of their businesses. For example, utilities are focused on reliability. A reliable electrical grid is so important, not just to keep folks safe from extreme heat and cold but also to support critical functions. We are so much more dependent now on the cloud and computing in general, services that are seriously dependent on electricity reliability! Can you imagine if you couldn’t find documents or bills or make payments, charge or fuel your car, confer with advisors, or call your mom and dad or daughters and sons! Water supply and wastewater management are essential services tied into this picture, too, as they are likewise dependent on electricity.
Companies and entrepreneurs are developing new technologies to enhance efficiency, reliability, and reduce carbon, which consumers value. Electric utilities and their regulators know how essential reliable service is and work hard every day to provide it. Their training compels them. They are first responders before we need first responders.
And keep in mind that, going forward, many employees will need to be retrained and not laid off, for an energy transition and the quickly changing landscape that AI is creating in many businesses. Some union rules and decisions work against retraining, and these will need to be rethought. New jobs will be created, and trained people will be needed to do them.
A final observation is that the vernacular appears to be changing toward emphasizing the sustainability of a company or municipality rather than ESG aspects. Some use ESG categories for risk analysis in their decision-making process for managing a business or investing in a company or municipality, while others use the terms to identify the impact of an investment that may be important to them. Although ESG factors will continue to be evaluated, the term may be too narrow or too politically charged a moniker. More recently, ESG-related conferences have emphasized sustainability, especially for companies and municipalities as well as investors. I started seeing the term sustainable frequently in 2010; then ESG came into vogue, and now sustainability is being emphasized again. The focus on ESG may have become too narrow and restrictive, not allowing for flexibility to accommodate new developments, risks (war, out-of-control wildfires), technologies, and events. The increase in AI computing power and the amount of data that can be collected, analyzed, and reported on also widens the focus. Regulatory changes being considered for transparency in disclosure in Europe and the US should include the need for flexibility.
At Cumberland Advisors, each client whose money we manage, whether a pension plan or individual, has their own separately managed account, held by a custodian. Most of our accounts are invested in tax-exempt muni bonds; however, we also utilize taxable muni bonds in our taxable fixed-income strategies. Our equity strategies utilize mostly ETFs. See https://www.cumber.com for a listing of our strategies. Municipal bonds have always been a natural ESG investment, as they serve the public. Historically, some clients have asked us to exclude from their portfolios tobacco, gambling, prison, “sin tax,” or other bonds. This is a form of impact investing, and it is possible with separately managed accounts.
In general, when looking at the credit quality of municipal bonds and a municipality’s sustainability, we evaluate security provisions; the strength of the service area economy; and financial strength indicators such as debt service coverage, leverage, cash levels, and reserves – not just at a point in time but instead at how those factors have been managed over time and expectations for the future. We also consider risks associated with changing weather and plans for resiliency (E). We look at affordability and crime, which may affect population trends (S). And we evaluate management by how it performs vs. its budget and capital planning (G). The credit assessment is one part of the analysis of a purchase decision; the other is pricing of the bond and whether the yield reflects the quality of the investment and has value relative to other bonds. Most of our investments are in bonds that are generally of good quality and have good liquidity.
Fed interest rate hikes, while producing higher short-term yields, also result in lower long-term yields because there is an expectation of the economy slowing and even lower long-term rates eventually. Long munis continue to provide value, with taxable equivalent yield of some tax-exempt munis topping 6%. John Mousseau discusses this in more detail in his second-quarter market commentary: https://www.cumber.com/market-commentary/2q-2023-bond-market-bank-crisis-rear-view-mirror.
Patricia Healy, CFA
Senior Vice President of Research & Portfolio Manager
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