Essex Global Environmental Opportunities Strategy (GEOS) February 2023 Update
Companies continue to face pressure from investors and other stakeholders to disclose more ESG-related information. However, it is important to differentiate strong ESG reporting from strong ESG performance. Strong ESG reporting can be characterized as companies disclosing useful information about their material ESG risks and opportunities. Frequently, companies align their disclosures, such as ESG or sustainability reports, to a standard like the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), or the Task Force on Climate Related Financial Disclosures (TCFD). The disclosed ESG information can then be used by investors as an input into research processes or valuation models and by other stakeholders interested in various ESG topics.
Unfortunately, good ESG reporting is often misinterpreted as strong ESG performance, whether your definition of strong ESG performance is managing material ESG risks or helping solve environmental or social challenges. Just as companies can have high quality financial reporting but low earnings quality, companies can produce detailed ESG disclosures but perform poorly across several elements of E, S, and G. Too often, there is a disclosure bias where companies who report more information on ESG topics, regardless of whether it is good or bad, are perceived as strong ESG performers. As an example, a company may produce a detailed sustainability report aligned with SASB standards that provides all information relevant to their material ESG risks and opportunities. However, the company may have a poor track record on worker safety, generate significant air pollution, and produce products that negatively impact consumer health. Yet, many investors may associate their good ESG disclosures with good performance. Investors must be aware of this bias and understand that some research shows that companies with severe deficiencies on ESG issues may in fact disclose more information to try to hide their shortcomings under a mountain of data.
The GEOS team welcomes more transparent disclosure on ESG topics from companies, but we understand good reporting does not equal good ESG performance. We look for companies providing sustainable solutions to environmental challenges that operate their business responsibly. While more detailed ESG disclosures can help us assess the material ESG risks and opportunities a company faces, we understand investors will never have perfect information. Furthermore, we don’t confuse quality of performance with ESG reporting quality.
We believe there are three primary drivers that continue to be supportive of GEOS:
Geopolitics – the global energy crisis, caused by the ongoing Ukrainian war is accelerating the adoption of renewable energy and clean technology, from solar energy development to energy efficiency technologies. Global trade frictions and the uncertainties stemming from the energy crisis are catalyzing onshoring of manufacturing as countries, industries and companies strive for economic growth and global competitive advantage. The global pandemic and geopolitical crises have strongly demonstrated the fragility of supply chains. Just in time manufacturing is no longer possible nor prudent. To limit business and execution risks, companies are moving manufacturing models close to customer bases – “nearshoring” is the new buzzword, to control inputs and harness economic growth. While companies viewed domestic production as defensive during the pandemic, it is now increasingly recognized as an offensive benefit by CEOs and politicians alike.
Climate change – severe weather is at hand, from super storms sweeping North America, to prolonged droughts in South America, while Europe experiences historically warm weather. The frigid weather of Texas and winter tornados in our south are alarming and illustrate the need to adapt to this severe weather, with more resilient and flexible electrical grids and water management solutions. We need to rapidly move to more flexible and adaptable infrastructure for climate resilience and public safety.
Policies – the US Inflation Reduction Act (IRA) provides at least $369 billion to support the energy transition, primarily through tax credits, with key areas of focus including renewable energy, electric vehicles (EV) and charging infrastructure, low carbon hydrogen, biofuels, carbon capture, utilization, and storage (CCUS), and establishing a domestic supply chain for clean technology components. While the $369 billion headline figure is significant, many of the IRA tax credits are uncapped which means actual investment will likely be significantly higher. The IRA is expected to drive meaningful progress towards meeting the 2030 US climate goal to reduce greenhouse gas emissions by 50-52% compared to 2005 levels. We believe this Act places a stake in the ground that the US can lead the global clean technology race. Since passing, the EU appears a bit flat footed, as several EU-based companies have announced significant expansions here in the US. The IRA has been positioned as a domestic economy driver, for energy independence while scaling global economic leadership.
We believe GEOS is positioned for and will benefit from each of these drivers. As domestic manufacturing increases in the throes of historically high labor pressures, companies must invest in productivity, from industrial automation to technologies that lessen commodity price volatility such as energy storage. Flexible and more resilient electricity distribution is needed as severe weather worsens. And, while many segments of clean technology are mature, taking share from the incumbents such as renewable energy, the IRA will expedite segments such as battery storage and green hydrogen where we are taking the lead in the US. Clean tech is now linked to job creation and “made in America.”
Disclosures:
This commentary is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. The opinions and analyses expressed in this commentary are based on Essex Investment Management LLC’s (“Essex”) research and professional experience and are expressed as of the date of its release. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is intended to speak to any future periods. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties.
This does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product, nor does it constitute a recommendation to invest in any particular security. An investment in securities is speculative and involves a high degree of risk and could result in the loss of all or a substantial portion of the amount invested. There can be no assurance that the strategy described herein will meet its objectives generally or avoid losses. Essex makes no warranty or representation, expressed or implied; nor does Essex accept any liability, with respect to the information and data set forth herein, and Essex specifically disclaims any duty to update any of the information and data contained in the commentary. This information and data does not constitute legal, tax, account, investment or other professional advice. Essex being registered by the SEC does not imply a certain level of skill or training.
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