TL;DR: Buffett, while notoriously quiet on ESG, might have a lot more in common with responsible investors than people think, but convincing him to take on more is through the language of risk, not social responsibility.
Over the weekend, Berkshire Hathaway, Warren Buffett’s investment vehicle, held its annual shareholder’s meeting, where the Oracle of Omaha shared his thoughts on various subjects including derivatives (described last year the “weapons of mass destruction”, this year described as “potential time bombs”), Valeant Pharmaceuticals (a “sewer” as Charlie Munger put it mildly), climate change and its impact on the insurance industry (he doesn’t think it will hurt his insurance business), and least but not the least, his daily diet of cherry Coca-Cola.
Berkshire Hathaway, one of the most profitable companies in the planet, is also one of the laggards when it comes to integrating ESG in its investment activities. Berkshire’s refusal to integrate ESG has frustrated responsible investors and advocacy groups, and if the last AGM was any indication, the frustration will continue.
But the last AGM also showed that while Berkshire may continue to resist any overt acknowledgment of the materiality of ESG issues, Buffett’s investment style has a lot in common with responsible investors than one would think. Here’s why.
Intrinsic Value is the Common Factor
Buffett’s investment style is well-known. He focuses what brings value and what reduces value of a company. In doing so, he looks at a variety of metrics that would point to the long-term value or the long-term risks. So one common ground is duration. Except of black swan cases, ESG issues typically play out over a longer time horizon. Responsible investors, like Buffett take a long-term view on their investments, but in the process analyze the trends that may affect a company’s value.
When asked about Valeant Pharmaceuticals, Buffett pointed out that Valeant’s business model was “enormously flawed” and Charlie Munger called the company a “sewer”, views that align with ESG analysis that Valeant’s business model was unsustainable over the long-term. The alignment is important because up until early March 2016, Wall Street analysts continued to give the company the benefit of the doubt and some analysts maintained their “buy” ratings, claiming they were looking at the company’s long-term potential. Anybody looking at the company’s long-term potential would see a different picture, and it is closer to what Buffett and Munger expressed last Saturday. The integration of non-financial metrics such as business model and governance, is a key area of commonality between Buffett and responsible investors.
Similarly, Buffett’s warning over derivatives also aligns with ESG analysis on the impacts of financial products. Buffett has never been a fan of complex financial instruments, and his view aligns with ESG analysis that such products raise a financial company’s risk profile. When used purely as hedging tools, derivatives serve a useful purpose. But as the Great Depression showed, derivatives, when used as trading instruments or for financial engineering, can indeed become “weapons of mass destruction”.
In short, Buffett aligns with the investment goals of responsible investors in that both seek to invest in companies with intrinsic value, companies that are responsible in running their business and ultimately preserve shareholder value.
Buffett is no ethical investor and remains at odds with many advocacy groups as well as socially responsible investors for his inaction on environmental and social issues. Perhaps the most controversial discussion on Saturday was Buffett comments that climate change, while serious, will have no significant impact on the insurance business. After all, insurance companies can simply raise premiums for those with the highest exposure. Noting that the increasing cost of repairs has raised the value of the insurance business. There is certainly short-term evidence that supports this line of thinking. Hurricane Sandy, one of the worst disasters in the US in the last five years, did not affect commercial insurance that much, although there is no denying that its overall economic impact was severe.
Buffett was also criticized for “predatory lending” by one of its investee companies to which he replied along the lines of his Coca Cola defense, that loans were not being forced on Clayton Homes customers. Buffett famously pushed back on criticism that Coca-Cola, a Berkshire investee, is partly responsible for increasing obesity, a position that, at first glance, counters growing shareholder concern over the societal impacts of obesity. In Buffett’s view, his companies cannot be faulted for personal choices of consumers.
Perhaps what irks advocacy groups the most is his thinking that societal problems are not something investors should lose sleep on. He acknowledges that these problems are serious, but his companies should not be expected to solve them. Buffett is of the era where a business exists to make money for shareholders (think University of Chicago school of thought) and that dealing with broad societal problems, while important, can take up too much resources of a company for little reward.
Bridging the Gap through the Language of Risk
The language of social responsibility does not appeal to Buffett, what appeals is the language of risk, and this is probably where both parties can meet halfway. I’m guessing that had obesity been raised as a risk factor to Coca-Cola’s long-term viability as a softdrink maker, Buffett might have responded differently, and his response might have aligned with growing concerns over obesity. Had the issue been framed in the lens of risk rather than corporate responsibility, we might have gotten a more thoughtful response other than his daily intake of Coca-Cola (and how this continues to make him a happy man).
If the end goal of the climate change proposal is to get him to openly make a stand against fossil fuels, that goal is unlikely to be achieved. But if the goal is to raise relevant emerging risks to the insurance business over the long-term (post Buffett era probably), the Oracle might have been more circumspect with his response. I did not watch the live stream of the meeting but would be curious to hear what he considers the the tipping point of losses attributed to extreme weather to have significant business impact on the insurance industry and how his insurance business is preparing for this.
Pursuing ESG as a risk management tool and bringing in more concrete risk factors may be a strategy worth trying in next year’s meeting. All business owners respond to the language of risk, and Buffett is no exception. Making that language more precise is the challenge, but may do more in bringing Buffett along to the ESG fold.