For Buffett, Berkshire, beating BlackRock ESG may be as hard as beating S&P 500

• Warren Buffett's Berkshire Hathaway is beating the S&P 500 in 2021 and over the weekend delivered second quarter earnings that showed its rebound from the pandemic.
• One area where Buffett and Berkshire aren't leading, though, is on environmental, social and governance (ESG) metrics, and on issues like climate change, where Buffett has said personal belief in its significance does not compel management to make decisions based on shareholder climate concerns. The UN's IPCC said it was "code red for humanity" in a new report on Monday.
• Buffett's iconic company may be a test of whether a well-run company, which delivers top financial performance, can continue to buck the market's embrace of formal and transparent ESG methods that are being advocated by influential investors including BlackRock, the world's largest asset manager.

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Berkshire Hathaway CEO Warren Buffett (L) and his business partner Vice Chairman Charles Munger are among the five Berkshire directors age 90 or older. Berkshire experts expect board changes to be among the most significant influences for the company's future path.Eric Francis | Getty Images News | Getty Images

Berkshire Hathaway is one of the best-run public companies of the 20th century, with the financial performance to prove it. But as the 21st century brings a new generation of investors shifting from pure shareholder capitalism to the stakeholder capitalism aligned with environmental, social and governance mandates, is Warren Buffett's company positioned to be an ESG leader or laggard? The answer isn't so simple.

Look at the ESG rankings — far from perfect methodologies at this early stage of the industry's development — and the answer isn't kind to Berkshire. Whether it's MSCI ESG or the scorecard from ESG specialist JUST Capital, Buffett is in a position he isn't used to: near the bottom. 

But by some operating business measures, Berkshire Hathaway — just by doing what it does — is delivering on ESG. Berkshire Hathaway Energy, its utility company, is the biggest producer of wind energy in the U.S. Buffett's largest stock holding, Apple, is consistently ranked among the best ESG companies in the market. On diversity, Berkshire just elevated the first-ever female CEO to run a U.S. railroad company, at Burlington Northern. Its board includes a Black director (Ken Chenault), an Indian director (Ajit Jain) and four women. But turnover of the board has been, according to Berkshire experts, too slow. 

The world's biggest investor votes against Buffett

None of the Berkshire attributes that can be judged as ESG favorable was a factor for BlackRock, the world's largest asset manger and the biggest force in ESG investing, when it came time to vote in the just-passed proxy season. BlackRock voted against two Berkshire directors — the directors of its audit and governance committees. And it voted with shareholders on requirements that the company produce a climate report and its holding companies produce diversity reports. BlackRock singled out Berkshire Hathaway — a step it takes with only a select group of companies in its annual investment stewardship report — as a company that left it with no choice but to vote against management.

"Berkshire Hathaway has a long history of strong financial performance; however, we had concerns related to our observation that the company was not adapting to a world where sustainability considerations are becoming material to performance. For several years BIS attempted to engage with Berkshire Hathaway, but our requests for direct dialogue were not granted," BlackRock wrote in the report.

What stands between BlackRock and engagement with Berkshire, may be no more than Buffett himself. And, according to Berkshire experts, there isn't an expectation that the company will more visibly embrace ESG as long as Buffett is running it. 

"He can do what he wants," said James Shanahan, an Edward Jones financial services sector analyst who covers Berkshire. "I don't think Buffet cares what Blackrock thinks. He runs the company for Berkshire investors, not BlackRock." 

Even the ESG experts are hesitant, for now, to take to hard a line against Berkshire.

Martin Whitaker, CEO of ESG investing specialist JUST Capital, which was co-founded by hedge fund billionaire Paul Tudor Jones, said the biggest problem with Berkshire Hathaway to date is the lack of disclosure, but that does not mean Berkshire isn't taking actions that are in line with ESG goals. It means Berkshire just isn't playing ball with the new way to show the market its ESG credibility. The problem: it's difficult to give companies the benefit of the doubt when the information isn't available.

"Look at the history of disclosure of financial performance over the past 100 years. Think of ESG in analogous terms being in the first inning," Whitaker said. "But if you're an emissions-intensive company and you're not disclosing emissions and all your competitors are, then it's natural people will look and say it's not good, maybe you're hiding something. Disclosure has always been a sign of having your act together and being confident about strategy."

He doesn't think Berkshire can stick with its current stance forever. "The issue with disclosure is it's coming, whether they like it or not, people want to know. .. and that journey starts with data and analysis, and at some point they have to start to disclose more," Whitaker said.

Buffett's 'unassailable control'

Buffett still owns a massive stake in Berkshire shares even as he has reached the halfway point of donating his company stock to philanthropy. In announcing the milestone in June, Buffett explained that one of the reasons he chose to make the share gifts gradually was to retain "unassailable control" over the company. That isn't changing yet. 

Shanahan, and others who closely follow Berkshire, are hesitant to say Buffett's company will ever take an approach to ESG that takes its lead from others. Rather, what ESG will mean to Berkshire could be already embedded in its management approach and its unique structure, decentralized with all the individual affiliate management teams at the operating companies making their own decisions. 

"ESG will matter at some point," Shanahan said. "But more from a business standpoint."

A good example of that ESG approach is the utility business. In the past, when challenged by shareholders, including one of the most formidable climate scientists in the world, James Hansen of NASA, Buffett said believing that climate change is real on a personal basis does not mean believing it should be the basis for investment decisions. And that is why for a capitalist running one of the largest utility company's in the U.S., and one of the largest insurance businesses in the world, Buffett's dismissal of climate disclosure as material to Berkshire shareholders has attracted criticism. 

On Monday, the UN's Intergovernmental Panel on Climate Change delivered its starkest climate change outlook yet, saying it is "code red for humanity."

If they focus on ESG through the business lens and financial lens, they will see climate as a big issue. I don't need them to make a big song and dance about it, but they should be disclosing what they are doing.Martin Whitaker, JUST Capital CEO

Whitaker, who worked in the insurance industry earlier in his career, said SwissRe began analyzing climate as an economic risk many years ago. Berkshire has a large presence in reinsurance like Swiss Re, and Whitaker noted, "as a reinsurer, you are holding the bag. … I'd be shocked if they are doing nothing on climate, they are in industries which are really in on the long-term climate risk: insurance, infrastructure, transportation, real estate. … they are all now already affected."

Berkshire's utility business — and its coal footprint — are changing. The percentage of generation from renewables has been rising steadily, whether in its Iowa wind corridor or in the Southwest where solar is economic as well. The percentage of coal shipments made by Burlington Northern have been going down (though a reflection of the market for coal more than conscious Berkshire strategy). Burlington Northern revenue from coal has declined from over 20% in the 2014/2015 period to 13%, Shanahan noted, while the utility company's contribution from renewables has steadily increased to over 40% of generation, among the highest in the U.S.

Siemens wind turbines operate on a wind farm in Marshalltown, Iowa, managed Berkshire Hathaway Energy's MidAmerican Energy.Timothy Fadek | Corbis News | Getty Images

Berkshire's $10 billion deal for the natural gas assets of Dominion Energy is an example of how the ESG issue can be viewed in more than one way. Natural gas has been taking share from coal for a decade and is a cleaner fuel which is viewed by many as a "bridge fuel" to a fossil fuel-free future, but it isn't a renewable and it is closely tied to fracking. 

Berkshire Hathaway Energy, specifically, voiced support for the Paris climate agreement and committed to some reductions in emissions as far back as 2015.

And there is Chinese electric battery leader BYD, which Berkshire invested in well before many companies were even talking in ESG terms or about electric cars specifically, over a decade ago, and which has been the hottest stock in Buffett's portfolio, trouncing even Apple.

BYD shares are up over 400% since the Covid crash, and are outperforming every stock investment the company holds, including Berkshire stock itself.

"It seems like the environmental footprint is improving," Shanahan said, and he worries about a company known for making shrewd investments that other investors bail on too quickly, moving to adopt an ESG approach dictated by outside factors.

Buffett invested in natural gas at a time when many ESG investors were critical of any fossil fuels, and invested in Pilot Flying J truck stops and a large network of auto dealerships. At the outset of the electric car and autonomous truck era, it's easy to see these investments as being out of favor and subject to ESG scrutiny. But Shanahan said if ESG thinking were to prevent Berkshire from making the value-oriented investments that generate a lot of cash flow over the next 10-15 years, it would have the wrong impact on shareholders. 

The next generation of Berkshire investors

Greg Womack, a long-time holder of Berkshire shares for clients of his investment company Womack Investment Advisers, said it isn't clear to him if Berkshire Hathaway would fit in an ESG portfolio today, but to date, the financial performance is there, including the most recent quarterly earnings released over the weekend that showed the company rebounding from the pandemic. 

Buffett has made an entire generation of American stock market investors wealthy, and mostly a generation of Baby Boomers whose investment process pre-dated the recent rise of ESG. But a post-Buffett Berkshire faces not only the CEO succession issue, but a generational transfer of Berkshire stock among its shareholders. Many current holders may choose to pass down shares rather than sell due to tax considerations, and that has Shanahan thinking about a gradual shift in investment beliefs.