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Warren Buffett's Billions at Risk; Berkshire Hathaway Is Lowest-Rated on Sustainability

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Co-authored with analyst Maximilian Lichtenheld of HIP Investor.

Warren Buffett is known as the "Oracle of Omaha," but does his view towards sustainability warrant this title in the 21st century? Not according to the "HIP 100" investment index and portfolio. Berkshire is rated dead last of the 100 largest companies in the U.S. based on low sustainability results and lack of information on its conglomerate's actions and results.

Why? Because Warren Buffett, vice chair Charlie Munger and the Board of Directors -- including Bill Gates --have yet to embrace sustainability, the concept that human, environmental, social and governance factors can drive increased profitability and shareholder value. The shareholders and Board voted down a proposal at last year's shareholder meeting in Omaha to quantify the risks related to pollution and carbon emissions, as well as rejecting the need for setting goals to reduce them. This is strange: because reducing waste and greenhouse gases leads to lower costs, fewer liabilities and reduced risk.

At that shareholder meeting, Buffett stated that climate change is not a material risk to Berkshire. Yet $30.6 billion, or 29%, of Berkshire Hathaway's operating company revenue is heavily contingent on the issues related to climate and energy. Berkshire's earnings growth has not met analyst projections as the reinsurance businesses of BRK suffered heavy losses due to extreme weather.

Moreover, the potential impact of climate change on BRK's equity holdings (partial rather than full ownership, like Coca-Cola, Kraft and Wells Fargo) is even higher. Approximately 40 percent of revenues are facing increased risk, representing about 1 in 4 employees, according to our analysis at HIP Investor.

An analysis of BRK's operating companies resulted in a peculiar result as sustainable business practices are incorporated at home construction and manufacturing firms, yet two of the biggest insurers, GEICO and General Re, appear not to pursue any strategies considering environmental impacts on their business models. Including these factors could lead to more sustainable profits with a largely reduced exposure to high-impact risks. The industry finally has to recognize that "black swans" risk becoming the "new normal."

Another crucial aspect that might be detrimental to BRK's performance is also rising prices of clean water. The Coca-Cola Company, in which BRK holds a major equity stake, uses 2.36 liters of water to produce 1 liter of soda -- consider that next time you drink a soda. In India, the water-to-soda ratio amounts to 4:1, resulting in the waste of 75 per cent of water input. As water is the main ingredient for all beverages, even a slight increase in its price could lead to a fall of profits. An improvement in water efficiency might incur capital expenditures in the short run, but will reduce costs in the long run, serving as a competitive advantage.

Some of Berkshire's businesses are actively expanding in the alternative energy sector, such as Mid American Energy Holding's acquisition of the Topaz project, one of the world's largest photovoltaic power plants, for $2 billion. Imitating this strategic expansion across the conglomerate could be quite beneficial for BRK.

For BRK's last fiscal quarterly statement, ending October 2011, Berkshire said "profit from underwriting insurance fell 83 percent to $81 million amid the most costly hurricane season since the record storms of 2005." As profits associated with the insurance subsidiaries fell by more than 77 percent on investments, it is time for Berkshire's board -- which includes Bill Gates -- to accept the importance of climate for business.

A study by the Intergovernmental Panel on Climate Change (IPCC) entitled "Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation" (SREX)' supports the notion that extreme weather occurrences are going to increase in frequency, hugely affecting BRK's potential for generating sustainable revenues in the insurance and re-insurance businesses. "Extreme events will have greater impacts on sectors with closer links to climate, such as water, agriculture and food security, forestry, health, and tourism," requiring economies to adapt and not stick blindly to a status quo. If weather-related disasters increase in frequency, profits could quickly evaporate, unless the issue of climate change is actively included in company strategies.

Other reinsurers, namely Swiss Re, do acknowledge the impact of climate change and estimate that the associated market accounts to $5 billion, which consists of various over the counter contract weather derivatives, as well as other insurable risks regarding renewable energies. However, the acceptance of the changed circumstances does not only create new markets, but allows to incorporate these changes into the risk models. Ignoring the tremendous risks of climate change can be lethal for a firm.

If BRK would take steps to counter these challenges through systematic implementations of sustainable business practices across all operating companies, as well as pushing for sustainable changes at their equity stakes, then revenues could be more stable, avoiding losses and positively impacting society.

Warren Buffett's potential impact on sustainability would go far beyond BRK though, as typically his investments are widely followed and influence investors in their decisions. Once this self-reinforcing cycle is initiated, economies and firms could become more sustainable in performance, hence they could weather economic shocks better. Volumes on IBM trading doubled days after Buffett announced his investment in the company in 2011. Forging ahead on sustainable firms could thereby lead to a large multiplier effect for the entire industry.

Will Buffett become more "HIP," supporting the theme that solving human, social and environmental challenges can increase the potential for more profit? Will BRK survive without adapting to more sustainable business practices? That is up to Mr. Buffett, Charlie Munger and the Board -- but it will determine whether BRK can continue its 20th century leadership into the 21st century.

Co-author Maximilian Lichtenheld is an Analyst at HIP Investor Inc., an MBA candidate at London School of Economics (LSE), and the Founder and President of LSE's M&A (Mergers&Acquisitions) Society, President of LSE's Swiss Society and Vice-President of the Austrian Society.

NOTE: This is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and does NOT imply any investment recommendations. Past performance is not indicative of future results. All investing risks loss of principal. The authors, HIP Investor and HIP's clients may invest in the securities mentioned above, including in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com