ESG Trends

Q4 2022

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Solar panels in city.

Inflation Reduction Act Is a Meaningful Step to Fight Climate Change

The Inflation Reduction Act of 2022 is a potential game changer. In addition to helping to reduce greenhouse gas emissions and support clean energy-related economic growth, it allows the U.S. to join the growing list of countries taking meaningful steps to fight climate change.

Many had given up hope that the Biden administration could craft climate legislation that would survive Congress. Although legislators scaled down the initial proposal, the nearly $370 billion bill is the largest federal clean energy investment in history.

The measure doesn’t explicitly phase out fossil fuels. However, estimates show that by 2030, greenhouse gas emissions in the U.S. could drop by as much as 42% compared to 2005.¹ This reduction comes closer to the Paris Agreement’s 50% target and compares to just a 35% reduction under current policies.

We note that the Act doesn’t penalize the fossil fuel industry as a tax on carbon emissions would have done. Instead, it focuses on encouraging new investment by providing ways to make renewable energy projects more competitive while providing significant support for carbon capture. It will help expand the country’s renewable energy infrastructure and promote green technology, including direct air (carbon) capture.

The Act also includes targeted incentives to encourage clean energy development in low-income communities to support a just transition to a clean energy future.

We believe it offers much for businesses and investors to like. Noteworthy highlights include:

  • Tax credits that support wind and solar power projects and cover newer energy technologies,
    such as hydrogen power.

  • Help for U.S. businesses that manufacture clean energy components to grow local supply chains for renewable energy infrastructure.

  • Tax credits for homeowners who install solar panels or switch to electric appliances and a $7,500 tax credit for those who buy U.S.-made electric vehicles (EVs) priced below $55,000 (not available to high earners).

  • Incentives to source EV battery components from U.S. factories or free-trade agreement partners. To claim the EV tax credit, batteries must be 100% made in North America by 2029.

  • Investments in disadvantaged communities to reduce legacy sources of pollution, promote
    affordable clean energy and provide good jobs.

  • Enhanced tax credits for carbon capture and incentives to use captured CO2 to produce low- and zero-carbon fuels, chemicals, building materials and other products.

  • Technology-neutral tax credits for low-carbon transportation fuels and investment in low-carbon materials and buildings.

While portions of the legislation are likely to become political talking points in the upcoming election season, we believe it’s more bipartisan than it may seem at first glance. There are no explicit penalties/phase-outs for the fossil fuel industry, and recent research shows many Republican congressional districts benefit from increased investment in solar and wind.²

This landmark action should create significant positive momentum going into the November 2022 U.N. Climate Change Conference (COP 27) in Egypt. This momentum is critical as the latest science shows that climate change is occurring faster than expected, and the world must respond.

Sarah Bratton Hughes

Sarah Bratton Hughes

Head of Sustainable Investing

Q4 2022 Investment Outlook Resources

Agency mortgages

A form of securitized debt that represents ownership in pools of mortgage loans and their payments.

Asset-backed securities (ABS)

A form of securitized debt (defined below), ABS are structured like mortgage-backed securities (MBS, defined below). But instead of mortgage loans or interest in mortgage loans, the underlying assets may include such items as auto loans, home equity loans, student loans, small business loans, and credit card debt. The value of an ABS is affected by changes in the market's perception of the assets backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans, or the financial institution providing any credit enhancement.

BB and BBB credit rating

Securities and issuers rated AAA to BBB are considered/perceived “investment-grade”; those rated below BBB are considered/perceived non-investment-grade or more speculative.

Central bank

Entity responsible for oversight of a nation’s monetary system, including policies and interest rates.

Collateralized loan obligations (CLOs)

A form of securitized debt, typically backed by pools of corporate loans and their payments.

Commodities

Commodities are raw materials or primary agricultural products that can be bought or sold on an exchange or market. Examples include grains such as corn, foods such as coffee, and metals such as copper.

Consumer Price Index (CPI)

CPI is the most commonly used statistic to measure inflation in the U.S. economy. Sometimes referred to as headline CPI, it reflects price changes from the consumer's perspective. It's a U.S. government (Bureau of Labor Statistics) index derived from detailed consumer spending information. Changes in CPI measure price changes in a market basket of consumer goods and services such as gas, food, clothing, and cars. Core CPI excludes food and energy prices, which tend to be volatile.

Corporate securities (corporate bonds and notes)

Debt instruments issued by corporations, as distinct from those issued by governments, government agencies, or municipalities. Corporate securities typically have the following features: 1) they are taxable, 2) they tend to have more credit (default) risk than government or municipal securities, so they tend to have higher yields than comparable-maturity securities in those sectors; and 3) they are traded on major exchanges, with prices published in newspapers.

Correlation

Correlation measures the relationship between two investments--the higher the correlation, the more likely they are to move in the same direction for a given set of economic or market events. So if two securities are highly correlated, they will move in the same direction the vast majority of the time. Negatively correlated investments do the opposite--as one security rises, the other falls, and vice versa. No correlation means there is no relationship between the movement of two securities--the performance of one security has no bearing on the performance of the other. Correlation is an important concept for portfolio diversification--combining assets with low or negative correlations can improve risk-adjusted performance over time by providing a diversity of payouts under the same financial conditions.

Credit quality

Credit quality reflects the financial strength of the issuer of a security, and the ability of that issuer to provide timely payment of interest and principal to investors in the issuer's securities. Common measurements of credit quality include the credit ratings provided by credit rating agencies such as Standard & Poor's and Moody's. Credit quality and credit quality perceptions are a key component of the daily market pricing of fixed-income securities, along with maturity, inflation expectations and interest rate levels.

Credit ratings

Measurements of credit quality (defined below) provided by credit rating agencies (defined below). Those provided by Standard & Poor's typically are the most widely quoted and distributed, and range from AAA (highest quality; perceived as least likely to default) down to D (in default). Securities and issuers rated AAA to BBB are considered/perceived to be "investment-grade"; those below BBB are considered/perceived to be non-investment-grade or more speculative.

Debt security

A debt instrument, including bonds, certificates of deposit or preferred stocks.

Duration

Duration is an important indicator of potential price volatility and interest rate risk in fixed income investments. It measures the price sensitivity of a fixed income investment to changes in interest rates. The longer the duration, the more a fixed income investment's price will change when interest rates change. Duration also reflects the effect caused by receiving fixed income cash flows sooner instead of later. Fixed income investments structured to potentially pay more to investors earlier (such as high-yield, mortgage, and callable securities) typically have shorter durations than those that return most of their capital at maturity (such as zero-coupon or low-yielding noncallable Treasury securities), assuming that they have similar maturities.

Eurozone

The eurozone is sometimes referred to as the euro area and represents the member states that participate in the economic and monetary union (EMU) with the European Union (EU). The eurozone currently consists of: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Federal Reserve (Fed)

The Fed is the U.S. central bank, responsible for monetary policies affecting the U.S. financial system and the economy.

Fundamentals/fundamental analysis

Investment "fundamentals," in the context of investment analysis, are typically those factors used in determining value that are more economic (growth, interest rates, inflation, employment) and/or financial (income, expenses, assets, credit quality) in nature, as opposed to "technicals," which are based more on market price (into which fundamental factors are considered to have been "priced in"), trend, and volume factors (such as supply and demand), and momentum. Technical factors can often override fundamentals in near-term investor and market behavior, but, in theory, investments with strong fundamental supports should maintain their value and perform relatively well over long time periods.

General obligation (GO) bonds

One of the biggest sectors in the municipal securities (defined below) market. Typically, these bonds are secured by the full faith and credit pledge (defined above) of the issuer and usually supported by the issuer's taxing power (tax revenues provide the means by which most interest payments are made). GO bonds can be issued by states, counties, cities, towns and regional districts to fund a variety of public projects, including construction of and improvements to schools, highways, and water and sewer systems.

Gross domestic product

Gross domestic product (or GDP) is a measure of the total economic output in goods and services for an economy.

High-yield bonds

High-yield bonds are fixed income securities with lower credit quality and lower credit ratings. High-yield securities are those rated below BBB- by Standard & Poor's.

Hybrid securities

Financial securities that combine two or more instruments, typically providing both debt and equity characteristics.

Inflation

Inflation, sometimes referred to as headline inflation, reflects rising prices for consumer goods and services, or equivalently, a declining value of money. Core inflation excludes food and energy prices, which tend to be volatile. It is the opposite of deflation (see Deflation).

Inflation-protected securities

Debt securities that offer returns adjusted for inflation; a feature designed to eliminate the inflation risk.

Investment-grade corporate bond or credit

A debt security with a relatively low risk of default issued and sold by a corporation to investors.

Leveraged buyout (LBO)

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

Mortgage-backed securities (MBS)

A form of securitized debt (defined below) that represents ownership in pools of mortgage loans and their payments. Most MBS are structured as "pass-throughs"--the monthly payments of principal and interest on the mortgages in the pool are collected by the financial entity that is servicing the mortgages and are "passed through" monthly to investors. The monthly and principal payments are key differences between MBS and other bonds such as Treasuries, which pay interest every six months and return the whole principal at maturity. Most MBS are issued or guaranteed by the U.S. government, a government-sponsored enterprise (GSE), or by a private lending institution.

Municipal bonds

These are long-term municipal securities (defined below) with maturities of 10 years or longer.

Municipal securities (munis)

Debt securities typically issued by or on behalf of U.S. state and local governments, their agencies or authorities to raise money for a variety of public purposes, including financing for state and local governments as well as financing for specific projects and public facilities. In addition to their specific set of issuers, the defining characteristic of munis is their tax status. The interest income earned on most munis is exempt from federal income taxes. Interest payments are also generally exempt from state taxes if the bond owner resides within the state that issued the security. The same rule applies to local taxes. Another interesting characteristic of munis: Individuals, rather than institutions, make up the largest investor base. In part because of these characteristics, munis tend to have certain performance attributes, including higher after-tax returns than other fixed income securities of comparable maturity and credit quality and low volatility relative to other fixed-income sectors. The two main types of munis are general obligation bonds (GOs) and revenue bonds. GOs are munis secured by the full faith and credit of the issuer and usually supported by the issuer's taxing power. Revenue bonds are secured by the charges tied to the use of the facilities financed by the bonds.

Nominal yield

For most bonds and other fixed-income securities, nominal yield is simply the yield you see listed online or in newspapers. Most nominal fixed-income yields include some extra yield, an "inflation premium," that is typically priced/added into the yields to help offset the effects of inflation (see Inflation). Real yields (see Real yield), such as those for TIPS (see TIPS), don't have the inflation premium. As a result, nominal yields are typically higher than TIPS yields and other real yields.

Non-agency commercial mortgage-backed securities (CMBS)

MBS that represent ownership in pools of commercial real estate loans used to finance the construction and improvement of income-producing properties. Non-agency CMBS are not guaranteed by the U.S. government or a government-sponsored enterprise.

Price to earnings ratio (P/E)

The price of a stock divided by its annual earnings per share. These earnings can be historical (the most recent 12 months) or forward-looking (an estimate of the next 12 months). A P/E ratio allows analysts to compare stocks on the basis of how much an investor is paying (in terms of price) for a dollar of recent or expected earnings. Higher P/E ratios imply that a stock's earnings are valued more highly, usually on the basis of higher expected earnings growth in the future or higher quality of earnings.

Quality

Nationally recognized statistical rating organizations assign quality ratings to reflect forward-looking opinions on the creditworthiness of loan issuers.

Real estate investment trusts (REITs)

Real estate investment trusts (REITs) are securities that trade like stocks and invest in real estate through properties or mortgages.

Russell 1000® Growth Index

Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with higher price-to-book ratios and higher forecasted growth values.

Russell 1000® Value Index

Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with lower price-to-book ratios and lower forecasted growth values.

S&P 500® Index

The S&P 500® Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.

Securitized debt

Debt resulting from the process of aggregating debt instruments into a pool of similar debts, then issuing new securities backed by the pool (securitizing the debt). Asset-backed and mortgage-backed securities (ABS and MBS, defined further above) and collateralized mortgage obligations (CMOs, defined above) are common forms of securitized debt. The credit quality (defined above) of securitized debt can vary significantly, depending on the underwriting standards of the original debt issuers, the credit quality of the issuers, economic or financial conditions that might affect payments, the existence of credit backing or guarantees, etc.

Senior-secured securities

A security that has a higher priority compared to another in the event of liquidation.

Sovereign debt

A country's own government-issued debt, priced in its native currency, that can be sold to investors in other countries to raise needed funds. For example, U.S. Treasury debt is U.S. sovereign debt, and would be referred to as sovereign debt when bought by foreign investors. Conversely, debt issued by foreign governments and priced in their currencies would be sovereign debt to U.S. investors.

Spreads (aka "interest-rate spreads", "maturity spreads," "yield spreads" or "credit spreads")

In fixed income parlance, spreads are simply measured differences or gaps that exists between two interest rates or yields that are being compared with each other. Spreads typically exist and are measured between fixed income securities of the same credit quality (defined above), but different maturities, or of the same maturity, but different credit quality. Changes in spreads typically reflect changes in relative value, with "spread widening" usually indicating relative price depreciation of the securities whose yields are increasing most, and "spread tightening" indicating relative price appreciation of the securities whose yields are declining most (or remaining relatively fixed while other yields are rising to meet them). Value-oriented investors typically seek to buy when spreads are relatively wide and sell after spreads tighten.

Spread sectors (aka "spread products," "spread securities")

In fixed income parlance, these are typically non-Treasury securities that usually trade in the fixed income markets at higher yields than same-maturity U.S. Treasury securities. The yield difference between Treasuries and non-Treasuries is called the "spread" (defined further above), hence the name "spread sectors" for non-Treasuries. These sectors--such as corporate-issued securities and mortgage-backed securities (MBS, defined above)--typically trade at higher yields (spreads) than Treasuries because they usually have relatively lower credit quality (defined above) and more credit/default risk (defined above), and/or they have more prepayment risk (defined above).

Subordinated security

An unsecured loan or bond that ranks below more senior loans in terms of claims on assets or earnings.

Stagflation

Stagflation describes slowing economic growth combined with high inflation.

Treasury inflation-protected securities (TIPS)

TIPS are a special type of U.S. Treasury security designed to address a fundamental, long-standing fixed-income market issue: that the fixed interest payments and principal values at maturity of most fixed-income securities don't adjust for inflation. TIPS interest payments and principal values do. The adjustments include upward or downward changes to both principal and coupon interest based on inflation. TIPS are inflation-indexed; that is, tied to the U.S. government's Consumer Price Index (CPI). At maturity, TIPS are guaranteed by the U.S. government to return at least their initial $1,000 principal value, or that principal value adjusted for inflation, whichever amount is greater. In addition, as their principal values are adjusted for inflation, their interest payments also adjust.

Treasury yield

The yield (defined below) of a Treasury security (most often refers to U.S. Treasury securities issued by the U.S. government).

Valuation

A quantitative estimate of a company or asset’s value.

U.S. Treasury securities

Debt securities issued by the U.S. Treasury and backed by the direct "full faith and credit" pledge of the U.S. government. Treasury securities include bills (maturing in one year or less), notes (maturing in two to 10 years) and bonds (maturing in more than 10 years). They are generally considered among the highest quality and most liquid securities in the world.

Yield

For bonds and other fixed-income securities, yield is a rate of return on those securities. There are several types of yields and yield calculations. "Yield to maturity" is a common calculation for fixed-income securities, which takes into account total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity.

Yield curve

A line graph showing the yields of fixed income securities from a single sector (such as Treasuries or municipals), but from a range of different maturities (typically three months to 30 years), at a single point in time (often at month-, quarter- or year-end). Maturities are plotted on the x-axis of the graph, and yields are plotted on the y-axis. The resulting line is a key bond market benchmark and a leading economic indicator.

John Larsen, Ben King and Hannah Kolus, et al., “A Turning Point for US Climate Progress: Assessing the Climate and Clean Energy Provisions in the Inflation Reduction Act,” Rhodium Group, August 12, 2022.

Entersection, “U.S. Renewable Power Generation Capacity Changes,” August 15, 2022.

Many of American Century's investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.

ESG Definitions:

  • ESG Integrated: An investment strategy that integrates ESG factors aims to make investment decisions through the analysis of ESG factors alongside other financial variables in an effort to deliver superior, long-term, risk-adjusted returns. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.

  • ESG Focused: An investment strategy that focuses on ESG factors seeks to invest, under normal market conditions, in securities that meet certain ESG criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. This investment focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. ESG-focused investment strategies include but are not limited to impact, best-in-class, positive screening, exclusionary, and thematic approaches.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.