When two of the biggest beneficiaries of fossil fuels abandon the cause is that an omen?
Start with Norway’s sovereign wealth fund, the biggest in the world. That nation created what is basically a giant investment portfolio with the huge profits earned from its vast oil fields. The managers of the fund just sold off positions in a bevy of coal miners and coal burning utilities, including Glencore, Anglo American and Germany’s RWE. The Norwegians have also pruned oil holdings modestly. This modesty here makes little sense from a risk management perspective (technically it is called a “Texas hedge”) because it leaves Norway doubly exposed to oil first as E&P capital provider/owner and again as an equity investor. But that might be next year’s story.
The question this raises is “Can a multi billion investment fund manage without owning energy companies?” Following their recent severe stock price decline oil companies make up roughly 3% of the S&P 500. The same size as the US utility sector. Ten years ago this industry had a 10% weighting in the S&P 500 stock index. Quite a comedown. Speaking broadly the biggest S&P sectors are about 10-15% of the index, the two biggest sectors currently being technology and health care.
Investment funds that aim to replicate or slightly outperform the broad equity indices have little discretion about owning the largest S&P sectors. However at a 2 or 3% industry weighting portfolio managers have more flexibility to operate without those relatively tiny sectors without fear of underperforming their equity benchmarks. In addition they can always buy financial instruments that mimic the actions of those stocks if they want to maintain a proxy for ownership. Related: Could This Become The World’s Newest Oil Exporter?
Given the concentration in investment industry firms like Fidelity, BlackRock and Vanguard control over half of the market. If they choose not to buy a particular group of securities that action alone will depress these prices. When energy companies were flush with cash and had impeccable bond ratings, keeping public investors happy may not have been a top priority for their investor relations teams. But with oil prices down sharply and once proud companies struggling to pay dividends and finance capital expenditure, they might have to rely more heavily on the capital markets to raise money. If investors become skittish then cost of capital rises. The same is also true for utility companies raising large sums to modernize and decarbonize plant.
Pressure groups of various types are demanding that investment funds, especially those associated with charities, universities, and government divest their ownership in carbon emitting, fossil fuel companies. This has engendered a three sided division of opinion.
The first group argues that it is immoral to profit from environmentally harmful activities. Hence energy companies should be removed from investment portfolios. Doing so, though, does not affect companies or even industries directly. Funds that sell out of stock or bond positions lose any leverage they may have had (through proxy voting) to effect corporate management change. Large blocs of disgruntled shareholders on the other hand typically receive at least some management attention.
The second divestment group, we will call them the pragmatists, argues that owning fossil fuel producing energy stocks no longer makes investment sense. As we have seen energy companies are losing prominence in investment indices. And investors do not fully realize the risks of owning this industry which is potentially experiencing a terminal, technological decline.
The third group, usually the investment fund directors and managers, try to take the high ground. They argue their actions, whether pro or anti fossil fuels, derive from a fiduciary obligation to preserve and enhance the value of their fund. And their role is not to make political or moral judgements about climate related matters. They further argue that limiting their choice of securities even modestly hinders their ability to make optimal investment decisions. That seems like dispassionate, if narrow, reasoning. But its real purpose may be to not antagonize oil companies, political interests and in the case of university endowments, conservative donors. Once investment managers declare that they make all decisions purely on the basis of economics, they can do what they want.
Do so-called “sustainable” investors earn more or less than conventional investors? The International Monetary Fund did a study last year that said, in effect, sustainable investors do as well as others. No big advantage or disadvantage. Other studies have found marginal differences in performance. So, it is hard to make the case that virtue, at least in terms of investment performance, has a steep cost.
Five years ago, the Rockefeller Brothers Fund, whose origins are in the Standard Oil Trust, the monopoly of all monopolies, decided that investment in fossil fuels did not mesh with one of the foundation’s goals, to combat the impact of climate change. The foundation hired a new investment manager. They concluded much of the value of energy stocks is determined by an assessment of the value of their assets in the ground and that a significant portion of those assets would be “stranded”. (Any industry confronted with a new technology faces this risk).
The Rockefeller Fund divested its fossil fuel investments, starting with coal and oil sands. They also made “impact” investments in firms whose activities mitigate climate change. Five years later, Rockefeller Brothers Fund reported that it had performed better than the standard portfolio (by roughly one percentage point a year) and that a companion index of sustainable stocks did even better, probably enough to pay any extra management fees.
Bottom line? Investors have figured out that they can reduce or eliminate energy holdings and still produce respectable portfolio performance. And a 3% S&P index weighting makes the energy group even easier to ignore. This has negative implications for cost of capital and is a message not to be ignored.
By Leonard Hyman and William Tilles for Oilprice.com
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