First appeared on ImpactAlpha
Growing risks make coal, oil and even gas a long-term drag on performance.
Should you or shouldn’t you divest your portfolio of fossil fuel securities?
Fossil fuel divestment is one of the major levers at the disposal of citizens and governments to address climate change and accelerate the transition to a clean economy. For many investors, a key issue is whether divestment is a smart decision in terms of financial performance.
From a smart investing perspective, the answer is “yes.”
Most recently, the city and state of New York has started to move away from fossil fuels. Mayor Bill De Blasio said the city’s pension fund will divest $5 billion of its $189 billion in assets from fossil fuel investments. The city is also suing five major oil companies for their contributions to global warming. Last month, New York Gov. Andrew Cuomo announced the state’s $201 billion pension fund will evaluate whether to divest its fossil fuel-related holdings.
Divestment is a wise financial decision judging by the performance of fossil-fuel free portfolios. Reallocating that capital to innovative new technologies that support clean, renewable energy can also improve portfolio performance. Investors face significant risk in holding securities tied to the incumbent fossil-fuel economy.
For investors, one fact is clear — fossil fuel companies can be a drain on portfolio performance. Recent research from index company MSCI shows that its MSCI ACWI ex Fossil Fuels Index outperformed the conventional MSCI ACWI index in five of the last six years. The MSCI AWCI index includes 2,400 stocks in 47 developed and emerging markets.
That finding aligns with the performance of the Nia Global Solutions portfolio, which is fossil-fuel free by design. The Nia portfolio significantly outperformed the S&P500 Index — by 15.77% over the last year. Nia portfolio’s outperformance is due in large part to our emphasis on investing in renewable energy innovations, such as wind and solar technologies. The portfolio’s performance is also the result of our purposeful lack of exposure to any companies profiting from harmful natural resource extraction or to financial institutions that finance fossil fuel projects.
What’s the impact to index investors when fossil fuel stocks are removed? The news is also good. A historical analysis by Impax of seven years of data shows that eliminating the fossil fuel sector from a global benchmark index had a small, but positive return effect.
Fossil fuels built the global economy we live in today. Yet the investment risks of holding fossil fuel securities are growing over the short, medium and especially long term.
First, oil is becoming more difficult to extract, refine, transport, and burn. When the Rockefeller family first commoditized oil, it was literally bubbling up from the ground. Those days are long gone. Drilling and extraction have become more remote and expensive. This increasingly difficult task means potential cuts in corporate dividends and payouts.
Second, fossil fuel companies will continue to lose market share to renewable energy providers. Renewable energy accounts for a growing amount of power production, driven by technologies that harvest energy from the sun, wind and waves. The rapid adoption of electric vehicles, in particular, is advancing the date of peak oil consumption.
The cost of renewable energy, particularly solar, looks set to decline over time, much like electronics and other semiconductor technologies have done for decades. With the development of more efficient batteries to store solar energy near its source or on site, the need to transport energy is reduced or eliminated.
Market growth and dominance, not decline, is what most investors look for in an investment. Energy derived from burning fossil fuels will continue to become less relevant.
Third, there is declining tolerance for government subsidies for big fossil fuel companies. Each year, the public is more aware of the unjustified, taxpayer-funded breaks for oil, coal, natural gas and nuclear power production. Any company whose primary business model is still focused on extraction or refinement will be left behind. The transition to clean energy is well under way, regardless of where the White House stands on the issue.
Finally, over the longer term, there is a very real risk that the balance sheets of fossil fuel companies will diminish in value. Many fossil fuel companies count their yet undrilled reserves on their balance sheets as assets. With mounting political pressure to restrict carbon emissions and limit extraction, these “stranded assets,” as they are known, face a clear risk of being worth far less than they are today.
This risk to the balance sheet could happen because of changes in policy or legislation for drilling, changes in relative costs and prices of oil as well as physical stranding” due to relative distance, or potential flood or drought. No intelligent investor wants to be left holding a stock whose underlying value proposition decreases over time.
Exit or engage?
Some environmental activists may take the view that retaining at least a few shares of companies like Exxon Mobil or Chevron within a portfolio allows individuals — and asset management firms — to write letters, file shareholder resolutions and vote proxies encouraging greener business practices. BlackRock, the world’s largest asset manager, last year switched sides and bucked management at Occidental Petroleum and ExxonMobil in shareholder votes for a full accounting of climate-related risks.
And activist organizations are taking on the fossil fuel industry. Greenpeace, Rain Forest Action Network, Amazon Watch and others are engaging with fossil fuel producers and big banks financing large projects such as the Keystone pipeline.
The Rockefeller Brothers Fund, among others, had personal meetings with executives at some of these extracting corporations. After years of advocating for greener business plans — without success, the foundation decided to divest all of their assets from the fossil fuel industry.
As a founding signatory for the Divest Invest movement, I have been quite vocal about the effectiveness of fossil fuel divestment. At Nia Impact Capital, we recommend divestment from stocks of any firm engaged in the prospecting, extraction, refining, transporting or distributing of fossil fuels due to both the financial and environmental risks.
While climate change stands to affect all holdings, now is a good time for financial advisors, wealth managers, pension plan participants, as well as each of us as individuals, to know what they own and to make prudent decisions according to their values and goals.
To be sure, caution is advised when investing in renewable energy, as with any sector of the economy. There will be winners and losers as we transition toward the next, just and sustainable economy. As many corporations seek to bring their potentially disruptive products to market, some will excel, gaining market share from extracting industries. Others will miss the timing, or be unable to compete. When choosing companies, investors are advised to engage in a careful stock analysis, and choose smart and prudent portfolio managers.
As we continue to see at Nia, global systemic risks can present great opportunities for innovative businesses and for investors. We specifically build portfolios that are an alternative to fossil fuel ethos by investing in innovative clean and renewable energy technologies. Our fundamental belief is that economic opportunities reside in the solutions needed for both people and planet.
Kristin Hull is founder, CEO and chief investment officer of Nia Impact Capital.