First appeared in Family Wealth Report
Should you divest your portfolio of fossil fuel securities?
That is the question on the minds of individual and institutional investors this week after New York City moved decisively away from fossil fuels. Mayor Bill de Blasio announced that the city will divest of $5 billion of its $189 billion pension fund now in fossil fuel investments. The city is also suing five major oil companies, stating they have contributed to global warming. This news follows last month’s announcement by New York Governor Andrew Cuomo that the state’s $201 billion pension fund is evaluating whether to divest of fossil fuel companies.
Fossil fuel divestment is one of the major levers at the disposal of citizens and governments to address climate change and transition to a clean economy. Yet, for many investors, a key issue is whether divestment is a smart decision in terms of financial performance.
From an investing perspective, the is answer is “yes.”
Divestment is a wise financial decision if judged by the financial performance of fossil-fuel free portfolios and the significant risk investors face in holding securities tied to the incumbent fossil-fuel economy. Reallocating that capital to innovative new technologies to support clean, renewable energy can also improve portfolio performance.
Compelling financial reasons
For investors, one fact is clear – fossil fuel companies are a drain on portfolio performance. The latest analysis to make that point is a 2015 study by global finance firm MSCI. The analysis showed that fossil-fuel free stock portfolios have outperformed conventional portfolios each year for the last five years.
That finding is confirmed by 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 per cent in 2017. The outperformance of Nia’s portfolio is due in large part to its emphasis on investing in renewable energy innovations, such and 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.
So, what’s the impact to index investors when fossil fuel stocks are removed? An analysis of seven years of data by Impax Asset Management, shows that eliminating the fossil fuel sector from a global benchmark index had a small, but positive return effect.
Fossil fuel risks
Fossil fuel has, in large part, 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.
Consider the following:
First, oil is becoming 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. Oil reserves have been drastically reduced by global consumption. Despite currently low prices of oil, 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 ocean waves. The cost of renewable energy, particularly solar, will likely 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 this energy is reduced. In some cases, it is entirely eliminated. In short, energy derived from burning fossil fuels will continue to become less relevant. Market dominance, not decline, is what most investors look for in an investment.
Third, there is currently less tolerance for government subsidies for big fossil fuel companies. Each year, the public is more aware of the 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. No intelligent investor wants to be left holding a stock whose underlying value proposition decreases over time.
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.