Economics

Fossil Fuel Divestment – What’s Next For Investors?

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The recent announcement that, by 2020, New York City will be the first city to divest from fossil fuels for its pension plans –at $189 billion among the largest in the world – sends an unmistakable message that a stronger economy rests on a greener planet. The city’s decision is a significant step forward for those who care deeply about the environmental.

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At the same time, the news raises important questions for investors about whether they ought to follow suit. For many of us, including wealth managers, pension managers and investment advisors, the question is what does divestment mean? And what does divestment look like at the portfolio level?

Where to start

While fossil-fuel securities generally comprise 2-8% of any given portfolio, it depends how one is defining the exposure. Most of us would expect to see a sell-off of the five “big players:” BP, Chevron, ConocoPhillips, ExxonMobil and Royal Dutch Shell. Not only are these five companies counted historically as some of the largest polluters, they are the five corporations named in New York City’s lawsuit for to their contribution to global warming. The court case is seeking billions to build climate-driven infrastructure projects to protect the city against future climate-related storms that Mayor De Blasio says these companies have caused.

When it comes to building a fossil-fuel-free portfolio, we might all agree that the companies extracting oil from the Earth should be the first to go. Many portfolio managers stop there. Others use the list of the 200 top fossil-fuel producers generated by Carbon Underground.

I have a few issues with this approach. It may not actually produce the social, environmental or financial results investors are hoping to achieve. By removing the largest 200 companies, an investor will be stuck with smaller extracting companies (such as PDC Energy or Miller Energy Resources). That could pose more risk to a portfolio because these smaller companies have even less bandwidth to transition their business models to the needs of a cleaner economy.

As it turns out, socially responsible investing (SRI) and now, the more popular term, environmental, social and governance (ESG) methods of screening indexes and stock portfolios are not perfect. In fact, slicing out different companies, industries and sectors of a diversified portfolio can still leave a portfolio with many polluting companies and businesses that contribute to climate change. For example, MSCI has created a fossil-fuel free index. However, while many extracting companies are removed, Toyota (a company whose products rely on the consumption of vast amounts of oil) remains as a top holding. Similarly, JP Morgan Chase and Bank of America, both well known for their funding of fossil-fuel projects including pipelines, are top holdings in several “fossil-fuel free” advertised portfolios.

Read the full article here by Kristin Hull, Ph.D. – Advisor Perspective