This article was written by Carsten Henningsen.
As the fossil fuel divestment movement continues to gain momentum, Portfolio 21 has received inquiries about our long-held rationale for not investing in the fossil fuel sector. Our firm is a pioneer in combining environmental, social, and governance analysis with fundamental investment research. Our research has found that fossil fuel companies face and pose unique risks that we believe are not manageable to the extent required to make them attractive investments. The good news is that it is possible to manage global equity portfolios without coal, oil, and gas exposure.
Climate change and uncertain energy policy point to a grim future for fossil fuel companies where the assets of an entire industry may lose their value. The amount of fossil fuels in global reserves is five times what would be safe to burn from a CO2 emissions perspective. Any sort of international agreement on climate change targets could severely curtail extraction and consumption of fossil fuel use. When countries adopt carbon regulations, or implement other policies to reduce greenhouse gas emissions, the fossil fuel industry could face increasing competition as new market opportunities for cleaner, renewable energy technologies develop.
While the global conversation is still evolving regarding the regulation of carbon emissions and fossil fuel demand, there are also environmental and social risks that impact supply. Access to reserves poses a major challenge for the fossil fuel industry. As conventional sources of fossil fuels have become exhausted and technological advancements are made, the search for new reserves has moved in to remote, pristine areas as well as densely populated communities. Unconventional fossil fuel development increases operating costs on a per barrel basis. Extreme operating conditions pose significant operational challenges and magnify environmental risks.
With all of these risks and others in mind, Portfolio 21 finds the fossil fuel sector unnecessary in an investment portfolio. Fossil fuel companies account for less than 10% of the market, and variation of more than 10% versus the benchmark is routine among active investment managers. Selecting investments of high quality stocks in economic sectors that have positive correlation to the energy sector provides exposure to the same characteristics as large cap energy companies. The materials, industrials, and utilities sectors exhibit the highest correlations. Our investment approach finds numerous other investment opportunities that provide exposure to the world’s growing need for additional, better, and cleaner energy infrastructure.
We believe that the fossil fuel sector is unnecessary to prudent investment management and that it is possible to produce risk-adjusted returns that are competitive through a portfolio that does not invest in fossil fuel companies. However, excluding fossil fuel is just the first step. The next step is to consider how to reallocate those investments. It goes without saying, you wouldn’t want to rid your portfolio of fossil fuel companies, only to fill it with corporations that are “gas guzzlers.” Fossil Fuel Free Investing becomes a complete story with energy efficiency and renewable energy. The opportunity to reduce energy use and greenhouse gas emissions through the adoption of existing energy efficiency is staggering. Saving a kilowatt-hour through improvements in energy efficiency is around one-third of the cost of adding new capacity. Energy efficiency is the world’s cheapest, cleanest, and most readily available energy source.
We believe that high quality environmental, social, and governance characteristics help identify the global leaders most capable of thriving in the emerging economy that will carry society forward.
Rob Thomas is a member of the DailyWorth Connect program. Read more about the program here.
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