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Ethical funds are booming but there are obstacles to momentum

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It looks as if 2020 will be another year of outperformance for ESG funds — those focused on investments with a positive environmental (E) or social (S) impact, and companies with a record of good governance (G). Some conclude that we are in the early stages of a “momentum trade” that favours sustainable investments.

Philipp Hildebrand, former head of the Swiss central bank and now vice-chairman of investment manager BlackRock, predicted as much at the start of the year when he said the huge quantities of money coming into ESG funds would push up the prices of the investments they own. The message: Get in now while the ESG train is still picking up steam.

It is a seductive idea, especially in an era when longtime activist investors such as Chris Hohn in the UK and Jeff Ubben in the US have shifted their focus to the area. Hohn has been pressing companies to do more to tackle climate change, while Ubben, who left his hedge fund ValueAct to found a new ESG-focused asset manager, is sniffing the wind.

Money invested in ESG funds jumped from barely $300bn in 2011 to close to $900bn last year, says BlackRock, citing IMF data. Morningstar pegged the $1tn milestone as having been passed in the second quarter of 2020.

In Europe, where regulators are giving the movement a push, ESG funds could outnumber traditional funds as soon as 2025, according to one startling prediction from PwC. Could this mean the outperformance of ESG funds is preordained? Morningstar, tracking such funds in the US, found that in every year since 2015, a majority beat their respective markets. That was the case again in the first nine months of this year. ESG funds tend to be focused on the tech sector, which has been the big winner this year, but that does not seem to fully explain the outperformance.

According to a study by the World Resources Institute, a Washington think-tank, the stocks that are picked by ESG funds seem to be beating the market, raising the prospect that Hildebrand’s predicted “sustainability premia” are creeping into share prices. There are problems with this theory, and not just that, with equity markets worth $70tn globally and about $130tn in bonds, it is too early to expect ESG fund inflows to be large enough to move markets.

A momentum trade in ESG stocks, where investors buy shares they think will continue rising, seems unlikely while there is such disagreement over what constitutes an ESG investment. In this respect, matters are getting worse. As the number of funds has risen, so too has the number of indices and scoring systems purporting to identify companies with positive, or relatively positive, ESG performance. A study this year by academics in Geneva found very little correlation between stocks favoured by different environmental and social ratings providers (and basically no correlation at all between those given high governance scores).

You know things are bad when there is a Twitter account parodying the standards setters. “My standards bring all the boys to the yard. And they’re like, it’s better than yours,” reads a tweet from @makeESGgreat.

Wildly complex or subjective rules can lead to a lot of chopping and changing even within an ESG index, further disrupting the possibility of a momentum trade. The S&P 500 ESG index is trying to maintain a sectoral balance similar to the wider market, as well as weighting for ESG scores, and it also reviews corporate “controversies” — such as a labour dispute or a human rights issue that appears in the news — after which a stock may be kicked out for a year. It eliminated thermal coal producers recently, adding them to the list of no-go sectors along with tobacco and some weapons manufacturers.

That leads to a third problem for an ESG momentum trade. If the cancel culture that did for thermal coal takes out other constituents, funds may end up missing out on some of the investments that could drive their returns the most. Ubben at least is trying to avoid that, by explicitly planning to consider companies in fossil fuels and for-profit education, for example. “By virtue of being incumbents and thus being perceived as part of the problem, so-called ‘legacy’ companies show the greatest potential to become part of the solution and to be revalued,” his firm’s mission statement says.

None of which is to say aligning an investment portfolio with your social and environmental goals is not a good idea. Just don’t expect the momentum behind ESG investing to put any more wind behind your sails.

Stephen is reading . . . 

Invisible Man by Ralph Ellison. Having recently become a US citizen, I’m catching up on my American literary classics. Nearly 70 years after it was published, this examination of racism and its effects on identity could not be more relevant today.

Follow Stephen on Twitter @StephenFoley

This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment





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How Jennifer Granholm will reshape the US Department of Energy

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Two things to start: ExxonMobil appointed two new directors to its board, its latest effort to placate activist shareholders. And Texas’s largest power co-op Brazos Electric went bust yesterday, as the financial damage from the arctic storm continues to mount.

Oh, and after the hiatus caused by the pandemic, energy-related emissions are rising again, according to the International Energy Agency. They were higher in December than a year previously, the agency said.

Welcome to another Energy Source. Our main item today is on Jennifer Granholm, whom the US Senate last week confirmed as the country’s new energy secretary. Myles McCormick reports on her plan to revitalise her department and reorient it towards clean energy.

Thanks for reading. Please get in touch at energy.source@ft.com. You can sign up for the newsletter here. — Derek

Granholm looks to reboot the Department of Energy

From scuppering the Keystone XL pipeline to freezing the allocation of new drilling leases on public lands, Joe Biden’s plans to shake up the American energy system are well under way.

Next on the president’s agenda is an overhaul of the sprawling leviathan that is the US Department of Energy. And the woman that will lead that process is now in situ.

Jennifer Granholm, a former two-term governor of Michigan, took the reins of the $35bn a year government agency five days ago. And already it is clear there will be a shift in its focus — away from promoting fossil fuel exports and towards driving innovation in clean energy and climate technology.

This is what Granholm wrote in a blog post last Thursday, her first day on the job:

“President Biden has tasked the Department, his in-house solutions powerhouse, with delivering a cornerstone of his bold plan: the goal of achieving net-zero carbon emissions by 2050. For DoE, that means developing and deploying the technologies that will deliver a clean energy revolution.”

That will require a shift in priorities at the “in-house solutions powerhouse” — but one that analysts said Granholm was well suited to execute.

“She understands the economic benefits of transforming the agency into the Department of Clean Energy,” said Mitch Bernard, president of the Natural Resources Defense Council.

Jennifer Granholm was sworn in as energy secretary on February 25 © Getty Images

What can the DoE actually do on climate?

American energy policy is divvied up among several government agencies, of which the Department of Energy is just one. Traditionally its primary responsibilities have been the US nuclear weapons programme, environmental clean-ups and scientific research and development through its oversight of the country’s national laboratories.

Despite the department’s name, Granholm’s ability to effect the Biden climate agenda is constrained. She does not have oversight of emissions targets (which fall to the Environmental Protection Agency) or oil and gas drilling licences (the Department of the Interior).

“I do think the DoE’s ability to advance climate goals is fairly limited,” Nader Sobhani, climate policy associate at the Niskanen Center, told ES.

But what it can do is reinvigorate the department’s R&D role.

“I think there will certainly be a shift in the programmatic focus of this DoE as compared to the previous administration, in that there will be a concerted effort to innovate, develop and deploy clean energy technologies that are critical to combating climate change,” said Sobhani.

That means driving forward research on carbon capture and storage, electric vehicle charging infrastructure, energy storage technology and zero-carbon fuels such as green hydrogen.

How will it set about doing this? The department has a few tools in its toolkit:

  • There are the 17 national laboratories, which are hotbeds for tech breakthroughs.

  • There are grant and loan programmes it can use to drive innovation and de-risk new technologies to coax in private sector investment. Granholm has already indicated she will restart a $40bn loan programme that was left untouched by the Trump administration.

  • Plus, it has regulatory authority to encourage energy efficiency in certain appliances and new transmission lines.

But all of this will require funding. While Congress ensured the agency was not financially gutted by the last administration, ramping up its R&D role will require more money. Biden has pledged $400bn over the next ten years for clean energy and innovation.

Granholm’s record on spending big — sometimes without the desired effect — has already sparked criticism from some quarters, with conservatives arguing her selection “should frighten every American taxpayer”.

Jennifer Granholm, former governor of Michigan, speaks during TechCrunch Disrupt 2019 in San Francisco
Jennifer Granholm, former governor of Michigan, speaks during TechCrunch Disrupt 2019 in San Francisco © Bloomberg

New leadership

Just as important as finance will be the shift in tone Granholm will bring.

While money kept flowing under the Trump administration, the agency lacked the strategic drive needed for clean tech innovation, said Emily Reichert, chief executive of Greentown Labs, North America’s biggest start-up incubator.

“When people look back on it, it was an absence of leadership — on innovation, on policy, on decisions, on strategy — that we needed to move forward faster,” she told ES.

The DoE’s role in convening experts from across the US has been central to driving the development of new technology. But as a divided country shifts rapidly towards a new approach to energy, that outreach role will be even more important.

That makes the appointment of Granholm key. A Michigan native, with years of experience dealing with the Detroit auto industry, she will be able to bring the climate change narrative to parts of the country that coastal liberals have often failed to reach.

“I think that Jennifer Granholm coming from a Midwestern perspective is a real game changer in terms of bringing the focus of this activity to the middle of the country, and recognising that the middle of the country can also get engaged in this developing the innovations around climate,” said Reichert.

But most importantly — four years after Donald Trump appointed an energy secretary who thought the department should be scrapped — Granholm’s championing of clean energy should get investors excited to spark the influx of funds needed for the “clean energy revolution” her boss has promised.

“The market signal it sends is that, one, the US is back in the game,” said Reichert. “And two, that climate related technology solutions around decarbonisation are a good place to invest your money, your time, your talents, and to move your assets.”

(Myles McCormick)

Data Drill

The energy transition could lower oil prices in the long term by $10 a barrel — by far the biggest threat to the net present value of oil companies, according to new research from Rystad Energy that assessed the resilience of 25 large operators. The consultancy quantified the risk to NPVs of stranded assets as less than 1 per cent, and that from rising CO2 costs at mostly below 10 per cent.

Oil sands and tight oil companies are most exposed to price risk because of high break-even costs. Oil sands would suffer most from higher CO2 costs. And ExxonMobil’s revenue risk is higher than its supermajor peers’, “primarily because its portfolio includes several large, capital-intensive projects”, including the Permian Basin assets and Guyanese shale.

Bar chart of Impact on net present value (%) showing The energy transition's corporate hit, quantified

Power Points

FT Energy Source Live

The FT Energy Source Live event will be taking place on 24 — 25 May 2021. Join industry CEOs, thought leaders, energy innovators, policymakers, investors and other key influencers to hear the latest thinking and insights on the future of US energy leadership and its global context. Find out more here.

Endnote

IHSMarkit’s CERAWeek, cancelled by the pandemic last year, is back on — and it has a new look.

Keynote speeches and panel discussions have moved from the Hilton’s plush ballrooms in downtown Houston to a slick new web interface. Many have been pre-recorded. Deals that came together in the hotel’s executive suites will have to wait. Journalists are missing the free lunches.

Still, the conference’s agenda boasts a who’s who of the energy industry, and increasingly beyond, as the sector grapples with the low-carbon energy transition — a topic that was scarcely mentioned just a couple years ago.

Andy Jassy, the head of Amazon’s cloud business, who has been picked to succeed Jeff Bezos as the company’s CEO later this year, had some advice that cut to the heart of the dilemma facing oil executives.

“If you want to be a company for a long period of time — which by the way turns out to be really hard to do — you have to be able to reinvent yourself, sometimes several times over,” said Jassy in a session with BP’s Bernard Looney, who pitched his company’s own transition away from oil.

“If something is going to happen, whether it’s good for you or not, if it is good for customers it is going to happen,” added Jassy. “So you have a couple of choices: you can howl at the wind and wish it away as a lot of companies do — big leading companies do — when there are new shifts technology, or you can embrace it.”

Energy Source is a twice-weekly energy newsletter from the Financial Times. It is written and edited by Derek Brower, Myles McCormick, Justin Jacobs and Emily Goldberg.



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Hedge fund manager Hohn pays himself $479m

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Billionaire hedge fund manager Sir Christopher Hohn has paid himself a dividend of $479m, one of the largest-ever annual personal payouts in the UK, after profits at his firm more than doubled last year.

Hohn, who is founder of Mayfair-based TCI Fund Management and one of the UK’s biggest philanthropists, made the payment to a company he controls during the year to February 2020, according to regulatory filings.

TCI, which manages more than $45bn in assets and tends to bet on rising rather than falling prices, has been a big winner from the bull market of recent years. During 2019 it made $8.4bn worth of profits for investors, according to LCH Investments, profiting from gains in stocks including Alphabet, Charter Communications and Canadian Pacific Railway.

TCI Fund Management’s profits for the year to February 2020 jumped 108 per cent to $670.9m. The $479m dividend was then paid to a separate firm TCI Fund Management (UK). Both companies are controlled by Hohn.

TCI declined to comment. The payment was first reported by The Guardian.

While the payout beats the £323m paid to Bet365 boss Denise Coates in 2018, much of it has been reinvested in TCI funds, filings show. It is also far from the biggest-ever hedge fund payday, being dwarfed by sums such as the $3.7bn earned by US manager John Paulson in 2007 thanks to bets on the subprime crisis.

In 2014, during testimony in his divorce battle with estranged wife Jamie Cooper-Hohn, Hohn described himself as “an unbelievable moneymaker”. A High Court judge later awarded Cooper-Hohn a $530m divorce payout.

Hohn, who grew up in Surrey and is the son of a Jamaican car mechanic, is known as one of Europe’s most aggressive activist investors. A backer of climate group Extinction Rebellion, he has been vocal in recent years in pushing companies to improve their climate policy, for instance threatening to sue coal-financing banks and warning his fund will vote against directors whose companies do not improve pollution disclosure.

In October Spanish airports operator Aena bowed to pressure from Hohn’s fund, becoming the first company in the world to give shareholders an annual vote on its climate policy.

Through his charity The Children’s Investment Fund Foundation, which in 2019 approved $386m of charitable payouts, he wrote to seven of the world’s biggest asset managers, urging them to put pressure on companies over climate policy.

Last year TCI was one of a number of funds looking to raise fresh assets from investors after suffering losses during the pandemic. It was also one of the big winners from betting against collapsed German payments group Wirecard, making as much as €193m in a week, according to data group Breakout Point.

Hohn’s fortune was estimated last year at £1.3bn by the Sunday Times Rich List.

laurence.fletcher@ft.com



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