Divestment Is Not The Answer: An Easy Way Out Of A Complex Problem

Divestment, the act of removing and or excluding particular sectors or segments of the market from investment portfolios, was all the rage at the beginning of the last decade in the face of climate change. Based on my perspective, however, the results of such action by institutions and portfolio managers have been uninspiring.

For citizens of a democracy, voting is the most important action one can take toward shaping the future path of economic and social policy in his or her municipalities, states and nations. George Nathan, an American editor in the early- to mid-1900s, has been credited with saying, “Bad officials are elected by good citizens who do not vote.”

A case can be made that the same level of responsibility held by voters in a democracy sits with the market when it comes to shaping a company’s business decisions. Shareholders, irrespective of size, are typically entitled “to vote in elections for the board of directors and on proposed operational alterations such as shifts of corporate aims and goals or fundamental structural changes,” according to Investopedia. When you consider the democratic tradition of voting to make a change, particularly in American culture, it is hard to “square the circle” when it comes to supporting divestment.

However, recently, the trend seems to be shifting. This year, shortly before Memorial Day, the board at Exxon “conceded defeat” to impact investment firm Engine No. 1, which drummed up (and won) a proxy fight by alleging the company was being disingenuous with its emissions targets and not taking its impact on climate change seriously enough. Through a combination of publicity and engaging with large shareholders, the newly launched firm used activism to, against the recommendation of Exxon’s executives, elect three candidates to the company’s board who are committed to pushing the company’s business model away from fossil fuels and toward renewable energy.

As an investor, one should strive to understand as many of the components of risk that will impact a company’s (or country’s) future rate of growth and ability to operate efficiently. We founded Norbury Partners, a sustainable macro fund, on the premise that it is impossible to make informed investment decisions without considering changing consumer preferences, as well as changes in the regulatory and policy environment arising from climate change mitigation and adaptation and access to basic services. However broad, certain sustainability information can be material to better understand macroeconomic variables and the idiosyncratic risks associated with countries and the future cash flows of corporations.

From severe flooding in low-lying cities caused by mega-storms to drought-stricken commodity harvests, and everything in between, it has become increasingly clear that fundamental data found on company 10-Ks, or in periodic sovereign data, does not always wholly paint a picture of the future. Like people and their voting habits, companies and countries change with the times. Look at the past six months: the United States rejoined the Paris Climate Agreement and the largest economies in the world committed to net-zero targets within the next 40 years.

Rather than divest, rational investors seeking to maximize their returns should look for companies in the early or interim stages of change that will create outsized value in a changing world energy paradigm. Often by the time companies mature, becoming renowned for their sustainability practices and stalwarts in environmental, social and corporate governance (ESG)-focused portfolios, the excess value created when a company managed its downsides and built upside has already been priced into the stock.

Furthermore, what industry is going to see a more significant shift in the changing world paradigm? Someone will have to provide the innovation and energy required to power a growing, more technology-centric world. By participating in a company that has long been called for divestment, Engine No. 1 has demonstrated that investors have a better chance of shaping the future and capturing upside for themselves as active shareholders than they do as spectators in the market.

Finally, the nature of markets guarantees that by divesting, particularly on a large scale, prices will be pushed down with more sellers than buyers. This, in turn, increases the expected return for divested company shares where business will continue as usual, bringing non-ESG-focused investors into the fold who are less likely to make the required changes (or vote along those lines) for a sustainable future.

By last fall, more than 1,200 institutional investors, with more than $14 trillion in assets, had made commitments to the divestment of fossil fuel holdings. Yet, the way I see it, the movement has failed to bring about the change it has been lauded to produce.

As citizens of a democracy, it is our right and our duty to exercise our vote in order to institute change. As investors, we should be looking for the upside to be found in energy companies transitioning to technologies more suitable for the future that policymakers have committed to. And as students of markets, we must recognize that by divesting shares and pushing prices down, we increase a stock’s expected return, thereby inviting marginal investors less committed to ESG and a sustainable future as shareholders, and creating a feedback loop of “more of the same,” with little prospects of advancing toward our goal.

Voting should not be something we talk about every four years. Utilize your ability to be an active market participant to drive the change you want to see.

Article also submitted to Forbes

What A Divided Congress Could Mean For Sustainable Infrastructure Investing

In a fitting end to an already tumultuous year, the 2020 election cycle has (nearly) ended with President-elect Joe Biden announcing members of his cabinet and further refining his platform. One key tenet of his preelection policy agenda was an infrastructure bill with a focus on the renewable sector, but the prospect of a divided government will meaningfully change the size and scope of any legislation passed.

As it stands, there will be 50 Republican senators and 48 Democratic senators, with two seats remaining to be decided in the Georgia runoffs this January. The best historical precedents for these races are the 1992 and 2008 Georgia Senate runoffs, both in presidential election years, which saw a decline in turnout from the general election and the Democrats losing more support than Republicans.

Given the aggregate Republican lead in both races on Election Day, it will be a steep hill for the Democratic Party to climb. Even in a narrowly controlled Democratic Congress, we predict it will be difficult to set pollution limits on greenhouse gases given the producer and consumer states from which certain senators hail. In the face of a divided government, Biden will have to pull on different levers to pursue an infrastructure and clean energy agenda. Following the last two presidents, I expect a healthy amount of regulatory and executive action to be used for achieving policy goals.

A narrow margin in Congress means a less aggressive Clean Energy Standard than Biden campaigned on and may require the inclusion of somewhat forgotten energy industries like nuclear and hydropower. A technology-agnostic clean-energy standard for utilities and the grid would likely include the continued use of natural gas power plants with carbon-capture technology because renewable energy remains intermittent.

From where we stand, improved battery technology can take two paths: First, batteries at the grid level could decrease natural gas dependence by solving the intermittence issues of renewable energy, and second, batteries at the electric vehicle (EV) and home level could increase the dependance on natural gas for the grid as residential consumers consume more electricity. This is all to say that prospects for traditional energy sources are not as bleak as one might think and that the accelerating adoption of EVs might accelerate demand for natural gas in the short to medium term and impact commodity prices.

The government also has massive buying power. We expect the Department of the Interior to be far more active in its pursuit and purchasing of alternative energy sources. Offshore wind and solar are proven technologies with decreasing costs that can be looked to by the administration to “green-ify” the grid without the need for massive fiscal stimulus simply by using the existing government balance sheet.

Some analysts believe that even with a Republican-led Senate, the multibillion-dollar planned spending on the electric grid from President-elect Biden’s “Build Back Better” plan could pass as part of a broader bipartisan stimulus bill focused on jobs and infrastructure next year. Said grid spending could encompass and support energy efficiency and weatherization technology. Grid innovation, in large part, is a necessary complement to the aggressive adoption of EVs while energy efficiency and weatherization legislation will impact builders, owners and retrofitters of both commercial and residential real estate.

In our experience, investors cleanly (forgive the pun) put environmentally innovative energy investments into two buckets: new technologies and process innovation. I believe that the forthcoming Biden innovation will use a mix of executive action and legislation to participate in both buckets, with a divided government forcing a greater emphasis on legacy process innovation than a democratic sweep would have otherwise pursued.

Three of the largest segments we expect the government to invest in are electric vehicles, electric vehicle infrastructure and hydrogen power. Having already discussed the first two, we will focus on hydrogen power: a possible substitute from electric generation in natural gas power plants. New York, Virginia and Ohio recently paid more than $3 billion for three power plants that will initially run on natural gas but be outfitted for using green hydrogen, produced by wind and solar, as collection ramps up. We expect hydrogen storage to be an ever-increasing pillar of the energy complex and look to companies in the space to offer value in the coming decade.

In conclusion, a divided government sets the stage for a smaller, albeit interesting, infrastructure and clean energy agenda that will impact both new inventions and legacy energy tech. We’re interested to watch how the incoming administration navigates all-too-familiar D.C. gridlock, a global pandemic and a recovering economy. A few other industries worth watching are renewable diesel and natural gas, energy efficiency as a service, and energy efficiency in oil fields and digital infrastructure.

Article also submitted to Forbes