The economic headwinds that have dogged the market this year are testing the resolve of investors who have shunned exposure to traditional carbon-intensive energies amid the recent surge in ESG.
Companies with tough energy exclusion policies have yet to capitulate, according to a survey of institutional investors by Alliance Bernstein earlier this month. But about a third of investors who maintained minimal exposure to energy added to the weight of the sector in their portfolio, a doubling from the 15% who added energy assets when the company polled them in March.
After stronger-than-expected inflation sent markets tumbling on June 10 and 13, energy is now the only S&P sector to post a positive return in 2022. It also outperforms all other sectors with a 53% gain since the beginning of the year.
The effects are clear among major ETFs in traditional and renewable energy. The four largest traditional energy ETFs are all positive for the year, with funds trailing large-cap energy stocks up more than 50% and ETFs focused on energy infrastructure Algerian MLP ETF (AMLP) up nearly 18%.
Renewables have been caught up in the broader market slowdown, with the sector’s four largest ETFs down between 4.4% and 28.7% year-to-date on Friday.
Funds that track the traditional energy sector can track much of their outperformance this year until Feb. 24, when Russia began its latest invasion of Ukraine and caused widespread restrictions on oil and gas. of western countries. Even if Russia were to withdraw its offensive immediately, the damage to the country’s reputation would likely mean that Russian oil would not be welcome in Western countries anytime soon.
The basket of the four largest traditional energy ETFs that track fossil fuel stocks lost $88.15 million net on Thursday after a series of profit-taking, while funds that track companies involved in solar power generation , wind and other forms of renewable energy lost a total of $776 million.
Conversation with customers
The sector’s outperformance amid market chaos this year has prompted advisors to consider adding more client assets to energy this year, especially since the Russian invasion and subsequent oil disruption. The result had repercussions on the markets by increasing the inflationary effects at all levels.
“I think that makes the decision whether or not to exclude legacy energy a bit more difficult for some investors and advisors,” said Paul Baiocchi, chief ETF strategist at SS&C ALPS. “I think there is real anecdotal evidence that counselors are struggling with this.”
For Massachusetts willowa $150 million consultancy boutique that is needed to create public good benefits as part of its designation as a B-Corp, conversations about how much energy exposure a client wants is a matter of setting expectations.
Willow Managing Director Paul Farella estimated that 10% to 15% of Willow customers have a hard screen against any exposure to traditional energy, with another large portion of customers who “would rather not” be in this sector but are willing to compromise for better returns.
Farella said clients who decide not to take energy exposure do so knowing that their returns will be affected by the current market cycle and macroeconomic environment. Customers who are open to energy exposure rely on Willow’s assessments of a specific company’s commitment to transitioning to a zero-carbon future.
The shift to a fully electrified economy will take several years at a minimum, as building or upgrading electricity grids and transportation infrastructure to not be based on the internal combustion engine only in the United States will require large sums of money. money, manpower and herculean resources. .
The aim is to determine which oil and gas companies are so-called “ESG improvers”, or companies that currently would not score well on climate and social impact metrics, but are taking important steps to improve.
Willow also votes her shares in energy companies in favor of social and environmental initiatives, though Farella admits the company’s voting power among oil and gas companies is minimal.
The particularly difficult set of circumstances surrounding the global economy and the fate of the climate could lead to rethinking the mechanism of action of ESG. The common method among ETFs, including the largest funds traded today, is to remove companies that do not meet specific thresholds in ESG ranking lists, or that derive part of their income from ESG taboos like carbon mining, firearms or tobacco production.
Farella argues that the reality of the markets may allow ESG-conscious investors to have some exposure to traditional energy not only to generate returns in the current cycle, but also to put some pressure on energy companies to decarbonization.
“We’ve never been fans of surrender moves because you’re basically giving up your seat at the table, you’re giving up your voice by doing that,” he said. “So by staying in these businesses, we can at least try to push that needle a little bit, and at the same time accept the reality that oil and gas is what makes the world go round right now.”
The long game
While the rush to secure enough traditional energy sources around the world has proven to be a strong performance base this year, it may not spell the end of the energy transition’s long-term investment opportunities. .
Dave Nadig, financial futurist at VettaFi, said ESG should not be seen as a bet that fossil fuel prices will fall, but that the global economy will restructure in the coming years away from its dependence on fossil fuels. carbon energy.
This transition will be messy, as evidenced by the war in Ukraine, with the resulting fuel price squeeze so strong that President Joe Biden has asked US refiners to increase output despite his campaign promises around climate change.
Still, the semester of soaring gas prices and growing pressure on Biden to stifle inflation won’t undo the advances in renewables Nadig points to within the existing economy, a transition he expects. to last over several market cycles and throughout the world.
“People aren’t going to rip their solar panels off their roofs,” Nadig said.
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