Does divestment produce positive results?

Posted by TEBI on May 22, 2019

Does divestment produce positive results?

 

By our staff reporter

 

A few weeks ago on TEBI we posed the question, Do sustainable investors behave better?

We focused in particular on research conducted by DEREK HORSTMEYER, Assistant Professor of Finance at the George Mason University School of Business in Virginia.

Using investor data from Morningstar for the ten-year period up to 2017, he compared the return gap on 864 US-domiciled ESG funds to the gap reported by mainstream funds. On average, he discovered, the gap for the former was 1.23% smaller than it was for the latter.

We’ve been talking to Derek Horstmeyer about the latest developments in the sustainable investing sector, his views on divestment, and about his latest research into the feasibility of creating a market-neutral ESG portfolio.

 

Derek, as an academic with a specialist interest in sustainable investing, presumably one of the problems you face is defining what it is. Are there any generally accepted industry rules as to what can or cannot be placed in an ESG fund?

That is a very good question. There’s still not a complete consensus as to what the correct definition is, but we have to have a much clearer and robust picture than we did ten years ago since so many people are spending time and effort to analyse companies along ESG dimensions and reporting such results.

We have a number of guidelines and indices that have been constructed, like the KLD and SRI, that attempt to codify what it means to be an ethical or sustainable company, but still this is very much open to debate.

The biggest debate is whether to invest in a negatively screened fund, where you take out companies from your index that are truly doing harm — tobacco, gas, oil and so on — and an actively sustainable fund, where you construct the fund by adding companies that are actively taking measures to be sustainable, address gender pay issues, and are acting ethically.

 

You’ve carried out some work with Centered Wealth, a financial advice firm based in Minneapolis, on the extent to which ethical investors behave in a different way to mainstream investors. What did you find?

Ethical investors definitely act in a different way to most other investors. The average investor weighs the risk and return of an investment. If the expected return is worth the risk then they will add it to their portfolio. An ethical investor will weigh the risk, return, and ethics or motive of the investment. So an ethical investor still clearly cares about returns versus risk, but will only place their money in a fund if they believe it is being responsible or bettering the world in some manner.

 

There are mixed opinions as to whether divestment is a worthwhile strategy — in other words, removing so-called sin stocks from your portfolio. Some advocate it, while others prefer to retain some influence by holding a stock they disapprove of. What are your views on that?

By divesting, for example, from a fossil fuel company, in theory the cost of capital for that firm will go up. This in turn will make it harder for them to raise money to finance new pipelines or other projects and will hurt their bottom line. This only really works if one is able to form a divestiture campaign en masse. And the body of evidence is still a bit mixed on how effective this can be as well.

From the investor’s point of view, divesting can add value to a portfolio if you happen to time when the technology change is taking place. For instance, oil and gas ETFs like the Energy Select Sector SPDR fund or the Vanguard Energy ETF, have gone straight down over the past five years. This has obviously been because the price of oil has dropped precipitously, but also because of a shift to other forms of energy production, such as solar, wind and renewables.

 

Are we starting to see the cost of ESG funds coming down, ratline to mainstream funds?

The cost of investing in ESG and socially responsible funds is a few basis points higher than standard equity ETFs — approximately ten basis points on average — but yes, this difference is coming down over time, which is really encouraging.

 

What trends or strategies do you foresee in the ESG sector in the near-to-mid-term?

With companies focusing on alternatives to meat, like plant-based products and lab-grown meat, coming to IPO this year, I think this opens up a new area of environmentally focused companies that will make an interesting addition.

One thing I am studying right now is the feasibility of creating a market-neutral ESG portfolio. In effect, can we create an ETF where we buy all the ethical companies and short all the unethical companies, while still being market-neutral?

This product does not exist yet and the preliminary results that I am looking at show that it can be created and demonstrate price stability. I hope one day this product does come to market since it would give investors the option of actively helping ethical companies and actively hurting, in a cost of capital sense, harmful companies. It would be an “ultra” impact portfolio of sorts.

 

Free sustainable investing event in Leeds, England, 9th July 2019

Are you a financial adviser, investment consultant or fund trustee? Do you want to learn more about ESG and impact investing? You may like to know that we’re helping to run a free one-day event in Leeds on Tuesday 9th July to highlight the latest developments in this increasingly important sector.

For more information and to register, follow this link:

The Values-Based Adviser, Elland Road Stadium, Tuesday 9th July

 

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