Bill Jamieson: Can renewables match oil and gas?

WHETHER you are a private investor or a fund manager, it has been impossible to avoid the growing calls for divestment out of companies whose business is fossil fuels and to invest instead in alternative energy.

Environmental protesters have targeted RBS over its links to investment in controversial tar sands projects. Picture: Getty

But can this be done without risking investment performance and ending up with a portfolio that lags the market benchmark?

Renewed worries about an approaching sharp fall in the price of oil provide an ­immediate reason to look more critically at buying into an index-tracker fund where holdings in oil companies dominate.

But pressure has been building for years on institutional investors to reassess their exposure to companies that extract fossil fuels. Whether concerns centre on pollution effects or the cumulative effects of greenhouse gas emissions, grassroots campaigns calling for fossil fuel divestment are growing. Investors are increasingly finding themselves the target of fossil fuel divestment campaigns that originated from within US universities, similar to the anti-apartheid divestment campaigns of the 1980s. Research from the London-based non-governmental organisation Carbon Tracker warns that regulations to limit ­carbon emissions could hit the market value of fossil energy companies as it becomes uneconomic to extract reserves.

Investors also face a more difficult regulatory environment, with controls on carbon dioxide emissions tightening. Falling demand for fossil fuels could also make fossil fuel reserves substantially less valuable, or even “stranded” – and ultimately rendered worthless.

Nor are concerns confined to the climate change lobby. A recent report by HSBC’s oil and gas analysts examined the effects on the sector of falling oil and gas demand in a “low-carbon world”. It warned European energy companies could see their market capitalisation fall 40-60 per cent if oil prices (net of any carbon tax or cost of pollution permits) were to drop to $50 a barrel.

But investment switching suffers from two widespread investor perceptions. One is the poor financial performance of many wind farm companies. The second – of particular concern to investment trustees – are issues of fiduciary duty in pursing an investment strategy that may lead to portfolio underperformance.

These issues have now been tackled head on in a research paper released in the past week, Beyond Fossil Fuels: The Investment Case for Fossil Fuel Divestment. It has been produced by one of the most innovative and thoughtful investment companies, Impax Asset Management. It handles a range of trusts and funds specialising in alternative energy, energy efficiency and water infrastructure and technologies.

The compelling argument that Impax presents is that investment in clean energy is far from confined to wind farms. Its holdings range across energy and clean energy in their widest senses. Its research paper also sets out the fact that investment portfolios focused on these areas may not be the index underperformers that fund managers fear.

It looks back over the past seven years and reviews returns and volatility of four alternative portfolio structures: a fossil-fuel-free portfolio, the MSCI World Index without the fossil fuel energy sector; fossil free plus alternative energy, replacing the fossil fuel stocks of the MSCI World Index with a passive allocation to renewable energy and energy efficiency stocks; fossil free plus alternative energy, replacing the fossil fuel stocks of the MSCI Index with actively managed renewable energy and energy efficiency stocks; and fossil free plus environmental opportunities, replacing the fossil fuel stocks of the MSCI Index with actively managed allocation to shares from a wider range of environmental companies.

Eliminating the fossil fuel sector from a global benchmark index over the past seven years would have actually had a small positive return.

An alternative, more diversified approach, would be to substitute the MSCI Energy with Impax’s leaders strategy, investing in companies specialising in environmental services and technology. It includes some 45 per cent exposure to energy, but also captures water, waste management and recycling, and other “resource optimisation” themes. Over five years, this more diversified approach would have delivered the highest annualised returns of the four approaches analysed.

The International Energy Agency estimates that more than half of the new investment required per year to 2030 to meet the climate challenge is needed for energy efficiency in the buildings and industrial sectors. Some 28 per cent is needed for low-carbon transport and 21 for low carbon energy including renewable energy power generation.

Business cycles are driven by adaptation and innovation. My own view is that the coming decade could see transformational innovation and technological advance in energy provision and major improvements in efficiency. And it is this that makes a powerful argument for the Impax investment focus: less fossil, more “future fuel”.