Published on October 12th, 2019 | by Andrea Bertoli0
Climate Action & Your Portfolio: A Conversation About ESG Investment & Greenwashing With ETHO Capital
October 12th, 2019 by Andrea Bertoli
In the interest of full transparency, it should be noted that I put a portion of my total investment in ETHO as part of my sustainable investment process. I was previously familiar with the platform and understood it to be one of the greenest ETF options available. Also note that I’m a novice investor, and neither my team nor I can offer professional financial advice. You need to do your own research and evaluate any investments before throwing your money at them, etc., etc.
I’ve long been interested in climate action, and as I’ve become more interested in investing, I’ve become totally passionate about how to do sustainable investment RIGHT – or at least BETTER. Basically… I spend a lot of time doing research.
In my last article about learning to invest sustainably, I wrote that it’s hard to find funds that truly align with my green sensibilities.
But there is one that stood out for me.
A few years ago I worked briefly with a company called Oroeco, an app that works to gamify our individual carbon footprint based on our purchases. Ian Monroe, founder of Oroeco and lecturer at Stanford University, is also the CEO of ETHO Capital, a firm he founded in 2015 to build a fossil fuel free exchange-traded fund (ETF). At the time, I wasn’t ready to invest, but I knew he was onto something really cool – something I knew I wanted to take part in. Once I was ready to invest last year, this was the first ETF that I put money into.
ETHO Capital has grown significantly since its founding in 2015; ETHO currently has about US $310 million in assets across two markets, and has outperformed the S&P 500 in the few years since its inception. Bloomberg recently recommended it ahead of Climate Week, specifically highlighting the rating process and ESG criteria. It’s also a certified B Corporation and is part of the Divest Invest initiative, among other socially responsible partnerships.
I reached out to the ETHO team to learn more about this company that seems to be doing sustainable investment (often referred to as SRI, or socially responsible investing) better than so many others. I had the opportunity to sit down with Amberjae Freeman, ETHO Capital’s Chief Operating Officer.
Amberjae is a finance professional with previous experience working at RBC Wealth Management, the Clinton Global Initiative, and the recently shuttered impact investing fintech, Swell Investing. With her strong background in portfolio construction and environmental, social, and governance (ESG) research, her answers are incredibly detailed and very interesting. Here are excerpts from our conversation, edited for brevity and clarity.
What Is ESG Screening, & What Does It REALLY MEAN For Investors?
Environmental, Social, and Governance (ESG) investing is a form of investing that incorporates metrics that may not be captured in traditional financial analysis, but that may have an impact on a company’s financial performance. This form of investing is becoming increasingly popular, especially with the post Gen X set.
If you do research on green funds, you’ll notice that more companies are incorporating ESG criteria in their investment process– but some of the holdings I’ve seen in ‘ESG’ funds makes me question how people building these ESG portfolios define what constitutes a sustainable company.
There are many distortions in this space and as I dug deeper into so-called green or socially responsible funds, I was (and continue to be) disappointed with the pale green offerings being labeled “sustainable”. For example, some large soda companies might have ‘better’ ESG metrics than their industry peers. However, given that soda companies produce non-nutritive, sugar-sweetened beverages that are conclusively linked to health issues, and that 1 million plastic water, soda, and juice bottles are sold globally each minute (of which only 30% are recycled in the US), I just can’t justify seeing soda companies as contenders for ESG fund placement.
So – I asked the ETHO team about their ‘feedback-driven ESG screening process’ and how ESG criteria can help inform a better vision for funds:
Amberjae: At Etho we have expertise in life and social sciences, public policy, corporate governance etc. We also leverage the collective expertise and experience of professionals in climatology, chemistry, global studies, sociology, economics, sustainability and other disciplines. We also consult with non-profit organizations and policy professionals because it helps us better identify the key issues that are most material to assessing company and industry risk.
What many do not understand about ESG research and analysis is that it is about assessing risk in the present and looking forward. Past performance is no guarantee of future returns, right? Assessing ESG risk is about taking the long view. Our approach at ETHO helps us avoid ESG risks to protect wealth, and helps identify opportunities for investment to help grow wealth. This is why we use a feedback-driven ESG screening process.
For instance, our comprehensive review of PG&E’s lackluster infrastructure investment, especially in light of the prolonged drought in California made them an unattractive investment and of course their bankruptcy risks were driven primarily by how their poor infrastructure maintenance may have caused wildfires. Volkswagen’s dieselgate scandal surprised a lot of people including many ESG investors (as did BP’s Deepwater Horizon explosion and oil spill back in 2010) – However, we avoid these kinds of risks by avoiding investments in industries that are participants in or heavily reliant on fossil fuels. Same with weapons and prisons.
Ultimately, we believe that the capital markets should work to create the most appropriate incentives for encouraging long-term value creation over the pernicious short-termism that currently infects our financial markets and the broader economy. We favor companies that manage their long term ESG risks because those companies tend to have better management and have been able to outperform their less sustainable counterparts. In fact, an excellent 8-year study conducted by MIT and the Boston Consulting Group that we track found that “Companies that focus on material [ESG] issues report up to 50% added profit from sustainability. Those that don’t focus on their material [ESG] issues struggle to add value from their sustainability activities.”
ETHO’s approach is a rebuke of a financial market that emphasizes short-term internalized profits that monetarily benefit a select group of shareholders while externalizing the negative costs of those profits off of corporate balance sheets and into the broader society. As it happens, our strategy works.
Greenwashing in the SRI Industry
One of the things I’ve seen repeatedly in some of these so-called “socially responsible investing” or SRI products is what I’d call greenwashing — making something look greener than it is. This is prevalent across all industries, from food to fuels, and it’s something that I’m well-attuned to, especially in regards to investment.
In a recent company quarterly newsletter, ETHO wrote that with the increased interest in ESG funds, there’s more opportunity for asset managers to greenwash the offerings and ignore key markers of true sustainability. I asked them to say more about this, and how investors can identify a truly green investment product and avoid green washing.
Amberjae: Because financial market participants place great emphasis on diversification to manage risk and return and also tracking error against an index benchmark, they may not realize the importance of ESG analysis in identifying risks that may be industry/sector wide. Attempts to minimize tracking error to a broad market index means that you are still going to necessarily share many of its constituents, even ones that may not be appropriate for sustainable investing products.
Excellent examples of this are present throughout many ESG products. For example, we have seen ESG products that use index methodologies that screen out the following items:
- Nuclear Power
- Conventional Weapons
- Nuclear Weapons
- Controversial Weapons
- Civilian Firearms
Fossil fuels are conspicuously absent from this list despite the ‘E’ in the “ESG.” As such, ETFs built from this type of index might include oil exploration and production companies such as National Oilwell Varco, Hess Corporation, ConocoPhillips, Marathon Oil and many others.
Also, curious is that the stock of the companies making these products are also constituents in their own ESG ETFs and mutual funds even though these companies are not ESG leaders. It makes us wonder how they define their ESG criteria.
For example, I was in attendance at a major SRI conference last year where a representative from one of the world’s largest asset managers was interviewed on the main stage. When asked about her firm’s significant investments in the world’s largest polluting fossil fuel companies, she responded by saying that her firm was not invested in those companies but rather, the people who are invested in their retail products are invested in those companies.
I found that to be an incredibly disingenuous response.
After all, their investors are invested in whatever holdings are put into the portfolios her company constructs. Her firm has total control over which stocks they put into their products. Candidly, I was aghast.
Peak Oil & Investments: What Does the Future Look Like?
We know peak oil is an imminent threat, and that most likely we’ll see massive changes in the oil and gas industry generally. We’re already seeing some big changes: Amberjae let me know that Exxon just lost its 90-year place on the top 10 of the S&P 500 earlier in September. It seems clear to me that big changes are coming, both because of increased electrification (e.g. electric cars and big rigs), along with the growth of solar, wind and other renewable technologies. And as she discusses below, oil and gas are massively overvalued.
As I posited in my previous article, even as a novice investor I see a problem with keeping our money locked into companies (and an industry as a whole) that will be facing MASSIVE changes in the very near future. This suggests to me that people should be divesting their portfolio at least from oil and gas. Amberjae gave me a different way to look at the peak oil issue and think about the risks these companies pose to investor portfolios.
Amberjae: We have plenty of oil. We simply cannot burn it safely. As you point out, newer technologies are replacing the much less sustainable incumbents. This transition is necessary, but it also means that as the transition accelerates, those holding fossil fuel assets (coal, oil, gas, etc.) cannot monetize them without grave consequences to our environment.
For example, Carbon Tracker Initiative (CTI) has been publishing excellent research on how the oil and gas and coal industries present significant stranded asset risks to investors for several years. The year they published their 2011 report, “Unburnable Carbon: Are the world’s financial markets carrying a carbon bubble?” (1) I had only been a year into my time at RBC and found it a compelling read. They argued that fossil fuel companies were significantly overvalued because they would not be able to monetize the assets (of proven oil reserves in particular) without exceeding our carbon budget for the century – i.e., the total amount of fossil fuel that could be burned before the temperature moved above the 2oC threshold.
Further, they surmise that reserves are a large component of an O&G major’s valuation, contributing around 40-50% of the financial value attributed to the company by investors. In a follow-up study in 2012 (2), the CTI estimated that oil, gas, and coal sectors proposed $1.9 trillion in capital investments to access known reserves through 2035. But those investments are directed to extracting only about a fifth of all identified fossil fuel reserves.
Further, in their report, “Unburnable Carbon 2013: Wasted capital and stranded assets” they argued that the allowed carbon budget, when allocated pro-rata to listed companies, cannot justify the observed CAPEX spending used to develop new fossil fuel reserves. Especially since by their calculations, only about 20-40% of fossil fuels currently booked as reserves could actually be burned under a 2-degree scenario. These reports were based on 2010-2013 data. This is 2019, O&G fundamentals have not improved.
We understand the risk to the planet already, but what is the risk to investor portfolios? A Citigroup report from 2015 states the financial risk of fossil fuels plainly. They estimated that the value of unburnable reserves could amount to more than $100 trillion out to 2050. With the biggest loser being the coal industry. They go on to say that while gas suffers a smaller reduction it is still likely to be impacted. The study also notes that over the next quarter century, renewables, wind, energy efficiency and even nuclear are the main beneficiaries of this energy shift.
Some investors have already felt the negative consequences of fossil fuels in their portfolio. When Canadian clean capitalism magazine, Corporate Knights applied their portfolio decarbonizer tool to the University of Toronto’s endowment fund, they found that the pool would have avoided paper losses of half a billion dollars had it sold its carbon-heavy oil and coal assets in 2013. (3)
We are not talking about environmental risk exclusively, we are talking about the risk of mispriced assets in the financial markets and in most investors portfolios great and small. These risks are the result of environmental factors which have an impact on the broader society and the failure of corporate governance to appropriately manage and de-risk the business in ways that would have added value for investors into perpetuity.
In fact, there is strong evidence to support that they failed to disclose these risks to investors and the broader public, once they became known. (4) In our view, this is a breach of their social license to operate. They knew of the value at risk and mislead investors anyway. (5)
Building a Brighter Future with Better Investments (?!)
I had also asked in the interview about recommendations for someone that wants to divest their portfolio entirely or mostly from their fossil fuels portfolio. She said simply that ETHO avoids these by opting out of these sectors at the outset, stating that, “Mispriced risk in the financial markets are the result of short-term thinking.”
She goes on to say:
“While I cannot necessarily recommend any one product or firm, no matter which investment vehicle you choose – the devil is in the details. Be sure that you can see all of the holdings that would be in your portfolio. You’ll also want to check out the holdings in bond ETFs and mutual funds just to make sure there are no surprises with respect to the holdings in them.”
In summary, as I wrote in the beginning, and as Amberjae confirmed, the devil is in the details. To start investing with greener focus, you need to do the research into your ETFs, mutual funds, and other holdings that you might have; get to know more about the criteria by which your fund managers screen their offerings, and how those align with your values as a human and as a shareholder.
There’s no clear answer here when it comes to building the best portfolio, and where your personal boundaries sit about how sustainable you want your portfolio to be. I opened my last article suggesting that I’m not 100% on board with this whole capitalism thing; I recognize it as a system that has benefited very few at the expense of many, and it is inherently flawed.
I’m also deeply conflicted about the way in which my privilege affects my presence in the markets and my opportunity to build my financial future. Should I be taking part in this system that is by design exploitative of human and natural capital? Can we build a better system from within, by choosing better companies, and buying into better investment opportunities – while understanding that perhaps we cannot dismantle the Master’s house with the Master’s tools. Or, can we fundamentally shift our understanding of markets and asset management to focus on building a future that builds a healthier future based on natural capital?
What if we could redesign the investment world to take humans, nature, and good business into account (the triple bottom line principle)? Can our investments help build a better financial world that benefits the collective of humanity. Can the shift really start with better investments? I think it can.
(1) This report coined the term “carbon bubble” and advanced the “stranded assets” thesis. Very elegant research they do over there.
(2) Carbon Tracker Initiative. “The $2 trillion stranded assets danger zone: How fossil fuel firms risk destroying investor returns” 2015
(3) Lorinc, John. “The tragedy of the horizon.” January 19, 2016, Corporate Knights, Winter 2016 http://www.corporateknights.com/channels/leadership/the-tragedy-of-the-horizon-14531832/
(4) Roberts, David. “Exxon research[ed] climate science. Understood it. And misled the public.” Vox, August 23, 2017
(5) Chen, Angela. “Exxon Mobil lied to investors about climate change regulation, New York lawsuit says.” The Verge (with supporting links), October 24, 2018
Thanks to Amberjae and the ETHO team for the time and consideration put into this article.
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