Multi Asset

Winds of change

Winds of change

Responsible investment approaches that consider environmental, social and governance factors look set to play an increasing role in multi-asset investing, according to Mellon Capital global strategist Jason Lejonvarn.

The quality of a company’s governance and the impact of its policies on society and the environment are no longer peripheral considerations in investment decision-making. Increasingly, these factors often play significant roles in the portfolio construction and management process.

In the context of multi-asset investing, portfolio managers are likely to have to contend with a variety of governance regimes and disparate levels of disclosure and transparency, especially if they are investing globally. There are a number of ways to engage with companies in an attempt to effect change but one crucial rule of thumb should be to do so in a thoughtful fashion and not solely to pay lip service to the idea of sustainability.


This is a factor Lejonvarn feels strongly about, most specifically with regards to fossil fuel divestment. This is the practice of removing investment assets, including stocks, bonds and investment funds from companies involved in extracting fossil fuels in an attempt to address the problem of climate change.

Says Lejonvarn: “The moral argument is that the majority of unused fossil fuels need to remain in the ground in order to prevent the potentially catastrophic levels of climate change that could occur if they were to continue being burned. Supporters believe if regulations were enacted to limit fossil fuel burning those assets remaining in the ground would become ‘stranded.’ The argument then goes that the inability to profit from these assets would increase investment in renewables and drive down the market values of those companies with large unused reserves.”

 At Mellon Capital, the belief is more nuanced, namely that divestment on its own is not a practical solution to climate change. There are two main reasons for this: firstly, divesting of fossil fuel companies does not reduce carbon emissions because fossil fuel companies simply meet the demand from our carbon-reliant society and divestment does nothing to tackle that demand; secondly, excluding fossil fuels from a portfolio, for example, does not have an effect on the profits of the underlying companies because of that aforementioned demand dynamic. Lejonvarn believes, therefore, that divestment can lead to a false sense of accomplishment. 

“While the stranded assets argument is powerful and has a number of prominent advocates, in our view it is incomplete. It requires assumptions about energy supply and demand that are driven by many complex factors such as regulations and innovation. In addition, it represents a practical challenge: The global economy is so energy dependent that we believe it is currently impossible to implement a near-term wholesale shift away from fossil fuels and the technologies that use them without a massive—some would say unacceptable—economic impact,” he says.

A number of states, as well as some countries, have mandated increased energy production from alternative means. But, says Lejonvarn, no viable and comprehensive alternative energy infrastructure currently exists to meet global energy needs.

He says at Mellon Capital the wisdom is that significant changes in energy production and usage will likely come about more gradually and in the meantime investors should find a way to have more of an immediate impact.

For this reason, the investment team at Mellon Capital prefers to focus on carbon emissions. “It is these that are raising temperatures, creating air pollution and damaging fragile ecosystems today,” says Lejonvarn.


According to research by NASA’s Goddard Institute for Space Studies, March 2016 set a new record temperature for that time of year: the global temperature was 1.34 °C (2.30 °F) warmer than the average month for March from 1951 to 1980, which is used as a baseline. This was the sixth consecutive month the earth has seen record-setting  heat.1

“The greenhouse gases emitted today will stay in the atmosphere for many decades to come. Almost every company emits greenhouse gases and contributes to global warming to some extent, but as we invest we have a choice to make regarding the companies we invest in and how much capital we allocate to them. That choice can have an environmental impact if we support those companies that make the world greener,” says Lejonvarn.

He believes divestment imposes investment risk in terms of increased volatility. To illustrate the point, he uses the Russell 3000 Index and, using the energy sector as a proxy for fossil fuels, a custom Russell 3000 ex Energy Index.

The ex-post tracking error of this Russell 3000 ex Energy Index against its parent Russell 3000 Index from 1997 to 2014 is 1.59% per annum (the ex-ante tracking error is 1.20%). Figure 1 depicts the annual returns of the Russell 3000 ex Energy Index relative to the parent index since 1997. While the divestment approach might look smart in light of the recent plunge in oil prices, the same approach would have struggled to gain adherents during the strong energy run-up from 2004 to 2007, during which the Russell 3000 ex Energy Index would have returned 36.10%, compared to the Russell 3000 return of 44.54%.

“Considerations of investment performance aside, those divesting their holdings in fossil fuel companies lose their voice of influence over those companies. There is also risk that the holdings, and with them the voice of influence on climate change issues, pass to other investors that are less concerned with such issues.”

“This motivates us to engage with companies that produce and use fossil fuels to adopt more environmentally friendly corporate policies in order to improve their carbon footprint. In addition, we think energy companies happen to be a convenient target, while many companies in the other sectors—predominantly utilities, materials, and industrials—make profits while ignoring or dismissing global warming (see chart at left),” Lejonvarn adds.

Fighting global warming is a long journey, from reducing carbon emissions in the near term to building a more environmentally friendly energy infrastructure globally. At Mellon Capital, the team believes divestment to be a missed opportunity to influence changes and prefers to pursue engagement and active underweights as a better strategy.

Green Thinking: Renewable Energy Investment

The renewable energy sector may offer investors more than an opportunity to show support for technologies intended to address carbon emission concerns. Investment in renewables may also offer exposure to potentially attractive returns.

In an investment environment characterized by low yields, investors are casting the net wider in search of real returns. Exposure to renewable energy projects can deliver just that. In addition, investments in renewables can offer a degree of diversification from traditional asset classes particularly given the longer timelines and inflation-linked characteristics of many projects.

Thirty-eight states have passed legislation to create renewable portfolio standards or goals that require power utilities to invest in cleaner generating technologies such as hydroelectric, solar and wind. These mandates vary from state to state and reflect local political conditions as well as the feasibility of implementing renewable technologies. Among the states that have passed renewable legislation, both California and New York have set targets of 50% of energy from renewable sources by 2030. Texas has set a target of 10,000 megawatts by 2025, and Hawaii seeks to meet 100% of its energy needs via renewables by 2045. At the other end of the spectrum, Kentucky and West Virginia, whose economies rely heavily on coal production, have yet to impose mandates. Nevertheless, the most populous regions of the U.S. now require substantial expansion of renewable energy-generating capacity over the coming years, which creates significant opportunities for investors in these technologies.

While the future appears bright for renewables, portfolio managers with Newton Investment Management caution that the nature and specifics of individual renewable energy projects can vary widely and can make it hard for investors to make accurate direct comparisons across specific projects. For this reason, they believe it is important for investors to be mindful of their investment horizon and risk tolerance, especially when the relative youth of the renewable market is taken into account.

This article is from the Multi-Asset Special Report Summer 2016.

1. NASA: ‘2016 Had Hottest March on Record,’ April 20, 2016

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