Amy H. from Austin, TX asks: Hi Mitch, I would like to hear your thoughts on ESG investing. Specifically, whether it’s a good long-term strategy, and if you think it could be a good time to reduce traditional energy company holdings? Thank you.
Mitch’s Response:
Thanks for sending your question, Amy. For readers who aren’t familiar, “ESG” investing refers to a fairly broad category of ‘environmental, social, and governance’ companies. These companies generally focus on areas like clean energy, social impact, diversity, sustainability, responsible sourcing, and so on.
There is growing investor interest in these types of companies, particularly as climate narratives become a greater focus in corporate boardrooms. That being said, the principles behind what qualifies a company as an ESG investment are, to date, quite vague. Third parties generally determine ESG status, and the qualifications are not very well defined.1
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I’ll focus my response on ‘clean energy,’ which is one of the more popular categories of ESG investing. The bottom line for me is this: does the ESG company you’re pursuing have growing earnings, with a history of positive earnings revisions and better-than-expected results? In my view, investors looking into ESG should not treat the category any differently than you would a traditional energy company, for instance. Oftentimes, when investors get too focused on aligning values with investment decisions, it can lead to bias when evaluating fundamentals. In other words, make sure your ESG investments have strong fundamentals in addition to a strong mission.
On the clean energy front, one key factor to consider is that S&P 500 energy companies only make up about 3% of the broad index, so an investor’s energy exposure – whether it is clean energy, fossil fuel companies or some combination of the two – should not be a significant portion of an overall portfolio, in my view.
I also believe the transition to renewable energy, while underway, may not happen as rapidly as many may think. Renewables are contributing an increasing amount to overall energy production in the U.S., but oil and natural gas still have the biggest market share and are not likely to lose it in the next several years. In the meantime, we are likely to continue seeing patterns like the ones that have emerged this year – crude oil prices are at their highest level in seven years, and natural gas has roughly doubled in 2021.
‘Traditional’ (fossil fuel) energy investors have seen the S&P 500 energy sector surge 54% in 2021 (through October 25), while the broad S&P 500 is up 21%. In my view, the argument is trying to find the middle ground between a very long-term view on clean energy and the short- to middle-term reality of earnings being generated by fossil fuel companies. I think the answer to your question is in finding a way to strike that balance while using fundamental and earnings analysis to see where you land.
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