With markets swinging amid Russia’s war with Ukraine, and oil prices above $100 a barrel and feeding inflation, allocators and asset managers who invest according to environmental goals are again weighing whether to divest from fossil fuel companies altogether, or hold on to them and work to curb their bad behavior.
Take asset manager Engine No. 1, whose activist campaign against Exxon Mobil put it on the map. Not surprisingly, it’s against divesting and the resulting loss of power over companies’ moves. In February, Engine No.1 launched its first thematic exchange-traded fund called the Engine No.1 Transform Climate ETF. The product will invest in companies that facilitate the energy transition and contribute to net zero goals, meaning that investments will span industries, including transportation, energy, and agriculture. The companies selected for the portfolio will be the ones that have plans and products in place to handle the changing climate and the dwindling supply of natural resources. This also means that the portfolio will end up invested in some of the most polluting companies, including General Motors, Ford, Canadian Pacific Railway, and Deere.
“We think there’s an opportunity to have investment funds with a charter to drive both performance and hold companies accountable. It’s part of the reason we started the business,” Jennifer Grancio, chief executive officer of Engine No. 1, told Institutional Investor. “We saw that [with] the Exxon campaign.”
In 2021, Engine No. 1 launched an unexpected — and successful — activist campaign against Exxon Mobil. The small firm, which opened its doors in December 2020, harnessed shareholders’ frustration with Exxon Mobil’s weak performance and general apathy toward climate risk. By May, shareholders elected three Engine No. 1 directors to sit on Exxon Mobil’s board.
Now, the impact investor is moving beyond its activist roots. Engine No. 1’s first ETF, which invests in the 500 largest U.S. stocks, launched in June 2021. As the name suggests, Engine No. 1’s VOTE ETF, with $329 million in assets, is focused on aggressively voting its proxies for the companies it holds.
Meanwhile, the Transform Climate ETF is more tailored to net-zero goals. Its portfolio is constructed of large carbon emitters that it believes will be part of the net-zero transition over the next decade. “At Engine No. 1, we do not believe in divestment,” Grancio said. “In the case of climate and emitters in particular, a lot of big asset owners have divested. And that’s led to shareholders not working with the companies to hold them accountable.”
The firm hopes to differentiate itself from other managers with its emphasis on active ownership — part and parcel of an asset manager’s responsibility, even if the list of companies it owns raises eyebrows in some corners of the impact world. Grancio said the firm believes it’s the asset manager’s duty to employ the full scope of available ESG data and to provide owners with an idea of how that information will translate into longer-term value.
While many institutions have announced complete or partial divestment from fossil fuel companies — take, for example, the New York State Common Retirement Fund’s divestment from 21 shale oil and gas companies in February — asset managers like Engine No. 1 believe that being an active owner is ultimately more effective than divestment.
According to Rob Day, partner and co-founder at Spring Lane Capital, a sustainability-focused private equity firm, Engine No. 1 is hardly alone in its efforts. Day said institutions like foundations are approaching investment in fossil fuel companies through a similar lens. “It’s a fascinating indication of how people are starting to be very pragmatic about this,” Day told II. “They're starting to say ‘we don’t want to just wag our finger. We want to roll up our sleeves and make this transition happen.’”
The $991 billion European asset management firm Schroders also takes an active ownership approach when investing in companies that may be high carbon emitters or produce fossil fuels.
In part, that’s because there is always another willing, if not caring, buyer. “If all you’re doing is decarbonizing your portfolio, that is going somewhere,” Marina Severinovsky, Schroder’s head of sustainability in North America, told II. “What it means is that someone else buys it from you, and, in all likelihood, they are less responsible owners.”
Instead, Severinovsky said the best solution is for managers to invest in high carbon emitting companies that have a plan and mission to shift toward cleaner energy solutions. In fact, Severinovsky said it’s not cut and dry, and the manager is willing to invest in some names that might be polluters now but that have a cleaner road map. Some of the companies that have negative environmental impacts in the present are actively working toward renewable energy solutions, she explained.
“With this new [Engine No. 1] ETF, there’s this built-in [idea] that [they] want to support companies instead of branding them as the bad guys,” Severinovsky said. “I think that’s the right approach.”
Not everybody agrees. While there is a larger institutional shift toward active ownership, Fabian Willskytt, associate director of public markets at Align Impact, an ESG-focused investment advisor, said it’s more likely that asset managers will take a diversified approach. In short, Willskytt said the main strategies for investing in carbon emitters are divestment, ESG integration, and active ownership. Some institutions are investing in strategies like the ETF from Engine No. 1 to diversify away from technology companies, which are the top holdings in a long list of ESG-focused funds.
“ESG and active engagement strategies are becoming more sophisticated, and managers are coming up with their own approaches...as a way to differentiate themselves,” Willskytt told II. “We’re seeing increased diversity in approaches rather than [a divergence] toward one approach.”
Nevertheless, Engine No. 1 is steadfast in its active ownership approach. For example, under its total value framework, Engine No. 1 can demonstrate that variations in the amount of value that companies create or destroy for shareholders and stakeholders is a strong predictor of future financial value, including revenues, earnings, worker productivity, and other measures.
The framework is indicative of Engine No. 1’s business model, which translates ESG data into a material economic impact. This “turns it into dollars and cents,” Grancio said. “And then we revalue the company.”
“Everything we’re doing now is very constructive. We think, in most cases, you don’t have to be an activist, because boards and CEOs want long-term investors that are thinking about how to help them drive change.”