The Fossil Fuel Free moment in ETF land

David Stevenson

I've always had ambivalent views about ESG investing. I see nothing wrong with it as such - at best it might actually help shift the short-termist nature of modern capitalism, while at worst it may stop investors putting money to work in some genuinely terrible business models.

But if I'm honest I can't quite drum up any enthusiasm. Part of me thinks the rise of ESG and stakeholder governance is part of a terrible new 'bureaucratisation' of modern business. Because of ESG we end up with yet another department of box tickers and regulation obsessives whose job is not actually to make anything - or decide anything - rather to stop people doing things.

Financial services businesses must now struggle with huge armies of compliance experts, draining most businesses of at least 20% of their cost base. ESG could easily turn into a similar exercise for corporates with paper shuffling and ass-covering absorbing 5%-10% of a business' overhead, all of it sucked into processes that are really designed to avoid the senior management ending up in court.

Then again the cynic in me also observes that at the very least it is a form of job creation but in reality can't we actually use that money on something slightly more innovative and enterprising? Perhaps more importantly when it comes to the ESG debate I've encountered many businesses that tick every single ESG box but are terrible places to work - with loathsome business practises.

The Fossil Fuel Free movement by contrast strikes me as something of a game changer. The idea that we should actively divest our portfolios of any business deeply implicated in the hydrocarbon energy complex was once deemed as revolutionary - even slightly insurrectional.

Now it is entering into the mainstream.

For the record I must declare mild opposition. I'm no deep green but I accept the need for a profound switch in our energy infrastructure. I also enthusiastically support a carbon tax and have no issue with my energy bill funding a switch to renewables.

But I'm also a pragmatist who believes that energy sources such as natural gas have a role to play over the next few decades as a stepping stone to a new energy paradigm. This transition period will also allow us to develop better technologies to ease the transition. Thus, any sharp move away from natural gas in particular would, I think, create too much economic dislocation especially around electricity generation. And if nothing else looking at the transport sector, I simply don't see how we can sensibly abandon oil for cars, lorries and airplanes in the next 10 to 20 years.

Freedom works

But despite my own scepticism I also accept that the fossil fuel movement is making headway, especially with long term investors such as pension funds. I also think that the "millennial" generation - as well as a swathe of older ESG engaged investors - might be very receptive to the message of keeping all that oil and gas in the ground.

To date most of the fossil fuel free activities have been confined to bigger institutional investors, as well as the odd demo or two outside a business AGM.

But now we've seen the first stab at a proper Fossil Fuel Free ETF. Here's what my colleague David Tuckwell (at ETF Stream) had to say about it a couple of days ago in his news report.

"ETF Series Solutions, of Brand Value ETF fame, is listing an ESG ETF with a bite, The Change Finance Diversified Impact US Large Cap Fossil Fuel Free ETF (CHGX). CHGX uses a purpose-built index made up of 100 US businesses and REITs.

"Its index is built by screening stocks in the Solactive US Large & Mid Cap Index for their ESG footprints. Oekam Research, a German sustainability ratings agency, looks at what industry companies are in and immediately excludes those in oil, gas and coal. Companies in weapons, nuclear power, pesticides and GMO receive negative scoring but are not ipso facto excluded. Oekam then looks at whether companies have a "history of controversial business practices". Controversial practices can include environmental destruction, treating employees badly, rampant tax avoidance and negligent safety records.

What companies remain are then sorted by sector, ranked by market cap and the top 100 selected. Selected companies receive an equal weight of 1%. Companies are deliberately chosen such that the sector balances correspond to the Solactive US Large Cap Index. "For example, if the technology sector makes up 13.27% of the Solactive US Large Cap Index, the 13 largest technology Eligible Companies will be included in the Index with a total weight of 13%," the prospectus says.

I think there's something quite powerful and very simple to understand about this new ETF. If I had one intellectual criticism of much of ESG investing, it is that I'm never entirely sure of what it positively stands for? Doing good? But what does doing good actually mean?

Simply excluding stuff you really don't like is a much simpler marketing exercise.

Hate oil, buy this ETF!

The Fossil Fuel Free movement has a singular, easy to understand target: hydrocarbons such as oil and coal. In fact, I'd go so far as to say that if someone ran a whole suite of ETFs that in every other sense tracked global indices (say the MSCI World) but excluded anything coal related - I'd buy it tomorrow.

And I also think the single-issue exclusion idea could be a powerful activist weapon.

Sweet like chocolate

My sense is that the next big thing could be sugar. It's increasingly clear that sugar and its pervasive use in modern diets is powering a massive upsurge in certain conditions and illnesses and is helping power an obesity epidemic. I can absolutely see a point within the next ten years where activists start to hoist banners and disrupt conferences to stop the food and drinks industry from drowning us in a veritable tsunami of sugar rich foods.

The implications for corporations on the wrong side of this debate could be huge - with the spectre of tobacco lurking in the background. Many of the most valuable businesses in the world are in the consumer products space, selling what is fundamentally bad stuff to people who can least afford it. Thus, a Sugar Free ETF could hit the spot. As could an Opioid free ETF that got investors a long way from the peddlers of prescription drugs that are killing hundreds of Americans every day.

But one last challenge awaits - how to get this stuff into the mainstream of investment product market.

Again, my best guess is that feel good ETFs and their siblings in actively managed funds land are largely bought by the dedicated enthusiasts - ordinary investors who care greatly. Most investors don't bother with these options because they are largely advised, and most professionals are cynical about these ideas as part of mainstream investment practise.

But the rise of the direct-to-investor market in all its incarnations - robos, internet dealing platforms, investment apps - will change that. Many robo platforms for instance are already offering ESG and feel good products as a CORE part of their offering.

The other challenge will be more political. If we all collectively feel strongly about abandoning fossil fuels, fiddling around with Fossil Fuel Free ETFs is really a side show. The main action belongs with the major indices which nearly everyone uses. Surely activists need to target these index developers - encourage or threaten them to drop fossil fuel businesses from their benchmarks? If these indices can set thresholds on say shareholder voting rights, why can't they also decide to exclude certain socially undesirable sectors?

It's not an argument I'd agree with but if I was a smart activist I'd make sure the index firms are the next political and ESG battleground. Only by changing benchmark indices will true change be enabled.


No ETFs to show.