Following-on from Tuesday's newsletter, the article in the url below challenges the idea that an investment fund that excludes certain industries cannot be as productive as one that has no such restriction. In particular, the article reports on research by Jeremy Grantham looking at the effect on returns of excluding specific industries from funds he created:
"Mr Grantham checked the data to find out whether, and how much, omitting the stocks of any industry over three decades would have hurt a hypothetical investor. He created synthetic portfolios that left out each of the ten broad stockmarket sectors and compared their returns with the market as a whole."
The results were surprising, to say the least:
"[Excluding specific industries] made hardly any difference. The S&P index returned an average of 9.71% annually between 1989 and 2017; the index excluding energy stocks returned 9.74%. The range of returns, from the worst portfolio to the best, was just 0.5 percentage points."
So surprising, that he double-checked his results:
"This finding seemed like it might be a fluke. But a further check, going back to 1925, had a similar outcome. The spread between the best and worst portfolios was 0.54 percentage points; there was hardly any gap between the portfolio with energy stocks and without them. … The market, it seems, has done rather a good job over time of pricing stocks so that no broad industry group yields abnormal returns."
Grantham's conclusion is that, since there is no effective difference in excluding specific industries, there is no (financial) reason not to exclude oil stocks from any fund, or divest any funds of existing investments in oil stocks. On the contrary, given the risks facing the oil and gas industry in the (near) future, Grantham recommends that there might be very good reason to exclude them:
"Oil demand has already peaked in rich countries and, as climate fears grow and green technologies become cost-effective, it will eventually peak worldwide. But not everyone is keenly focused on this prospect. Scepticism regarding climate science is common in America. To the extent that sceptics are investors, and are betting on business as usual, at least some of the risks facing Big Oil may not be in the price. Investors might, for instance, miscalculate the speed of transition to greener energy. Advances in materials science and battery technology are making electric vehicles a cost-effective alternative to petrol-fuelled cars, Mr Grantham reckons. Other potential hazards face oil companies, including increased regulation and costly lawsuits. In other industries, such as tobacco, firms have been forced to pay up when found to have knowingly sold harmful products. He thinks the oil industry faces a similar reckoning."
He goes further:
"Is there also a moral case for disinvestment? … Bill Gates, a software mogul and philanthropist, has argued that people should not waste idealism and energy on a policy that will not cause any reduction in the use of fossil fuels. What matters are incentives set by governments: tax breaks to fund research in green energy; tax rises to discourage carbon use. But this misses the point, says Mr Grantham: 'You have to make the oil industry a pariah for bad behaviour.' Only then will politicians feel the need to act."
Take care
David
David Chandler
© Sage Publications, 2020
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Inessential oils
By Buttonwood
January 11, 2020
The Economist
Late Edition – Final
61
https://www.economist.com/finance-and-economics/2020/01/09/jeremy-grantham-on-divesting-from-big-oil
