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If you support green energy, you should buy utilities and oil stocks — here's why

By Debbie Carlson

Some ESG investors say divestiture doesn't get companies to change

The fossil-fuel divestiture movement grabbed headlines in December when New York's state comptroller said the $226 billion New York State pension fund plans to drop many of its fossil-fuel stocks (link) in the next five years and sell shares in other companies that contribute to global warming.

The fund owns stakes in big oil -- stocks like Exxon Mobil (XOM) and Chevron (CVX) as of Sept. 30, according to Holdings Channel (link) -- and shunning fossil-fuel investment is a hallmark of longtime socially responsible mutual funds. Many of those funds outperformed last year when traditional energy prices cratered.

But dumping these stocks means investors miss out on buying the companies powering a transition to green energy and making an impact on the environment. That's one of the reason why some ESG fund managers say divestiture doesn't work.

"There's a fundamental mythology in the divestment movement that when you divest, you're somehow fundamentally hurting that company, and that's just not how the markets work. When we sell, someone else buys," says Mark Regier, vice president of stewardship at Praxis Mutual Funds, the mutual fund family of Everence Financial, a Christian-based socially responsible financial services organization.

Granted, some people have moral reasons not to want to hold stocks in certain industries, but for those who want to make an impact with their investments on climate change, one way is to look for companies and funds that are pushing for better behavior.

Advocacy works in a way that divestiture doesn't, says Chris Meyer, manager of stewardship investing research and advocacy at Praxis. The fund family targets their advocacy by engaging with specific companies to influence their transition to greener energy. Praxis owns shares or green bonds from companies such as ConocoPhilips (COP), The Southern Company (SO) and NiSource (NI), advocating for greenhouse gas reduction and phasing out coal-burning power plants.

One recent success Praxis had was with NiSource, a natural gas utility with a stock-market value of about $8.6 billion.

In 2017, Praxis started engaging with NiSource about its Northern Indiana Public Service Company subsidiary, which now gets 50% of its electricity from coal plants. By 2018, NiSource not only committed to a complete coal phaseout by 2028 but said it would bypass using natural gas, a common step in green energy transition, and instead plans to use wind and solar power generation. That will effectively double the amount of installed renewable energy capacity in Indiana and cut overall greenhouse gas emissions by 90%, Meyer says.

Pressure from other community groups and market forces -- coal became less economically viable and the cost of renewable energy fell -- also was behind NiSource's decision, he adds.

A further step was to encourage NiSource to offer jobs to coal-plant workers, which so far the firm is doing. Meyer says is part of a "just transition," making sure people's livelihoods are considered in the green transition.

Divestiture of NiSource stock wouldn't have accomplished any of those goals, he adds, noting NiSource was open to many of the advocates' suggestions. NiSource said in a September 2018 news release (link) that moving up the retirement of all its coal plans in 10 years and replacing it with lower-cost renewable energy sources was "the most viable option for customers." It did not mention shareholder advocates.

Peter McNally, global sector lead for industrials, materials and energy at Third Bridge Group, says energy and utility companies take shareholder advocacy seriously, especially in Europe, where this type of engagement has gone on for much longer than in the U.S. The European energy companies also see the strong financial performance by Danish wind energy firm Vestas(VWS.KO) and power company Orsted, so they're paying greater attention alternative energy, he adds.

With 30% of overall greenhouse gas emissions coming from power plants, the utilities sector is an area ripe for transition to green energy, Meyer says.

In addition, utilities have proven they can make renewables work at scale, McNally says, and they all are investing in renewables in some way.

NextEra Energy(NEE) is the poster child for this transition as this company, with a $162.2 billion market cap, builds out its renewable portfolio of wind and solar energy. But because it still gets some power from fossil fuels, some ESG funds don't hold it.

McNally and Meyer caution that because there are different regulatory regimes across the U.S. for utilities, some are at different stages of energy transition.

A number of utilities are still messy from an ESG view, like Southern Co., which owns the U.S.'s only nuclear plant under construction. But the firm has been issuing green bonds to fund its renewable transition, which Praxis owns, and Praxis see strong corporate governance to continue to their transition.

ESG raters are noticing the improvements. MSCI upgraded its ESG rating on Southern Co. from BBB in December 2016 to AA by December 2018, and considers it a leader in the utilities industry. It also upgraded Duke Energy (DUK) to an A rating in August as Duke expands its renewable power generation and retires coal plants. MSCI's top rating is AAA.

Read:Here's how you can add sustainable investments to your 401(k) holdings even if your plan doesn't include ESG funds (link)

Oil companies are behind the utilities, but some major European oil companies such as Total, Royal Dutch Shell(RDSA.LN) and BP (BP.LN) are pushing to a greener transition. But McNally and Meyer say rather than becoming completely fossil-fuel free, they may transition to being integrated energy companies. Even so, advocates can pressure oil companies to decarbonize, such as fixing methane leaks, or abandon expensive projects like drilling in the Arctic.

Investors interested in holding utilities at the forefront of green transition could look at a utilities ETF. One is Virtus Reaves Utilities ETF (UTES), which has a top MSCI ESG Fund Rating of AAA. However, many index funds are considered light-touch ESG, meaning they aren't shareholder advocates.

However, this is starting to change as large fund providers like BlackRock and State Street Global Advisors say they are becoming more active at shareholder meetings

Read:Your ESG investment may be a 'light-touch' fund and not as green as you think (link)

Investors also shouldn't expect the sort of rapid results that Praxis had with NiSource. Shareholder engagement takes time, but is more successful than divestiture. While many divestiture advocates point to the success of ending South African's apartheid in 1994, anti-apartheid activism started in the 1960s, and there was a lot of shareholder engagement, too.

Greg Wait, adviser at Riverwater Partners, who specializes in ESG, says investors who buy advocacy mutual funds or companies transitioning to green energy should make sure there's clear evidence that the transition is happening, such as by building more renewable power or retiring coal plants to avoid greenwashing. And be patient.

"All this positive change takes years. You can't just say if we own a bunch of big mutual funds ... there's going to be automatic change. That's not how it works," he says.

Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1 (link).

Also read:Rockefeller Foundation built on a fossil-fuel fortune becomes largest philanthropist to shun oil investments (link)

And:Asset managers with $9 trillion under watch launch a plan for net zero emissions -- and U.S. funds sit this one out (link)

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