ETFs that exclude fossil fuels need closer scrutiny: expert

Cutting carbon producers from green ETFs is key to being an impactful investor, Jochen Wermuth says

Passive investments are vital to drive positive change within the environmental, social, and governance (ESG) investment space, according to an impact investing expert.

Speaking as a keynote at the end of last year at Expert Investor’s ESG Congress, Wermuth Asset Management founder, Jochen Wermuth said more passive exchange traded funds (ETFs) that excluded fossil fuels needed to be created and this was the change that the industry needed.

“By excluding the fossil fuel companies in the long term, it will have a positive impact. I would count them as impact but it’s very important not to be invested… in things like cluster bombs and coal mines that promote marketing trends like #positiveimpact – that’s a big issue,” he said.

“We want to make sure that we have a high standard.”

Scrutiny key

Addressing green washing concerns and ETFs, Wermuth singled out an unnamed ETF which he called an “amazingly idiotic product” as it sought to exclude the companies on the Carbon Underground 200 list, which identifies the top 100 coal and top 100 oil and gas publicly-traded reserve holders ranked by the potential carbon emissions content of their reported reserves.

“As a result, it called itself fossil free, which is good, but then they said there was a tracking error to the actual MSCI index,” he said.

“So, they thought, ‘Okay, I’ll take Carbon Underground 201 to 400 and add it back in’.  So, the tracking error went down but the total carbon footprint of the fossil fuel index was above the MSCI index.  So, you should look carefully when you do this.”

Liquid investments

Wermuth noted that the best approach to impact investing with liquid investments was to first exclude the companies on Carbon Underground 200 list from the portfolio.

“Immediately you have a relatively clear statement that I’ve taken out the biggest oil, gas and coal companies that are listed, and are no longer in my portfolio.  I think you have every right to call yourself an impactful portfolio.  You could also go all out and call yourself an activist,” he said.

“How would you invest if you were limited to liquid and Ucits?  I would exclude the fossil fuels.  If I had the luxury of more research, I would think about all the suppliers to fossil fuel companies, I would think about the combustion engine market and the suppliers to them and exclude those.

“Then, you’d probably have an outperformance over the next 10 years or even 100 years because these industries are likely to disappear.”

This article first appeared on ESG Clarity‘s sister title Expert Investor.