By Debbie Carlson
Engine No. 1, the small hedge fund that scored a coup this year by placing three climate-focused, independent directors on oil giant ExxonMobil’s board, said it has already had an early win.
Jennifer Grancio, the CEO of Engine No. 1, said Exxon (NYS:XOM) has scaled back new long-term production targets. Exxon is keeping oil output at the lowest level in two decades in the years through 2025. That would be a 25% decline from forecasts before the pandemic started.
“That was a good kind of early win,” she said Friday at the Morningstar Investment Conference in Chicago.
Grancio said her hedge fund had been working with Exxon for about a year until news broke about the board seats in May.
Work began as the fund started by looking at how Exxon allocates capital and could plan for growth when including the social cost of carbon. That is, how to price the future harm caused by the release of one additional ton of carbon dioxide, using a present monetary value.
Including those costs, Engine No. 1 showed that investing in big, long-term projects that would take years to produce oil wouldn’t be profitable.
When accounting for carbon output, the social cost falls under Scope 3 emissions, which indirectly impacts the value chain of an organization due to activities from the assets not owned or controlled by it. Scope 1 emissions are direct greenhouse gas emissions caused by sources owned by an organization, such as heating and cooling systems. Scope 2 are indirect greenhouse gas emissions associated with the purchase of energy, such as when utilities buy coal to produce electricity.
Grancio said Engine No. 1 won over other shareholders during proxy voting in May by presenting the economic argument, using the available environmental, social and governance data showing that Exxon could improve its long-term returns by reducing emissions.
Engine No. 1’s aim is that, by working with a large company such as Exxon, it can encourage others to invest in energy technologies including solar, wind and batteries as a way to more quickly reach net-zero. Net-zero is defined as the goal of offsetting greenhouse gas emissions.
What comes next
Grancio said Engine No. 1’s point of view when it comes to stewardship and investing is to use ESG data and integrate it into the core financial analysis of a company to uncover material impacts of these metrics, either positive or negative.
“We use this … data to improve the long-term financial and economic outcomes of these companies,” she said.
Other socially responsible, actively managed mutual funds engage in stewardship on specific issues. What makes Engine No. 1 different is that it uses data science to show companies an analysis of material ESG risks in their financial models to help with capital allocation, Grancio said.
“That’s sort of taking that very deep analysis, data financial modeling approach to help these companies,” she said.
Engine No. 1’s data analysis is called Total Value Framework , a way to get companies to understand their risks and forge a better long-term strategy that may lead to better returns. The hedge fund also plans to work with private equity firms on ESG.
A new exchange traded fund, Engine No. 1 Transform 500 ETF (BATS:VOTE) , intends to invest in the 500 largest U.S. stocks. It uses an index created by Morningstar.
Grancio, who was a founder of iShares ETFs, said the fund will vote proxies every year with an ESG bent. It won’t be able to get through every company at first.
“It gives us an opportunity to work through different companies in different sectors over time,” she said.
ESG investing has come under criticism lately. Tariq Fancy, former chief investment officer for sustainable investing at BlackRock, called out ESG funds as a “fairy tale.”
Grancio countered, saying ESG risks are “extremely material” and that companies need to include the long-term impact of their investment decisions rather than Wall Street’s focus on short-term returns.
“I don’t think Milton Friedman meant to take us on a path where you only ever look at quarterly returns,” she said, referring to the Nobel-winning economist.
By supporting big companies making big transformations at scale, there’s the potential for longer-term outperformance, she said.
“Potentially, [companies] increase their multiples, and it’s extremely lucrative just from a financial perspective,” Grancio said. “So our answer on that is, it’s certainly not a fairy tale. … As we get more and more data, it’s going to become more (based on) math and science and economics.”