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Ethical investors can avoid energy stocks, but should they?

There is plenty of evidence that human activity is causing climate change and the Global Risks Report 2020 from the World Economic Forum has revealed that it is the number one long-term concern of the interviewed stakeholders.

Willingness to do more to safeguard the environment, particularly encouraging the slashing of emissions seems to be growing among the investment community.

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BlackRock, a US-based global investment manager, will be offering more sustainable investment funds, and some individual investors globally are shunning the shares of polluters. Putting your capital in ‘green’ companies supports the efforts of those firms to make a difference and could mean that ‘dirty’ companies change their ways in response, or suffer if they do not change.

Energy stocks (oil, gas, and coal shippers) are obvious candidates for avoidance for investors who want to go green. But will we jeopardise our financial futures, if we avoid them?

Lacking in energy

Not so. According to Grantham, Mayo & van Otterloo (GMO), an asset manager, you could have invested in the S&P 500 excluding energy stocks without significantly affecting your returns.

GMO found that the index as a whole returned 9.71% per year on average between 1989 and 2017. Excluding energy stocks, it returned 9.74%. Going back even further, from 1957 to 2017 the average annual return was 10.25% if you excluded energy stocks, it was 10.18%. 

Extrapolating these results to the FTSE 100 is, however, hard. Energy stocks make up 4.3% of the S&P 500’s total market capitalisation, but 14.38% of the FTSE 100. The FTSE 250 has just 1.99% in oil and gas stocks and is more comparable with the S&P 500, but FTSE 250 companies are, of course, smaller than the energy giants in the FTSE 100. Also bear in mind that while the FTSE 100 oil and gas sector excludes coal producers, the S&P 500 energy sector includes them.

Ethically sourced

So what can ethically-minded UK investors do? They could use an ETF to track the FTSE 250 rather than the FTSE 100. That choice would mean lower exposure to oil and gas stocks. Or they could buy an ETF that tracks the FTSE 250 excluding energy stocks (if BlackRock or another provider releases one). Assuming the FTSE 250 behaves like the S&P 500, then returns should not suffer significantly from this choice. 

Stock pickers can actively avoid oil producers like BP, and Royal Dutch Shell, and miners like Anglo American that have significant exposures to coal. My colleague Thomas Carr recommended three ethical shares that could take their place. But should all energy stocks be shunned?

Anglo recently made an offer for Sirius Minerals and its polyhalite fertiliser deposits. It is also upping its copper output. Fertiliser helps grow more food, copper wires go into wind turbines and electric vehicles. I think Anglo knows its coal reserves could end up worthless.

Both Shell and BP recognise the need to produce more energy with fewer emissions too. BP has a venture capital division for and is looking to create five $1bn companies in the low-carbon and carbon management, biofuels and energy efficiency space.

The economy cannot switch off its dependence on fossil fuels overnight. Big wind turbine and photovoltaic projects will take time and expertise to develop, and require resources to build. The oil majors and miners have the experience to help, and I think we need it. If they are moving in the right direction, I feel they should be encouraged to carry on.

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James J. McCombie owns shares in Anglo American, BP, and Sirius Minerals. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.