When it comes to achieving ESG objectives, is short selling more effective than shareholder activism?

Shareholder activism and divestment have been the preferred strategies of investors seeking to achieve environmental, social and governance goals. But taking short positions on companies that do not comply with ESG rules could also be useful.

James Jampel, founder of the $700 million hedge fund HITE Asset Management, believes short selling can play an important role in helping the economy reduce carbon emissions. It may even work better than shareholder engagement, as it allows investors to avoid the conflict of interest that comes with holding long positions in ESG lagging companies, he said. declared.

According to Jampel, the problem with shareholder activism is that investors with long positions are often bound by fiduciary obligations to make money from rising stock prices. Therefore, they are less likely to support ESG policies that would depress company valuations. But the short circuit solves the problem. For example, if investors take long positions in both ExxonMobil and Chevron, they are unlikely to welcome a carbon tax policy – ​​at least not one that would hurt both companies. But if they short either of them, they would become indifferent to politics and could act as neutral investors.

“You really can’t, without a conflict of interest, argue for meaningful government intervention in carbon markets [with a long-only portfolio]Jampel said. “There is this inherent conflict within investors [who] care about ESG, because they want to be able to change the company by owning it. But if you own it, you don’t want to diminish its profits, even though that’s what might be needed to reduce emissions.

There has been renewed interest in research to measure the impact of short selling on ESG objectives. A Harvard Management Company and Managed Funds Association white paper recently found that short positions can reduce capital investment in the most polluting companies by 3-8%. In addition, short selling can put downward pressure on stock prices and increase the cost of capital, according to the white paper. The results earned HMC a nomination for the fifth annual Allocators’ Choice Awards.

Yet not all investors agree that short selling should be considered ESG. In a MSCI study published in April, the researchers found “limited evidence to support the view that short selling consistently increases the cost of capital.” They added that short positions give shareholders no direct control over the company, meaning they cannot be treated the same as long positions. While MSCI has not ruled out the possibility that short selling may help improve companies’ ESG performance in individual cases, it recommends that investors report long and short positions separately for maximum transparency.

Jampel warns that removing short selling from the ESG equation will have a negative effect on hedge funds with long-short strategies. “Without counting the short circuits [as ESG], you’re discouraging energy market-neutral funds from getting capital,” he said. “And these types of funds have the greatest chance of influencing change with the least risk to the investor.”

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