Paul Warner explains why the oil price should not be seen as a reference point for SRI portfolios.
At the end of the last quarter, when analysing one of our third party SRI portfolios, we found that the slight underperformance of the SRI portfolio compared to its benchmark was due to the sharp rise in oil producers’ shares, which are not allowed in SRI portfolios. This set us thinking whether this was something we should always expect from the SRI portfolios, or just relevant to that quarter. Using FE’s Analytics, we looked at the periods of the main movements in the oil price, and put these into a table showing the performances of our SRI portfolio compared to the IA Mixed Investment 85% Shares sector. We also added other indices in case these were likely to be other reasons for variances in performance from our portfolio to the sector average.
These are the figures that FE produced:
Source: FE Analytics
As you can see from the table, there is no clear evidence that the SRI portfolio underperforms when the oil price is moving upwards, or vice versa. As you might guess from the other indicators that we have put into the table, we think there are other factors that are potentially more important to relative performance. If you look at the first period in the table, when the oil price rose nearly 87%, the SRI portfolio pretty much matched the performance of the sector. The oil and gas producers rose 25% over the period, matching the FTSE 100.
Of more interest to the SRI portfolio is probably the fact that the FTSE 250 index was up more than the FTSE 100. Just as our portfolios will not contain the big oil companies due to the SRI credentials required, many other large companies are unable to meet our requirements. This does give our portfolios a slight bias towards mid and small cap companies. So in this period the lack of investment gains from all producers was offset by the better performance of mid-cap companies. In fact this analysis is confirmed by the third period in the chart, where the oil price actually fell by nearly 27%. In that time period, our portfolio underperformed by nearly 1.5%, which coincidentally is very close to the underperformance of the FTSE 250 versus the FTSE 100.
When we first started to investigate any link between the oil price and relative SRI portfolio performance, we had just three rows in the table above. As you can see, we added a good number more as we looked further into the various factors affecting our relative performance. If you look at the second period in the table, the oil price moved sideways for nearly a year. Historically, we used to say that the alternative energy funds moved in tandem with the oil price. The obvious reason being, as the price of oil increased, so oil consumers looked for viable alternatives. However, in this period you can see that the iShares S&P Global Clean Energy fund fell 46%, whilst the oil price was flat. It was this period that blew apart the casual link between oil and alternative energy funds.
So what changed? It pretty much came down to the fortunes of one company: Vestas, the Danish wind turbine manufacturer.
Rapid expansion due to the rise in oil price in the first period of the table above, was coupled with cost overruns resulting in two profit warnings in 2011. The Vestas share price saw a high of 232 in March 2011, and fell to a low of 24.6 by July 2012, and it was a big constituent in most clean energy indices and funds. Although since then the fortunes of Vestas have improved, the competition within the alternative energy sector has increased significantly. As you can see from the table, the oil price no longer has a significant impact on the clean energy index. With oil rising 95% from January 2016 to February 2017, clean energy rose just 9.8%, when the oil producers were up 67%.
Similarly, in the recent period from June 2017 to May this year, the oil price was up 72%, oil producers were up 36%, and the clean energy index was up just 19%. Thankfully, our SRI portfolios did not suffer in these periods, and closely matched the sector, or outperformed it. In the period where we slightly underperformed the index (January 2016 to February 2017), you will see that there was a considerable disparity between the performance of the FTSE 100, which was up 31%, compared to the FTSE 250, which was up 22%. The reason for this disparity? BREXIT! You will recall that after the UK voted for BREXIT, the pound fell precipitously. Project fear suggested that the domestic economy was going to hell in a handcart. So we saw the FTSE 250 become a proxy for the domestic economy, and the FTSE 100 a beneficiary from the weak pound. This labelling was compounded by the huge growth in passive funds following these indices.
In conclusion, there are a number of factors which will affect relative performance between a mainstream sector and our SRI portfolios. Over time these have not been detrimental to the relative or absolute performance of our portfolios. As they say, it all comes out in the wash.