By Mark Hulbert, Callaway Climate Insights
(About the author: Mark Hulbert is an author and financial markets columnist. He is the founder of the Hulbert Financial Digest and his Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org.)
CHAPEL HILL, N.C. (Callaway Climate Insights) — Might short sellers have a positive role to play in cooling the climate?
It’s an intriguing possibility, since short sellers otherwise have a terrible reputation. Corporate CEOs hate them, and many investors consider them to be immoral. Fighting climate change could be just the opportunity for short sellers to redeem their sullied reputation.
But just as short selling is itself controversial, its role in fighting climate change is proving to be surprisingly contentious as well. The debate recently erupted into full view with an op-ed in the Financial Times in which Jason Mitchell, co-head of responsible investment at Man Group, argued that “Short selling does not count as a carbon offset.”
This prompted an immediate counterpoint from Richard Slocum, Chief Investment Officer for the Harvard Management Company, the manager for Harvard’s endowment, and Michael Cappucci, Managing Director for Sustainable Investing at Harvard Management Company. They argued that Mitchell’s argument was “disappointing” and “unhelpful.”
Cliff Asness, founder of AQR Capital Management, also took issue with Mitchell. In a blog post titled “Shorting Counts,” he argued that Mitchell’s logic leads to “full-on ESG nihilism” in which climate-friendly investors should simply give up.
Divestment versus shorting
To appreciate what’s at stake in this debate, it’s helpful to step back. When you sell a stock short, you borrow shares from your broker and sell them in the open market —and commit to return to your broker an equivalent number of shares in the future, hopefully at a lower price. The stock exchanges have no way of knowing whether the shares you’re selling were owned outright (whether you’re divesting, in other words) or borrowed, so the act of short selling exerts just as much downward pressure on a stock’s price as divestment.
So if selling ExxonMobil (XOM) shares short doesn’t “count,” then divesting yourself of the ExxonMobil shares you own outright also doesn’t count. This is the ESG nihilism to which Asness is referring.
Needless to say, however, Mitchell undoubtedly knows this about the mechanics of short selling. Instead, I believe he is arguing that the mere act of selling shares (whether owned outright or borrowed) does very little to reduce carbon in the atmosphere. (In response to an email, he declined to comment.)
So the real issue is not whether short selling “counts” as much as divesting, but how much real-world effect either activity has.
What really ‘counts’?
If selling of any type is to have a real-world impact, it will be by increasing a company’s cost of capital. And, in theory, every share sold will marginally increase that cost.
In practice, however, that increase is minimal until the investors who are selling (or shorting) reach a critical mass. Absent that critical mass, selling the shares of a GHG-emitting company has little real-world impact other than enabling other investors who don’t care about the climate to purchase the shares at better prices.
This is a point that many have made before, of course. Tariq Fancy, who until 2019 was the chief investment officer for sustainable investing at investment firm BlackRock (BLK), the world’s largest asset manager, recently made this argument in an interview in the Wall Street Journal:
“There is no compelling empirical evidence that ESG investing mitigates climate change. Outside of a very small minority of private, long-term funds, such as venture-capital funds that back promising technological solutions to the climate crisis, the vast majority of funds marketed as ESG and sustainable funds today — as well as the non-binding practice of ESG integration into existing investment processes — can’t point to any real-world impact that would not have otherwise occurred.”
A counterargument that often comes up when discussing these issues is the campaign in the 1970s and 1980s to divest South African equities in protest of that country’s apartheid policies. While that campaign was ultimately successful, Lawrence Tint said that what made it successful was that the divestment effort eventually reached critical mass. Tint is the former U.S. CEO of BGI, the organization that created iShares (now part of BlackRock).
In an interview, Tint said that it took more than a decade of a broader social and political campaign against South Africa, including a boycott of South African company products, before the divestment effort began to have teeth. He said that he’s unaware of any other divestment campaign that was as successful as in the case of South Africa, so in that sense it is the exception rather than the rule. We’re kidding ourselves if we think that, absent critical mass, our individual efforts at divesting or selling short will have any impact on corporate behavior.
Fancy generalizes this point: “Divestment, which often seems to get confused with boycotts, has no clear real-world impact since 10% of the market not buying your stock is not the same as 10% of your customers not buying your product. (The first likely makes no difference at all since others will happily own it and will bid it up to fair value in the process, whereas the second always matters, especially for a company with slim profit margins and high fixed costs.)”
Two kinds of carbon offsets
With this discussion out of the way, we can return to this recent debate over whether shorting counts as a carbon offset. It turns out that there are two types of carbon offsets, and it’s important to keep them distinct.
The first type of carbon offset is what allows a money manager to tell the world that his portfolio is carbon neutral — a claim that an increasing number of managers are making. In this context, selling shares short can count as a carbon offset.
To illustrate, let’s say that a manager wants to continue owning Apple in his portfolio, even though the company says it won’t reach carbon neutrality until 2030. By shorting the shares of a big polluter — say ExxonMobil (XOM) — the manager can offset Apple’s carbon emissions and claim to be carbon neutral now — rather than in a decade’s time.
I’m fairly cynical about this type of carbon offsets, which strike me as being more about bragging rights and marketing than about changing the world. It’s not that such offsets have no impact whatsoever; it’s just that their impact is too little and too late to reduce carbon emissions by what’s needed to live up to the IPCC’s carbon budget for what will keep the climate from warming more than 2°C. above pre-industrial temperatures.
The second type of carbon offsets are those that at least hold out the hope of actually reducing the amount of carbon in the atmosphere: These are the projects in which corporations invest that sequester carbon from the atmosphere and permanently store it. Firms invest in these projects in order to offset the carbon emissions of their regular operations that they aren’t otherwise able to eliminate.
I hasten to add that many of the carbon offsets in this second sense are ineffectual—or worse. As I’ve written before, the vast majority — 82% in one study — of these offsets do not represent true emissions reductions. But at least offsets in this second sense are asking the right question, even if they come woefully short of answering it.
The bottom line? I come down on the side of those in this recent debate who believe that short selling “counts.” But I suspect that the victory they win is largely a Pyrrhic one, since in most circumstances what they count for is very little.