At Ruffer, we seek to engage with the companies we invest in, both to foster good corporate ESG practices and to help identify areas of potential risk or reward for our portfolio. Given finite resources, we focus these efforts where we believe they can have the greatest impact. But some asset classes and some types of security pose particular challenges, calling for a more creative approach to engagement. Here’s a case in point.
In late 2022 and early 2023, we began to build exposure to oil and copper. The investment case was clear. We expected both commodities to benefit from China’s re-opening after three years of covid-related lockdowns. In addition, the supply of oil was constrained in the near term, while copper is a key material for the energy transition, a longer-term structural theme. For both investments, we chose to use an exchange-traded commodity (ETC), a security that derives its value from the price of the underlying commodity. It gives investors exposure to the movements in the price of the commodity without having to buy, sell or store it or to take equity risk through holding shares in oil producers or copper miners – something we wanted to avoid given our cautious view on the equity market. The ETCs we opted for were constructed by WisdomTree, an asset manager offering exchange-traded fund and commodity products. This was not Ruffer’s first foray into
exchange-traded products – we have long been invested in gold exchange-traded funds (ETFs), backed by physical gold bullion, as an inflation protection asset.
In contrast to our equity holdings, where we can engage with companies and exercise our voting rights, we have limited scope for engagement with respect to derivative financial instruments, especially when they are linked to an underlying commodity price which is determined by supply and demand forces in the market.
But, within those limits, we do what we can to engage. For example, we met with WisdomTree this quarter to discuss how its ETCs are structured and how ESG factors are considered within this process. The meeting was focused on gold ETFs and copper ETCs, as well as instruments derived from critical raw materials such as lithium and cobalt, as investor appetite for exposure to the energy transition grows.
FIGURE 1 RUFFER'S COMMODITY HOLDINGS (£ MILLIONS)
Of course, commodities and, by extension, commodity miners are often considered problematic from an ESG perspective. Environmental concerns such as resource depletion, biodiversity loss, pollution and water scarcity can arise due to the extraction process. On the social front, human rights violations such as unsafe working conditions and child labour are common in some commodity supply chains and, given the geographical location of some mines, mining activities can displace indigenous communities. However, what could be described as the narrow interpretation of ESG belies the bigger picture: these commodities are critical ingredients to a sustainable, lower carbon future which helps the overall economic system as well as the environment.
Unfortunately, it is slightly more complicated when considering financial instruments that derive their value from a commodity price. WisdomTree has limited (if any) control over the ESG practices of companies involved in the extraction or production of the commodities that its products are structured upon. At present, nor do markets. It is at this juncture that gold – often regarded as a store of value – diverges from other commodities. WisdomTree’s gold products are usually physically backed: it holds gold bullion in a vault on behalf of its investors, and the value of the ETF/ETC is tied to the value of the gold in the vault. So some gold ETF/ETC providers are able to set stipulations or standards for the gold miners that extract or produce the gold they hold. Indeed, WisdomTree is working on a sustainable gold product that would require producers to set science-based emissions reduction targets, for example, and to meet minimum standards for human labour rights. Fund providers are also increasingly focusing on the origin and value chain of the gold they store, promoting full transparency. If the
industry continues to evolve in this direction, such ‘green’ gold ETFs could come to command a premium over standard products.
WisdomTree is working on a sustainable gold product that would require producers to set science-based emissions reduction targets, for example, and to meet minimum standards for human labour rights.
Unlike gold, critical raw materials such as copper are required for the energy transition, to build electric batteries, solar panels and other emerging technologies. It wouldn’t make sense to store them in a vault – especially when there are legitimate concerns over the mismatch between supply and future demand if we are to meet the climate goals set out by the Paris Agreement. So, instead of being backed by the physical commodity, products linked to these raw materials are structured as futures contracts – a contract based on the future price of the commodity. These prices are set by supply and demand in the market, rather than through ethical or sustainable product differentiation. As a result, asset managers are left with few options for promoting best practices. That said, WisdomTree is in a position to convey the wants of its investors to commodity exchanges, like the London Metals Exchange. We therefore intend to keep communicating with WisdomTree as the industry evolves and develops processes to integrate ESG factors into these financial instruments.