The big green short: Hedge fund titan’s warning sparks fresh concerns the ASX is vulnerable

One of the world’s biggest and most powerful hedge funds has told Australia’s top financial regulator it expects global investors will increasingly short-sell shares in high emissions companies to reduce risks in their portfolios, sparking fresh concerns the resources-heavy ASX could be vulnerable to shifting sentiment on climate change.

US hedge fund titan AQR Capital Management told the Australian Prudential and Regulatory Authority in April that its clients – including some of Australia’s biggest super funds – would need to move beyond simply divesting shares in companies that produce substantial carbon emissions and look to actively short sell them to achieve net zero emissions targets in their portfolios.

The resource-heavy ASX looks vulnerable to shifting investor sentiment.Credit: Louie Douvis

“The usual approach of security selection (e.g. divesting from firms with the highest emissions) can lead to a substantial carbon reduction but may not be enough for investors with the most ambitious reduction targets,” AQR said in an email to APRA in April, obtained by The Age and The Sydney Morning Herald in a freedom of information request.

“Such investors may need other techniques to achieve their goals, for example shorting high carbon-footprint companies or trading instruments such as carbon offsets and carbon permits.”

AQR, a quantitative focused hedge fund, oversees investments worth $US143 billion ($200 billion) for major institutions including local funds such as Cbus, Aware Super and Colonial First State.

The comments were made in a consultation process after APRA released draft guidelines on how all banks, super funds and insurers should mitigate risks of climate change. Short selling is a trading strategy where investors can benefit from falling stock values by borrowing shares, selling them and buying them back at a lower price for a profit.

Australia’s largest super funds and banks have introduced ambitious targets to achieve net zero emissions exposures in their portfolios and loan books by 2050. Super funds are meeting these targets by dumping stocks in high-carbon companies, while banks have stopped lending emissions intensive sectors, like thermal coal miners.

Meanwhile, many of the nation’s biggest resources companies have also pledged to cut their carbon emissions in line with the international Paris Climate Accord.

However, fund managers say moves by global investors to short stocks with high carbon footprints could still impact Australia’s sharemarket, which is heavily tilted towards miners and fossil fuel energy producers.

Atlas Funds Management founder Hugh Dive said such a move could impact more than 20 per cent of the local sharemarket. “Looking across the ASX, the whole energy sector and miners would be very exposed to that,” he said. “But you’d want to see earnings falling off rather than shorting it because you don’t like what the company does. That could be a fast track to poor performance.”

In the letter to APRA, AQR said its Australian clients were now exploring the use of short selling stocks to reach decarbonisation targets in two ways – to hedge the risks of remaining exposures to high-emitting companies and to increase the cost of capital for polluting industries.

A report by AQR, also sent to APRA, said investors with net zero emissions targets are shorting companies they believe will decrease in price “when transition and/or physical climate risks materialise and goes long in securities that are likely to be relatively less harmed in such an event”.

Super funds have long promoted the benefits of “engagement” where retaining a stake in polluting companies can give the fund power to influence change, particularly in regard to encouraging decarbonisation.

“However, carbon-sensitive investors are unlikely to hold large emitters at all, which limits their ability to engage (or even communicate with) such companies. We posit that establishing a short position is more effective for engagement than not holding any position at all,” AQR’s report stated.

AQR says investors are increasingly looking to short-sell carbon-heavy companies to meet net zero emissions targets. Credit: AP

“This is because corporate management teams are generally aware of what the short community think about their companies, and even if they disagree, there is at least some communication.”

The AQR Australia employee, whose name was redacted from the documents said its Australian clients “representing many billions of dollars” were increasingly interested in new ways to reduce carbon emissions.

“We are in constant dialogue with these clients and can attest to the increased importance that climate change, carbon targeting and reduction and more broadly, responsible investment principles, have become for our Australian clients,” the email to APRA said. “Since publication [of the report], we have had several related meetings and discussions with our Australian clients and the feedback has been overwhelmingly positive.”

AwareSuper’s chief investment officer Damian Graham said the $140 billion fund was currently exploring ways to use short-selling to maximise returns from its corporate research, but added targeting high emitting companies was not on the agenda.

“Divestment, selling out of the holding and not being exposed to it, is as far as we’ve contemplated going,” Mr Graham said. “The short selling piece is the amplification of that but it’s not something we’ve thought about to be honest.”

Mr Graham said the fund would prioritise existing strategies, pointing to $1 billion that has been invested in renewable technologies over the past 12 months and ongoing engagement efforts with heavy emitters. “What we find is a lot of these companies are thinking deeply about this. We’ve engaged with a number of the larger emitters over time, a lot are doing good amounts of work to think through how they evolve their businesses in a lower carbon future.“

Cbus and Colonial First State both confirmed AQR managed investments on their behalf, but said short-selling to meet decarbonisation targets was not part of the relationship. “We do not believe that short selling the shares of a carbon intensive company is a valid approach to assist with moving towards lowering carbon emissions,” a CFS spokeswoman said.

High profile short-seller John Hempton, who founded asset manager Bronte Capital, said high emitting companies were already fertile ground for short-sellers because they are “economically unviable, socially unviable, [and] just a bad idea”.

“You short a lot of these coal players for the same reason you once shorted buggy whips for your horse and cart,” he said. “They smell of yesterday.

”At some point they’re cheap in the cigar butt sense, meaning you’ll get one breath out of them, but don’t pretend,” he said. “Certain high emitting businesses are not good businesses because they don’t have a future. You see fund manager after fund manager saying they own them because they’re cheap, I think they own them because they’re stupid.“

Mr Hempton said short-sellers are currently targeting energy giant AGL, after it reported this month a $2.06 billion loss for the previous financial year. “The argument is what does it look like in five, seven years? The answer is not very pretty.”

APRA declined to comment.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.