“A man must consider what a rich realm he abdicates when he becomes a conformist.” —Ralph Waldo Emerson
It might surprise
some readers but the topic du jour for many asset
owners—especially American endowments, foundations, and public plans—is fossil
fuels divestment. The mere mention of divestment is probably causing some CIOs
to squirm in their seats. It conjures up memories of past divestment movements,
with their negative screens and the associated slippery slope, and the equally
slippery board discussions. Or maybe it brings to mind the YouTube video of
Swarthmore students disrupting the college’s intercultural center meeting with
their divestment message.
While previous well-known and now well-studied
divestment campaigns (e.g., South Africa, tobacco, firearms, and Sudan) sought
to address important issues, they also demonstrated that divestment as
an investment activity fails. These divestment movements certainly
signaled the need for change, but the academic literature unequivocally
demonstrates that as investment activities they failed to either impact the
share price or borrowing costs of the target companies. According to a study
from the University of Oxford, the results of fossil fuel divestment are likely
to be the same.
Yet fossil fuel divestment differs in a primordial
way from single-issue divestment campaigns because it deals with a temporally
exigent, transphenomenal issue: climate change.
goal of fossil fuel divestment is to reduce anthropogenic greenhouse gas (GHG)
emissions to a level that could limit the increase in average global
temperature to two degrees Celsius above pre-industrial levels—the estimated
ceiling above which we could face catastrophic and irreversible changes in our
Will an asset owner’s divestment of fossil fuel
companies help achieve this goal? Not likely. As Gerrit Heyns, co-founder of
Osmosis Investment Management, writes in the Journal of Environmental Investing,
“Divestment as an investment strategy is inherently flawed… At best, the
complete closure of every listed fossil fuel business on the planet would
impact less than 70% of the world’s combustible carbon reserves, most of which
are held by state-owned companies in largely single-commodity countries. At
worst, even nominal success would result in the ownership of listed fossil fuel
businesses by more people and institutions that have less interest in
protecting the environment, further gridlocking the ability to make changes
within these businesses. There may be a sense of political currency, but there
is no win for the planet in an institutional divestment strategy.”
However, the suboptimal nature of fossil fuel
divestment does not mean that CIOs should ignore the call for divestment.
Instead, they should embrace it as an opportunity to prudently address
stakeholders’ concerns and achieve an important investment objective.
The meta goal of divestment is squarely aligned
with a CIO’s fiduciary duty of constructing and managing a portfolio over
multiple time periods to achieve a target return for a given level of risk
(within the constraints of the investment policy).
To start, every portfolio is embedded with
exposure to carbon and climate, and these exposures—like those to interest
rates and inflation—represent existing and future material risks present in
every investment decision. The call for divestment should cause CIOs to address
these risks with same rigor as they approach other risks: They should be
identified, measured, and managed.
tools that exist could provide such an assessment. But because of reporting
deficiencies and the multi-dimensional nature of carbon and climate risks,
they would provide imperfect assessments. But as Voltaire wrote, the perfect is
enemy of the good.
knowledge, a CIO could stress test the portfolio to see how it might respond to
exogenous events like carbon tax in certain countries, government-imposed
carbon emission standards (Americans can laugh at this, but it is going to
happen), or weakening demand for fossil fuels (which is already occurring in
developed nations). These and other such events could negatively impact
carbon-intensive companies (think stranded assets). Let me provide a historical
analog: In September 2008, you were certainly asked, “What’s our exposure to
Lehman?” In the next few years you will almost certainly be asked, “What’s our
exposure to carbon?” Forewarned is forearmed.
This assessment and stress test would allow a CIO
to revise his or her investment policy to ensure it accounts for carbon and
climate risks and, equally importantly, actively supports allocations to low-
or no-carbon investments that provide the desired risk/return attributes and
result in a direct reduction in GHG emissions.
A final point: By not divesting, asset owners
could directly engage with fossil fuel companies, which according to Jack
Ehnes, the CEO of the California State Teachers’ Retirement System, is “an
effective strategy to mitigate risks, such as climate change… Engagement
through educated dialog will be far more productive in accomplishing our goal
that these companies publicly price the risk posed by unburnable fossil fuels.”
In the end, a fossil fuel divestment is a
signaling device, not an investment strategy. It’s a sell order that fails to
bridge the chasm between intention and change. It is more an abdication than a
fulfillment of responsibility, eliminating an asset owner’s transformational
powers, masking significant investment risks, and diverting resources from
finding and funding market-based solutions.
, PhD, is CEO of Impact Investment Partners.