Op-Ed: The Climate Investment Dilemma—Divestment or Decarbonization?

FEG’s Tim O’Donnell explores the merits of engagement.

Figuring out how to reverse or slow climate change is widely seen as the defining issue of our time. To address this challenge, some investors are using their investment portfolios as leverage. The difficulty facing investors, however, is determining whether it makes more sense to fully divest from fossil fuels or whether it is more prudent to retain shareholder status as a means of engaging in dialogue with companies to influence them to change their ways.

Divestment has certainly grown in acceptance and implementation over the past decade. Institutional investors including, recently, Harvard and Boston universities, are choosing to divest from large CO2 producers in the fossil fuel industry and replace them with cleaner renewable energy companies.

Investors are also increasingly choosing investments with an eye toward renewable energy investments, as evidenced by the fact that sustainable exchange-traded funds (ETFs) are one of the fastest-growing areas in asset management, according to Morningstar.

And investors certainly have a wealth of investment options—by most recent count, there are more than 300 mutual funds and ETFs with zero exposure to fossil fuels, according to As You Sow, a nonprofit that aims to promote corporate social responsibility.

The process of reducing a portfolio’s carbon footprint by eliminating those companies not on a path to meet the goals of the 2015 Paris Agreement (i.e., to limit global warming to 2 degrees Celsius) is rather quick and painless. With a few cuts and some additions, investors can alter a portfolio and feel good about their actions. This approach has merit, no doubt, and can even have a meaningful impact on an industry. The argument in support of divestment is that if enough investors stand in opposition to ownership, it will send a strong and public signal to the industry that change is needed. This approach can also bring to light the rising concern of stranded assets, which assumes fossil reserves still in the ground will become nearly worthless in a net-zero carbon world.  

However, some challenge the divestment strategy, arguing that without ownership of a stock, one does not have the power to challenge management and effect change from within an organization.

Moreover, since every seller of stock is joined with a buyer of that stock, it raises the question of whether divestment actually makes an impact on the climate or whether it simply shifts the problem elsewhere. As environmentally-focused investors exit the industry, they are being replaced with the buyers on the other side of the transaction who are likely not as concerned with carbon intensity and are more concerned with maintaining the status quo. The concerns of the climate-focused investor, therefore, are even less likely to be considered in this scenario. Conversely, when they act as company shareholders, climate-focused investors have the leverage they need to demand decarbonization.

So is shareholder engagement with fossil fuel companies the best path forward? If the true goal is to stem climate change, then sitting down face-to-face and working with those who can make the biggest impact indeed seems like a prudent course of action. Ignoring and punishing industries that have a detrimental impact on the future of the planet by excluding them from a portfolio certainly improves the environmental, social, and governance (ESG) quality of the portfolio, but is it really addressing the problem investors are trying to solve?

In other words, does the true answer lie with decarbonizing at the portfolio level or decarbonizing at the company level? What about using the opportunity to present your concerns and suggest a strategy for change to company management under the expectation that it sees the future on the same terms as you? If the true goal is CO2 reduction and a path toward climate impact, then companies with the largest negative impact arguably also have the potential for the largest positive impact. A small reduction by a large carbon-emitting company can have a larger global impact than focusing solely on companies that are non-carbon intensive.

The power of proxy votes, the power of your voice of opposition, and the ability to work with like-minded investors can effect change from within a company. But it must be pointed out that if decarbonization efforts are not paired with measurable impact goals for the future, then that engagement can look suspiciously like business as usual. This issue goes beyond the fossil fuel industry. For example, despite well-organized efforts to divest from banks which provide funding to fossil fuels, those global banks have continued to provide more than $3 trillion to fossil fuel companies over the past five years, according to the Sierra Club.

So what is the best option? Like many things, the answer is: It depends. As a shareholder, you have multiple arrows in your quiver. Engagement with companies that are willing to listen makes complete sense. For companies where engagement efforts yield little change, then divestment of the company and decarbonization of the portfolio is the sensible and defensible choice.

Tim O’Donnell, Chartered Alternative Investment Analyst (CAIA), is a senior vice president at FEG Investment Advisors, an independent, full-service investment advisory firm with more than three decades of experience helping institutional investors build long-term focused portfolios. 

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

Related Stories:

Boston University Joins Harvard in Divesting From Fossil Fuels

The Exxon Vote: Pension Supporters Stay Onboard to Advance Change

Maine Becomes First State to Pass Fossil Fuel Divestment Bill 

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