Part 1 in a series on the ESG risks and opportunities associated with the transition to a more sustainable economy.
Supported by Impax Asset Management
The Divestment Debate
As the climate continues to heat up, and as the federal government drags its feet on providing climate leadership, activists are putting increasing pressure on pension funds, university endowments, governments and other institutional investors to get rid of their fossil fuel holdings.
Proponents say it’s a moral issue — investors shouldn’t invest in an industry that’s helping to destroy the climate — as well as a financial one, with oil, gas and coal securities looking increasingly risky. In response, some investors have been trimming or entirely divesting from their fossil fuel investments.
Not every investor, though. “We do see differences in views on fossil fuel divestment by region and investor type,” says Christie Zarkovich, Global Head of Mission-Related Investing at investment consulting firm Cambridge Associates. But, speaking broadly, she adds: “Many investors are questioning the economic basis for the size of their exposure to traditional fossil fuel energy, given technological and political progress towards the potential for a low carbon future”
Indeed, the fossil fuel divestment movement is well underway, with nearly 1000 institutional investors worldwide having pledged to divest some or all of their fossil fuel assets, according to a tally kept by the non-profit group Divest-Invest. Those 924 investors have a combined $6.3 trillion in total assets, according to the group, although it’s not possible to say how much they collectively held in fossil fuel investments.
Among the investors that have said they’ll divest all of their fossil fuel holdings is the
Rockefeller Brothers Fund, founded by members of the family that made its fortune from oil. The RBF started to divest from fossil fuels in 2014 because of what it calls a “deep commitment to combating climate change.” Fossil fuel holdings made up about 6.6% of total assets in April 2014; four years later, it was down to 1.6% and still falling. (It takes some time to unwind some commingled funds and other investments.)
In January, the $189 billion New York City Employees Retirement System announced plans for the pension system to sell off all of its fossil fuel holdings over the next five years.
“The effects of human-induced climate change are taking an undeniable toll on our planet,” says NYCERS trustee Tish James. “As the largest city in the country, New York has a responsibility to act and to lead, particularly when our federal government is moving backward.” Divesting from fossil fuels, she says, will ensure that the pension funds’ investments “reflect our commitment to creating a more sustainable future, while keeping with our fiduciary responsibilities.”
The appetite for divestment comes from two distinct places, says David Richardson, executive director and global head of client service at Impax Asset Management, a global asset manager with $16 billion in assets under management, which has captured some of the flows coming out of fossil fuel divestments. “It’s driven morally by a sense that our investments ought to be aligned with things that are good for the world rather than bad for the world, and it’s easy to connect fossil fuels to the systemic risks we face with climate change,” he says.
Just as important is the financial side. “We understand investors’ moral positions, but our focus is on the rational investment reason for making changes to a portfolio’s energy exposure,” Richardson says. “We have many institutional investors who want to make sure their portfolios are well-positioned for the future, and who don’t think all of the uncompensated risks associated with fossil fuels are priced into today’s stock prices for fossil fuel companies.”
The RBF has found divestment to be a solid move financially, says president Stephen Heintz. “We’re confident that sound portfolios can be created without exposure to fossil fuels and, four years into the divestment process, our investment performance supports that belief,” he says, adding that the fund “also believes divestment from fossil fuels contributes to less volatility in the portfolio over time.”
That experience is part of the mounting evidence that investors don’t have to give up investment returns when they give up fossil fuels. For example, MSCI says that indexes that excluded fossil fuels, like the MSCI ACWI ex-fossil fuels indexes, actually performed better than their parent indexes from 2010 through late 2017.
Still, there’s considerable resistance to fossil fuel divestment, for a range of reasons.
For instance, among big public pension funds, New York State Comptroller Thomas DiNapoli, who oversees the $207 billion New York State Common Retirement Fund, has resisted calls for divestment, saying it’s better to engage with fossil fuel companies as an owner. Giant pension funds like the California Public Employees’ Retirement System and the California State Teachers’ Retirement System have divested from some coal companies while holding on to most of their oil and gas stocks. And the San Francisco Employees’ Retirement System earlier this year considered a proposal for full divestment, but decided instead on a scaled-back plan to get rid of fossil fuel companies that the pension considers the “worst of the worst” when it comes to carbon emissions.
Among university endowments, Cambridge University this summer rejected divestment, saying it worried that doing so could hurt investment returns. The decision came despite intense lobbying by students and faculty, and after BP officials argued against divestment and noted that the oil giant has given donations to the university in the past. Two years earlier, Stanford University said it, too, was rejecting total divestment, though it had already divested from coal.
The divestment debate is still active. Norway has a $1 trillion sovereign wealth fund, which gets much of its assets from the country’s oil reserves. Last year, Norway’s central bank recommended the fund sell off its $40 billion worth of oil and gas securities, largely to cut the risk that the fund would lose money in a long-term oil price decline. Last month, though, a government commission recommended against divestment, saying it would not provide much protection from falling oil prices and would in fact expose the fund to more risk and lower returns.
Another sovereign wealth fund built on petroleum revenue, the $65 billion Alaska Permanent Fund, has yet to make a formal divestment decision, but the fund has reduced its fossil fuel holdings from more than $3 billion in 2011 to about $1.7 billion last year. Officials have said they may further reduce the fund’s fossil fuel holdings to close to zero over the next decade, but they stress that any reduction will be based solely on financial considerations, not “causes” like the divestment movement. Among its recent investments was last year’s backing of clean energy financing firm Generate Capital.
A popular alternative to full divestment is to do what New York Common has chosen: try to influence oil companies through a seat at the table. “We are seeing increased interest from both clients and managers in leveraging their role as owners to change corporate behavior, which includes owning companies with exposure to carbon intensive assets,” says Cambridge Associates’ Zarkovich.
Other observers note that, with some oil and gas companies moving into renewable energy, holding their equity gives investors some exposure to renewables.
Impax Asset Management says that, based on its own research, eliminating roughly a third of fossil fuel holdings is appropriate for most investors. “We believe about 30% of fossil fuel stocks do not adequately compensate investors for the risk of future actions governments are likely to take to address climate change,” Richardson says.
He explains: “We don’t think the risk of climate change right now is rising sea levels; that will come in the future. The risk right now is government intervention to reduce climate change” — including policies that support renewable energy, call for reducing energy intensity in the economy and, especially, put a price on carbon.
Cambridge Associates also doesn’t think full divestment is always the answer. “We believe investors seeking to deploy capital into sustainable solutions and avoid the risks associated with carbon emissions and climate change will continue to take a more comprehensive and integrated approach,” Zarkovich says, “For some of these clients, divestment will be a part of the strategy to meet these objectives; however, it is not the only strategy clients are using, and for some it may not be the most effective, depending on their objectives.”
For example, the $356 billion Canada Pension Plan Board and the $194 billion Ontario Teachers’ Pension Plan have both recently stated they will pursue shareholder engagement and increased transparency to manage climate risk in their public equity portfolios, rather than divestment. At the same time, each fund is investing in a range of renewable energy projects.
And although Japan’s $1.5 trillion Government Pension Investment Fund has not committed to divesting from fossil fuels either, it has committed to increasing its ESG equity allocation from 3% to 10% of the total portfolio. In November, the fund launched a search for global environmental stock index managers to “reduce the negative impacts of corporate activities on the environment.”
When an investor does divest from fossil fuel holdings, whatever the amount, the investor is left with some cash that needs to be reinvested somewhere. What’s the best place to put it? We’ll explore that in the next article in this series.
Upcoming Event
Please join CleanTechIQ, alongside Impax Asset Management | PAX World Funds & Carbon Tracker Initiative, at the Divest-Reinvest Strategies Breakfast Briefing on September 27th at the Yale Club as part of Climate Week New York City.
As institutional investors increasingly consider divesting from fossil fuels, they must evaluate the potential impact of such a move on their portfolio, how it could alter risk and returns, and consider opportunities for reinvesting those proceeds. We will also discuss shareholder engagement as a means of taking action rather than divesting.
Our speakers include CalSTRS, Wespath, Rockefeller Brothers Fund, JP Morgan Private Bank, NEPC, Impax Asset Management, Ceres, Carbon Tracker Initiative and more.
Click Here to see the agenda and reserve your seat. Institutional asset owners (pension funds, foundations, endowments, SWFs) and single family offices receive complimentary admission. Please email info@cleantechiq.com to register.