Part 2 in a series on the ESG risks and opportunities associated with the transition to a more sustainable economy.
Supported by Impax Asset Management
Fund Managers Develop Products to Help Reinvest Fossil Fuel Assets
Last year, Pitzer College had a problem. The liberal arts college in suburban Los Angeles was well on its way to divesting from all fossil fuel investments, which left it with a pile of cash that needed to go somewhere — ideally into investments that met the same ideals and standards that prompted the college to divest in the first place. But school officials couldn’t find the right place to reinvest.
A trio of financial services companies — BlackRock, Mercer Investment Consulting and MSCI — got together to find an answer. Before long, Pitzer was the founding investor of the new MSCW ACWI ex-Fossil Fuel ESG Focus Index fund, the first global equity index fund to be both ESG-focused and fossil fuel-free.
The situation illustrates the challenges, as well as the creative solutions, that can arise when institutional investors divest from fossil fuels. This model of collaborative product development seems likely to continue as more and more institutional investors divest from fossil fuels and want to reinvest the process in a thoughtful way.
The trend of pensions, endowment and other institutional investors divesting some or all of their fossil fuel holdings is already well underway, as reported, and is creating opportunities for asset managers to capture some of those reinvested assets. Exactly how big those opportunities are is hard to say, but last year, investment consulting firm NEPC estimated that pension funds, endowments and foundations worldwide had, collectively, between $700 billion and $1.7 trillion directly invested in fossil fuel-related stocks and bonds.
Even at the low end of that range, that’s a lot of money to potentially be divested and then reinvested. Much of it will go back into funds or investments that explicitly support sustainability or cutting carbon emissions. Asset managers are doing what they can to make sure such investments are broadly available.
It can be hard to track those reinvested assets, as much of it will go into private investments. “Generally speaking, divestment is typically a public markets concern, involving equity and corporate debt allocations which can be readily traded,” notes Alex Bernhardt, principal and U.S. head of Responsible Investments at Mercer Investment Consulting. On the other hand, he adds, “reinvestment is often a private markets proposition which typically takes longer to diligence and implement.”
Consulting firm Cambridge Associates sees the same thing. “There is increasingly more interest in private capital strategies that target sustainable real assets and venture-oriented solutions, particularly from families and foundations,” says Christie Zarkovich, Cambridge’s global head of mission-related investing. However, the firm also sees assets returning to the public markets. “Public equity strategies that proactively integrate sustainability and ESG considerations as core to the investment philosophy have more general appeal across our clients,” she says.
Impax Asset Management, which runs environmental- and sustainability-focused investment strategies and funds for institutional and individual investors, has seen its own assets under management grow from $2.5 billion six years ago to $16 billion now. While some $4.5 billion of that growth came from the firm’s acquisition of Pax World Management and the Pax World Funds in January, there was still a lot of organic growth. And that’s a clear indication that at least some divested fossil fuel investments have gone into carbon-free or carbon-negative strategies, says David Richardson, the company’s global head of client service.
“We’ve certainly benefited from institutional investors looking for investment opportunities in the transition to a lower-carbon economy,” Richardson says. The company’s investors come from the high-net-worth and retail markets as well. “It’s pretty encouraging to see the broad range of investor appetite for these types of strategies,” Richardson adds.
Impax’s own research suggests that investors should divest about 30% of their fossil fuel portfolio and reinvest those assets into what it calls a “new energy” portfolio, emphasizing both renewable energy and companies that focus on energy efficiency products and services. The firm offers a range of both private and public-oriented funds to help investors create such a portfolio.
Like other managers, Impax has also been developing new strategies like its new Global Opportunities strategy, which invests in public companies that are poised to “benefit from the transition to a more sustainable economy,” the firm says. Its major sector exposures include information technology, materials and healthcare. The fund opened to investors earlier this year after a three-year incubation period.
Impax’s expanding product line is part of a growing trend across the industry. “There are a number of low carbon and fossil fuel free products available on the market today,” Mercer’s Bernhardt says. “More such products are coming to market all the time.”
The market is far from saturated, however. “There are still definitely gaps in the universe where if an investor wants a particular style tilt or regional composition, off-the-shelf commingled solutions likely aren’t available,” he adds. Larger investors have an advantage here, as it’s usually possible for them to meet a manager’s minimum account size to set up a separate account where screens can be applied. Because of those account minimums, “It can be difficult for smaller investors to customize solutions,” Bernhardt says.
CleantechIQ has surveyed institutional investors and found much the same when it comes to ESG investing overall. Several investors tell us that a major bottleneck keeping them from full ESG integration is a lack of “credible” sustainable investment solutions being available across every asset class, particularly in the private markets.
There has certainly been some improvement, however. Officials at the Rockefeller Brothers Fund — which slashed its fossil fuel exposure from 6.6% in 2014 to just 1.6% today, with further cuts still to come — say they’ve seen an increasing number of products intended to meet the needs of investors looking for carbon-friendly strategies. The fund doubled its exposure to impact investments, from 10% of its overall assets to 20%, in 2016, in the midst of its divestment.
“We are encouraged by the growing availability of these products,” says RBF president Stephen Heintz. “The divest-invest movement, including significant commitments to divestment by the Rockefeller Brothers Fund and other foundations and high-net-worth individuals, has galvanized an ever-broadening interest in, and offering of, fossil fuel-free investment products, even from mainstream firms and fund managers.”
He adds: “We now see more managers willing to offer fossil fuel-free funds or to carve out sleeves for asset owners who want to invest in a fund but avoid fossil fuel exposure.”
It’s happening around the world. For instance, in 2016, the city of Copenhagen announced it would stop investing in fossil fuel companies as it moved toward becoming a carbon-neutral city. Within months, two major Danish asset managers, Danske Capital and Hyske Bank, had created fossil fuel-free investment products, according to Divest-Invest. Several others joined in later.
Investment consulting firms are playing an important role in developing new products as well. Like Mercer, Cambridge Associates has also worked to bring new investment strategies to market, Zarkovich says.
“We worked closely with a manager to develop a specialized financing platform to address the growing demand for smaller-scale and often distributed sustainable infrastructure projects across energy, water and waste,” she says. “We also worked collaboratively with asset managers to create a new fossil fuel-divested and low carbon emission emerging markets fund, and are at the forefront of driving low-cost solutions adding low carbon and divested tilts to passive indexes.”
For Mercer, the index fund it helped develop last year for Pitzer College is just the latest example. “We’ve worked with multiple clients over the years to develop new investment strategies which meet their specific carbon/fossil fuel requirements.” Bernhardt says. Back in 2014, for instance, Mercer, Mellon Capital and registered investment advisor Imprint Capital, which was acquired by Goldman Sachs in 2015, teamed up to create Mellon’s Carbon Efficiency Strategy for the McKnight Foundation. The product seeks to give investors lower exposure to carbon emissions, and launched with $100 million from the foundation.
Experts say that, as more institutions look to divest from fossil fuels, asset managers and consultants will respond by launching similar initiatives to develop a wide array of replacement products, from active to passive and covering everything from renewable energy and green buildings to Ag-Tech and sustainable water systems. “It is an exciting time,” Zarkovich says.
Upcoming Event on Fossil Fuel Divestment & Reinvestment Trends
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 experts from CalSTRS, San Francisco Employees’ Retirement Fund (SFERS), Wespath, Rockefeller Brothers Fund, JP Morgan Private Bank, NEPC, Impax Asset Management, Ceres, Principles for Responsible Investment (PRI), Carbon Tracker Initiative and more.
Click Here to see our agenda and reserve your seat. Institutional asset owners (pension funds, foundations, endowments, SWFs) and single family offices receive complimentary admission and can email info@cleantechiq.com to enquire about registering.