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Engagement gains investors’ favor in fossil-fuel debate

Coal being extracted from a surface mine.

All-or-nothing approach of divestment leaves some seeking options

As demands for fossil-fuel divestment become increasingly strident across the globe, a quieter voice calling for engagement with fossil-fuel companies is striving to be heard.

Sources at institutional investment funds, associations representing asset owners, and in the socially responsible investment community, say more needs to be done to bring engagement further into the spotlight.

“The funds that we talk to are already heavily into engagement, but the difference is that they have never before been put on the spot for their engagement performance,” said Julian Poulter, London-based CEO at the Asset Owners Disclosure Project.

AODP's latest index tracking the climate performance of the largest 500 global asset owners found that 232 continue to invest in assets heavily exposed to carbon. Just 24 engage with companies, divest or hedge against climate risk.

“We need to take engagement from being a safe, fluffy, cozy concept that is done in a convivial manner ... and make it a bit more hard-edged,” Mr. Poulter said.

“There is pressure on the investors to show that engagement delivers results, and they should be held to account,” said Edward Mason, head of responsible investment at the Church Commissioners for England, London, which has a 6.7 billion ($10.5 billion) investment portfolio that supports the Church of England.

The starting point is investors' investment beliefs when it comes to climate change and environmental, social and governance factors, said Jane Ambachtsheer, Toronto-based partner and global head of responsible investment at consultant Mercer LLC. “Both divestment and engagement have a place. The appropriate response is investor specific, relating to your ambitions, perception and investment structure.” She said executives at Mercer, which releases its own climate change report this week, also are seeing asset owners engaging further with managers over ESG issues.

Divestment and engagement

The current debate around fossil fuels is part of a continuum that runs through other ESG issues. “The merits of voice or exit are the thrust of the debate around stewardship and ESG,” said Will Pomroy, London-based policy lead, stewardship and corporate governance, at the National Association of Pension Funds. “With many issues "not-yet financial,' investors have a choice as to whether to engage with their investee companies to ensure issues are managed effectively, to do nothing and free-ride, or to exit — hoping to get the timing right or forgo potential returns.”

While divestment from companies that are particularly fossil fuel-heavy has been gaining traction over recent months, sources are concerned that, in some cases, ridding institutional investors' portfolios of these assets is not enough.

“Many of our signatories ... believe that divestment, although it can send a powerful message to the market and help bring climate change to the top of the news agenda, doesn't solve the long-term problem of fossil fuels,” said Fiona Reynolds, London-based managing director of the United Nations-supported Principles for Responsible Investment, which has almost 1,400 signatories across asset owners, money managers and other financial companies.

Some signatories in the U.S., for example, have resisted pressure to divest, “because they feel that divestment is not in the best interests of their beneficiaries, and that they can actually accomplish more through engagement,” Ms. Reynolds said. With the exception of some pure-play coal companies, signatories to the PRI are now in favor of engagement over divestment.

“Being a universal owner requires pension funds to be aware of and engaged with all of the significant risks to their investment universe,” said Mr. Pomroy. “By simply divesting, you lessen and significantly diminish your influence, becoming an outsider looking in.”

The concern is that every trade has a seller and a buyer. By divesting from fossil-fuel assets, they are simply being released back to be purchased by another investor.

“Divestment from a pure investment perspective is a naive strategy,” Mr. Poulter said. “If the objective is to manage climate change risk, then (investors) need all three tools” — that is, divestment, engagement and hedging.

There is also market risk associated with the pressure to divest, Ms. Reynolds said. “(D)ivestment en masse could trigger serious volatility and asset price risks that will impact every fund and beneficiary.”

Right decision

But sometimes, investors decide divestment is the right decision. Recent high-profile divestment-related decisions include:

nNorway's parliament unanimously agreed to divest the 7 trillion Norwegian kroner ($957 billion) Government Pension Fund Global, Oslo, from companies that derive 30% or more of their business from coal. A vote in government takes place June 5.

nUniversity of Edinburgh, Scotland, which has almost 300 million ($472.4 million) of assets, announced last week its intention to divest from three fossil-fuel producers in the next six months. In line with its engagement policy, the investment committee will give these companies four weeks to respond to its letter of intent.

nGoddard College, Plainfield, Vt., moved its $1 million endowment funds out of fossil-fuel holdings.

However, institutional investors also are heeding calls to engage. NAPF member pension funds realize that engagement “on the whole is more powerful than divestment,” Mr. Pomroy said. “Divestment is a one-shot thing, and possibly not the best way to fulfill fiduciary duty.”

The $191.2 billion California State Teachers' Retirement System, West Sacramento, which alongside other California-based institutional investors has been under pressure to divest from fossil-fuel companies, uses engagement as a tool to influence company decisions. “Engagement with fossil-fuel companies affords us the opportunity to shape the future and preserve our valuable natural resources,” said Ricardo Duran, spokesman for the pension fund, in an e-mail.

Meanwhile, BlackRock (BLK) Inc. (BLK) has teamed up with non-profit sustainability firm Ceres to create guidance for U.S. institutional investors on engaging with companies and policymakers on sustainability issues.

And the Church Commissioners and Church of England Pensions Board, London, announced a 12 million divestment from thermal coal and tar sands companies last month, with its “red line” drawn at the highest-carbon fossil fuels, Mr. Mason said. But engagement is the main part of its policy. “We are still invested in other companies involved in the fossil-fuel sector that do not have the same focus on the highest-carbon fuels,” he said. “Engagement with them is a critical part of our approach.” n

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This article originally appeared in the June 1, 2015 print issue as, "Engagement gains investors' favor in fossil-fuel debate".