The past year has seen a sharp increase in activity by students across the United States advocating for divestment from fossil fuels by school endowments. For the investors struggling to address these requests, there are no easy answers.
One of the prime arguments encouraging endowments, foundations and other funds to divest from fossil fuels cites the United Nations' 2009 Copenhagen Accord on climate change, which recognizes "the scientific view that the increase in global temperature should be below 2 degrees Celsius." By certain measures, the earth's proven fossil-fuel reserves represent five times the level of emissions recommended by climate scientists to stay below a 2-degree Celsius rise in temperature.
These are the same reserves which are already priced into the market value of many energy companies and their cost of capital. If governments act to keep the temperature rise below 2 degrees Celsius by putting a higher price on carbon, then the value of those companies — and the sectors that hold those carbon assets — will decrease sharply. This assumption is the basis for a campaign arguing for divestment from the companies with the largest proven fossil fuel reserves as a means to protect long-term investors and the environment from the risks of climate change.
Is climate change a risk worth addressing?
Stakeholder campaigns such as those now focused on university endowments and other non-profits typically ask for divestment from specific sectors or companies. They also seek to raise awareness about a particular issue, which may be material for investors. From our perspective, the key questions in this case are:
- Are climate change issues material to investment portfolios?
- Can these issues be addressed in a manner which maintains (or enhances) long-term investment objectives and responds to stakeholder concerns?
We believe that the answer is yes to both questions. Whether or not climate change is relevant to an organization's mission, the issue can pose risks and opportunities worthy of serious consideration by investors. Our 2011 study on the potential impact of climate change for asset allocation ("Through the Looking Glass,") found that climate risk may represent 10% of portfolio risk for a hypothetical investor (with this number rising as asset allocation becomes more complex).
What should investors do about climate change?
Step one in our mind is a discussion with investment staff and board members about the nature of the risk (and opportunity) presented by climate change. Relevant factors include technology shifts, regulatory/policy risk and physical impacts. From here, each organization can determine the most appropriate way to address the risks/opportunities.
Divestment is only one tool in the toolbox. While divestment is not a new approach, divestment from fossil fuels is relatively untested and potentially difficult for investors for many reasons, such as:
- Fossil fuels represent a significant component of today's energy mix and they are used in a wide range of commercial and consumer uses beyond the energy sector (e.g. automotives, manufacturing);
- Appropriate substitutes for fossil fuel companies may be fewer compared to other divestment campaigns, such as South Africa and Sudan;
- Divesting from such a large sector of equities markets might be considered a breach of fiduciary duty;
- Divestment eliminates a shareholder's ability to engage with companies and influence business strategy and companies may not be impacted by divestment on a relatively small scale, as a result;
- There is active debate over the ability of divestment to impact the value or behavior of companies, particularly in such a large and profitable sector;
- Divestment is likely to have up-front and recurring costs; and
- Institutions may be wary of setting a precedent where they are subject to more frequent company or issue specific student requests (a.k.a. the “slippery slope” of divestment).
For all the improbability of wide-scale divestment from fossil fuels, a number of institutions are nonetheless looking into the idea. The campaign has succeeded in raising awareness of the issues and encouraging endowments and intermediaries to take a look at the math, their fossil fuel exposures and the feasibility of divestment.
In our view, the issue remains complicated. The size or structure of an investment program can make wholesale divestment impractical, expensive or risky. Among the alternative or complementary options that investors can consider are to:
- Review approaches of existing and prospective investment strategies: Information and tools exist to help investors see how their investment managers consider climate risk in their investment processes, measure the carbon intensity of their portfolios or tilt portfolios towards more sustainable assets. Investors can ask if managers consider future carbon pricing scenarios when assessing investment opportunities, or if they favor companies who manage climate change risks better than peers.
- Access sustainable investment themes: These strategies offer exposure to long-term growth beyond renewable energy and build in downside protection against future carbon pricing. Such strategies are increasingly available across asset classes, and can be particularly attractive in real assets.
- Vote your shares: Proxy voting guidelines can be amended to actively respond to shareholder votes on climate risk disclosure, political lobbying and sustainability.
- Engage with companies and policy makers: Participation in collaborative initiatives like the Investor Network on Climate Risk, Carbon Disclosure Project the Forum for Sustainable and Responsible Investment and the Principles for Responsible Investment urge companies, investors and governments to consider the benefits of climate change mitigation from an economic perspective. These initiatives allow investors of all types to share resources and maximize impact while providing valuable learning and networking opportunities.
- Start a committee: Higher education endowments often have campus sustainability committees with student representation. Expanding the scope or creating a new committee to review sustainability issues related to the endowment can provide the investment committee with useful information and enhance the student experience. Such committees are already in place at several institutions.
Ultimately, each institution has its own spending policies, objectives, governance structure, and current list of priorities. For some of them, divestment may be a viable option. For others it may be a non-starter. Regardless, the conversation about fossil-fuel divestment and its implications should be an informed and open exchange exploring the relationship between sustainability and long-term investment objectives so that the goals and needs of stakeholders are addressed for the future.
Currently, there is a lively debate in the media and at many institutions about whether divestment of fossil fuel companies is feasible for investors or can be effective in the transition to a lower-carbon economy. As fiduciaries, we should make sure that the decision whether or not to divest does not ignore the evidence that climate change impacts pose real risks for investment portfolios. Corporate disclosures, increasing investor sophistication and networks of like minded institutions, are making it easier for investors to consider climate change and a broad range of sustainability issues within the context of their current investment structure and objectives.
We encourage investors to ask their managers, consultants and stakeholders about these issues and evaluate wide range of tools and approaches at their disposal. Deciding whether or not to divest from fossil fuels (or any other sector or company) should be the beginning of the conversation, not the end.
Craig Metrick is a principal and US Head of Responsible Investment for Mercer. Jane Ambachtsheer is a partner and Global Head of Responsible Investment at Mercer Investments.
