The worldwide movement to divest endowments and pension funds from fossil fuel holdings is growing rapidly, having now reached well over two trillion dollars in commitments. Although only a small fraction of total global investment capital, pledges to divest by major institutions represent, at the very least, a public relations headache for the fossil fuel industry. Therefore, it is not surprising that a series of analyses have started to appear making the claim that divestment is a poor financial strategy and perhaps even a dereliction of fiduciary responsibility. Also not surprising is that these anti-divestment reports have been given prominent forums, such as in the Wall Street Journal (with a response here).
My institution, the University of Dayton, announced in June 2014 that we would fully divest fossil-fuel (and not only coal) holdings over time. That process is well underway, and together with the Wallace Global Fund and other co-organizers, we recently hosted the first Divest/Invest Conference. As I see it, there are four main questions to be addressed by those who insist that institutions of higher learning should continue to support investment in a sector that undermines the future of the students we educate. Many of the ideas expressed below come from conversations with participants at the conference.
First, in a world increasingly threatened by climate change, how can we justify actively working, through our investment strategies, to maximize yields today by supporting the corporations that are the leading cause of future climate instability? This is not a question of making our current generation feel guilty for living in a world dominated by fossil fuels. Although we have dithered too long about taking strong action to mitigate the worst effects of climate change, our parents and grandparents who built the modern energy infrastructure did so in the good-faith assumption that they were simply providing a better future for their heirs. We who have profited immensely by the enabling power of fossil fuel energy must now take the initiative to use our accumulated wealth and knowledge in a new effort to avoid climate change, wean ourselves from fossil fuels, and work intentionally to leave a healthy planet for future generations.
A second question for institutional investors and those using past performance to argue against divestmetn relates to modeling the future returns portfolios based on past performance. Do we really believe that fifty years from now, fossil fuel companies will be making the same rates of return on investment as they have over the past half century? The whole premise of a changing climate is that the future world will look very different from the past. Whereas physical scientists can use laws of nature to help guide projections of the future based on immutable principles of physics, chemistry and biology, this is not true of the financial world even in the best of times. That's why we are all familiar with the disclaimer, "past performance does not guarantee future returns."
With regard to the fossil-fuel industry, there are likely to be only two choices for the future. On one trajectory, we collectively make a decision not to act on climate change and to double down on fossil fuel extraction. In that case, we are condemning future generations to bear the immense costs that will result, described here and here, thus throwing into doubt any sense of certainty as to what the financial landscape will look like. The second trajectory is one in which we make serious efforts to mitigate climate change, and therefore necessarily leave fossil fuels in the ground and decrease the value of that extractive industry. In either case, a simple extrapolation of past sectorally-balanced stock market portfolios into the future is meaningless, and certainly not at the level of small fractions of a percent per year.
A third fundamental question to ask of endowment managers, and more importantly, of the institutions for whom they work, is to what end they are aiming. If the only purpose is to grow at all costs, are there really no limits as to what can be considered for investments? None whatsoever? Universities with large and growing endowments such as Harvard and Yale state proudly that their endowments grow at rates of 8-10% per year, after factoring in costs and disbursements. It is those disbursements that are used for research, scholarships, attracting top faculty, etc. Thus, even after subtracting off the actual money needed to run the university, the endowment will double in value every eight to ten years. These institutions, refusing to divest from fossil fuels, are being disingenuous when they claim that doing so would harm the academic mission. Potentially earning 0.2% or 0.3% less per year (but see the previous point above) means the endowment might double in eight years instead of in seven and a half years. Is striving for financial gain at any cost the lesson we want to impart to students?
Many institutions use the rationale that divestment would take away their leverage to effect change from within through the use of proxy voting power. This raises a fourth question to pose to endowment managers and universities - if you are interested in creating real progress in the mitigation of climate change and transformation of the energy system to one that is more sustainable, what is your "ask" of the fossil-fuel industry? (Thanks to Cutler Cleveland and Ellen Dorsey for succinct versions of this question.) Is it that they should come up with plans to wind down their core business over the next few decades? Is it that they should leave their main asset in the ground? Or might it be a demand that they change their business model to become renewable and sustainable energy companies? The latter would be a reasonable choice, but it flies in the face of all evidence thus far that the coal, oil and gas industries are moving in this direction in a significant way.
There are many more questions that could be asked of portfolio managers when it comes to the subject of fossil fuel divestment. In the end, one of the key take-away messages of the University of Dayton Divest/Invest Conference was that divestment is possible, as witnessed by the increasing number of institutions making the decision to do so and evidence given by the financial analysts who attended. As more universities, religious organizations and individuals divest from fossil fuels, the financial industry will increasingly be willing to provide investment products that will perform as well as a portfolio containing fossil fuels. And that, in the end, is exactly what the fossil fuel industry is worried about.