On November 4th, student demonstrators from the Zero Carbon Society called for the University of Cambridge to “clean up its act” over fossil fuel investments. Lining the bridges along the River Cam with banners, the group hopes to follow the success of campaigns in Warwick and SOAS and have the University divest such holdings. The Fossil Free List reports that 837 institutions globally have shunned coal, oil and gas investments in 2015 alone.
It is not just universities who are involved. NORGES, Norway’s sovereign wealth fund, divested some US$9bn of oil and coal investments this June. With the UN Climate Change Conference in Paris recently concluded, divestment appears to be gaining momentum.
What’s good about Divestment?
Activist Group, ‘Go Fossil Free’, defines divestment as “the opposite of investment” or simply getting rid of investment funds that are “unethical or morally ambiguous”. Although the concept began in 1980s South Africa, only now are financial institutions becoming more receptive to the idea. High costs of extraction of fossil fuels or increasingly tight emission laws could render a large portion of fossil fuel stores unusable, negatively affecting the cashflows of firms that depend on them. While global oil majors’ capital expenditure (CAPEX) has increased by 169% over the last 9 years from 2005-2014, total productivity has fallen.
Changing attitudes to the concept of ‘fiduciary duty’ – or the responsibilities of investors – also makes divestment increasingly attractive. In the past, Trustees justified investments in tobacco firms by arguing that their sole responsibility was to deliver the best total returns to their investors. Yet this approach is clearly unsustainable and by necessity, there must be some limits. The majority of the 89 Funds that manage some £180 billion of assets under the Local Government Pension Scheme (LGPS) in the UK have explicitly stated that whilst Environmental, Social and Governance (ESG) investments should not yield diminishing returns, such social-impact factors, positive or negative, must be factored in when evaluating investment opportunities.
Divestment is also an appealing option for beneficiaries. Just as markets overlooked lending risks in 2007, it is possible that investment decisions ignore the interlocking interests of shareholders and customers. The very people whose pension investments are tied up in utilities, healthcare and transport, are also the customers who buy such services. Commuters theoretically would tolerate lower dividend yields if their tickets were relatively cheaper. Moreover, households may be indifferent between a better return on energy securities or a proportionally lower heating bill.
Yet, in reality, households face no such choice. They can support a sustainable environment and still get the most out of their investment. MERCER, a consultancy, notes if the stranded asset problem exists, fossil fuel free funds can outperform conventional counterparts. The 2014 All World Ex Fossil Fuel Index Series, a ‘green investment index’, performed 7.6% stronger in the last 5 years than the traditional All World Index and with 0.4% less volatility. Allianz Chief Risk Officer, Tom Wilson, notes that as divestment and profit need not be mutually exclusive, “climate considerations should be influencing our asset-by-asset determination, not from an ESG perspective, but from an enlightened self interest”.
The Wrong Tool for the Job
All this suggests funds should participate in divestment immediately. Yet divestment only offers half the solution. The University of Cambridge could sell its £12 million in fossil fuel investments but then it must decide what securities to invest in next. Also, what happens to the offloaded stock? Critics argue that any buyer who acquires the divested stock is one who is even less concerned about fossil fuel emissions. Divestment, they claim, simply passes on the problem.
Wiping your hands off the stock also ignores the role of shareholder engagement. By actively holding shares in fossil fuel companies, fund managers can use shareholder votes and rights to steer company direction away from fossil fuels. It gives investors a place at the table to negotiate rather than simply walk away. The Divestment movement places an emphasis on zero carbon strategies rather than strategically identifying the risk carbon can pose. Selling oil assets to buy ‘low carbon emitting stocks’ may just increase exposure to risky financial securities, for instance. Japanese pharmaceutical company Eisai could be viewed as a green investment as it emits just 315 tonnes of carbon dioxide per $1 million in revenue. Yet recent protests against controversial animal testing practices may not align with the ‘responsible and moral’ motivations for divestment. Traditional divestment therefore can’t help fund managers make informed investment decisions.
Divestment needs to be altered and ‘Reinvestment’ strategies need to take its place. If Divestment is the “opposite to investment”, Reinvestment is the positive alternative that emphasises finding alternative funds to sink divested capital in. The Carbon Tracker Initaitve (CTI) analyses and aims to minimise carbon risk at both the fund and portfolio level. In 2014, the FTSE developed a fossil-free index tracker and in February this year, Blackrock followed suit. Such products show particular promise in Europe, where passive-mandates, or when an investor is committed to simply investing in indexes that follow the market, are much more common. In 2014, pubic sector pension funds were encouraged to increase exposure to passive investment as part of a drive to save approximately £680 million in fees.
Although these tools aren’t new, the climate change conference in Paris showcased the innovative ideas and technology that have made these tools more attractive. ET Index, a London-based start-up has created its own unique approach to better managing carbon risk. Although conventional indexes consider direct and indirect emissions, or in the World Resource Institute’s terminology, Scope 1 and Scope 2 source emissions, they ignore “indirect influence-able decisions like transport” categorised under Scope 3. These can account for up the majority of carbon risk and suggests the traditional products aren’t at all as effective they could be. ET Index has instead collated an independent carbon ranking known as the Carbon Index Series that adjusts for verifiable data. By weighting investments based on carbon emissions, green companies enjoy the rewards of a greater weight, while big polluters are simultaneously penalised with a lower share of investment. This desire for transparency also follows the sentiment behind the Principles for Responsible Investment (PRI) Montreal Pledge, which commits signatories to disclose annual carbon emission data publicly.
Collaborative discussion over rigorous and innovative financial products is therefore likely to be one of the biggest, yet most understated results of the conference in Paris. Although divestment has gained the support of the Pope, and even though the Bank of England has warned about fossil fuel risks, the movement is unlikely to ever cause fund managers to engage in “opposite investment” practices.
Divestment needs to be smarter, and understand it is only part of the solution. Cambridge need not divest, but should commit to reinvesting.