There is a strong financial case for institutions to divest from fossil fuels – supporting moral grounds for divestment.
As the discourse around climate risk, the ‘carbon bubble,’ and ‘stranded assets’ moves into the mainstream of finance, coupled with the competitive returns of fossil free investing, campaigners have a robust set of resources to dismantle informational barriers like fiduciary duty and the cost of divestment.
This infographic lays out the key arguments. For detailed information on financial arguments, check out the sections below.
Key arguments against shareholder engagement:
- Engagement has no track record of success on this issue. There have been no significant direct reductions in the production of fossil fuels achieved through shareholder advocacy over the last two decades. There is no evidence that engagement is an effective tool to prohibit the fossil fuel industry from growing their core business, producing fossil fuels.
- The SEC does not recognize resolutions that inhibit the core business of a company. If the goal is to keep 80% of current reserves underground, engagement is an insufficient tool. Shareholder advocacy has succeeded when investors press companies to make changes in their supply chain or in their sustainability policies, but not in changing their core business model.
- We’re running out of time. The two core elements of shareholder engagement are an “ask” and a “timeline” – what you want the company to do and by when. No engagement strategy meets the size and urgency of the climate challenge. Significant corporate changes from shareholder advocacy typically take years and only involve target companies.
- Trust dirty energy when they tell you they won’t stop production. Fossil fuel companies have shown no inclination or ability to lead a transition to a cleaner economy. In fact, in the last decade, many oil and gas companies have sold their wind and solar operations and have publicly stated they plan on burning all of their reserves and more.
- If you truly believe engagement has potential, divest anyway. Technically, you can divest everything and hold onto the minimum for the companies you have the capacity to address through engagement. SEC Rule 14a-8 states, investors need to have held $2,000 worth of a company for one year before you can file a shareholder proposal. Investors can divest and participate in shareholder resolutions by holding an insignificant (from a risk perspective) amount of stock.
- Proxy votes: The opportunity for shareholders to vote on shareholder resolutions by proxy, as most shareholders are unable to attend the company’s annual meetings in person. Many institutions hire a proxy service that will vote on your behalf based on predetermined criteria.
- Shareholder resolutions: Proposals submitted by shareholders for a vote at the company’s annual meeting. Other advocacy includes direct dialogue with companies, multi-stakeholder efforts, public statements, and policy engagement.
- Clean Yield: Talking to the Hand: Why Engagement With Fossil Fuel Companies Offers So Little Promise
- Green Century: The power and limitations of shareholder advocacy with fossil fuel companies
- GreenBiz: Why shareholder engagement with fossil-fuel companies won’t work
- PRI: Focus On Climate: The United Nations-supported Principles for a Responsible Investment, or PRI, recently published an empirical report looking at emissions disclosure over the last 5 years. “The results of the study indicate that pressure from the state, NGOs and the public impact a corporation’s decision to report GHG emissions data, but pressure from equity investors and debt lenders does not.”
The problem with investment consultants?
In many cases, ultimate fiduciary responsibility for the performance of the assets rests with trustees who are non-specialists and require independent and specialist advice. This is where consultants come in. In addition to financial expertise, consultants have ‘political value’ when considering fiduciary duty. Investment consultants provide a shield which institutional investors can use to defend their stock selection or deflect divestment pressure.
- Asset Manager: A financial services company that invests a client’s funds with a particular strategy
- Asset Owners: The trustees of the institutional fund
- CIO/CFO: Oversees a team of professionals that have responsibilities such as managing and monitoring investment activity, working with external analysts and developing investment policies.
- Looking back over more than 10 years, fossil free portfolios would have had a tracking error of less than 1% (Compared with the average tracking error of active managers, 5%)
- S&P 500 without fossil fuels has higher annualized returns over the last 10 years and weathered the 2008 crisis better than the S&P 500. A fossil free global market (MSCI ACWI) and domestic market (Russell 3000) each outperformed their corresponding indices over 16 and 22 years respectively
- Fossil fuel divestment has the potential to reduce overall portfolio risk (e.g. oil price volatility and carbon risk)
- The S&P 500 without fossil fuels has had a higher sharpe ratio over the last 10 years
This is good defense, but what about offense?
It’s smart not to try to sell divestment as a way to outperform a current investment strategy (even if you may be right). It often comes off as speculation from an unofficial source. With that being said, you can talk about reducing the “risk exposure” of a portfolio by divesting. Sell trustees on being more conservative by divesting than not divesting. Trustees are always looking for ways to reduce “risk.” For more information about carbon risk to your portfolio see the Stranded Assets page. And remember, institutional investors have long timeframes to consider. Do you think fossil fuels are a good long term bet?
- Benchmark: A [usually large] group of stocks that represent the movement of a given market (e.g. S&P 500 = US large cap domestic stock market or the top 500 companies in the US). Benchmarks are used as a point of reference to measure progress of a portfolio. The MSCI ACWI is a benchmark of global stocks (All Country World Index), and the Russell 3000 is a benchmark of the top 3000 companies in the US.
- Tracking error: A difference between the price changes of a portfolio (or group of stocks) and the price changes of a benchmark. “Tracking error is analogous to the concept of darts thrown at a dartboard, where the bull’s-eye is the benchmark return and the measurement of the dispersion of dart throws around the bull’s-eye is the tracking error over a particular time frame. A small or tight tracking error means the darts are clustered around the bull’s-eye, and a large or loose tracking error means the darts are all over the board.” – Aperio Group
- Sharpe ratio: Tells us whether a portfolio’s returns are due to smart investment decisions or a result of excess risk. Although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio’s Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.
- Optimization: The process of adjusting the proportions of various assets in a portfolio to best suit the given risk/return objectives.
- Key arguments
“Anticipatory divestment in recognition that at some unknown and unknowable point down the road, markets will suddenly adjust equity prices downward to reflect swiftly changing prospects for fossil fuel companies, is well within the charged responsibilities of a fiduciary.” – Bevis Longstreth, Former SEC Commissioner Under The Reagan Administration
- “Whether your portfolio will under or outperform after divestment is unknowable. Fiduciaries need not worry about short-term results. Anticipatory investment should be viewed as having unknown short-term consequences. In the long run, those results are unimportant. A decision to divest rests on the claim that fossil fuel companies will prove to be bad investments over the long-term and, therefore, should be removed from the fund.” – Bevis Longstreth, Former SEC Commissioner Under The Reagan Administration
- “A responsible fiduciary would be asking questions like, ‘Can a diversified portfolio be managed for the long term without these investments, which “externalize” unacceptable harm to participants and beneficiaries?’ A modern fiduciary must understand how the corporation affects the health of the systems upon which it depends for its long-term survival.” – Bevis Longstreth, Former SEC Commissioner Under The Reagan Administration
- Fiduciary duty: A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets for the benefit of the other person rather than for his or her own profit.
- Risk tolerance: The degree of variability in investment returns that an individual is willing to withstand. In general, institutional investors have low risk tolerance, meaning they are conservative investors who are more concerned about long timelines.
- Fossil fuel reserves are currently more than 5 times the amount we can burn before hitting the internationally agreed upon ceiling of 2°C of warming.
- However companies in the coal, oil and gas sectors seek to develop further resources which would double the level of potential CO2 on the world’s stock exchanges. In 2012 the top 200 fossil fuel companies allocated up to $674 billion for finding and developing more fossil fuel reserves and new ways of extracting them. We already have more on the balance sheets of these companies than we can burn and they are still looking for more. This is an illogical business plan.
- Thanks to crumbling demand and weak prices, coal stocks (KOL), have plummeted by 85 percent over the past five years.
- Due to the drop in oil prices, shares in broad oil/gas industry (FENY) have tumbled 29 percent over the last five years.
- Not a single large oil extraction project in the last three years has come on stream with a break-even cost below $80 a barrel (click here to check oil prices)
- Stranded assets: An asset that is worth less on the market than it is on a balance sheet due to the fact that it has become obsolete in advance of complete depreciation
- Cost curve: A graph showing the hypothetical supply of a product or service that would be available at different price points
- GtCO2: A gigaton or billion tons of CO2
- Proven reserves: A classification that refers to the amount of resources that can be recovered from the deposit with a reasonable level of certainty. The difference between proven and probable reserves is the likelihood of extraction (see The Carbon Underground report)
- Carbon Tracker: Unburnable Carbon – Are the world’s financial markets carrying a carbon bubble?
- Standard & Poors: What A Carbon-Constrained Future Could Mean For Oil Companies’ Creditworthiness
- Kepler Cheuvreux: Stranded assets, fossilised revenues
- Carbon Tracker: Unburnable carbon 2013: Wasted capital and stranded assets
- University of Oxford: Stranded Assets and Scenarios
For guidance on deploying these arguments with decision-makers, check out this handy guide to common misconceptions about divestment.
To find out how much money your target institution has lost by investing in fossil fuels over the last three years, check out The Decarbonizer, a free online tool for campaigners!