To divest or not to divest? Border to Coast revisits the dilemma
Research commissioned by the British local government pool Border to Coast Pensions Partnership sheds light on the academic evidence on divestment
It’s been over three years since Tariq Fancy – BlackRock’s former chief investment officer – made a passionate plea against divestment. “There’s a difference between excusing yourself of something you do not wish to partake in and actively fighting against something you think needs to stop for everyone’s sake”, he wrote in The Secret Diary of a Sustainable Investor.
Fancy’s words sparked interest in a debate that had been brewing for some time: how should asset owners deal with the world’s largest emitters? should they retain a seat at the table and hold them to account? Or should they divest and favor companies with lower emissions?
In the years that followed, the debate evolved in its legal complexity, economic logic and ethical reasoning. The optimism for engagement over divestment, once broad-based and confident, is now more cautious.
Asset owners have shown they are willing to divest. In June 2023, the Church of England Pensions Board announced they would divest from emitters if they were not Paris-aligned. In September 2023, Akademiker Pension took a similar decision – the Danish pension fund divested from Eni, the Italian energy company, citing frustrations over engagement outcomes.
The question remains: does divestment work?
New research, commissioned by the Border to Coast Pensions Partnership and spearheaded by Dr. Tom Gosling – an executive fellow at the London Business School – offers an overview of which way the academic evidence leans.
A decision to divest could have a tangible impact on the £64bn pool. According to research by campaign group Platform, it currently has more than £2bn invested in fossil fuel firms. The pool also plays an active role in climate stewardship discussions having backed some 76% of environmental resolutions, according to its latest stewardship report.
Fiduciary duty
Any discussion of pension funds divesting on the grounds of climate change is set within the legal context of their fiduciary duty. The inclusion of “non-financial factors”, of which climate change is one, in investment decisions requires a legal clarification over an asset owner’s “fiduciary duty”.
In February 2024, a report by the UK’s Financial Markets Law Committee - which Gosling’s report cites - found that how pension funds consider climate change is driven by three factors linked to fiduciary duty:
Whether such considerations improve risk-adjusted returns, whether these “non-financial” factors have financial consequences and whether such considerations improve the fund’s ability to manage long-term risks.
On the question of divestment, intent and extent matter for fiduciary duty:
“Exclusions motivated by values alignment on a wide scale are generally not permissible for a pension fund but may be considered if they are limited in scope, can reasonably be expected to be aligned with beneficiary preferences, and leave a sufficiently wide remaining investment universe”, the report says.
Stranded asset risk
One of the strongest arguments in favour of divestment has been risk management. The worrying prospect of stranded assets – most notably unexploited fossil fuel reserves – looms large for investors with exposure to companies in the fossil fuel sector.
The academic evidence offers a few caveats to the stranded assets argument.
First, the extent to which fossil fuel reserves remain “unexploited” depends on how quickly the demand for oil and gas demand falls. This in turn, changes the financial consequences of assets considered “stranded”.
“Reserves do not create balance sheet liabilities for fossil fuel firms until capital is committed to exploit them, and firms therefore have substantial optionality to react to their view of demand and price changes”, the report says.
The evidence also does not offer any conclusions regarding the the extent to which stranded asset risk is priced in. Additionally, Gosling highlights that divestment, at times, could lead to unintended consequences:
“Alternatively, it could be that some investors divesting from, say, oil and gas stocks cause their prices to be depressed leading to higher future returns – a similar effect has been documented in the tobacco sector”.
Cost of capital
When Akademiker Pension took a divestment decision last year, the fund hoped it would send a message to Eni and its peers that there is a cost to unsatisfactory progress on the engagement front.
“When we and other investors sell our holdings, it puts upward pressure on the capital costs of the fossil fuel companies. All things being equal, it will therefore be more expensive for them to raise capital to fund their capex”, said the fund’s chief investment officer Anders Schelde.
A higher cost of capital, the argument goes, will incentivise a change in corporate behaviour.
There is some evidence, Gosling says, to support this claim but the effect itself is weak. In equity markets, for instance, research estimates suggest the greenium is lower than 100 basis points.
“Overall, those signals that are sent via the cost of capital channel, even if they were fully recognised and acted upon by management, appear to be entirely insufficient to have a material impact on the trajectory of emissions and global warming”, the report finds.
Seat at the table
The strongest case against divestment is the one Tariq Fancy put forth – divestment reduces the possibility of engaging with companies on their emissions reduction. A seat at the table, in other words, seems too valuable to forego.
In the academic world too, the consensus is that engagement works. The report suggests that the evidence leans towards engagement, but this is far from a definitive view. For one, it depends on which yardstick one chooses to measure the success of engagement.
“Evidence of engagement leading to material improvements in real-world dimensions such as emissions reductions are generally not found in the systematic academic evidence, and when they are found they tend to be modest, although this does not mean that such improvements do not exist”, Gosling’s report says.
In addition, whether or not researchers found evidence of successful engagement seems to depend on where the researchers were looking.
“Indeed, a number of studies find a positive relationship between successful engagements and share price movements, suggesting that the engagements studied in the academic literature focus on the ‘win-win’ areas where shareholder value and environmental or social performance is aligned”, the report concludes.
