As global commitments to a low-carbon economy strengthen, we consider the complexities of divestment strategies.
This year, the Norwegian Pension Fund, which controls about 1.3 per cent of global market capitalisation, excluded more than 50 coal-related companies from its portfolio. In October 2014, the Australian National University sold stakes in fossil-fuel companies worth $A6 million, drawing both praise and criticism; and initiatives such as Super Switch in Australia now allow members to gauge their superannuation fund’s estimated exposure to fossil-fuel investments.
Toss in the Paris Agreement emerging from the 2015 United Nations Climate Change Conference (COP21) negotiations that calls for net zero carbon emissions by 2100 and for climate finance to help emerging economies along a low-carbon development pathway, and suddenly long-term investors are facing unprecedented pressure from both internal and external stakeholders to do something about climate change and carbon emissions in their portfolios.
Crucial questions to consider
For Mercer’s Alexis Cheang, Principal, Responsible Investment, negotiating these myriad pressures begins with two fundamental questions. “For clients who approach Mercer with questions about fossil-fuel divestment, we ask: ‘What are your beliefs around fossil fuels and climate change? And were you to divest, what would that do to your investment risk and expected returns and ability to meet investment objectives?’” Cheang says. “That helps us answer the question of whether divestment is the right solution to the underlying problem.”
For many funds on the back foot from activists or responding to surveys questioning their readiness to transition to a low-carbon economy, this period of reflection is critical. “We try to prevent a knee-jerk reaction of just dumping shares,” says Cheang. “We say, hold on, what do you believe, do you share their beliefs (of the activists), is their criticism fair and reasonable?
“It’s also about choosing the right time to start talking about investment decisions because as a director of a superannuation fund, endowment or charity, you’re on the hook. You need to act in accordance with your organisation’s beliefs and your legal requirements as a fiduciary.”
It’s important to consider exactly what you are trying to achieve with a given investment decision around climate change and fossil fuels, and what options you have. Is the goal improving risk adjusted returns, or reducing the carbon footprint of your fund, or actually reducing greenhouse gases in the atmosphere?
“It’s good to ask why you are excluding these companies and what you’ll accomplish with different investment strategies,” Cheang says. “We often advocate an integration strategy when dealing with fossil fuel companies that says ‘Is a low-carbon future priced in, is the company prepared, will they benefit or not in the transition?’ It’s about making a more nuanced assessment of how well-prepared a company is and how well they’ll make that transition.”
Squaring beliefs with strategy
And while making any investment decision based on risk, returns and reputation is a strong strategy, aligning these with the potentially more contested notion of belief can be fraught. Cheang says Mercer’s Sensitive Investment Topics Analyser (SITA) is helping boards come to the right solution for their organisation on issues from fossil fuels to tobacco and controversial weapons.
“It explores different investment paths based on risk, return and reputation from exclusion to portfolio tilting to positive, thematic investing,” she says. “SITA was developed to take what can be a subjective decision around Beliefs and provide some rigour and assessment to an investment decision. It’s a process that’s repeatable, scalable and data-driven and, importantly, our clients own the outcomes.”