Practical analysis for investment professionals
14 April 2015

David Swensen on the Fossil Fuel Divestment Debate

By Robert Litterman

Many educational endowments and other investment organizations are struggling with the question of whether to comply with the widespread demands of students and other constituencies to divest their fossil fuel stocks.

Some, such as Stanford University, have already announced divestment actions in response to such demands. In May 2014, Stanford president John Hennessy announced that

the University’s review has concluded that coal is one of the most carbon-intensive methods of energy generation and that other sources can be readily substituted for it. Moving away from coal in the investment context is a small, but constructive, step while work continues, at Stanford and elsewhere, to develop broadly viable sustainable energy solutions for the future.

Stanford will also recommend to its external investment managers that they avoid investments in 100 public companies for which coal extraction is the primary business.

Other universities have announced decisions not to divest their fossil fuel stocks. In October 2013, Harvard University president Drew Faust wrote:

While I share their [students advocating for divestment] belief in the importance of addressing climate change, I do not believe, nor do my colleagues on the Corporation, that university divestment from the fossil fuel industry is warranted or wise.

The divestment movement started in the United States but has since expanded to become a global platform. In October 2014, both Glasgow University, in the United Kingdom, and Australia National University announced decisions to divest some of their fossil fuel stocks.

In addition to university endowments, some foundations, such as the Rockefeller Brothers Fund in September 2014, and pension funds, such as the Local Government Super in October 2014 (one of Australia’s largest public sector pension funds), have also announced decisions to divest fossil fuel stocks.

In August 2014, when Yale University announced that it would not divest its fossil fuel stocks, its Corporation Committee on Investor Responsibility also made an announcement:

As an investor, Yale should emphasize that companies, as a matter of sound business practices, should take into account the effects of climate change and anticipate possible regulatory responses with actions that recognize the externalities produced by the combustion of fossil fuels. The Chief Investment Officer is communicating this position to Yale’s external investment managers.

At the same time, David Swensen, Yale’s chief investment officer, wrote the following letter to Yale’s external investment managers:

I write to discuss climate change and Yale’s investment program. The Investments Office bases its approach to global warming on the conclusion that greenhouse gas emissions pose a grave threat to human existence. Climate change (caused by deforestation and emissions of carbon dioxide, methane and other gases) creates a substantial risk of significant changes to the world’s ecosystem and in actions to address those changes, making consideration of the impact of climate change essential when evaluating investment opportunities.

Yale asks that when making investment decisions on the University’s behalf, you assess the greenhouse gas footprint of prospective investments, the direct costs of the consequences of climate change on expected returns, and the costs of policies aimed at reducing greenhouse gas emissions on expected returns. Simply put, those investments with relatively small greenhouse gas footprints will be advantaged relative to those investments with relatively large greenhouse gas footprints.

A full accounting of the internal and external costs of greenhouse gas emissions will call into question the business models of some investments, which will require especially careful consideration. Today, examples include thermal coal producers, tar sands operations, companies that rely on cheap power from coal and low-lying coastal real estate. Of course, the list of investments requiring special consideration will change along with changes in the population of investments with business models that rely on mispriced externalities.

Conversely, fully pricing the externalities created by greenhouse gas emissions will create opportunities for profit. Examples include companies that produce renewable energy and products that facilitate demand shifting or otherwise promote efficient use of energy.

With respect to the particular case of investments in corporate entities, as you consider the implications of climate change, Yale expects you to discuss with company managements the financial risks of climate change and the financial implications of current and prospective government policies to reduce greenhouse gas emissions. You should encourage managements to mitigate financial risks and to increase financial returns by reducing greenhouse gas emissions. Yale asks you to avoid companies that refuse to acknowledge the social and financial costs of climate change and that fail to take economically sensible steps to reduce greenhouse gas emissions.

Government policies addressing climate change will impose costs on many investments, especially those with relatively high greenhouse gas footprints. If countries around the world implement pricing schemes that reflect the true costs of greenhouse gas emissions and if in your investment decisions you properly account for the costs and risks of greenhouse gas emissions, Yale’s investments will be well positioned to deal with a more enlightened regulatory environment. On the other hand, even if governments adopt imperfect policies to control greenhouse gas emissions, the University’s position will be protected by accounting for the financial impact of these policies on portfolio investments. Even in the absence of effective government policies to mitigate greenhouse gas emissions, your consideration of the costs and risks of climate change should lead you to better investment decisions.

Analyzing the greenhouse gas emissions associated with investments is far from simple and fraught with challenges. As in all aspects of investment analysis, decisions will be based on incomplete, imperfect information. That said, consideration of the risks associated with climate change should produce higher-quality portfolios.

The following guest editorial was published in the May/June 2015 issue of the Financial Analysts Journal.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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7 thoughts on “David Swensen on the Fossil Fuel Divestment Debate”

  1. Chuck t says:

    Financial analysis and climate change have the same limitation, modeling. Models are based on estimates and assumptions that are unknown. Warren Buffet and the recent financial meltdown exposes these limitations. I can just image how wrong these climate change models are given the political psuedoscience motivation of its practitioners.

    1. Bob Kingsley says:

      The large majority of the scientists studying the problem agree global warming is occurring. The rapid reduction in global ice cap thickness and size and the continued rise in sea levels (including the flooding of low lying cities in GOP controlled states, such as Miami, Florida) is strong model confirmation.

      1. Chuck T says:

        Key word is majority. Consensus science is not science.
        I suggest you read Michael Creighton’s essay “Aliens caused global warming”.
        I don’t put much faith in politically motivated quasi-science and I won’t frame investment decisions around it. We will never no the answer. To each your own. Invest the way that makes you feel good about yourself. I just disagree with the climate change narrative.

  2. Savio Cardozo says:

    Hello Robert
    That was a thoughtful, well articulated position from David Swensen on the subject of greenhouse gas footprints of companies.
    Thank you for sharing that – I quite enjoyed reading it as it served as a reminder to me of the urgency to recognize and deal with the issue – the almost in passing reference to low lying coastal real estate (I had to read it twice as it lay scattered with coal producers and consumers) really woke me up.
    Best wishes

  3. Richard Chauvin Jr. says:

    I cannot imagine basing investment decisions on politically-based pseudoscience. SRI has it’s place for individuals and organizations with strongly-held beliefs, and I have no problem with that. However, there should be a sound footing in science supporting the proposition to divest an entire industry, the consequences of which could be quite costly if the decision turns out to be faulty. I am well aware of the strong beliefs concerning the scientific basis for climate change caused by human activity. However, it may be an unprovable proposition, and certainly has not been modeled to any satisfactory degree to date. We may never understand the interaction of all the variables involved. As has happened many times through history, a consensus has formed around a theory because the costs of dissent are just too high for many scientists. Politicians love the theory, for it provides support for higher taxes and regulation. Call me skeptical.

  4. Fred says:

    To call the science of climate change pseudo science is to display a level of ignorance unfitting for anyone who manages other people’s money professionally.

    When people complain of the lack of ethics sometimes present in the finance industry, the comments here will hardly provide a strong refutation.

    Slave owners hundreds of years ago also looks at the economics of slavery above the ethics of it. Hopefully today’s money managers will not do the same with climate change.

  5. Nico says:

    Has Harvard rebutted?

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