The cost of divestment may be too high for institutions to bear, according to a study published last week by researchers from Compass Lexecon, an economic consulting firm.
The study found a “highly likely and substantial” potential for lower investment returns on divested institutional portfolios. Critics, though, have argued that the study’s results merely reflect the interests of the pro-energy group that financed the report, the Independent Petroleum Association of America.
The report — which analyzed the effect of divestment over a 50-year period — cited higher trading costs, diversification costs and compliance costs as among the potential consequences of divestment.
“The economic evidence demonstrates that fossil fuel divestment is a bad idea,” former dean of the University of Chicago Law School and lead author Daniel Fischel wrote in the study. “These costs have real financial impacts on the returns generated by an investment portfolio, and therefore, real impacts on the ability of an educational institution to achieve its goals.”
The conclusion of the report was based on a study comparing two portfolios — one “optimal equity portfolio” without divested assets and one divested non-energy stock portfolio. After analyzing the investment returns over the timeframe from 1965 to 2014, the study found a gross reduction in returns of 0.7 percent per year due to divestment.
Over the past decade, Yale has earned an average 11 percent annual return that has brought the endowment total to $24 billion as of June 30, 2014.
Senior vice president at Compass Lexecon Alexander Rinaudo, who was part of Fischel’s three-person team of researchers for the study, said divested portfolios may have lower returns due to decreased diversification of assets.
Rinaudo said that compared to other industrial sectors in the market, the energy industry is the “least correlated” sector. He added that because energy stocks are not closely tied to the performance of other stocks, they have provided a stable source of investment for years — despite the recent fall in oil prices.
The School of Management finance professor Roger Ibbotson said that though divestment may have negligible impact on the market, it can come at a cost for the institution selling the energy stocks. Since these stocks would likely be sold at a price below the value of their future cashflow, investors in fossil fuels would benefit while sellers would miss out on these returns, he added.
The study also argued the compliance and trading costs associated with divestment may be another drain on endowment returns.
Moreover, the trading of divested stocks would result in transaction costs for universities through additional brokerage fees and other price impacts, Rinaudo said.
Ibbotson said, however, these compliance costs would likely not be too great. He added that compared to the past, the availability of computer technology has made it relatively easy to mechanize one’s portfolio to meet different standards.
Following the publication of the Fischel report, pro-divestment activists have come forward to argue that the study is fundamentally flawed in its conclusions and methodology.
Fossil Free Yale Policy Coordinator Nathan Lobel ’17 said the financing for the report may have influenced its pessimistic findings for divestment.
“These portfolios were put together retrospectively by people with a strong interest in finding a certain outcome — it seems far fetched that they would be completely bias free,” Lobel said. “Considering that [Fischel’s] entire claim rests on the performance of hypothetical portfolios that [was] funded by the Petroleum Association, there would seem to be huge possibilities to stack the deck against fossil free portfolios.”
Rinaudo denied any conflict of interest between his team and the funding for the study. He said the financing party had no involvement in the design, implementation or construction of the report and the data was used to consider the issue “agnostically.”
Still, Lobel said there remain compelling financial reasons for Yale to divest, ranging from the volatility of fossil fuel investments to increasing regulations on carbon emissions.
Brett Fleishman, senior analyst from the pro-divestment group 350.org, argued that the methodology failed to consider the significant differences between today’s marketplace and the economy decades earlier. Specifically, he said the model failed to reflect how oil has become a less dependable investment in recent years.
“One might argue that the last five years are a better representation of the future than the last 50 years of which the Fischel report looked at,” Fleishman said. “The trend for fossil fuel investments is shifting to a high-risk, low-return profile.”
Though the Yale administration formally announced it would not divest in August, weeks later, Yale’s Chief Investment Officer David Swensen wrote a letter to the University’s money managers requesting they consider the long-term financial implications of fossil fuel investments.
“Yale asks [its investment managers] 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,” the letter stated.
Still, according to Yale’s most recent endowment report, Yale has kept 8 percent of its investments in natural resources — which include oil and gas, timberland, metals and mining.
Other studies released on the topic, which include research from Northstar Asset Management and Aperio Group — both of which analyzed returns over a shorter period of time — found that the impact of divesting from fifteen fossil fuel securities would be “virtually nonexistent.” Specifically, Northstar found that the actual cost of divesting from these stocks would be 0.15 percent annually— roughly a fifth of the Fischel’s findings.
Fleishman said that if Yale had divested two years ago, when the divestment campaign first kicked off, it is likely the University would have an even stronger performance. Over the last year, the S&P 500 stock market index without the top 200 fossil fuel companies outperformed the current index by 1.5 percent, he added.
Finally, Lobel said that even if the financial impacts of divestment remain contested, the moral justifications for removing University assets from fossil fuels remain clear.
“There is no certainty that divesting will be the more profitable option — just as there is no certainty that it will be less profitable — but we are certain that investing in fossil fuels is wrong,” Lobel said. “If it is wrong to wreck the planet, abuse vulnerable communities, and distort our political process, then it is wrong for Yale to profit from that wreckage, abuse and distortion.”