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Sunday, April 12, 2015

Stephen Mulkey: Divestment from fossil fuels: An ethical imperative for higher education

by Stephen Mulkey, Environmental Century, April 10, 2015
On November 5, 2012, the Unity College Board of Trustees voted unanimously to divest our $15 million endowment from the top 200 fossil fuel companies, making Unity the world’s first institution of higher learning to explicitly target – using Carbon Tracker, a financial think tank – companies that produce these carbon-based fuels. Since our action, hundreds of campuses have started divestment movements. An increasing number, including Pitzer, Stanford and Syracuse, have voted to divest billions from fossil fuels.
Arguably, our small endowment is considerably more sensitive to bad investment choices than those of elite institutions such as Harvard, Princeton, and others. To date, our investments have thrived. But, as I will explain, divestment is largely immaterial to returns and fees.
With so much at stake for our financial well-being, why would Unity take such bold action? I believe the answer is that our Board viewed divestment as obligatory if the College is to honor the overarching mission of higher education. To be sure, the fiduciary responsibility of boards of trustees extends well beyond financial considerations, and legally requires them to act in the ethical interests of their institution. You might think the ethical imperative derives from the fact that we are an institution informed by the U.S. National Academy concept of sustainability science. But, this aspect of our academic mission is largely irrelevant to this decision; we believe divestment is obligatory, as both an ethical imperative and a fiduciary responsibility for all institutions of higher learning.
The overarching mission of higher education is the maintenance and renewal of civilization. By contrast, the continued business of fossil fuel extraction will, with high certainty, result in significant decline of civilization in the latter half of this century. This derives from the fact that climate change, driven by emissions from these fuels, is an extreme and unique category of threat to our children and all future generations. Although there are compelling arguments to divest from tobacco stocks or companies that did business with apartheid dominated South Africa, the costs of inaction on climate change are staggeringly high. Continued business as usual will result in irrevocable consequences on a millennial time scale.
Put simply, we must leave the carbon in the ground. Generous estimates suggest we can burn only about 20% of conventional reserves without pushing atmospheric warming beyond the putative 2-degree-Celsius guardrail the United Nations Framework Convention on Climate Change determined as the threshold for “dangerous” climate change. As climate science has advanced, we now know that this rather arbitrary limit is not safe for the maintenance and renewal of civilization in its current form because of the enhanced biogenic sources of emissions that will ensue as the atmosphere warms. Presently, we are on a trajectory that will warm the planet between 4 and 6 degrees C by 2100, a condition that would be catastrophic for humanity and many of the Earth’s living systems.
As the consequences of climate change continue to unfold, governing boards will want to be in the strongest ethical position to preserve the relevance and value propositions of their institutions. Accordingly, the first step in deciding divestment is for stakeholders, leadership, and governance to reach a consensus about the ethical imperative of divestment and its relation to the values of the institution.  It is my experience that financial experts should not be engaged until the ethical imperative has been accepted or rejected by the institution’s governing body.
In the near to intermediate term, there is a very pragmatic reason for divestment. If we assume that humanity will wake up in time to avoid catastrophic climate change, most of the carbon reserves of these companies will become stranded assets and this will significantly diminish their assessed value. If mitigation of climate change is to be effective, these assets must become stranded within no more than 15 years. Once regulation of carbon emissions begins in earnest, the perception that these assets are of dubious value will occur long before they are likely to be mined. This drop in value will be a direct threat to the value of the institution’s portfolio.
Most portfolios have holdings that commingle desirable and undesirable assets, so it is necessary that divestment be executed over a considerable period. The approach that works best is to progressively reduce exposure to the top 200 fossil fuel companies over a period as long as five years. This should not require additional fees, because it does not involve extraordinary trading or management. Divestment simply adds a new criterion to routine portfolio management.
One way to accomplish divestment is to avoid the energy sector entirely. This approach, taken by Unity College, cut exposure to the 200 targeted companies to less than 1 percent of overall returns in less than two years. There has been no apparent opportunity cost with respect to returns because there are thousands of financial products that can replace, replicate, and sometimes even outperform the energy sector. Moreover this process is becoming easier as institutional clients continuously push the financial industry to create new fossil fuel free products.
When such a direct approach is not possible for large endowments, slow and steady reduction of exposure over longer horizons achieves the same result, realizing that, because of derivatives trading and the interdependence of holdings within equities, “absolute zero” exposure will be elusive – even unlikely – in most scenarios.
It is important to understand that returns on a divested portfolio are largely unrelated to the act of divestment. Returns are primarily determined by the overall performance of the market and asset selection by savvy management. Studies have shown a small tracking error in returns of a divested portfolio relative to major market indices primarily because, periodically, the energy sector can drive overall market performance.
As higher education faces extreme disruption during the coming years, risk – particularly fiduciary risk — will manifest in many forms. Remember that divestment and returns are not automatically correlated, and higher education must meanwhile make clear statements and be public about ethical values. Unity views this articulation of values as an essential market position, and views the downside fiduciary risk of divesting as less challenging than the risk of not upholding its unimpeachable moral imperative to distinguish itself as an ethical bulwark for higher education in the marketplace of this, the Environmental Century.
As president of the first college to divest, I am enormously proud of our visionary board, faculty, and students. Unity College has entered a new era in which our brand and ethos are a national province. Parents and students look to us an example of what higher education can be. We are all in this together to develop a model in which financial risk is mitigated by investing choices that are ethically and financially sound while – most importantly – nurturing a civilization on which all our endeavors depend.

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