Meeting in the middle

The pressure is growing for pension investors to begin divesting from fossil fuel companies, Nina Röhrbein finds

In October 2013 a 70-strong coalition of investors called on the world’s 45 largest oil and gas, coal and electric power companies to assess the financial risks that climate change poses to their business plans. The move followed studies by the Intergovernmental Panel on Climate Change and the International Energy Agency suggesting that to achieve the international goal of limiting global warming to 2˚C, a significant portion of proven global fossil fuel reserves will need to be left in the ground. The world is on a path towards global warming of 4˚C or more, which the World Bank says must be avoided to prevent catastrophic climate-change impacts.

According to the Unburnable Carbon report by the Carbon Tracker Initiative, in 2012 alone the 200 largest publicly traded fossil fuel companies collectively spent an estimated $674bn (€500bn) on finding and developing new reserves – some of which may never be used.

Since these reports, calls for investors to divest from fossil fuel companies have grown louder. The most high-profile campaign,, began by urging US colleges and endowments to divest and has since reached European shores, recording successes such as financial services company Storebrand’s divestment from the 13 biggest coal companies.

“We suggest investors screen the top 200 companies identified by Carbon Tracker from their portfolio,” says Tim Ratcliffe, European divestment co-ordinator at “They represent the vast majority of the huge reserves that are accessible but should not be burned in order to stick to the carbon budget. A number of studies, such as Aperio [Group]’s Do the Investment Math: Building a Carbon-Free Portfolio, suggest that funds could fully divest from the 200 companies on the Carbon Tracker list and not see any significant increase in risk or loss in returns.”

The World Wide Fund for Nature (WWF) published a report on the Swedish AP buffer funds’ investments in November, calling on the government to prohibit the funds from investing in fossil fuels. But the consultant Mercer, while recognising this as a client-specific issue, does not recommend that pension funds initiate a divestment programme at this stage.

“The key duty of pension scheme trustees is to meet the needs of their beneficiaries,” says Kate Brett, senior associate at Mercer. “Divestment from individual sectors of the market is typically not on the agenda for most pension scheme trustees. Divestment from fossil fuels is largely untested and presents several difficulties because they represent a significant component of today’s energy mix and are used in a wide range of commercial and consumer applications beyond the energy sectors. In addition, divestment from such a large sector of the equity markets may be considered a breach of fiduciary duty, and there is an active debate over the ability of divestment to affect the value or behaviour of companies. A recent report by the Smith School of Enterprise and the Environment noted that divestment campaigns have had limited impact to date.”

According to Brett, pension funds that integrate environmental, social and corporate governance (ESG) issues in their decision-making are aware of the broader issue of stranded assets and are taking steps to mitigate risks posed by climate change.

The charity Operation Noah has urged UK churches to divest from fossil fuel companies, saying that the opportunity for fossil fuel firms to improve their credentials has passed.

“There has to come a point when engagement has reached its limit and divestment is the natural course of action,” says Ray Dhirani, sustainable finance manager at WWF-UK. “But that point is for investors themselves to decide, based on the nature, purpose and length of their engagement strategy.”

AP3, which has met with WWF, tries to integrate ESG issues in various ways. “We engage with several companies in different industries on increased transparency with regard to environmental impact and a reduction of their environmental footprint,” says Christina Kusoffsky Hillesöy, head of communications and sustainable investments at AP3. “As environmental issues are both risks and opportunities for companies, we have also made dedicated environmental allocations such as investments in green bonds, alternative energy and green buildings. We have long called for changes to our investment rules, which only allow us to invest 5% of our assets in unlisted assets. Several of the investments within the alternative energy side and climate-friendly infrastructure project fall within this unlisted assets bucket, which hinders us from investing.”

Mercer has facilitated collaboration between pension funds and campaign groups where it believes it to be beneficial. Some pension funds have met with groups such as, the UK’s ShareAction and academic bodies such as the Smith School at Oxford University.

The campaign groups are keen to stress that they do not necessarily expect pension funds to divest from all fossil fuel companies or switch their entire portfolio to renewables.

“While we are essentially looking to retire an industry that is not fit for purpose in the future, we are not asking for full energy sector divestment immediately,” says Ratcliffe.

“Investors should initially identify the type of carbon exposure they have,” says Dhirani. “Following that, they could undertake stress tests on how policy changes and physical impacts of climate change will affect their portfolio over the medium and long term. It may be prudent to look at steps to decarbonise, which may involve some immediate divestment from fossil fuels, starting, for example, with pure-play coal companies. It is not necessarily a blanket approach but pension funds should have a plan on future strategy and resilient asset allocation.”

ShareAction’s Green Light campaign looks at what pension funds can do, identifying the risks that climate change poses for pension fund portfolios and the various steps they can take to address them. These include reallocation of capital towards the transition to a low-carbon economy, engagement with carbon-intensive companies on climate change risk and with fossil fuel companies on their continued exploration for new, high carbon reserves, such as Arctic and tar sands. The project also calls for active investors to set a time for exiting pure-play coal stocks, and for policy measures to create a suitable environment for investing in the transition to a low-carbon economy.

“The strategic long game of this divestment campaign is to reduce the enormous lobbying power that fossil fuel companies enjoy, especially in Washington,” says Dhirani at WWF-UK. “Once their inordinate lobbying power diminishes we are much more likely to get the policy change needed for added investor certainty.”

Divestment or engagement becomes more complicated for passive investors. “The problem for a manager who relies on mainstream indices is that the amount of carbon on the main exchanges is so high that there is a built-in and sometimes under-appreciated inherent bias towards high-carbon companies,” says Dhirani.

“Passive investors should look at low carbon or carbon-optimised indices,” says Louise Rouse, director of engagement at ShareAction.

George Latham, CIO of listed equities at Wheb, questions the use market cap-weighted index benchmarks in the first place, with their bias towards what has succeeded in the past, rather than what has the potential to succeed in the future.

He says: “The index is characterised by what happens to be big. If that dictates what their portfolio looks like, then the tail is wagging the dog.” Instead, he suggests approaches such as thematic analysis, identifying future growth industries or smart beta, which could easily be tailored to any set of measures, including carbon risk. He also recommends that passive pension investors look at listing standards around ESG risks.



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