I used to think divestment was obvious. If you don’t like or agree with something, why would you invest in it?
Divestment is essentially the opposite of investment. But, in the context of this article, we are talking about its role in shaping sustainability outcomes.
Since I joined Money Marketing, I’ve begun to think differently and realise that divestment may not always be the way to go. After all, ignoring a problem is sometimes not the answer.
As an asset owner, the ability to influence corporate behaviour is arguably an effective way to implement change
There is no doubt over the need to decarbonise the economy. Things have been heating up since the mid-20th century.
According to NASA, this is “clearly the result of human activities since the mid-1800s” and it is proceeding at a rate not seen over many recent millennia.
But lately the UK government seems to have lost its nerve and, in September last year, it scaled back its net-zero targets. The announcement boasted about the fact that the UK had set the “most ambitious” target to reduce carbon emissions by 68% by 2030 compared to 1990 levels; and that it was the “only major economy” to have set a target of 77% for 2035.
It is true that the UK has set some ambitious targets, including pledging to reduce its greenhouse-gas emissions to net zero by 2050. But concerns have been mounting that the UK may miss its future targets thanks to its recent scale-back.
Mission 2025
The Financial Times recently reported on a coalition of businesses, mayors, governors and investors, backed by former UN diplomat Christiana Figueres and calling themselves Mission 2025, which has formed in support of “robust climate action”.
If pension schemes are mandated to remove fossil-fuel assets, we do worry that these may be bought up by hedge funds and other investors who may not be as interested
Figueres told the newspaper that the group wanted to rebut the view that moving more quickly on tackling the climate crisis was “too difficult, too unpopular or too expensive”.
It has been widely reported that various companies have rolled back on net zero and other environmental measures. Critics argue that businesses are responding to “mixed messages” from governments.
So, perhaps it is up to investors now. And this is where divestment can be a sound strategy.
By divesting from industries or companies involved in practices deemed unethical — such as fossil fuels, tobacco and arms manufacturing — investors can align their portfolios with their moral values.
This is not only beneficial for the investors themselves but it also sends a powerful message to companies about societal norms and expectations.
Sustainable investing shouldn’t be a style of investing; it should be a movement. It should be about how you use your assets to drive change
By moving away from fossil fuels, for example, investors hope to address climate change by stigmatising investments in carbon-intensive industries.
If done right, divestment can influence corporate behaviour. This is especially true if the investors are large institutions such as universities and pension funds. In this case, divestment can lead to a decline in stock prices and increase the cost of capital for the targeted institutions .
This may, in turn, force companies to look again at their business practice and, potentially, adopt a more sustainable and ethical approach.
Threatening to divest can be just as effective as actually divesting. It can encourage firms to engage more transparently with stakeholders and consider the long-term social and environmental impacts of their operations.
Although divestment can raise awareness of ethical and environmental issues, and apply pressure on firms, it alone cannot be relied upon to drive systemic change
If divestment is used, capital taken away from ‘dirty’ companies should be re-invested in sustainable alternatives, to help support the development of a more sustainable and equitable economy.
Unintended consequences
One party that is backing divestment is the Green Party. In its pre-election manifesto, it laid out plans that included forcing non-bank financial institutions — such as UK pension funds, investment funds, mutual funds, brokers and insurance companies that sell policies in the UK — to remove fossil-fuel assets from their investment portfolios, securities transactions and balance sheets by 2030.
But not everyone agrees with such a forcible policy.
Broadstone investment consultant Matthew Downey says that, while prohibitions on investments may appear an efficient way of reaching the goal of net zero, a policy such as that proposed could have “unintended consequences”.
Divestment should work hand in hand with engagement. Try engagement first but, if that does not work, divestment may be the only thing you can do
He continues: “There is demand from the pensions industry to decarbonise and engage with companies to improve working practices. If pension schemes are mandated to remove fossil-fuel assets, we do worry that these may be bought up by hedge funds and other investors who may not be as interested in how the underlying companies operate.
“As an asset owner, the ability to engage and influence corporate behaviour is arguably an effective way to implement change.
“We would also need to see how the plans for the Financial Conduct Authority to stop shares relating to fossil-fuel exploitation are implemented. As the [Green Party’s] manifesto stands, the wording does not prohibit debt financing, so there are potential loopholes that could be exploited.
“That said, supermarkets make money by selling fuel, banks may finance oil and gas firms, and there is even an airline in the FTSE 100. So, depending on how the targets are set, they could have a significant impact on the UK stockmarket.”
Divestment is not always the answer. As Downey lays out above, it can have a limited direct impact on the financial health of targeted companies. It can, in fact, have the opposite effect.
Divestment can have unintended consequences for company stakeholders, including employees, communities and suppliers
Investors who have sold their shares no longer have a say in how a company is run. And, if the shares are bought by investors who do not share the same ethical or environmental concerns, there is no longer any hope that the company in question will be lobbied for poor practice.
The transfer of shares will be unlikely to reduce the company’s access to capital. At the same time, it will be less likely to change its business practices without the threat of money being pulled.
There is also a danger that divestment financially hurts the ‘divestee’. This is especially likely for large institutional investors with complex portfolios.
As is often pointed out by a select few Money Marketing readers, divesting from profitable industries such as fossil fuels can result in short-term financial losses for investors.
Divestment can also act as a trigger for companies to engage in greenwashing — saying they are environmentally friendly when they are not.
There is demand from the pensions industry to decarbonise and engage with companies to improve working practices
This is something the FCA is aiming to tackle with its new sustainability labels and anti-greenwashing rule, as part of its Sustainability Disclosure Requirements.
The anti-greenwashing rule was put in place to clarify to firms that sustainability-related claims about their products and services must be “fair, clear and not misleading”.
Stakeholders
Divestment can also have unintended consequences for company stakeholders, including employees, communities and suppliers.
Taking money away from a company may lead to reduced investment in the local community, job losses and economic instability — impacts that are often particularly pronounced in regions heavily reliant on industries such as coal mining or oil.
So, although divestment can raise awareness of ethical and environmental issues, and apply pressure on firms, it alone cannot be relied upon to drive systemic change.
In many cases, it is better to try to engage with companies to encourage them to change their ways.
Supermarkets make money by selling fuel, banks may finance oil and gas firms, and there is even an airline in the FTSE 100
CCLA head of sustainability James Corah believes that divestment should work hand in hand with engagement. Try engagement first, he says, but, if that does not work, divestment may be the only thing you can do.
The whole point of sustainable investment is to “drive outcomes”, says Corah.
“Sustainable investing shouldn’t be a style of investing; it should be a movement. It should be about how you use your assets to drive change.”
This article featured in the July/August 2024 edition of Money Marketing.
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