Report finds divestment a “slippery slope” that “has not been shown to be in the best interests of VPIC pension beneficiaries, and conflicts with VPIC governance structure.”
A new report conducted by an independent consulting firm for the state of Vermont confirms what economists, pension fund managers and academics have long said about fossil fuel divestment: it’s costly, hurts pension fund returns, and has no tangible impact on climate change.
For over a year, Vermont has been a battleground state for divestment with prominent activists like 350.org founder Bill McKibben urging schools and pension funds to divest, and former Governor Peter Shumlin making divestment a signature issue in 2016. Yet at every turn, efforts to divest have been rejected by everyone from the Treasurer’s office to pensioners – the same sentiments reached by colleges and funds across the nation.
After legislative proposals to mandate state pension divestment failed in March 2016, a subcommittee of the Vermont Pension Investment Committee (VPIC) was assembled to study the issue. The result of that process is a new report, released today by the Pension Consulting Alliance (PCA), analyzing several fossil fuel divestment scenarios for the Vermont pension fund at the request of the VPIC. Across all scenarios studied, PCA concluded that divestment would have adverse impacts for pension beneficiaries. The executive summary concludes divestment from fossil fuels, thermal coal, or ExxonMobil could:
Today’s report is one of a growing list of reports at the college, state, and national level that find divestment to be a costly, ineffective, and overblown campaign. Below we break down the report’s top five key findings and why it is the end to the divestment debate in Vermont – and should be for pensions across the country.
As of June 30, 2016, the VPIC held 3.6 percent ($134 million) of its $3.74 billion total portfolio in fossil fuels, with nearly all of these holdings in commingled funds. This may not seem like much by comparison to the overall fund, but in order to divest the VPIC would have to incur substantial management costs to remove these securities from its portfolio. From the report:
“The largest measurable explicit costs of divestment to VPIC would be ongoing increased management fees. Management fees would increase under each of these three divestment scenarios because VPIC commingled funds, where the bulk of VPIC’s fossil fuel were held, would have to be restructured into materially higher-cost SMA funds.” (emphasis added)
The report continues, explaining just what these costs entail:
“VPIC’s commingled fund managers, which held the vast majority of VPIC’s fossil fuel positions, cannot divest VPIC from individual securities, because VPIC does not hold direct ownership of individual securities in a commingled fund. Thus these funds would have to be closed and restructured as SMAs. In addition to the ongoing higher management fees of a new SMA, the costs to close down these funds and reopen SMAs, where possible, would include the administrative costs of opening an SMA, new custodial costs to allow VPIC to hold the individual securities, and transaction costs to buy in VPIC’s name the full set of ex-fossil fuel, ex-thermal coal, or ex-Exxon securities.” (emphasis added)
In fact, the report highlights how management fees should actually be spent on real investment strategies, stating “Divestment constrains active managers in their mandate to find the best opportunities to invest. Thus divestment conflicts with the underlying reason VPIC pays active managers higher management fees.”
These high management and monitoring costs come as no surprise. A study last year by Prof. Hendrik Bessembinder of Arizona State University found that the transaction and management costs related to divestment, also known as “frictional costs,” have the potential to rob divested endowment funds of as much as 12 percent of their total value over a 20-year timeframe. Likewise, in November 2014 the Vermont Treasury calculated divestment would cost the state pension funds $10 million per year in lost returns and $8.5 million in implementation fees.
If that wasn’t enough, divestment imposes new diversification losses associated with implementing such a complex procedure. As the report notes, “Divestment does not consider short-term financial risks or long-term diversification risks, which increase as the universe of divested stocks increases.”
The study’s findings conclude that the high implementation costs and lower returns divestment imposes would be an explicit breach of pension managers’ fiduciary responsibility to ensure high returns to the beneficiaries whose livelihoods depend on the fund. The PCA report notes:
“Divestment conflicts with VPIC governing policies: Given the financial and governance costs that come with fossil fuel divestment, in PCA’s opinion, divestment of fossil fuels, thermal coal, or Exxon has not been shown to be in the best interests of VPIC pension beneficiaries, and conflicts with VPIC governance structure.”
VPIC chair Tom Golonka also pointed out that pension beneficiaries would ultimately be forced to pay for the losses, despite the pensioners not supporting divestment themselves. He notes, “Divestment is a hot button issue, and it’s not coming from the pension beneficiaries — it’s coming from the governor’s office and from the environmental groups here in Vermont.”
The consultants behind this report agreed, noting “Divestment from fossil fuels sets a ‘slippery slope’ precedent for VPIC to restrict its manager’s stock selection based on criteria that are not proven to benefit VPIC.”
The PCA report confirms what environmental experts have been saying for years about divestment’s inability to effectively combat climate change. As the study notes, divestment “does not reduce the global economic dependence on, or demand for, fossil fuels, or impact the financing of the targeted companies.”
The report continues:
“In our opinion, fossil fuel supplier divestment can be a tool primarily in public equities to remove exposure to potentially stranded fossil fuel owner assets. In our opinion, other portfolio-wide potentially material financial risks and opportunities posed by climate change are not addressed by fossil fuel divestment. Divestment does not: address climate change material risks (including technological, policy, physical) evident in other industries from agriculture and forestry to infrastructure, buildings and insurance. Divestment does not provide enhanced exposure to companies involved in energy efficiency and renewable energy. Publicly held equity divestment only transfers ownership of fossil fuel securities; it cannot provide fossil fuel alternatives with any new financial resources.” (emphasis added)
Many others have come to the same conclusion, including Frank Wolak, director of the Program on Energy and Sustainable Development at Stanford, who similarly argued that divestment “comes at the expense of meaningful action” as it does nothing to reduce global greenhouse emissions or change a company’s funding or behavior.
Not surprisingly, last year five different groups representing state employees and Vermont retirees submitted formal resolutions calling for VPIC to maintain fiduciary responsibility in making investment decisions, rather than allow them to be legislated. As we reported earlier, Vermont Pension Investment Committee (VPIC), Vermont Troopers’ Association, Vermont Retired State Employees Association (VRSEA), Vermont League of Cities and Towns and Vermont State Employees Association (VSEA) were among the groups calling on VPIC, not the Legislature, to make “prudent investment decisions.”
As a part of the report, the consulting team looked at decisions from other funds across the country to decipher who else had moved forward with divestment to date. What the report found, is “divestment from fossil fuels is a sparsely used strategy among U.S. public pension plans, including by those plans, large and small, that are active on potential climate change risks to their investment portfolios.”
In fact, the report went as far as to debunk previous findings from Arabella Advisors and the Divest/Invest network, stating that of the “seven U.S. public pension plans that have divested from some version of fossil fuel securities…only four of those seven plans have divested from any version of fossil fuels.”
The report continues, stating:
“None of these pension plans have divested from Exxon individually, all fossil fuel companies, companies based on high stranded carbon reserve assets, high carbon emissions, or broader climate risk.”
Ultimately, the PCA report and the definitive outcome of this divestment debate can serve as an important example for other state pension funds and universities to follow when considering activist demands to divest.
Bottom line: Vermont’s careful study of divestment, and its financial impacts, can be a model for the nation.
The findings of the report on costs and governance should put an end to a long standing campaign launched by divestment activists to get pension funds to drop fossil fuel holdings. As the report sums up, “Given the financial and governance costs that come with fossil fuel divestment, in PCA’s opinion, divestment of fossil fuels, thermal coal, or Exxon has not been shown to be in the best interests of VPIC pension beneficiaries, and conflicts with VPIC governance structure.”