September 8, 2015

New Report: Divestment Would Cost Harvard, Yale, Columbia, MIT, and NYU More than $195 Million per Year

As schools continue to reject calls to divest their endowments of fossil fuels, one common question is often left unanswered: How much does divestment actually cost?

In an effort to answer this critical question, a new report released today, commissioned by the Independent Petroleum Association of America (IPAA) and authored by a researcher from Caltech, quantifies for the first time the actual, real-world costs that individual, select schools could expect by divesting. Looking at the real-world cost of divestment for five leading U.S. universities with significant endowments — Harvard, Yale, MIT, Columbia, and NY– the report finds that these five schools collectively could lose more than $195 million by divesting from fossil-fuel related equities – $195 million for each and every year the portfolios are active in the market.

Led by Dr. Bradford Cornell, a visiting professor of financial economics at Caltech and a senior consultant at Compass Lexecon, the report draws on publicly available data to model thousands of different proxy portfolios for each school studied. Dr. Cornell and his team were then able to approximate the composition of each school’s investment fund, and then analyze those portfolios’ performance under both divested and diversified scenarios. Among the schools evaluated, Cornell and his team found that Harvard would experience the most significant loss if it decided to divest – roughly $107 million per year. Yale’s losses are projected to exceed $51 million year per year. MIT would lose $17.75 million; Columbia would lose $14.43; and NYU would see a reduction of $4.16 million.

As Dr. Cornell highlighted upon release of the report, “The fact that divestment has the potential to generate lower returns for schools and other institutions isn’t particularly earthshattering news. But the fact that the projected shortfalls associated with divestment are this significant, and this universal – that is the real critical finding here, and one that schools would be smart to evaluate as part of any discussion on divestment moving forward.”

IPAA senior vice president for operations and public affairs Jeff Eshelman also noted that, “This report adds to the growing body of research and real-world evidence out there showing that divestment is a bad policy based on a bad premise, with the potential to produce really bad outcomes for the schools and institutions that adopt it.” In fact, the Cornell report builds off previous research by University of Chicago Law School professor Daniel Fischel that analyzed the performance of two investment portfolios over a 50-year period: one that included energy-related stocks, and another that did not. The Fischel report found that fully diversified portfolios generated average, absolute returns 0.7 percentage points greater than portfolios that excluded energy stocks — meaning the “divested” portfolio lost roughly 70 basis points relative to the optimal scenario for each and every year over the 50-year period in which the portfolios were active.

As experts and prominent universities alike have already stated, divestment comes with serious costs and little tangible benefits. We suggest you read this report in full, but here are a few key findings you don’t want to miss:

• “Consistent with basic financial economic principles, divestment almost always generates long-term investment shortfalls due to reduced diversification, and the shortfalls are typically substantial, given the size and importance of the energy sector being divested.” (p. 3)

• “The mean risk-adjusted shortfall due to divestment for a weighted average across the five universities is approximately 0.23 percent per year, each year.  This mean shortfall varies across the universities: 0.16 percent (Columbia), 0.30 percent (Harvard), 0.14 percent (MIT), 0.12 percent (NYU), and 0.21 percent (Yale).” (p. 4)

• “As applied to these schools’ current endowments, shortfalls of this magnitude would translate to annual reductions in endowment value of $14.43 million (Columbia), $107.81 million (Harvard), $17.75 million (MIT), $4.16 million (NYU), and $51.09 million (Yale).  Therefore, these five schools alone stand to forfeit more than $195 million in investment returns each year, without changing portfolio risk.”  (p. 4)

• “On a gross (not risk-adjusted) basis, the mean annual shortfall due to divestment for a weighted average across universities is 0.31 percent per year, and, for individual universities, the gross shortfall is 0.24 percent (Columbia), 0.37 percent (Harvard), 0.19 percent (MIT), 0.17 percent (NYU), and 0.33 percent (Yale).  Whether risk-adjusted or not, reductions in investment returns of these magnitudes would likely have a meaningful impact on universities’ ability to satisfy their institutional goals of research and education.” (p. 4-5)

• “Using a weighted average across the five universities, fully 91 percent of these proxy portfolios produce a risk-adjusted divestment penalty over the past 20 years that would generate a shortfall for the endowment fund.  This indicates that, regardless of how successful my attempt to proxy for these schools’ endowment holdings is, it is in any case very likely that the actual endowments would experience a shortfall due to divestment.  Focusing on the five universities individually, the share of constructed portfolios for each university with a risk-adjusted shortfall is never less than 88 percent.” (p. 3-4)

• “Sizeable declines in the endowment fund … would likely have material impacts on a university’s ability to achieve its institutional goals.  Specifically, endowments fund a material share of the operating budget for all five universities, and reductions in returns specifically harm key institutional objectives, such as funding research and student support.” (p. 10)

• “Due to the plasticity of the capital markets and the diversity of investors worldwide, basic financial economic theory indicates that it is unlikely the divestiture movement, with or without any specific university’s participation, will have any material effect on the cost of capital of the divested companies or any other relevant outcome.  The history of prior divestment campaigns is consistent with this basic theory.” (p. 13)