Institutional investors increasingly pair engagement and divestment to address climate-related financial risk
Key Takeaways:
Investors seeking protection from the market impacts of climate change have grappled with whether to sell fossil fuel companies or demand change as owners.
The stakes of this decision are heightened by fossil fuel companies’ long history of rejecting good-faith investor engagement on issues of climate risk.
Investors should view divestment as an important tool that accompanies an engagement strategy.
Grappling with these matters has led a number of leading institutional investors to take additional steps such as energy transition investments.
For investors seeking to address climate-related financial risk, investor strategy has outgrown tired debates between shareholder engagement with fossil fuel companies or divestment of holdings in the sector. A new briefing note from the Institute for Energy Economics and Financial Analysis (IEEFA) summarizes ongoing developments in investor practices and standards that illustrate how investors do not need to choose one or the other.
As institutional investors seek to harden their portfolios against the challenges of a warming world, they face a problem. The traditional energy sector stands disproportionately proximate to many of the causes and effects of climate instability—yet many fossil fuel companies are refusing to meaningfully adjust their business plans. The onus has fallen to investors to reduce threats to their portfolio.
“Investors should engage across their portfolio to reduce climate risk exposure and transition misalignment and should see divestment as an important tool to achieve the same ends,” said Connor Chung, IEEFA research associate and co-author of the report. “In practice, the engagement and divestment approaches strengthen and facilitate each other. Engagement needs divestment to have teeth, and a specific divestment decision can strengthen fund-wide stewardship efforts.”
In response to growing investor concern about climate risk, commentators have traditionally theorized two options: exit or voice. Should institutional investors cut exposure to the most misaligned assets? Or should they retain a seat at the table and try to steer corporate policy from within?
A growing body of evidence suggests that the choice is not so binary in practice. Institutional investors such as the New York State Common Retirement Fund and the Church of England have reduced exposure to the fossil fuel sector after significant but unsatisfying attempts at engagement. The funds continue engaging with non-fossil fuel companies and employ additional strategies such as expanded investments in climate solutions.
“The fossil fuel sector’s role in investment portfolios has shrunk at the same time as questions about its future pile up,” said Dan Cohn, IEEFA energy finance analyst and co-author of the briefing note. “Investors eventually must ask whether continued exposure to a diminished sector with poor financial performance and a negative long-term outlook is truly in their fund’s best interest—or helpful for their broader stewardship goals.”
