Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 88

Divesting from fossil fuels and from rational economics

John D Rockefeller turned in his grave when the news drifted down to Hades that the Rockefeller Brothers Fund was divesting from fossil fuel companies … even from John D’s once very own Exxon.

The shrill yelps that greeted ANU Endowment’s similar decision confirm that others too feel threatened. The decision was likely arrived at through the confluence of economic/financial and moral/political criteria. On the economic side ANU’s view seems to be that fossil fuel companies are becoming dangerously risky as the world acts on climate change through the development of alternative sources of energy, actions that will leave their assets stranded. On the moral/political side its view seems to be that burning fossil fuels is wrong because of the damage it does to society. Therein lie the dual threats. On one hand, the (supposedly flawed) economic analysis threatens the industry as it is currently structured while on the other hand the very use of moral/political analysis threatens economics as it is currently structured. To use other than ‘pure’ economic/financial criteria is an affront to the dominant paradigm that economics is a Value-Free, Objective Science and that, as a consequence, free markets produce optimal economic outcomes. Hence free markets are sacrosanct.

According to that paradigm the market is always right and its righteous power ensures fossil fuels are correctly priced given the risks involved. Correctness is attained through the objective actions of rational corporate decision-makers responding to price signals who drive their fossil fuel companies to adapt to the changing world. For the paradigm’s true believers, that most companies have made but token, PR-driven changes typified by BP colouring its bowsers green, confirms the incorrectness of ANU’s decision. For them, taking any investment action on climate change is likely to be ‘sub-optimal’ as even if markets don’t instantly set the right price (a possibility they admit to sotto voce) doing nothing remains optimal over the shorter-term until pricing signals become clearer.

Investors do see climate change affecting portfolios

But waiting for greater clarity, waiting until the assets are exposed to a ‘clear and present danger’ of being stranded or until pricing is almost certainly correct is surely ‘sub-optimal’ risk-management. Increasingly institutional investors do see climate change affecting their portfolios and justify their actions through economic/financial risk analysis. Too often for paradigm believers an unstated moral/political framework underlies those decisions and actions. A common strategy, less extreme than ANU’s, is to underweight exposure to fossil fuels and hedge the remaining exposure with overweights to alternative energy, perhaps augmented by actively encouraging portfolio companies to reduce their carbon emissions. A different strategy, one adopted by the Yale Endowment, is to ask the funds’ investment managers to “avoid companies that refuse to acknowledge the social and financial costs of climate change and fail to take economically sensible decisions to reduce greenhouse gas emissions.”

The approach taken by the ANU and some large Dutch pension funds is to totally divest from fossil fuels … now. From a long-term perspective that’s justifiable even within the narrow confines of the rational paradigm of maximising expected risk-adjusted returns, but it does expose the fund to the risk of significant shorter term underperformance. ANU did consider social, moral and perhaps political criteria which inflamed market fundamentalists – hence the yelps. Yet all decisions do and should have moral, social and political dimensions. Would those making value-free purely financial decisions have invested in gas chambers in 1941, a legal investment with spectacular prospective returns, or would even they find it too morally repugnant? Making trade-offs between the social and the economic, between the ‘soft’ and the ‘hard’, requires a wisdom and judgement untouched by universities’ narrow ‘value-free’ training. ANU’s public statements lacked that judgement. To declare that it won’t invest in anything that does ‘social harm’ is naïve and disingenuous. Will it divest from armaments and alcohol and from banks that lend to harmful activities? Will it divest from the sovereign bonds of all countries that do ‘social harm’? Harvard, one of the keepers of the value-free paradigm, argues for a clear separation between the financial and the social; it doesn’t wish to be a ‘political actor’ implying that the courses it teaches, the appointments it makes, the research it does, the consulting to corporations it undertakes and the advice its professors give to politicians are all value-free. How’s that for naïve and disingenuous?

Profits are a consequence not the aim

Those who see a nexus between the economic and the social, who reject the value-free belief as not just false but undesirable must confront Milton Friedman’s famous dictum that “the sole purpose of a company is to make (legal) profits.” His dictum is four-times wrong. It is technically wrong because directors are legally responsible for the entire company not just the equity holders. It is systemically dangerously wrong because the purpose of companies should be to produce goods and services people will pay for. Profits are a consequence not the aim. Once profit becomes the aim companies can readily justify the legal selling of NINJA loans to poor unemployed black men in Alabama, with the massive human and global consequences we’re still struggling with. It is wrong structurally because companies are social constructs so decisions will always be redolent with non-objective, extra-rational, value-laden non-economic influences and outcomes. Was decision-making at the University of Chicago really not like that? But Friedman’s grandest failure is that he is wrong socially: we expect more than mere legality from every other entity. We expect more than mere legality from our friends, relatives and colleagues; we expect more than mere legality from universities, pension funds and governments, from all entities that form our civil society. Do we want companies and funds to be the only entities excluded from our social norms?

The shrill yelpers see their oft-heard tag-line, ‘governments distort markets’ being threatened by the little-heard ‘markets distort society’ … and it should be threatened. Our world urgently needs alternative renewable sources of energy and alternative renewable sources of economic thinking.

 

Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.

5 Comments
Ramani
November 21, 2014

Those who take issue with those who take issue with fossil fuels (or racing, gambling, alcohol, killing animals, arms-production...) forget that collective investment vehicles (super, unit trusts etc) are run by people managing others' money as fiduciaries. Provided they do not abuse this (which of course the retail, industry and even corporate sectors routinely do, as has been documented ad nauseam) the decisions are for theirs to make.

Our system does allow fund choice and portability, so while remaining in the system, they can switch at will (subject to transaction costs). Like a prisoner given the choice of jails.

These antagonists would have objected from palm-leaving to printing to wordprocessing; walking to bullock carts to automobiles to trains to aviation; raw food to cooked, wood-fired to gas to micro ovens; leaches to anesthesia to keyhole surgery. Each step of human progress attracts inevitable rent-seekers who feel hard done by the next step. Like the inmates of a crowded train resenting new arrivals at the next stop, only to make common cause with them against the next batch of usurpers!

ANU is merely a messenger being a shot. Inexorable innovation entails, as its epiphenomenal collateral, the phasing out of existing industries and associated workers. If, in this process, some feel the pain of extraordinary rendition (a la the Gulf war), they should exult in the glow and glory of martyrdom. Amen.

Jerome Lander
November 21, 2014

Great article Jack. You are a clever guy. To be more effective, I suspect you might benefit from making your language less sophisticated so that you can be more effective at educating those of us who are less well educated (they will spend less energy interpreting your prose, and more energy focused on your impressive arguments!) It is the difference between winning a debate and making a lasting impact.

But really, great stuff. A company is a social construct, not an end in itself.

Adrian
November 18, 2014

There is an old adage that the first one to compare the other side to the Nazis loses the argument. Your reference to gas chambers was completely unnecessary.

jack gray
November 18, 2014

The adage may sound clever but it's irrelevant. Extreme examples expose weaknesses in supposedly true broad principles. They make those espousing the broad principle uncomfortable - hence the adage. It's a defence against having to examine the universality of a belief. (PS. The example is neither extreme nor hypothetical.)

Andrew Tyndale
November 14, 2014

Thank you, Dr Gray.
All investment decisions have social impact, whether we recognise it or not. Once realised, this can only lead reasonable investors to consider the social or environmental impact when making investment (or divestment) decisions.
If enough capital providers agree on moving capital away from one sector and towards another, the greatest global force known to man will be applied, with devastating effect on the rejected sector.
In Australia, the asset owners - you and me as retirement savers - have an unique opportunity to influence our superfund managers. Demanding a socially positive investment option (backed up by the threat of using portability to change managers) will see these options emerge quite quickly.

 

Leave a Comment:

     

RELATED ARTICLES

The switch is on as the EV revolution approaches

Ignore solar parity at your investing peril

Sin stocks, divestment and the right to choose

banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Among key trends in Australian banks, one factor stands out

The Big Four banks look similar but they are at fundamentally different stages as they move to simpler business models. Amid challenges from operating systems, loan growth and neobank threats, one factor stands tall.

Why mega-tech growth are the best ‘value’ stocks in the market

They are six of the greatest businesses ever and should form part of the global portfolios of all investors. The market sees risk in inflation and valuations but the companies are positioned for outstanding growth.

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

How to manage the run down in your income in retirement

The first of five articles on modern retirement income products that aim for an increasing pension that lasts for life and on average should not decline in real terms. They are not silver bullets but worth a look.

Latest Updates

Superannuation

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Superannuation

How retirees might find a retirement solution in future

Superannuation funds need to establish a framework that offers retirees a retirement income solution that lasts a lifetime. It will challenge trustees to find a way to engage that their members understand and trust.

Investment strategies

Dividend investors, your turn is coming

Dividend payments from listed companies, depended on by many in retirement, have lagged the rebound in share prices over the past year. Better times are ahead but sources of dividends will differ from previous years.

Investment strategies

Four tips to catch the next 10-bagger in early-stage growth

Small cap investors face less mature companies with zero profit that need significant capital for growth. Without years of financial data to rely on, investors must employ creative ways to value companies.

Investment strategies

Investing in Japan: ready for an Olympic revival?

All eyes are on Japan and the opportunity to win for competing athletes. After disappointing investors for many years, Japan is also in focus for its value, diversification and the safe haven status of its currency.

Fixed interest

Five lessons for bond investors from the Virgin collapse

The collapse of Virgin Australia not only hit shareholders, but their bond investors received between 9 and 13 cents in the $1. A widely-diversified portfolio can tolerate losses better than a concentrated one.

Investment strategies

The 60:40 portfolio ... if no longer appropriate, then what is?

The traditional 60/40 portfolio might deliver only 1.5% above inflation in future without diversification benefits. Knowing an asset’s attributes rather than arbitrary definitions is better for investors.

Retirement

Two factors that can transform retirement investing

Retirees want better returns but they have limited appetite to dial up their risk exposure in order to achieve it. Financial advice and protection strategies in portfolios can enhance investment outcomes.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.