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Sin stocks, divestment and the right to choose

The notion that superannuation funds and other fiduciary investors may choose to divest themselves of certain investments, typically stocks, on philosophical grounds is not a new one. But the debate surrounding divestment has grown louder in the past year or so, especially in Australia.

There are now several prominent examples of Australian funds, from super funds to university endowments, which have announced certain divestments, typically in fossil fuel companies.

Most recently, a lot of attention was given to the health industry fund HESTA divesting itself of Transfield shares on the grounds that the investment looked unsustainable in the light of the company’s apparent involvement in morally suspect practices at the detention centres it manages.

Last year, and more commonly around the world, a similar debate focused on divestment of fossil fuel stocks – a debate which continues to rage. Once again, fiduciary investors usually emphasise that a decision to divest is taken on the grounds of lack of sustainability.

Are trustees acting in the best (retirement) interests of members?

But super funds and other fiduciaries manage money on other people’s behalf, often people who have little or no say in how the money is to be directly managed. This places considerable pressure on the trustees and management of the funds to make sure they really are acting in the long-term interests of their investors.

In the case of super funds, there is the Sole Purpose Test which makes it clear all decisions of the fund have to be made with a view to providing (maximum) retirement benefits to members. With university endowments, the position is not as uniform as superannuation funds, although trustees are aware the purpose of endowment funds is in contributing to the long-term viability of the institution.

The Australian National University announced in October 2014 it would divest itself of $16 million worth of shares held in seven stocks involved in fossil fuels, creating quite a political storm, although it represented a tiny component of the $1.1 billion fund. Other stocks, such as BHP, Woodside Petroleum and Rio Tinto, were retained. The decision was modelled on that of Stanford University’s sustainability review, announced a few months earlier.

Both decisions followed considerable student body lobbying.

In an interesting note on another set of deliberations, which ended in a different course of action, the University of New South Wales, through the then Vice-Chancellor and President, Professor Fred Hilmer, said last October that the University Council met and resolved ‘overwhelmingly’ to maintain the current approach – to retain its existing investments in fossil fuel stocks.

After outlining the University’s concerns about greenhouse gas emissions and global warming, and its considerable research and other efforts relating to clean energy, he quoted the words of Drew Faust, President of Harvard:

“Conceiving of the endowment not as an economic resource, but as a tool to inject the University into the political process or as a lever to exert economic pressure for social purposes, can entail serious risks to the independence of the academic enterprise. The endowment is a resource, not an instrument to impel social or political change.”

A key element in the debate is how much, if any, short to medium-term financial damage a divestment program is going to cost the stakeholders. Professional fund managers assume there will be a cost.

New research both supports this view over the shorter term and also suggests divestments may be counterproductive over the longer term. The research paper, ‘The Unintended Consequences of Divestment’, by Shaun William Davies and Edward Dickersin Van Wesep from the University of Colorado, says there are two major flaws in the pro-divestment argument. First, any reduction in the target companies’ share price will benefit other ‘amoral’ investors who buy the initial dip and in any event the price discount will shrink over time. Second, executive stock options will work in the opposite direction. A higher return, after the granting of stock options, increasing their value, so executives would prefer the high returns that being subject to a divestment campaign would provide, according to the paper.

The belief sets in a co-mingled fund

Any investment programme should match the belief sets of the investor. In the case of big co-mingled funds, such as an industry super fund, the members need to be informed of the implications of investment policies so they can make an informed decision.

One industry fund which uses an aspect of its investment programme for marketing purposes is Cbus, the multi-employer fund for the building and construction industry. Cbus has for many years held overweight positions in direct property. Asset consultants, however, are critical of this because the fund is ‘doubling up’ the members’ risk. If the building industry goes into a slump then members’ returns would decline at precisely the time they may need extra money. But the members love the fact that their fund invests back into their industry. The policy attracts and helps retain members in a competitive world. The programme fits the beliefs.

All big super funds provide considerable investment choice for members within their fund and most – but not all – members can readily change funds if they so wish. This adds to the responsibility on trustees to provide adequate information about what is happening in their fund.

Default option is where debate is most relevant

It is the default component of the fund which is the most important for the purposes of this debate because it is usually the largest component and because it usually represents the least-engaged members.

To my mind, the smoking analogy is appropriate. People are entitled to exercise a right to smoke, without harming others, as long as they understand the risks. It may well be, in a similar vein, that divestments of fossil fuel stocks and other ‘sin’ stocks can damage your financial health. The choice should be the members’.


David Gallagher is the chief executive of the Centre for International Finance and Regulation (CIFR) and Professor in the UNSW Australia Business School.

Pablo Berrutti
November 12, 2015

I think the issue is more complex than the article suggests. The idea that environmental or social considerations can be separated from financial ones is incorrect, they influence each other in significant ways. The belief that using ethical or SRI strategies will result in under performance has been repeatedly disproved yet in persists.

The 'From Stock Holder to Stakeholder' report from Oxford University and Arabesque Partners, and the Responsible Investment Association of Australasia benchmark report are the two most recent examples which show this.

Superannuation is a long term investment over which time ESG issues like carbon constraints to avoid climate change will play out. A prudent fund should (and arguably must) take these factors into account when making investment decisions. Particularly when there is a well documented market failure and significant concern from credible bodies. See Minter Ellison, Baker McKenzie and the UK Law Commission for more on this.

For endowments, it is right to see it as a resource rather than a political tool, however if investments can be made which achieve the investment objective but do not conflict with the purpose of the institution surely that is a better option? In the case of ANU they actually avoided losses through their divestments.

These are far from purely 'moral decisions' which Trustees should leave to members (most of whom are in the default option anyway). The key to getting it right is ensuring that a trustee's 'values' don't override the members interests or what members would reasonably expect the trustee to do. These are difficult decisions that require an appropriate decision-making framework to reduce the risk of bias or group think. Despite their difficulty however they are decisions which should be properly assessed and made.


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