Investments in fossil fuels are not needed for the financial performance of pension funds. Divestment has no negative impact on yields. That is the conclusion from recent research by Auke Plantinga and Bert Scholtens from Groningen University in the Netherlands.
The fossil fuel divestment movement tries to increase awareness for divestment from fossil fuel producers as a means to combat climate change. Financial investors are increasingly showing interest in the non-financial impact of companies they invest in, i.e. responsible investing. However, they also want to be assured of sufficient returns and limited risks to support the living costs of their ultimate beneficiaries.
The authors investigated the impact of divestment and the transition of the energy system on investment performance. They find that the investment performance of portfolios that exclude fossil fuel production companies does not significantly differ in terms of risk and return from unrestricted portfolios.
Key policy insights of the research are
- Financing the exploration and exploitation of fossil fuel resources is increasingly being regarded as controversial, leading to divestment from this industry.
- Fossil fuel divestment does not seem to significantly harm financial investors and is not at odds with the fiduciary duty of institutional investors. This paves the way for more extensive initiatives to promote fossil fuel divestment.
- A smooth energy transition will most likely erode the profitability of fossil fuel firms and their ability to invest. Therefore, governments cannot rely on the fossil fuel industry to finance the energy transition.
From the perspective of national GHG reduction policies, findings provide room for stricter policies to promote fossil fuel divestment. Fossil fuel divesting does not conflict with the fiduciary duty of institutional investors, which might provide them with an argument to invest in fossil fuel stocks for the sake of financial returns and lower risk. It also paves the way for more extensive initiatives to promote fossil fuel divestment.
National governments may decide to support these without harming the financial interests of investors. This could be done by creating mandatory divestment policies for specific groups of investors, such as pension funds. This avoids the risk of stranded assets, which could threaten pensions in the future. Fossil fuel divesting is currently only done by a limited group of investors on a voluntary basis. While its effectiveness as a tool to curb GHG emissions has not been proven yet, it is most likely to become effective when supported by a substantial cohort of investors. The results from the study neutralize the arguments that fossil fuel divesting is detrimental for financial returns and that divestment would penalize, for instance, retirees, who depend on investment returns in funded pension schemes.
A second policy implication is that national governments should not count on the fossil fuel industry to finance the low carbon transition: in a smooth energy transition, fossil fuel companies will lose their profitability and ability to invest. While this should not be very surprising in itself, it also implies that fossil fuel companies are not very likely to finance the energy transition. Divesting from fossil fuel stocks will not be a substitute for national government climate policies. Therefore, national governments should be expected to play an active role in financing the energy transition, and should not be misguided by the optimism expressed by some oil companies as to their future role in alternative energy generation.