Attend enough faculty lounge cocktail parties or homeowner association Earth Day events and you're likely to encounter a strange term: "divestment." Also formerly known as "disinvestment," it's a fancy word for a simple concept: namely, urging investment pools (like pensions, university endowments, etc.) to shed themselves of stock ownership in companies unpopular with contemporary leftist sensibilities. While these efforts are couched in a kind of self-congratulatory ignorance only found among the country's elite and wannabe elite, it's actually ordinary taxpayers, workers, students, and seniors who end up paying the price for these fuzzy feelings of bourgeois superiority.
The cause of the day is against so-called "fossil fuel companies." Search the internet for the phenomenon, and you'll find dozens of half-baked calls for this pension fund or that university endowment to sell off their shares in "Big Oil." There are several problems with this from both a logical and a logistical perspective.
What's a "Big Oil" company? Is this limited to actual oil companies like Exxon-Mobil or Shell? Does it also include oil refiners? What about pipeline companies? Gas stations? What about businesses that depend on oil like airlines, automobiles, and even your pro-divestment neighbor's lawn mower manufacturer?
People don't know how investments work. In the mind of the divestment enthusiast, the solution is simple. The pension fund or university endowment should just sell all its shares of Big Oil Company, Inc. (once they figure out what that means--see above). The problem is that a very small percentage of assets under management are direct ownership in companies which meet even a broad definition of this term.
Take CALPERS, the giant California state government employee pension plan. As of this writing, they have about $300 billion in assets under management. Of that, fully half their funds are invested in things other than publicly traded stocks (i.e., bonds, private equity, real estate, cash, etc.).
The remaining half, the part that invests in publicly traded companies, is going to include direct ownership in companies (mostly tech companies in California, if their annual report is a guide). More likely, it will seek out diversification by investing in stock mutual funds and stock exchange-traded funds (ETFs). These latter instruments themselves contain hundreds of publicly traded companies--only a few of which could be considered "Big Oil." In order to divest, CALPERS would have to sell shares of mutual funds, effectively divesting from hundreds of companies in order to divest from a few.
It just isn't that easy mechanically to divest.
Divestment costs money. Another way in which people don't understand how investments work relates to transaction costs. Endowment and pension fund managers have to get paid money to do what they do. Researching what companies are "Big Oil," and then identifying which direct stock ownership and indirect mutual fund ownership the endowment or pension has in "Big Oil," and then reporting the recommendations for board review every year is costly. So are the commissions and fees of the divestment sales themselves. According to a new study from Arizona State University, these so-called "frictional costs" rob university endowments of 2 to 12 percent of assets over the very long run.
“This translates to a reduction in the value of the weighted average large endowment after 20 years of between $1.4 billion and $7.4 billion. The equivalent reduction in value for the weighted average medium endowment is between $52 million and $298 million, and the equivalent reduction in value for the weighted average small endowment is between $17 million and $89 million,” the study states.
Divestment lowers the rate of return on investment. Daniel Fischel, an economist formerly with the University of Chicago, ran a study comparing a portfolio containing energy-related stocks with a portfolio with no energy-related stocks. He found that over a 50 year window, the energy-included portfolio outperformed the energy-excluded one by 0.7 percent annually. For every $1,000,000 invested, that means $7000 less per year in annual growth. Over time, that can really add up.
I asked Chet Thompson, President of American Fuel and Petrochemical Manufacturers, about the effects of divestment on universities based on this study. “The divestment movement is symbolic in terms of its financial impact on the industry, but it comes at a steep price for schools and other institutions that chose that path," said Thompson. "While I appreciate that some university officials find themselves under pressure to respond to student body demands, I believe they have an obligation to consider the financial costs, as well as societal, in making that decision...Divestment isn’t good for universities, foundations, or even the environment. The very companies these groups wish to stigmatize have helped to raise billions of people out of poverty; and without their products, the world would be deprived of life saving medications and medical devices, and essentials from soaps and detergents to computers and cell phones.”
Divestment costs taxpayers. Proponents of divestment forget that the money lost due to hair-brained divestment political exercises has to be made up for elsewhere. In the case of government pensions, the source is clear--taxpayers. Any additional contributions to these plans resulting from the asset gap created by divestment has to be funded by state and local governments, meaning higher taxes.
It's also true with regard to public universities. All state college systems rely to one degree or another on government funding. If the endowment is not pulling its weight as much as it could due to divestment mania, pressure increases on taxpayers to kick in even more to the ivory tower. Separate and apart, students and researchers at universities suffer when divestment robs endowments of resources needed to fund scholarships and grants.
Private pensions, too, are not immune. Besides the workers and retirees who suffer, taxpayers are on the hook for failed pensions via the government-created Pension Benefit Guaranty Corporation (which is due for a massive taxpayer bailout). Finally, charitable trusts finding their returns under pressure from divestment will need to curtail their help for the poor, foisting even greater burdens on government welfare agencies and requiring even higher taxes than today.
CALSTRS Chief Investment Officer Chris Ailman summed it up best: "I’ve been involved in five divestments for our fund. All five of them we’ve lost money, and all five of them have not brought about social change."
More brie, anyone?
