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Yale’s Swensen: Consider Climate Change When Investing

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To divest (fossil fuels), or not to divest? That seems to be the question plaguing many educational endowments and other investment organizations in recent years.

Of course, the fossil fuel divestment debate would be remiss without talking about climate change.

A recent publication by CFA Institute titled “David Swensen on the Fossil Fuel Divestment Debate” – to be published in the May/June 2015 Financial Analysts Journal – examines the divestment question, with a specific focus on Swensen’s emphasis on companies that consider the effects of climate change. Swensen is Yale University’s chief investment officer and has run the university’s $23.9 billion endowment since 1985.

“Many educational endowments and other investment organizations are struggling with the question whether to comply with the widespread demands of students and other constituencies to divest their fossil fuel stocks,” writes Robert Litterman, executive editor of the Financial Analysts Journal and author of the paper.

Some have already announced divestments – such as Stanford University, who announced in May 2014 that it was moving away from coal in the investment context and also recommending to its external investment managers that they avoid investments in 100 public companies for which coal extraction is the primary business.

The divestment debate has since grown beyond the U.S. and universities.

“The divestment movement started in the United States but has since expanded to become a global platform,” writes Litterman.

In October 2014, the U.K.-based Glasgow University and the Australia National University announced decisions to divest some of their fossil fuel stocks.

In addition to university endowments, Litterman points out that some foundations (such as the Rockefeller Brothers Fund in September 2014) and pension funds (such as Australia’s Local Government Super in October 2014) have also announced decisions to divest fossil fuel stocks.

Most recently, the California State Teachers Retirement System, one of the largest educator-only pension funds with a portfolio valued at $190.8 billion, entered the debate and has started to discuss whether or not to divest holdings in thermal coal companies.

Although Yale University said that it would not divest its fossil fuel stocks, it did take a decided stance on climate change.

“The Investments Office bases its approach to global warming on the conclusion that greenhouse gas emissions pose a grave threat to human existence,” Swensen wrote in a letter to Yale’s external investment managers. “Climate change (caused by deforestation and emissions of carbon dioxide, methane and other gases) creates a substantial risk of significant changes to the world’s ecosystem and in actions to address those changes, making consideration of the impact of climate change essential when evaluating investment opportunities.”

Rather than divesting, Yale said it would emphasize companies that “take into account the effects of climate change and anticipate possible regulatory responses with actions that recognize the externalities produced by the combustion of fossil fuels,” according to a statement from Yale’s Corporation Committee on Investor Responsibility.

In his letter, Swensen asked of Yale’s external investment managers “that when making investment decisions on the University’s behalf, you assess the greenhouse gas footprint of prospective investments, the direct costs of the consequences of climate change on expected returns, and the costs of policies aimed at reducing greenhouse gas emissions on expected returns.” Simply put, he added, those investments with relatively small greenhouse gas footprints will be advantaged relative to those investments with relatively large greenhouse gas footprints.

A 2014 survey, “Climate action and profitability: CDP S&P 500 Climate Change Report 2014,” showed that S&P 500 firms that are actively preparing for climate change demonstrated an 18% higher return on equity and 50% lower volatility of earnings.

Swensen, in his letter, asked its external investment managers to talk with company managements about the financial risks of climate change and the financial implications of current and prospective government policies to reduce greenhouse gas emissions – and encourage them to mitigate financial risks and to increase financial returns by cutting emissions.

“Yale asks you to avoid companies that refuse to acknowledge the social and financial costs of climate change and that fail to take economically sensible steps to reduce greenhouse gas emissions,” he wrote.

One example of the financial risks of climate change: Last summer, Investment Advisor magazine reported on Farmers Insurance’s nine class-action lawsuits against dozens of municipalities around Chicago for “failing to prepare adequately for heavy rains and flooding caused by increasingly warmer temperatures — in short, by climate change.”

Swensen is quick to realize that analyzing the greenhouse gas emissions associated with investments is no easy task.

“As in all aspects of investment analysis, decisions will be based on incomplete, imperfect information,” he wrote in his letter. “That said, consideration of the risks associated with climate change should produce higher-quality portfolios.”

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