Stop Politicizing Investments

Stop Politicizing Investments

The University of California Board of Regents just announced that “the endowment, the pension and all of our working capital pools are fossil-free at the University of California”. The Regents justify the divestment based on their belief that “continuing to hold fossil fuel assets poses too great a financial risk.”

Instead of an achievement, these actions actually raise important questions. The divestment decision is couched as being financially responsible, but the Regents decided to divest from fossil fuels more than five years ago in response to student protests. Further, if not owning stocks of fossil fuel companies were purely a financial decision, then no divestment policy is needed. The investment managers could simply sell all of the relevant holdings. By definition of creating a divestment policy, the UC system has established a politically motivated investment policy.

Politicizing the university’s investments creates unnecessary risks to the university’s pensions and endowment without achieving the political goals of its advocates. The political goals cannot be met because if fossil fuels are a sound investment, then divesting for political reasons simply create an investment opportunity for other investors. There will be no long-lasting financial consequences from politically inspired divestments.

From a financial perspective, it is important to recognize that since the Regents decided to divest from fossil fuels five years ago, energy firms’ stock price have underperformed the broader market. This means that, financially, selling the stocks years ago made sense.

However, having underperformed for so many years, perhaps there is a reason to own some of these stocks today, and the more recent divestments may not be as financially savvy as it may currently seem.

First, there is the issue of the dividend yield of these stocks. The dividend yield is, essentially, interest income that a stock investor receives. As of June 3rd, Exxon’s dividend yield was 7.1 percent – so for every $100 in Exxon stock someone holds, they will earn $7 in dividends. Chevron’s dividend yield is 5.3 percent.

Compared to the current interest rate on a 10-year Treasury bond, which is 0.8 percent, buying these energy companies could make a lot of sense for some investors. Particularly, conservative investors or investors near retirement age who believe that the global economy will continue to demand fossil fuels for years to come. Investors who meet this criterion will value the ability to earn $7 in dividend income (per $100 invested) rather than a mere 80-cents they would receive from owning Treasury bonds.

Second, according to the World Energy Outlook 2019 growth in global production of oil and natural gas will continue. Once the current supply glut has dissipated, this expected growth in production coupled with the recent stock price declines could become a large positive for energy stocks. If this is the case, then financially the UC funds will have sold some of their energy holdings during the industry’s 15-year low.

This positive scenario is not a sure thing, of course. The future is unknown and perhaps fossil fuel production will decline, not rise as the IEA expects. But, the possibility of future growth demonstrates that divesting from energy is not a one-sided proposition for the current and future retirees.

There is also the question of the alternative energy investments the UC system is using to replace their fossil fuel investments. In its June 3rd letter announcing the full divestment, the Regents state that “the University will continue to diversify its energy holdings by investing in sustainable, and scalable, clean energy projects beyond the $1.036 billion that represents the culmination of its five-year goal. We believe there are more attractive investment opportunities in new energy sources than in old fossil fuels.”

Again, maybe this is true, but maybe it isn’t. The future is unknown, and by definition of investing, the university funds are taking risks on behalf of investors, even the investments in the “new energy sources” of the future. Efficiently managing these risks, and the tradeoff between risk and return, is the most important social responsibility of the fund managers.

While the decision to own alternative energy stocks rather than fossil fuel stocks is an investment decision, prohibiting investments in fossil fuel companies is a political one. Investment policies based on political interests creates unnecessary risks for the current faculty and staff, as well as the university endowments that could help improve the viability of the UC system in the future.

Dr. Wayne Winegarden is a senior fellow in business and economics at the Pacific Research Institute.  He is the author of the PRI study, “Environmental, Social, and Governance (ESG) Investing:  A Review of the Evidence.”

Subscribe to our newsletter:

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.