Considerations around fossil fuel divestment for endowments and foundations

Investments in the energy transition economy can help support sustainability goals for endowments and foundations interested in taking a less restrictive approach. To learn more about this topic, please read What portfolios may miss by divesting from fossil fuels by Fidelity's Sustainable Investing team.

What divest-and-exclude strategies focused on carbon-intensive companies overlook

There are many factors that nonprofits consider when constructing a portfolio, and the degree to which they should integrate sustainability is often debated by committee members. For endowments especially, they often consider views from their student stakeholders in their investment discussions. When posed with the topic of potentially divesting and excluding carbon-intensive companies and industries, it is worth considering that a divest-and-exclude approach to tackling portfolio carbon emissions is often skewed toward historical carbon emission data and may not be representative of the future emissions profile of the issuer.

We believe a divest-and-exclude approach is often narrowly focused on curtailing exposure to historical emitters by removing those companies from their opportunity set. Importantly, for actively managed funds, this approach may also remove potential return opportunities to invest in companies that may have historically been high emitters but are now proactively working on emission-reduction solutions. These innovations may represent small portions of the businesses of higher-emitting companies today, but many active investors believe these companies can provide attractive returns in the future as the transition to a lower carbon economy evolves. As a result, staying invested in large incumbents in thoughtful ways can be important for investors looking to generate transition-based returns.

Consider the impact on real-world emissions, not just portfolio emissions

Divesting or excluding carbon-intensive assets may have an impact on a portfolio's carbon footprint, but doing so will not necessarily have a real-world impact on global carbon emissions. Even after an institution divests, a carbon-intensive company will continue to operate for the benefit of its remaining shareholders. Investors can leverage research and engagement to determine if a company's transition plan presents financially material risks and/or opportunities to achieve long-term performance, while keeping an eye toward intended real-world outcomes.

Not all carbon-intensive companies are created equal

For actively managed strategies with constraints on tracking error, it is often limiting to exclude entire industries or segments of the market from the opportunity set. Rather than avoiding whole sectors altogether based on backward-looking emission data, taking a sector-relative approach allows investors to focus on best-in-class companies positioned to win while maintaining exposure to the industry. It allows managers' active risk budgets to be directed toward high-conviction investment ideas rather than sector or industry exclusions.

Conclusion

Taking a blanket divest-and-exclude approach to decarbonization may be a quick way to decarbonize a portfolio; however, we view divestment as a blunt tool that may have unintended consequences and limited real-world emission impact. In our view, active investing offers better ways to navigate in carbon-intensive sectors.

Please feel free to reach out to your Fidelity relationship manager if you would like to discuss sustainable investment options and associated trade-offs to consider in your nonprofit portfolio.