Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 88

Divesting from fossil fuels and from rational economics

John D Rockefeller turned in his grave when the news drifted down to Hades that the Rockefeller Brothers Fund was divesting from fossil fuel companies … even from John D’s once very own Exxon.

The shrill yelps that greeted ANU Endowment’s similar decision confirm that others too feel threatened. The decision was likely arrived at through the confluence of economic/financial and moral/political criteria. On the economic side ANU’s view seems to be that fossil fuel companies are becoming dangerously risky as the world acts on climate change through the development of alternative sources of energy, actions that will leave their assets stranded. On the moral/political side its view seems to be that burning fossil fuels is wrong because of the damage it does to society. Therein lie the dual threats. On one hand, the (supposedly flawed) economic analysis threatens the industry as it is currently structured while on the other hand the very use of moral/political analysis threatens economics as it is currently structured. To use other than ‘pure’ economic/financial criteria is an affront to the dominant paradigm that economics is a Value-Free, Objective Science and that, as a consequence, free markets produce optimal economic outcomes. Hence free markets are sacrosanct.

According to that paradigm the market is always right and its righteous power ensures fossil fuels are correctly priced given the risks involved. Correctness is attained through the objective actions of rational corporate decision-makers responding to price signals who drive their fossil fuel companies to adapt to the changing world. For the paradigm’s true believers, that most companies have made but token, PR-driven changes typified by BP colouring its bowsers green, confirms the incorrectness of ANU’s decision. For them, taking any investment action on climate change is likely to be ‘sub-optimal’ as even if markets don’t instantly set the right price (a possibility they admit to sotto voce) doing nothing remains optimal over the shorter-term until pricing signals become clearer.

Investors do see climate change affecting portfolios

But waiting for greater clarity, waiting until the assets are exposed to a ‘clear and present danger’ of being stranded or until pricing is almost certainly correct is surely ‘sub-optimal’ risk-management. Increasingly institutional investors do see climate change affecting their portfolios and justify their actions through economic/financial risk analysis. Too often for paradigm believers an unstated moral/political framework underlies those decisions and actions. A common strategy, less extreme than ANU’s, is to underweight exposure to fossil fuels and hedge the remaining exposure with overweights to alternative energy, perhaps augmented by actively encouraging portfolio companies to reduce their carbon emissions. A different strategy, one adopted by the Yale Endowment, is to ask the funds’ investment managers to “avoid companies that refuse to acknowledge the social and financial costs of climate change and fail to take economically sensible decisions to reduce greenhouse gas emissions.”

The approach taken by the ANU and some large Dutch pension funds is to totally divest from fossil fuels … now. From a long-term perspective that’s justifiable even within the narrow confines of the rational paradigm of maximising expected risk-adjusted returns, but it does expose the fund to the risk of significant shorter term underperformance. ANU did consider social, moral and perhaps political criteria which inflamed market fundamentalists – hence the yelps. Yet all decisions do and should have moral, social and political dimensions. Would those making value-free purely financial decisions have invested in gas chambers in 1941, a legal investment with spectacular prospective returns, or would even they find it too morally repugnant? Making trade-offs between the social and the economic, between the ‘soft’ and the ‘hard’, requires a wisdom and judgement untouched by universities’ narrow ‘value-free’ training. ANU’s public statements lacked that judgement. To declare that it won’t invest in anything that does ‘social harm’ is naïve and disingenuous. Will it divest from armaments and alcohol and from banks that lend to harmful activities? Will it divest from the sovereign bonds of all countries that do ‘social harm’? Harvard, one of the keepers of the value-free paradigm, argues for a clear separation between the financial and the social; it doesn’t wish to be a ‘political actor’ implying that the courses it teaches, the appointments it makes, the research it does, the consulting to corporations it undertakes and the advice its professors give to politicians are all value-free. How’s that for naïve and disingenuous?

Profits are a consequence not the aim

Those who see a nexus between the economic and the social, who reject the value-free belief as not just false but undesirable must confront Milton Friedman’s famous dictum that “the sole purpose of a company is to make (legal) profits.” His dictum is four-times wrong. It is technically wrong because directors are legally responsible for the entire company not just the equity holders. It is systemically dangerously wrong because the purpose of companies should be to produce goods and services people will pay for. Profits are a consequence not the aim. Once profit becomes the aim companies can readily justify the legal selling of NINJA loans to poor unemployed black men in Alabama, with the massive human and global consequences we’re still struggling with. It is wrong structurally because companies are social constructs so decisions will always be redolent with non-objective, extra-rational, value-laden non-economic influences and outcomes. Was decision-making at the University of Chicago really not like that? But Friedman’s grandest failure is that he is wrong socially: we expect more than mere legality from every other entity. We expect more than mere legality from our friends, relatives and colleagues; we expect more than mere legality from universities, pension funds and governments, from all entities that form our civil society. Do we want companies and funds to be the only entities excluded from our social norms?

The shrill yelpers see their oft-heard tag-line, ‘governments distort markets’ being threatened by the little-heard ‘markets distort society’ … and it should be threatened. Our world urgently needs alternative renewable sources of energy and alternative renewable sources of economic thinking.

 

Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.

5 Comments
Ramani
November 21, 2014

Those who take issue with those who take issue with fossil fuels (or racing, gambling, alcohol, killing animals, arms-production...) forget that collective investment vehicles (super, unit trusts etc) are run by people managing others' money as fiduciaries. Provided they do not abuse this (which of course the retail, industry and even corporate sectors routinely do, as has been documented ad nauseam) the decisions are for theirs to make.

Our system does allow fund choice and portability, so while remaining in the system, they can switch at will (subject to transaction costs). Like a prisoner given the choice of jails.

These antagonists would have objected from palm-leaving to printing to wordprocessing; walking to bullock carts to automobiles to trains to aviation; raw food to cooked, wood-fired to gas to micro ovens; leaches to anesthesia to keyhole surgery. Each step of human progress attracts inevitable rent-seekers who feel hard done by the next step. Like the inmates of a crowded train resenting new arrivals at the next stop, only to make common cause with them against the next batch of usurpers!

ANU is merely a messenger being a shot. Inexorable innovation entails, as its epiphenomenal collateral, the phasing out of existing industries and associated workers. If, in this process, some feel the pain of extraordinary rendition (a la the Gulf war), they should exult in the glow and glory of martyrdom. Amen.

Jerome Lander
November 21, 2014

Great article Jack. You are a clever guy. To be more effective, I suspect you might benefit from making your language less sophisticated so that you can be more effective at educating those of us who are less well educated (they will spend less energy interpreting your prose, and more energy focused on your impressive arguments!) It is the difference between winning a debate and making a lasting impact.

But really, great stuff. A company is a social construct, not an end in itself.

Adrian
November 17, 2014

There is an old adage that the first one to compare the other side to the Nazis loses the argument. Your reference to gas chambers was completely unnecessary.

jack gray
November 17, 2014

The adage may sound clever but it's irrelevant. Extreme examples expose weaknesses in supposedly true broad principles. They make those espousing the broad principle uncomfortable - hence the adage. It's a defence against having to examine the universality of a belief. (PS. The example is neither extreme nor hypothetical.)

Andrew Tyndale
November 14, 2014

Thank you, Dr Gray.
All investment decisions have social impact, whether we recognise it or not. Once realised, this can only lead reasonable investors to consider the social or environmental impact when making investment (or divestment) decisions.
If enough capital providers agree on moving capital away from one sector and towards another, the greatest global force known to man will be applied, with devastating effect on the rejected sector.
In Australia, the asset owners - you and me as retirement savers - have an unique opportunity to influence our superfund managers. Demanding a socially positive investment option (backed up by the threat of using portability to change managers) will see these options emerge quite quickly.

 

Leave a Comment:

RELATED ARTICLES

Uranium and the fear of running out

Is the fossil fuel narrative simply too convenient?

Beyond the acronym, navigating important ESG choices

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Retirement

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Shares

On the virtue of owning wonderful businesses like CBA

The US market has pummelled Australia's over the past 16 years and for good reason: it has some incredible businesses. Australia does too, but if you want to enjoy US-type returns, you need to know where to look.

Investment strategies

Why bank hybrids are being priced at a premium

As long as the banks have no desire to pay up for term deposit funding - which looks likely for a while yet - investors will continue to pay a premium for the higher yielding, but riskier hybrid instrument.

Investment strategies

The Magnificent Seven's dominance poses ever-growing risks

The rise of the Magnificent Seven and their large weighting in US indices has led to debate about concentration risk in markets. Whatever your view, the crowding into these stocks poses several challenges for global investors.

Strategy

Wealth is more than a number

Money can bolster our joy in real ways. However, if we relentlessly chase wealth at the expense of other facets of well-being, history and science both teach us that it will lead to a hollowing out of life.

The copper bull market may have years to run

The copper market is barrelling towards a significant deficit and price surge over the next few decades that investors should not discount when looking at the potential for artificial intelligence and renewable energy.

Property

Global REITs are on sale

Global REITs have been out of favour for some time. While office remains a concern, the rest of the sector is in good shape and offers compelling value, with many REITs trading below underlying asset replacement costs.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.