This summer, the San Francisco Employees’ Retirement System board is expected to consider a limited fossil fuel divestment proposal. However, the available evidence shows that divestment is not only a costly investment decision for funds to pursue, but also carries no tangible impact on targeted companies or the environment.
In a report released earlier this year, Compass Lexecon specifically examined how divestment would impact SFERS (among other major pension funds). Our study found that divesting from oil, natural gas and coal securities would cost SFERS $11.5 million annually. Over 50 years, that equals a $149 billion loss. If divestment were expanded to include utilities, the losses would grow to $15.7 million annually and $201 billion over 50 years.
In our study, we measured losses caused by reduced portfolio diversification — a key principle of investing that all advisors recognize as critical to increasing returns and managing portfolio risk. Despite the rhetoric of divestment advocates, the reality is that the energy sector has the lowest correlation with all other majority industry sectors in the U.S. equity markets and, as a consequence, the largest potential diversification benefit. Removing this sector of the economy from a pension fund’s portfolio reduces this benefit, either limiting potential returns or increasing portfolio risk (or both).
The lost diversification costs alone mean a loss of $11.5 million annually for the 59,000 active and retired employees that rely on SFERS. We also performed the same analysis for CalPERS, the nation’s largest pension fund. For the 1.6 million California public employees, retirees and their families who rely on CalPERS, this loss translates to a shortfall of $210 million to $289 million annually, and up to $2.3 trillion to $3.1 trillion over the next 50 years.
In fact, divestment also imposes additional costs, such as transaction fees, commissions and compliance costs, that are unavoidable when buying and selling securities. For instance, selling fossil fuel stocks and buying replacement stocks will result in transaction costs, and compliance costs associated with maintaining a pension fund’s adherence to divestment goals will, in most cases, impose higher management costs, thereby reducing the returns of the fund. As a result of these additional costs, total losses due to divestment are likely to be even higher than reported in our study.
Fossil fuel divestment isn’t just costly; it’s ineffective. There is no evidence that divestment has any tangible impact on the companies targeted and, therefore, no evidence of any environmental or climate benefit. Giving up shares in a fossil fuel company merely makes them available for others in the market to purchase, having no impact on a company’s bottom line. Instead, fossil fuel divestment is a symbolic endeavor. This is acceptable for an individual investor, but public pension funds must consider their larger obligations to provide returns to pensioners before making such a decision.
The upcoming vote on limited divestment at SFERS comes at a time when San Francisco’s retirement fund is already expected to have a $119 million deficit in the next fiscal year. To make up for these shortfalls, our report finds that institutions like SFERS would be forced to either cut payments to pensioners or find another funding source, such as a taxpayer bailout — a risky approach given the state’s precarious financial position.
Some advocates, recognizing the costs and fruitlessness of divestment, propose instead a smaller scale divestment focused only on thermal coal. With a smaller divestment, the costs will naturally be smaller given the limited exposure to these securities by the fund at this time. But there are still costs, and at the same time, no evidence of any benefits. Cutting off less of your nose to spite your face is better that cutting off more, but that doesn’t make it a good idea.
The SFERS board continues to delay the vote on divestment, and hopefully this extra time will be used to research the facts. SFERS may very well find that the symbolic value of supporting divestment is a worthy cause. But it’s important to have an informed conversation that provides information on how much a symbolic cause will actually cost the retirees the fund is in place to support.
Christopher Fiore is vice president at the economic consulting firm Compass Lexecon. Todd Kendall is executive vice president at Compass Lexecon.