Divesting Is ‘Counterproductive,’ New Research Says

Tilting a portfolio away from carbon emitters just continues the cycle of pollution.

Chris Ratcliffe/Bloomberg

Chris Ratcliffe/Bloomberg

In the divestment versus engagement debate, climate-conscious institutional investors have generally tried for the last decade to “tilt” their portfolios away from heavy carbon emitters and toward companies with lower carbon footprints. But tilting may not be enough.

According to a paper entitled “Decarbonizing Institutional Investor Portfolios,” by Vaska Atta-Darkua, a research associate at the University of Virginia’s Darden School of Business; Simon Glossner, an economist at the Board of Governors at the Federal Reserve; Philipp Krueger, an associate professor of responsible finance at the University of Geneva; and Pedro Matos, a professor of Business Administration at UVA, avoiding high carbon-emitting companies may just shift the onus of mitigating climate impact onto the next buyer.

The authors analyzed the portfolio decarbonization strategies of “climate conscious” institutional investors, defined as investors who were involved with the CDP (formerly the Carbon Disclosure Project), the first large-scale climate investor initiative. On average, institutional investors who signed the CDP had stock portfolios that featured smaller carbon footprints than others. Using data on global institutional equity holdings from FactSet Ownership, the authors found that CDP signatories held stocks of companies that had lower average and intensive carbon emissions than their non-CDP institutional investor counterparts. CDP investors also decarbonized their portfolios — across multiple carbon metrics — at a faster rate than those who did not sign on to the project.

Within the group of CDP investors, the authors tested the two primary approaches — portfolio tilting or targeted engagement — to portfolio decarbonization. Portfolio tilting occurs when institutional investors reduce their stakes in high carbon emitters and rebalance their portfolio toward lower emitters. Engagement occurs when investors buy a stake in a “brown” firm — a high carbon emitter — and work with other stakeholders to lower the company’s emissions. For example, in 2021, Engine No. 1 launched an activist campaign against Exxon Mobil that was largely designed to correct Exxon’s general apathy toward climate risk. By May, the small firm had elected three Engine No. 1 directors to Exxon Mobil’s board.

In the context of the study, the tilting method was responsible for the majority of CDP investors’ smaller carbon footprints when compared to non-CDP investors. According to the paper, this was particularly true of European CDP investors, most likely due to the fact that lowering emissions is a “more salient issue” in Europe, especially after the introduction of carbon pricing in the European Union.

However, while tilting away from high emitters and toward low carbon emitters may reduce the overall emissions of climate conscious institutional portfolios, the pollution doesn’t go away. Instead, it goes into the hands of other, potentially less environmentally responsible investors. Consequently, argue Alta Darkua, Glossner, Krueger, and Matos, investor-led initiatives to divest from brown firms are flawed.

“In a way, this is a little bit counterproductive,” Matos told Institutional Investor. “By selling [brown firms], someone else is buying on the other side.” Those buyers could potentially be less concerned with reducing the portfolio company’s carbon emissions than the seller, thus perpetuating the cycle of pollution. In a way, Matos said, “climate conscious” institutional investors are simply passing the problem onto someone else.

“Overall, our paper [makes the case] that addressing the steep challenge posed by climate change and energy transition requires more than portfolio tilts,” the authors wrote.