The Cost of Complete Divestment

The University of Massachusetts last week joined a growing number of endowments to announce divestment from fossil fuel.

The $770 million UMass Foundation said Wednesday it would dump all direct holdings in fossil fuel companies. The action followed similar steps by funds including the University of California, Georgetown, Stanford, and Oxford, which have all sold off direct investments in coal or oil sands companies.

“With this vote, the UMass Foundation adopts a divestment position that is among the most aggressive established for any major university—public or private—in the United States,” said Board of Trustees Chairman Victor Woolridge.

As “aggressive” as UMass’ stance may be, the divestment—like those of the University of California, Georgetown, Stanford, and Oxford—is limited in that it only includes direct holdings. But a complete divestment from fossil fuels—a ban extending to the holdings of hired asset managers as well as the endowment’s own direct investments—could prove too costly to carry out, according to Hendrik Bessembinder, finance professor at Arizona State University.

Regardless of the potential long-term impacts on returns from investing in or divesting from fossil fuels, any degree of divestment will by nature entail what Bessembinder termed “frictional” costs: transaction fees and monitoring expenses to ensure continued compliance with divestment goals.

To fully divest from fossil fuels, including exiting indirect investments through asset managers, could cost an endowment of UMass’ size between $52 million and $298 million in frictional expenses over the next 20 years, he said. For the Harvards of the world, it could cost as much as $7.4 billion.

“These frictional costs of divestment are large enough to impose substantial costs on institutions that decide to divest,” Bessembinder argued.

While Bessembinder’s study was commissioned and financed by the Independent Petroleum Association of America—an organization unlikely to endorse fossil fuel divestment any time soon—many endowments have cited transaction and monitoring expenses as a barrier to a real divestment.

Williams College, American University, Middlebury College, Bates College, and Swarthmore College have decided against divestment due to the frictional costs a move of that nature would incur. While all five endowments acknowledged the importance of addressing climate change, they said divestment from fossil fuels was simply too expensive an approach.

“Given its fiduciary responsibilities, the board cannot look past… the difficulty and material cost of withdrawing from a complex portfolio of investments,” said former Middlebury College President Ronald Liebowitz in a 2013 statement.

The board of trustees and president of Williams College, meanwhile, called divestment a “largely symbolic strategy” with “concrete and enormous” costs.

Instead of divesting, these endowments committed to following environmental, social, and governance (ESG) principles and promised to make new investments in clean energy.

Their philosophy on how to best address climate change, as summed up by Williams College: “We will invest, not divest.”

Related: Divestment as Abdication