How to Weigh the Future

Would you be willing to pay about $13,000 more a year in tuition to go to a college that doesn’t invest in fossil fuels?

That’s the amount of revenue – a total of about $204 million over 10 years -- that Swarthmore College administrators recently estimated the college would forgo in endowment returns if the college’s governing board decided to divest from fossil fuels.

“There is no way in advance to predict the cost of something,” said Suzanne P. Welsh, vice president for finance and treasurer at Swarthmore. “But as the board looks at this, there is a reasonable case that can be made that there would be a significant cost that the board should take into account.”

Swarthmore, like many higher education institutions, has been under pressure for the past few years from a variety of student, faculty and outside groups to divest from companies that extract and burn fossil fuels. Those activists, pointing to the perceived success of a 1980s divestment movement that many say helped end South African apartheid, say divestment could be an effective tool to get companies and the government to address issues of climate change.

That pressure has ramped up in recent months, with groups targeting institutions with some of the largest endowments. And with few signs that national policy regarding fossil fuels will change in the near future, the debate is likely to be a continued point of contention on college campuses into the next year.

Part of the reason why the debate has such staying power is that it is almost impossible to know the true costs and benefits of an action like divestment. There are few historical case studies that can be examined, and those that do exist might not be applicable to the current situation. Estimating the cost would require predicting investment returns, and, as investors often say, “past performance is no guarantee of future success.”

Proponents of divestment argue that the costs would be negligible and that action in that direction could have a profound impact on the national debate. Opponents say institutions that divest would see a hit to their bottom lines while having little or no economic impact on the divested companies. Neither side can marshal much compelling evidence to prove the other wrong.

Several college administrators have argued that the costs of divestment would be large, but Swarthmore’s estimate, part of a presentation administrators were scheduled to deliver at a May 9 board meeting, is one of the first attempts to put to paper what a college thinks it would lose by divesting.

What’s Costing So Much?

The bulk of Swarthmore’s estimated losses would not come from screening out fossil fuel companies directly. Such investments do not make up a large portion of the university’s portfolio and could likely be replaced by other investments with similar predicted returns. Instead, administrators argue that a divestment screen of any kind would require the college to fundamentally change how it manages its endowment.

At the moment, the university invests in a range of asset classes -- domestic and international equity, alternative assets, private equity, real estate, and bonds and cash -- all of which carry different levels of risk and return. Within these asset classes, the college’s investment committee picks outside investment managers who employ diverse strategies. (Some institutions -- particularly the wealthiest -- also invest directly instead of going through investment managers. Swarthmore does not do that.)

“The success of the college’s investment strategy depends on having a diversified mix of investments and hiring the best investment firms to manage specific portfolios of investments,” the report states.

In general, investment managers can employ one of two tactics: they can either attempt to mimic the market using index funds, a strategy called “passive management,” or take a more active approach and put together customized portfolios that attempt to outperform the market. These active portfolios can either be customized for an institution, an approach that often comes with a high fee, or combine a bunch of investors’ money into a commingled fund.

Swarthmore does not use index funds, believing that it will see a higher return by trying to beat the market. Some of its money is in separately managed portfolios of just Swarthmore money and some of it is in commingled funds. About $660 million of the university’s $1.5 billion endowment is tied up in commingled funds that possibly include fossil fuels, according to the report.

Through active management, the college’s domestic and international equity portfolios have outperformed indexes by 1.8 percent and 1.7 percent, respectively, over the past 10 years, according to the report.

The Swarthmore report argues that divestment would essentially require the college to shift the money it currently places in actively managed commingled funds to passive index funds, which saw lower returns over the past 10 years, and administrators believe they will have lower returns in the long run. Administrators say there are few options of actively managed – yet screened – commingled funds.

If the college switched to separately managed funds of just Swarthmore money, it would likely have to pay higher fees, which would also limit returns.

Swarthmore administrators also said that a fossil fuel screen would make it so the college could not replicate the diversity of the current portfolio. “Because there are so few funds that are actively managed and screen out fossil fuels, it would be hard to replicate diversification that we currently have in the portfolio,” Welsh said. “We would likely have to replace them with index funds, and to do that we would have to give up performance.”

Swarthmore's Asset Allocation
Asset Category	Target Allocation	Value (6/30/2012)	Composition	Could Include Fossil Fuels?
Domestic Equity	20%	$288 million	Separate portfolios and commingled funds	Yes
International Equity	20%	$285 million	All commingled funds	Yes
Alternative Assets	21%	$283 million	All commingled funds	Yes
Private Equity	17%	$342 million	All commingled funds	No
Real Estate	7%	$68 million	All commingled funds	No
Bonds/Cash	15%	$234 million	Bonds and cash	No

Not Applicable for Everybody

Welsh said Swarthmore’s analysis likely isn’t relevant to the majority of colleges and universities. The college’s endowment is one of the country’s 50 largest. Its investment strategy, portfolio mix and reliance on outside investment managers are likely different from those of other institutions.

The half-dozen colleges -- including Green Mountain College, which announced earlier this week that it would divest from fossil fuels – that have divested from fossil fuels or added additional screens to their investment policies all have relatively small endowments, often less than $10 million. They rely less on their endowments for funding operations, which makes divestment a less risky proposition.

Swarthmore, on the other hand, finances about half its operating budget through investment returns.

Most of the divested institutions also lack the funding to buy into the better actively managed funds, meaning they are more likely to take a more passive approach to managing their investments, often placing them in index funds.  

Too Many Assumptions

Investment managers that specialize in socially responsible investing say the Swarthmore paper – like other studies that have tried to estimate the cost of divestment – makes too many assumptions about the nature of the market and tend to overestimate the cost.

“My view of the Swarthmore paper is that it’s asking, ‘What’s the worst possible case of what it’s going to cost to divest?’ " said Christine Jantz, an investment analyst with NorthStar Asset Management, a socially responsible investment management firm based in Boston.

Jantz and Julie Goodridge, NorthStar’s founder and CEO, said there’s no reason to believe that divesting from fossil fuels would require that Swarthmore shift away from active management to index funds. They said there’s a good chance that some of the college’s current investment managers don’t have money in the sector and that there are a range of investment management firms that actively manage portfolios while making consideration about social causes.

“People have been doing this since the South African divestment movement,” Goodridge said. “There are a number of individual managers who specialize in it, who are quite skilled at social investing. It has been 25, 30 years since this became its own industry.”

Jantz and Goodridge also said the college – especially if joined by other institutions concerned about fossil fuel use – could likely ask investment managers to change their practice slightly. “Active managers would not care to lose this money,” Jantz said. “You’ve got to assume that they would be willing to try to work with them around concerns if they would ask.”

Swarthmore students advocating for divestment say they don’t buy the college’s logic. “I believe that there are options other than index funds,” said Patrick Walsh, a Swarthmore junior who is part of Mountain Justice, one of the student groups advocating divestment. “There exist separately managed funds that screen for the fossil fuel industry, and there do exist socially responsible investments, so we believe there are more options than the administration is presenting here.”

Jantz and Goodridge also took aim at a paper by Timothy Adler and Mark Kritzman at Windham Capital Management that has been widely cited during the debate about divestment, saying its assumptions about what percent of the market colleges would have to divest from, the size of a portfolio and the expected return of the energy sector over the next few years are all too high, meaning the cost they estimate, a decrease in returns of about 0.4 percent, would be even smaller.

Unpredictable Benefits

But even with various estimates of potential costs, the calculation about whether or not a given higher education institution should divest from fossil fuel use is still almost as murky because the benefits of doing so are so unclear.

Studies of the South African divestment movement suggest that the actual economic impact of divestment was minimal, but that the movement raised significant awareness of the issue in the public consciousness.  

It is unclear if colleges and universities divesting from fossil fuel companies would have the same political impact, particularly given political polarization around the issue.

Welsh, the Swarthmore treasurer, said there are reasons to believe that the college would be more effective addressing climate change through other avenues.

“If Swarthmore were to divest, it could not participate in shareholder activism efforts, many of which have resulted in tangible progress,” the Swarthmore report states. “If engaged shareholders were replaced by shareholders without conscience on these issues, it would not deprive companies of capital, but would rather make it easier for them to maintain the status quo.”

For some, the numbers about cost aren’t particularly relevant. Activists say that if some estimates about the human and economic cost of climate change are to be believed, $200 million – or even $200 billion – would be a small price to pay for averting it. “Climate change is one of the largest moral and ethical problems we are going to face in the next century,” Walsh, the Swarthmore student, said.