To divest, or not to divest? That is the question

by Fran Lopez de Saa, Russell Investments

Executive summary:

• We believe that avoiding whole sectors or business models introduces portfolio risk and should be done only with careful consideration and a strategic, holistic plan.
• We believe that active ownership—whether through engagement or proxy voting—is typically a better approach to influencing corporate behavior.
• When engagement falls short, we believe a clear and robust escalation strategy is vital to addressing investor concerns.

The debate

When you have a stock that does not align with your values or investment beliefs, divestment seems to be a straightforward decision that follows common sense. However, it can be argued that this approach only makes sense on paper, and that a systemic divestment approach could have a potential negative impact on your portfolio and your good intentions. Let’s explore why.

The concerns

One of the main arguments against divestment is that exiting controversial stocks simply makes them somebody else’s problem. In other words, selling your shares in a company will have no impact on reducing environmental or societal damage. James Alexander, Chief Executive of the UK Sustainable Investment and Finance Association (UKSIF) summarized divesting as: “You’re just throwing trash across the fence.”

Once you make a decision to sell your stake, you lose your rights and voice as a shareholder. Furthermore, unless you are a large or vocal shareholder, your sale is likely to go unnoticed. Another key point to consider is that divestment may come at a cost, meaning lost returns. Companies that are under pressure due to controversial activity can adopt strategies to mitigate or adapt, recovering their value. When shareholders divest from contentious companies, they lose the potential investment benefit. Avoiding whole sectors or business models introduces portfolio risk and should be done only with careful consideration and a strategic, holistic plan.

The alternative

Active ownership offers an alternate course of action. Through stewardship activities, shareholders can leverage their power to influence corporate behavior. This can be done through engagement and proxy voting. Over the last decade, engagement has become common practice among institutional investors and involves undertaking a series of meaningful communications with corporate leaders to understand and question current practices and to encourage positive change. Proxy voting is also seen as a powerful stewardship tool, whereby shareholders have the opportunity to express their approval/disapproval on certain practices, and it is available to all shareholders, small and large alike.

Divestment can be perceived as a rather aggressive and simplistic approach to addressing shareholder concerns, and it is often applied without meaningful consideration of the differences among firms within the same sector. For example, a common target for divestment is companies involved in energy production. Energy transition is a complex issue that is difficult to adequately address through black and white levers like divestment. Let’s take the common exclusion of thermal coal to dig deeper: Production of power from coal, which is the highest emitting feedstock in terms of emissions per unit of heat, is not a simple dichotomy as one may expect. Decommissioning existing coal infrastructure in developing countries can jeopardize access to electricity for populations that have only just been connected to the grid. So, there are social costs to consider. Companies involved in coal power production today are also in many cases the same utilities supplying renewable power. Their power mix takes time to transition, and excluding companies involved in one type of generation without consideration of their total power mix inevitably leads to reducing exposure to companies who will play a key role in powering the economy. This requires careful calibration of exclusion criteria and a willingness to engage in the nuance of complex topics.

By engaging with companies, shareholders and stakeholders can exert influence on corporate decision-making processes from within. Ultimately, when you initiate an engagement with an issuer, the main objective is to promote good practices on material issues that may protect and enhance long-term sustainable value creation. An example of successful engagement is the outcome at the Italy-based integrated operator in the global power, gas, and renewables markets Enel SpA, which aligned their practices and disclosures with the Climate Action 100+ Net Zero Company Benchmark in 2022 following engagement with CA100+members.¹ The benchmark defines key indicators of success for business alignment with a net-zero emissions future and the goals of the Paris Agreement. Year on year, the company has shown significant progress, including on the acceleration of its coal-phase out timelines, adoption of emissions reduction targets aligned with a 1.5 ºC scenario across all material emissions, reviewing its trade association memberships alignment with the goals of the Paris Agreement, and enhancing climate-related financial disclosures. This proves that collaborative engagement is a powerful tool to enable progress towards real world decarbonization and to protect the long-term health of our planet.

A combined strategy

Whether investors should divest or engage is a debate that continues among investors and across the financial industry. A high-profile recent example comes from the U.S. market, where a California bill that requires public asset owners to divest from fossil fuel companies recently passed the state senate.² Certain large public investors opposed the bill, stating the preference for addressing climate risk through advocacy and engagement. Meanwhile, on the other side of the coin, some U.S. states have chosen to restrict business with financial institutions that they perceive as boycotting energy companies. And so, the debate continues.

We believe that a rigid rules-based approach, driven by backward-looking data, can have unintended consequences. A reasonable investor does not have to choose between divestment or engagement since they are not mutually exclusive. Why not think about executing a combined strategy? This is what it would look like:

We have established that engagement takes a more nuanced and thoughtful approach to drive positive change than divestment does. However, we must also acknowledge that engagement can, ultimately, fall short. Whilst most companies are open to constructive engagements with investors to improve their practices, some companies are less amenable. What should we do if a company is not willing to engage with investors, does not sufficiently address the risks facing its business, and/or does not seize the opportunities to create shareholder value? A clear and robust escalation strategy is fundamental.

Many institutional investors have escalation strategies. When used appropriately, these can further push those laggards that are not progressing fast enough. Escalation may take many forms, from a simple vote against management at an annual general meeting to a press release raising concerns publicly and, as a last resort, divestment. Escalation strategies should be assessed on a case-by-case basis, taking into consideration, among other factors, the market, the size of the company, the industry, the engagement history, and the business case.

The Russell Investments approach

At Russell Investments, being an active owner is an important component of our investment responsibilities and fiduciary duty. We are a long-term shareholder across thousands of securities on behalf our clients, and we engage knowing our clients should benefit over the longer-term. Our engagement approach is to encourage risk mitigation on the most material opportunities through building mutually beneficial long-term relationships with the investee companies which offer the highest return or risk mitigation opportunities. Therefore, ongoing dialogue with companies is a fundamental part of our responsible investing strategy, and we see divestment as a tool of last resort. From that perspective, we believe that continued engagement is likely to be more effective than divestment or exclusion.

We have several avenues for escalation, including enhanced dialogue with our sub-advisers and other market participants that result in coordinated or collaborative engagements, sharing concerns in writing (publicly or privately), and/or adverse proxy voting on related items. Regardless of engagement status, we challenge and monitor our subadvisor partners on the sustainability risks of their holdings on a regular basis, assessing their insight and analysis to ensure strong oversight.

As a global investment solutions provider, we seek to maintain a broad investible universe that provides the greatest scope for identifying excess return opportunities and diversified portfolio positioning.

We believe that in many circumstances there are better alternatives to managing risk and sustainability outcomes than outright exclusion, and we adopt a multi-disciplinary approach to managing sustainability risks, as detailed in our Sustainability Risks Policy.³ Where appropriate, exclusions are used to meet client preferences, manage risk, or to deliver on strategy objectives.  When using an exclusion, we strive to employ a thoughtful approach to calibrating criteria so as to meet complex topics such as energy transition with an equally holistic approach to identifying companies whose business models are at risk versus those likely to contribute to real-world solutions.

As committed stewards of our clients’ capital, active ownership is an important part of our investment responsibilities and decision-making process. Further information can be found in our Investment Stewardship Report.