Head to Head: When it comes to fossil fuels, is divestment or engagement the right route for institutional investors?

The common framing of engagement versus divestment is a false dichotomy. They aren’t mutually exclusive approaches — both are essential tools for pension managers, protecting beneficiaries from climate-related financial risks, generating returns and aligning portfolios with a safe climate future. Engagement and divestment work most effectively when used together.

Read: Do institutional investors have to choose between divestment and engagement?

As part of a robust climate strategy, pension managers must adopt an escalatory, timebound engagement program that requires companies to create profitable net-zero strategies, aligning capital expenditure plans with safe emissions pathways while ensuring companies respect Indigenous rights, pay for environmental liabilities and prepare for a just transition for workers and communities. Engagement can be effective for many companies, but there are obvious limits.

When engagement tactics don’t work, investors must be prepared to sell holdings that fail to meet requirements. Indeed, this is common practice — pension funds regularly divest from assets that carry unacceptable levels of risk. The fact that some managers continue to say they don’t believe in divestment suggests a hidden political hang-up, not a financial one.

Owning and engaging fossil fuel companies isn’t working. Years of effort from Climate Action 100+ have largely failed to ensure credible transition pathways for high-carbon companies. Canadian and global oil and gas companies still lack credible Paris Agreement-aligned climate plans. ABP, Europe’s largest public sector pension fund, cited limited engagement potential as the reason for its decision to divest from fossil fuels last year.

Read: Considerations for institutional investors around divestment

Beyond limiting investor exposure, divestment has been proven to limit carbon lock-in, depressing fossil fuel company share prices and raising the cost of capital for oil and gas expansion projects. Timebound and robust engagement toward climate-safe pathways is essential, but if companies or sectors are unable, or unwilling, to align their business model with a net-zero pathway, pension managers should make sure their divestment tool is taken out and put to good use.

Richard Brooks, climate finance program director of Stand.earth:

Public pension funds’ top priority must be fiduciary responsibility to workers who pour wages and livelihoods into the funds and rely on hard-earned pensions to sustain retirement.

Even with recent upticks in stock prices due to Russia’s war in Ukraine, investment and climate risk is increasing for volatile fossil fuel companies. Over five- and 10-year horizons, performance of coal, oil, gas and tar sands corporations underperformed the overall market.

To date, more than 1,500 institutions globally, representing more than $40 trillion in assets, have committed to some level of fossil fuel divestment — many that attempted shareholder engagement for years eventually deeming it futile and wisely moving to divest.

Read: Divesting from fossil fuels doesn’t mean sacrificing returns: report

Years of research from mainstream pension funds have concluded that investment in and engagement with fossil fuels is risky and incompatible with the financial livelihoods of pensioners — not to mention a livable planet for workers.

In September 2021, the Caisse de dépôt et placement du Québec announced oil producer divestment “in the interests of our depositors, our portfolio companies and the communities we invest in.” In October 2021, Dutch-based ABP announced accelerated divestment, citing “insufficient opportunity for us as a shareholder to push for the necessary, significant acceleration of the energy transition.”

There’s no evidence that engagement with fossil fuel companies has led to meaningful pollution reduction or climate action and expending staff capacity attempting to do so is a dangerous distraction. A sound fiduciary must recognize this and invest limited resources into protecting pensioners and ensuring a climate-safe portfolio.

Other carbon-intensive sectors, such as global banks with billions in fossil fuel holdings, have more viable pathways to transition and reduce financed emissions and associated climate risk. This is the place to focus any shareholder engagement efforts. The time for engagement with fossil fuel companies is over.

Read: OMERS committing to net zero, UPP facing divestment calls from university staff