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07.10.2014

Of hedge funds and fossil fuels: Are we seeing a new era of divestment?

By Judy Kuszewski

Creative Commons: Tim Quijano, 2011

Recent developments have brought divestment prominently to mind and prompted me to wonder if we are seeing the start of a wider trend.

Calpers trims its hedges

In the first instance, Calpers, the California Public Employees’ Retirement System, announced it was divesting altogether of hedge funds. Hedge funds often have an immediate negative connotation for sustainability advocates, due to the fact they are aggressively managed, require very large initial investments (making them only available to the rich), and are highly opaque. This, combined with their notorious ‘two and twenty’ fee formula – where fund managers are paid 2% of net assets plus 20% of profits – along with a structure designed to avoid most regulation, leads many observers to conclude that hedge funds only exist to line the pockets of hedge fund managers, rather than add any value to society.

Misgivings hit a new level last year when the Co-operative Group was forced to seek hedge fund investment in the wake of major accounting failures at the bank, which subsequently prompted much hand-wringing over the future of the Group’s ethical policy and co-operative ownership model. The intervention – some said ‘invasion’ – of the hedge funds was seen as potentially fatal to the bank’s raison d’être: “[The Co-operative Bank] can’t sacrifice profits for social goals any more,” lamented Tony Greenham of the New Economics Foundation; “Is that what the pioneers who formed the Co-op anticipated? That it would be in the hands of American hedge funds?” asked Labour MP John Mann.

So, should hedge funds’ detractors hail the Calpers decision as a repudiation of dark-side capitalism? After all, Calpers is something of a bellwether among major institutional investors, with others often following their lead. The fact that Calpers are charged with managing money from the public purse may also cause some to see hedge funds as an inappropriate investment altogether. Dean Baker argues in Al Jazeera America: “It is debatable whether pension funds should be investing in hedge funds or private equity funds at all, but one point that should not be in question is the need for transparency with these investments. This is the public’s money, and the public should have a right to know what is being done with it.”

In truth, the Calpers decision probably does not portend any major reckoning for the hedge fund industry, or at least not for any reason connected to the ethics, transparency or social value of hedge funds per se. The truth is that Calpers’ hedge fund investments were just not performing well. The typical hedge fund return in 2013 (net of fees) was 7.4%, compared with 32% for the S&P 500. For this desultory performance, Calpers paid some $135 million in fees last year. Their trustees apparently decided they simply couldn’t justify holding on to an under-performing asset class at such cost.

We will be able to draw more conclusions about Calpers’ approach to investing when we see what they do in the future with this reassigned hedge-fund money. Even though the short-term decision to exit hedge funds may be justified in performance terms, the worry is that pensions (which face high and rising demands to look after an ageing population) are over-invested in equities, risking potential havoc in the event of another stock market crash. Meanwhile, bonds are poor value at present due in large part to extremely low interest rates, forcing pension funds to look elsewhere to balance their portfolios. The fact that Calpers will take a year to figure out where to put the $4 billion it currently has in hedge funds is a reflection of the lack of clear alternative options currently available.

And in spite of all this, the size of the hedge fund sector has doubled since the 2008 financial crisis, with little evidence of this growth slowing any time soon. Nathan Vardi, writing in Forbes, said: “Nothing seems to stop hedge fund inflows these days. The hedge fund business has seen assets grow big time in recent years, marching on inevitably to $3 trillion.”

 Divesting for the post-oil age

In other divestment news, the Rockefeller Brothers Fund (RBF), a New York-based philanthropic foundation set up by descendants of Standard Oil founder John D. Rockefeller, has recently declared it is going fossil-fuel free. In one sense, this divestment of fossil fuels from the foundation’s investment portfolio is simply consistent with the group’s long-standing commitment to funding sustainability groups and causes, including the influential 350.org campaign. But with the family’s roots drenched in crude oil, there is huge symbolic value in the act of abandoning those companies Rockefeller helped launch, including ExxonMobil and Chevron.

Perhaps symbolic value is the most important immediate result of this decision, as RBF assets amount to some $860 million, of which only 7% are invested in fossil fuel companies – hardly enough to dent the broader market. But RBF is joined by a far larger coalition of 800 institutional investors who collectively pledged last week to divest some $50 billion from fossil fuels over the next five years.

With climate change set to be this generation’s defining ethical challenge, it is fitting that an increasingly strong divestment movement is now rising to the cause. In fact, the fossil-free movement sprang up originally on university campuses in the United States, much as the apartheid South Africa divestment movement did a generation ago. Adding further to the parallel, Archbishop Desmond Tutu contributed to last week’s Climate Week events by publishing a rousing essay in which he describes responding to climate change as “the human rights challenge of our time.” While the paltry attention paid by the media and policy makers may suggest Tutu is overstating the problem, the hundreds of thousands of people participating in the People’s Climate March all over the world stand as testimony to a rising tide of public opinion that the time to act on climate change is now.

Indeed, the moral argument for divestment is now increasingly supported by a convincing economic rationale too – predicated on the notion that the end of the oil age is imminent, and thus presents a losing investment strategy. As Stephen Heintz, president of the Rockefeller Brothers Fund put it: “John D Rockefeller, the founder of Standard Oil, moved America out of whale oil and into petroleum. We are quite convinced that if he were alive today, as an astute businessman looking out to the future, he would be moving out of fossil fuels and investing in clean, renewable energy.”

The combination of ethics and economics is irresistible. As I pointed out in my blog on the South Africa divestment movement of earlier years, many experts then felt that the minority apartheid regime – and the patchwork policies that served to prop it up – was economically unviable. The country’s economy was effectively dependent on a market comprised of a small minority of its citizens, such that subsequent sanctions and private-sector divestments merely nudged the inevitable collapse into happening more quickly.

Campaigners are counting on a similar collapse of the unsustainable fossil fuel market – not because of any particular evil, but because it is on the cusp of being replaced by renewables on a grand and global scale. The International Energy Agency itself has predicted that solar could exceed oil as the world’s main energy source by 2050.

We know that the potentially catastrophic effects of climate change will hit the poorest and most vulnerable people in the world, generally those without access to hedge funds or any other sort of mainstream investment vehicles. At long last, we are seeing divestment decisions that unite ethics and economics to deliver value for the poorest and most vulnerable – be they the growing numbers of elderly or populations most threatened by climate change.