The Climate Change Challenge for Institutional Investors

Climate change poses a wide-ranging danger to the entire global economy. As such, even the most diversified investors cannot ignore the risks of climate change. Leading long-term focused investors, including the California Public Employees’ Retirement System (CalPERS), have taken decisive action to wield their economic influence in support of climate mitigation efforts. To date these have stopped short of divesting from fossil fuels, though the fund should re-consider divestment in light of the fiduciary risk that policy changes might pose to the fossil fuel industry.


Pension Funds and Climate Change’s Threat to the Future

Though climate scientists agree that greenhouse gas emissions have already begun to irrevocably alter the world climate, economists disagree as to how to value the economic risk these changes pose. In particular, these estimates vary depending on the discount rate chosen, as this dramatically affects how the predicted economic losses over many decades should be valued in present terms.[i] Regardless of what discount rate is chosen, however, highly long-term investors—such as pension funds—face a particular need to take the threat seriously given their mandate to ensure stable returns over an extremely long time horizon.

CalPERS, which manages over $300Bn to provide for the pensions of the state of California’s public employees, issued new policy guidelines in 2008 which identified three core threats to its financial returns connected to climate change:

  • Regulatory Risk: should federal legislation to restrict carbon emissions occur in the future, the additional cost of carbon would likely reduce the earnings of CalPERS portfolio holdings
  • Physical Risk: The physical consequences of climate change—such as increased extreme weather, threats to world food supplies, and rising sea levels, would cause tremendous economic harm and impact CalPERS portfolio assets
  • Reputational Risk: As public support for anti-climate change action grows, the likelihood of public action to punish unresponsive companies—including negative ads or boycotts—could hurt companies that CalPERS has invested in.[ii]

Over the past decade CalPERS has emerged as a leader among the institutional investor community for ambitious action against climate change, including:

  • A mandate to its investment professionals to consider climate change impact as a factor in choosing investments. In particular, it has shifted its real estate portfolio toward holdings with a lower carbon footprint.
  • Commitment of $1.7Bn in funds to invest in clean energy and other low-carbon industries
  • Membership in a series of investor industry groups that lobby policy-makers as well as the investor community to support climate protection policies
  • Leading shareholder actions (an area in which CalPERS is particularly known as a leader) to lobby companies to adopt more sustainable practices, including supporting 66 shareholder proposals related to sustainability in 2014

The result, CalPERS would argue, is a concerted effort to wield the fund’s substantial industry clout to shift capital toward climate-mitigating economic activity and to promote a more climate-friendly policy agenda.

The Fossil Fuel Divestment Debate

However, the fund has resisted substantial political pressure to take an additional action in the form of divesting more than $80 million in current holdings in the fossil fuel industry. Divestment activists and the state government of California—which passed a law in 2015 mandating that CalPERS divest—argue that divestment would help to further weaken the power of fossil fuel companies in the economy. However, the fund has claimed that its fiduciary mandate to maximize returns for beneficiaries compels it to keep oil and gas in its portfolio. Furthermore, CalPERS argues, in today’s global equity markets, any holdings sold off would be instantly bought up with no impact to gas companies.[iii] In contrast, the fund argues that it wields greater influence on the industry as an investor, and can in fact point to recent shareholder initiatives which forced energy firms such as ExxonMobil and BP to adopt stricter reporting standards around climate risk and to explore alternative fuels.[iv]

The Fiduciary Argument for Divestment

While limited evidence exists of divestment’s economic or policy influence,[v] as the climate policy landscape shifts CalPERS should reconsider leaving fossil fuels precisely in pursuit of its fiduciary duty. In particular, most investor models do not account for the possibility that, if policymakers truly take steps to limit carbon consumption to the levels required to limit warming to 2 degrees, that will require that vast fossil fuel assets currently held on global balance sheets remain “stranded” in the ground and never consumed. Such policies could, by some estimates, impact 40-60% of the current market value of the oil and gas industry.[vi] If this risk were properly accounted for, therefore, it could dramatically diminish the projected value of the stock. CalPERS should consider divesting from fossil fuels, therefore, not to achieve influence but to maintain its commitment to high returns for its beneficiaries.


[i] William Nordhaus, “Critical Assumptions in the Stern Review on Climate Change,” Science Magazine, Vol. 317, 13 July 2007.

[ii] “The Importance of Corporate Engagement on Climate Change,” CalPERS website.

[iii] Michael Hiltzik, “Weighing the Cost and Benefit of Divestment,” Los Angeles Times, January 15, 2016.

[iv] “The Importance of Corporate Engagement on Climate Change,” CalPERS website

[v] William MacAskill, “Does Divestment Work?” The New Yorker, October 20, 2015.

[vi] Rebecca Henderson, Sophus Reinert et. al., “Climate Change in 2016: Implications for Business,” Harvard Business School Teaching Note, Rev. October 14, 2016.

(792 words, excluding footnotes)


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Student comments on The Climate Change Challenge for Institutional Investors

  1. Thank you for this very interesting article, which made me think on the broader role of institutional investors towards climate change.

    Funds like CalPERS hold tremendous power to shape our future economy. As you mentioned, institutional investors make investment decisions (i.e., they choose whom to give and not to give capital to) and can take active positions as shareholders (i.e., they can demand specific initiatives from their portfolio companies). These two mechanisms, combined with huge warchests gathered from working individuals, give institutional investors tremendous influence over companies, and thus over entire industries.

    With such power, it is reasonable to wonder: Is CalPERS mission solely to maximize returns for its pensioners? Or should CalPERS also seek other initiatives that would be well regarded by pensioners, such as helping stop climate change?

  2. Evan, thanks for an insightful post – I’d never really considered the role that institutional investors can play in shaping the course of climate change. It seems that CalPERS is taking a fairly myopic perspective and as such, is unwilling to divest from fossil fuels. Do you think that they actually have more control on companies by being investors as opposed to divesting (especially in companies where they don’t have large stakes)? My sense is that if a highly respected investor, such as CalPERS, were to systematically sell off its stakes in oil and gas, it could create a PR nightmare for the given companies. I’d imagine that if CalPERS set this precedent, other institutional investors would need to be prepared to defend their buy position.

  3. Hey Evan, great post – thanks for sharing your thoughts on this. Coming from the oil & gas investing world, I can certainly attest to this debate. My previous firm invested in a number of oil & gas and mining companies, and there was certainly a lot of consideration given to our investor base’s sentiment on these activities. That said, I think a lot of divestment over the “dirtiest” fuels is already taking place – most of our investor base was quite strongly anti-coal (particularly met coal). And as it relates to natural gas, I think many of these firms are still in favor of investing in this commodity given that, while natural gas still creates GHG, it does so to a much lesser extent than coal, and in fact is a vast improvement for our environment versus previous practices.

    I think these investor bases understand that there needs to be a shift to greener technologies in general, but they also feel that we need to do so as the economics make sense. To that end, I certainly believe our government can play some role in incentivizing that investment and improving economics for renewable technologies. That said, we’ve seen a lot of capital wasted on failed renewables investments in the recent past, so it’s a difficult balance for investors like CalPERS, the companies themselves and the government to manage.

  4. This was very interesting to read. I have heard of many early-stage investment firms focusing on green technology, but was surprised to see such an established company that invests in the public market pursuing a similar strategy. One pushback I have is on your argument that it should divest these stocks due to its commitment for high returns for its beneficiaries given the negative impact policies could have on these companies. Given my experience as a public market investor, one lesson I learned is timing is everything. As simple as it sounds, you want to buy low and sell high. While I agree such policies could be detrimental to the firm’s investments, is it really a near-term threat? As we have seen regulation takes time and unless there is reason to believe legislation will be passed in the next year, I would agree with the investment firm, they are better off staying invested, leveraging their influence on the company and maximizing returns for the investor.

  5. That was an interesting article to read. I don’t necessarily buy the fiduciary duty argument that you proposed because there’s an underlying assumption that fiduciary duty applies to time-frames of that magnitude. I think most investors would argue that, even in a long-holding strategy, they typically look at investments on a shorter time horizon, in which case the argument breaks down. That said, I agree with the spirit of the case that we do need to divest from fossil fuels in general, while strategically balancing that with the need to have better oversight and control of companies in the non-renewable sector.

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