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Private Equity Strategies

Does Institutional Divestment Really Matter?

Friday, March 22, 2013

By: Bailey McCann, Private Equity Strategies

Since the beginning of the year, there have been two fairly significant movements to drive institutions to divest from certain portfolio holdings. Specifically, the push after the Newtown, Connecticut shootings to get pensions and other institutional investors to divest from gun manufacturers, and a second movement across more than 200 college campuses nationwide to get endowments to drop their investments in fossil fuel companies. Both movements have had mixed success so far, and divestment skeptics say that the efforts are misdirected. Either way, any time an institution makes a significant shift in its allocations, the impact for GPs can often outlive the movement itself.

Consider what happened for investments in tobacco companies after whistleblowers shed light on how these companies were actively trying to hide the adverse effects of cigarette smoking. Consider also, the effects of student movements in the US against apartheid. While both cigarette smoking and bigotry still exist, you won’t see many glowing announcements of recent tobacco company acquisitions by GPs – at least not GPs angling for favor with some of the market’s most public investors.

When the push for divestment in both guns and fossil fuels started to gain traction, articles started making the rounds questioning the financial responsibility of these moves. A report surfaced in the Associated Press that when the trustees of the $46.6 billion New York City Teachers' Retirement System, took up the idea of dropping their gun investments - with the support of outspoken gun control advocate Mayor Michael Bloomberg - one of his own administration officials cast the lone vote against the measure. According to the report, he said that he thought these decisions should look at what is best for beneficiaries.

On financial grounds, it might be hard to argue for pulling out of gun investments. Gun manufacturers saw a dramatic rise in product sales following the re-election of President Obama, on fears of his goals for gun control. This rise was bolstered by the Newtown shootings, when many pro-gun rights citizens headed to their local gun shop ahead of what they feared would be a spate of new gun control laws. Looking at the numbers, these factors might be considered reasons to hold on to gun makers in a portfolio, as better returns go hand-in-hand with a buying spree.

A variation on this theme is also true for fossil fuels. Energy prices and US supply are hitting new highs. Not only are university endowments invested in these companies through their portfolios, they’re also deeply invested as some of the larger consumers of these fuels Cornell University’s president David Skorton noted these points in an interview with the Cornell Daily Sun, as part of his reasoning behind why, despite broad student support for the idea, Cornell wouldn’t be dropping fossil fuel investments. “One, it has to be robust on returns we’re counting on in the short-term,” he told the student paper. He urged students to push for government action on curbing climate change, saying divestment wouldn’t achieve the goals they were working for.

While the skeptics make some plausible points, they’re only half right. Sure, individual companies make the bulk of their profit on actual sales, not in the stock market, and yes government action on climate change would be more definitive, but these movements have a bigger impact – even if unsuccessful – than merely denting stock price once you dig in.

Guns, climate change v. butter

The move to divest of gun makers provided some interesting insights to what GPs may be looking at when these movements happen. Even before any pension or other institution announced plans to pull out of these companies Cerberus said it wanted to sell Freedom Group its investment in gun makers. Suggesting that some private equity firms may be less keen on short-term profits in the wake of broader issues around long-term investor interests, and press scrutiny around holding on to hot button companies.

This may also be happening at universities, as a movement to get university endowments to divest from fossil fuel companies swept across nearly 250 universities nationwide, led by climate change activist, Bill McKibben and his organization So far, the bulk of that action has resulted in student led campus resolutions against investment in fossil fuels, but some of the student groups have also been successful in pushing endowments to divest, despite the criticisms outlined earlier.

While divestment may not immediately impact stock prices, pushing institutions to divest can have a wider impact. First, institutional portfolios like pensions or endowments are some of the last vestiges of long-term investment in the marketplace. In that vein, companies like Exxon, which are profitable now, at the height of the fossil fuel economy, may not be that way forever. Joe Romm suggests that these companies are headed for a stock price collapse in the future, as the reality of climate change sets in, unless they too stake out positions in more sustainable sources of energy.

Given the long term nature of a pension or endowment portfolio, they may also be uniquely well suited to act ahead of government intervention or short term profit cycles, and start picking winners in tomorrow’s energy economy. This is also around investments in gun makers, as the groundswell of public opinion and new state laws, builds around issues like background checks and greater gun control. Those companies could face the same level of public stigma as big tobacco, making them less palatable long-term investments, no matter what the current profit picture looks like.

Indeed, CalPERs, one of the nation’s largest institutional investors said as much in their proposed divestment resolution – “The Board further finds that the growing national controversy over gun violence, and the state and national legislative and regulatory efforts which now accompany the debate, will generate administrative and opportunity costs to address the system’s continued ownership of the stocks of these two companies and that these ongoing costs will likely exceed any possible risk-diversification and portfolio return benefits from these investments.”

Divestment could potentially impact government intervention too. Would state supported public pensions or endowments that are no longer directly tied to the overall well being of gun manufacturers and fossil fuel companies feel freer to pursue legislation that controls both of their relative outputs? Perhaps. The New York Teachers have divested out of their gun exposures, and Governor Cuomo recently signed some of the toughest gun laws in the country. Compare this to the US Congress, which is still heavily controlled by the NRA, and dropped its effort to ban assault weapons this week. While not directly causal, it may be easier for other Governors to make those decisions knowing their state pension liabilities are unlikely to take a hit.

So too for endowments, the move toward long-term sustainable investments would signal not only actions in the interest of the portfolio, but in the interests of the students universities support. They could take an active role in finding GPs and portfolio companies in industries their graduates will be working in when they become contributors to their alma maters. GPs like Cerebus that react quickly may be the most well positioned to advise institutions on how to invest for the future.

This article was published in Opalesque's Private Equity Strategies our monthly research update on the global private equity landscape including all sectors and market caps.
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