One of the most contentious policy debates on campus is that of divestment. Divest DU, a student organization in favor of the University divesting funds from energy companies that extract or sell fossil fuels, is very active in spreading awareness of the issue on campus. While many of the awareness campaigns highlight the environmental benefits that may be reaped from a decrease in fossil fuel use, they rarely address the financial impact that such an action could have on the future of the University’s endowment.
Earlier this year the Board of Trustees for the University of Denver released a statement regarding the results of the vote against divestment that occurred on Jan. 20, 2017. The investment policy outlined in that statement is as follows: “The Board has directed its Investment Committee to manage University investments with the goal of achieving a highly competitive rate of return for a defined level of risk, within the framework of overall portfolio goals, without investment constraints established for political or social reasons.”
The University’s current endowment is slightly over $600 million. This money is carefully invested in a variety of different assets, representing a diverse set of industries, so as to maintain and grow the endowment for generations of students to come. Of the total endowment, an estimated $22.6 million, or about 3.7 percent, is invested in fossil fuel related holdings.
The strategy behind portfolio management is to invest in a mix of different assets so that the risk of any particular asset is balanced out by the other assets. This mix is determined based on the correlation of the assets. Having a low correlation means that the asset will increase the diversification effect which lowers the overall risk of the portfolio. To put it simply, it is wise not to put all of your eggs in the same basket.
The diversification effect can be used to explain why universities often have investments in their portfolio that may not be aligned with the social sentiment of students and faculty. A historical example of this phenomenon can be seen in the Harvard Trust’s investment strategy in the late 1970s and 1980s. During this time a movement to divest from South Africa began due to the nation’s institution of apartheid. Many calls were made to withdraw investments as a way of applying economic pressure in order to force the South African government to change its racist policies. Despite the strong anti-apartheid activism on Harvard’s campus, the University never fully divested from their South African holdings. The reason for this decision was not motivated by a desire to support racist policies, but rather because of the diversification effect that these holdings had on Harvard’s portfolio. During these years South Africa’s economy had a negative correlation with the U.S. economy which made South African companies a very attractive investment to reduce portfolio risk.
In this same way, energy companies today often have a low correlation with other U.S. industries. This is because when fuel costs are low most non-energy companies are more profitable and when fuel costs are high most non-energy companies are less profitable. By investing in both energy companies and non-energy companies a dependable return can be achieved regardless of fluctuations in the cost of energy. This strategy more fully explains the decision of the Trustees to continue their current investment portfolio rather than selling and reinvesting the University’s fossil-fuel holdings in other assets.