If you’re new to Carbon Collective, we help people align their values around climate change with how they invest their savings. We build low-fee, diversified climate-friendly portfolios. They’re kind of like climate-focused index funds that divest from the high-carbon parts of the market in order to invest in the companies solving climate change.
In the world of ethical investment, this strategy is known a divest invest.
Here, we want to address the question of: why?
Why does it matter where you keep your retirement savings or other investments? How can changing where you invest change our planet’s climate trajectory? We’ve done a lot of thinking on this. We’d like to share where we landed.
Below, we walk through a summary of our beliefs about how the world of investing works. Then, we explore each of the top arguments against letting ethical approaches to investing like divest, invest. For each, we’ll share what we think they get right and where we think they are wrong.
Before we dive into the top arguments against ethical investing, let’s walk through some of our beliefs about how the world works, particularly when it comes to investing.
We often find that when we read economic arguments against ethical investing seem to operate under a different set of assumptions than we do. So in the efforts of full disclosure, we want to lay out our assumptions first.
These are two sets of theories that get thrown around when people start arguing about economics. We find people often put them at odds with each other, like they are mutually exclusive. They’re not. This is not a case of “either, or” but of “both, and.” They each explain part of the truth.
The first pair of theories, Homo Economicus vs. behavioral economics explore the question: how do humans make decisions?
Homo Economicus is a fictionalized character based upon Rational actor theory. Economists using this theory argue that we are fundamentally self-interested creatures. The driving force behind our decisions is one of logic, where we weigh different outcomes and attempt to optimize what will best meet our goals.
If you’ve ever compared the price per ounce of the generic vs. name brand in the grocery story, that’s your Homo Economicus coming out.
Behavioral economists argue that as much as we might wish to be like Homo Economicus, we make poorly optimized decisions all the time. Pioneered by a couple of psychologists (Kahneman and Tversky), the field of behavioral economics seeks to study the times when humans slip up and fall short of our logic-driven potential. Many of the field’s observations have been given names you might have heard of like: recency, hindsight, and confirmation bias.
Who is right and why does this distinction matter? Our collective decision-making drives the prices of stocks up or down. If the goal of investing with your values is to impact a company’s stock price (either positively or negatively), we need to understand ultimately why we make decisions.
This brings us to our second pair of theories. They are trying to answer the question: how do investors value a stock today?
The firm foundation theory asserts that you can determine a stock’s value just by looking at a company’s performance in relation to its competitors. Is the company doing well? Did its earnings beat its expectations? How about compared to its closest competitor? From these questions a fundamental analyst (a professional who uses firm foundation theory) can arrive at a concrete number that represents the “true” value of a stock today. If the market price is above this value, they’ll sell the stock (if they own it). If it’s below, they’ll buy it.
Not everyone agrees. John Meynard Keynes coined the term “castles in the air” to describe his philosophy for valuing stocks. He argues that fundamental analysis only goes so far. Instead, he believes an investor’s decision on whether to buy or sell today should depend on their estimation of how other people will view the value of the stock in the future. In other words, the value of a stock today is dependent upon how you think your neighbor will value it tomorrow.
So who is right? How do we make decisions and how do these impact the prices of stocks? Both! All four explain some part of our behavior. Some people and investors are able to operate closer to Homo Economicus by using fundamental analysis. They determine their “true value” of a stock. Others trade based upon where the “winds of the market” are headed.
We start with this distinction because we find that many arguments against divest/invest and ethical investing begin with the assumption that we are all Homo Economicus. They believe all investors are looking just at a company’s books and competitors while ignoring the rest of the world.
We push back on that. Homo economicus might explain some of the reason a stock’s price changes, but certainly not all of it. If your goal is to use your investments to slow down fossil fuel companies (divest) and speed up the companies solving climate change (invest), then we need to understand how investors build “castles in the air” and what your investments can do to help.
One of the most powerful forces that can construct and demolish castles in the air is herd mentality. Beginning with the famous Asch conformity experiments in 1951 (the one with three lines of different lengths where everyone in the room gave the wrong answer but you), many studies have demonstrated that “what everybody else is doing” weighs heavily on our decision making.
In our daily lives, this phenomenon can be quite helpful. From product reviews to home repair videos, making the same choice as the herd can often result in us making a smart, satisfying decision that saves time and money. Decision fatigue is a real phenomenon and going with the crowd can save valuable brain power for more important decisions.
In the world of investing, herd mentality can get supercharged. Not only can the collective mentality of investors drive the market into highly irrational directions (tulips, pets.com, mortgage-backed securities), but single, influential individuals can make billions of dollars of value appear or disappear overnight.
Jim Cramer, host of CNBC’s “Mad Money,” makes comically loud recommendations to “buy, buy, buy!” These messages to the “herd” are strong enough to have earned their own financial term – the Cramer Bounce. While not large, stocks he recommends get an average short term increase in value of 3%.
Why does this matter for climate change investing?
The investor community has shared narratives about fossil fuel and renewable energy companies. You probably could name some. Do investors generally believe fossil fuels are a good investment or a bad one? What about renewable energy companies?
These narratives are powerful because they build castles in the air. If we all believe that even though fossil fuel companies are evil, they are a good investment, the castle will get built in the air. Stock prices will go up and they will be more likely to be a good investment. The reverse is also true.
Our narratives are powerful. When we can recognize them, we get to choose which to support and which to go against. Because part of the price of a stock is based upon our collective belief of how other people will value this stock in the future, such narratives can easily become self-fulfilling prophecies.
Historically, the narrative around renewable energy investments and green investing in general was it underperformed the market. In spite of the strong financial performance of many solar and wind companies, this narrative still may be holding back renewable energy stock prices.
Why does this matter? The big pools of money from institutional investors (think pension funds) have still largely been on the sidelines of investing in renewable energy. The reason is because money creates its own gravity and there isn’t enough yet in these companies. Let’s get a little technical.
Liquidity is the term analysts use to describe how easy it would be to find buyers if you wanted to sell a valuable amount of a company’s stock (say, $100 million worth). Higher liquidity = its easier to find buyers when you want to sell. Lower = the opposite.
Institutional investors (pension funds, endowments, etc.) operate by strict guidelines regarding liquidity. If the liquidity is too low for a stock, regardless of how good of an investment it could be, they simply will not buy it. If they go too low, they will risk that their decision to sell the stock would hurt its price and they would not find enough buyers for their shares quickly enough.
For example: A pension fund owns 1% of the stock in Company A and they decide to sell. If less than 1% of the stock is being sold every day, it could take them two days to sell it all. Because so much stock was being sold on Day 1, the rest of the market could see the pension fund’s sale as a negative sign. So, on Day 2 this could lead to a price drop, meaning the remaining shares the pension fund is trying to sell on Day 2 will be worth less than the ones they sold on Day 1.
Liquidity matters to ethical investing because it has historically been a barrier for institutional investors to buy renewable energy stocks, even if they want to and the stocks are performing well. Forbes wrote about this phenomenon in 2020:
“In answer to why investment in renewables remains relatively low despite apparently stellar returns, the Imperial College report noted that large asset managers and institutional investors such as pension funds required deeper liquidity than the renewables market currently held.”
Without major investors being able to put their money in, such companies can get stuck in a chicken/egg, unable to get the traction in the stock market they need for institutional investors because… they don’t already have institutional investor support.
Why do narrative, herd mentality, and liquidity matter for ethical investing? They can influence a company’s stock price. A company’s stock price impacts the plan its management sets forth and the amount of cash they have access to fund it.
Company managers pay close attention to the company’s stock price. An elevated price is like a public gold star for company management. The investor community is demonstrating their support for the direction of the company and management’s leadership. The inverse is also true. When stock prices are depressed, this sends a signal that the public is not satisfied and management should change course or find a new job.
In its Q2, 2020 BP reported a $16.8 billion loss, cut its dividend in half, and also said it would increase investment in renewable energy 10x over the next decade. Despite the losses, the public approved of management’s plan for BP and share prices increased by 7% that day.
Similarly, a company’s stock price can impact how easily and cheaply a company can raise capital to pay for their expansionary plans. Elevated stock prices allow a company to increase the supply of shares by selling new ones without risking too much dilution of existing shareholders. This can be the cheapest form of raising capital for a company because it’s essentially like printing money. Tesla leveraged the high demand for its stock to issue new shares twice in 2020 (February, September).
If the price of a company’s shares are low, this option is generally off the table because it can be a strong signal to investors that the company is in trouble and its prospects are grim.
Similarly, when looking to raise new debt to fund expansion, a company’s finance team would strongly prefer the company’s stock price to be high as this gives further social proof that the equity community believes the company’s future is bright. The reverse is also true. If a company has a depressed stock price, it can be harder or more expensive for a company to access debt because of the red flags the lowered raises.
The castles in the air we build around fossil fuel and renewable energy energy companies matter. They impact the direction management takes the company and how quickly they can go.
An old proverb goes: “if not me, who?”
Some pretty famous thinkers argue individual actions don’t matter. Stephen Dubner argued in Freakonomics that the only utility of voting was to be able to say you voted, as one vote does not change elections.
So who’s right? In this case, it’s the proverb. On a macro level, change only happens when enough people individually decide to make the change themselves. These changes can have ripple effects. More cyclists can lead to more bike lanes which can lead to more cyclists. More vegans lead to better meat substitutes, which enables more vegans.
You deciding to make a change can influence the “herd” of others around you to do the same.
But what about on a micro level? Do my actions really make a difference? How many elections have been decided by one vote?
Dubner and such thinkers do have a point, there is a low likelihood that your vote will swing an election. But this is only half of the equation. In the chance that your vote does swing the election, the impact of your action would be very high. William MacAskil makes this argument well in Doing Good Better (this excerpt laying out the logical argument for vegetarianism is worth reading). In it he argues that the impact of ethical personal actions is a step function, not linear one.
Here’s an example he uses: Most of the time you choose to not buy meat at the grocery store, it will not impact the amount of meat the store manager orders. But if the manager orders meat in units of 1,000 and your decision not to buy meat that week meant the store sold 4,999 chicken breasts rather than 5,000, your single action reduced the next weeks’ order by 1,000. That’s a huge swing for one action and can make up for all of the times it didn’t make an impact.
We would make the same argument for stocks. If you choose to divest your portfolio from high carbon companies (like fossil fuel extractors and coal-burning utilities) and reinvest that money in renewable energy companies, will it make an immediate tangible difference?
Likely not, but like store managers ordering next week’s chicken breasts, institutional investors also operate in a step function. A company is liquid enough or it isn’t. If your investment happens to be what puts the company’s total value over the edge into “liquid-enough,” you could unlock institutional capital for the company, which can better position the company’s management to realize its mission, faster.
In this second half, we’ll explore some of the top arguments against using ethical parameters when evaluating investments, particularly when it comes to divesting from fossil fuels and investing in companies solving climate change. We’ll layout our response, pulling from the arguments we made above.
This argument got pretty well articulated in Forbes in 2015. The author made a few points (some of which we touch on in lower sections), but his main argument was as follows:
Even though the amount of money institutional investors had pledged to divest from fossil fuels seemed large ($3.4 trillion at the time), in reality that number was much smaller (only $125 billion) because they had relatively low fossil fuel holdings to begin with. The fossil fuel industry had ~$4.4 trillion in public holdings (stocks and bonds) at the time, so this divestment only represented ~3% of the total value. Given that stocks can swing by 3% in a single day, the drop and ocean analogy arises.
Our response: Let’s begin with updates on the numbers. Since this was published, divestment momentum has increased. In 2020, the total committed to divestment has risen to $14 trillion. Over the past 5 years, the publicly traded energy sector as a whole has lost 45.63% of its value (09/09/15 – 09/09/20). We’re still waiting on the next batch of academic papers looking at the extent correlation equals causation here.
We believe this argument falls prey to the same logical fallacy as Stephen Dubner’s argument that voting does not matter. Divestment often will not matter, that is, only until it does. In the infrequent times when it does matter, it can matter a great deal.
Reinvesting divested money into companies solving climate change can have an even greater impact. As a planet, we’re investing only ~50% of what’s needed annually to transition to a clean energy system in time to avoid 2ºC of warming.
Unlocking virtuous cycles of investment from institutional investors into these companies could change the narrative around renewable energy investing. Such an updated castle in the air can allow these companies to finance capital projects more easily while also putting pressure on management of high-carbon companies to follow suit.
Proponents of this argument claim that because the act of divestment implies a willing buyer of your fossil fuel stocks on the other side, the sale of your shares will not actually have a tangible impact on the company.
Bill Gates is maybe the most famous voice behind this argument stating in 2019: “Divestment, to date, probably has reduced about zero tonnes of emissions.” He continues to argue that investors and philanthropists can get more emissions reductions for their money by investing in companies solving climate change like meat substitutes and innovative energy storage.
Our response: The mechanics of this argument are correct. On that day, the market did set the price of the stock. But we need to zoom out and focus on the power of narrative. There is a narrative that fossil fuel companies are a strong investment as they tend to offer predictable, high dividends. Similarly there is a narrative that renewable energy investments tend to underperform.
As laid out earlier, our herd mentality grants such castle in the air narratives strong power (here’s a good example, not related to climate change or fossil fuels). By going counter to such narratives, we begin to change them. We can harness the power of narrative and herd mentality to accelerate positive change rather than work against it.
While the market set the stock price on that day, the narrative surrounding the value of a given stock sets the stock price that year and beyond.
Imagine if Bill Gates had instead come out and said something like: “investing in fossil fuels is stupid. It’s a dying industry. Solar generates 2% of our energy today and it will need to generate 30% by 2050. I’d put your money in the growing industry.”
What impact could such a sentiment have on the narrative around fossil fuels and renewables. What impact could it have on the herd of investors? The stock market can create self-fulfilling prophecies. It’s up to us to create them.
A few further notes on this argument:
In order to understand this argument, let’s do a quick refresher on how public stock markets work. When a company “goes public” they decide to sell shares (aka ownership) of the company to anyone who wants to buy them. They work with a bank to set the price for the Initial Public Offering (IPO). If a company is selling 1 billion shares and the IPO price is $10/share, the company can directly raise $10 billion that can be used to finance its growth.
So let’s say the company is popular and sells out all of the 1 billion shares immediately when they IPO and by the end of the day the shares are trading at $20 each. Does the company get $20 billion?
No. The only money the company gets from selling shares to the public is from its initial offering at the price it pre-determined. From then on, the shares trade on the secondary market, and the shareholder, not the company, receives any value gained or lost in trading.
Buying shares on the New York Stock Exchange is the equivalent of buying a pair of limited edition sneakers on eBay. Nike doesn’t make any money from the eBay sale.
Therefore, proponents of this argument claim that trying to negatively impact a fossil fuel company or positively impact a renewable energy company by buying or selling shares on the secondary stock market will have no real impact on the bottom line of either company.
Our response: We agree, buying and selling shares of a company on the secondary market does not meaningfully impact the amount of money a company received for selling its stock to the public.
But share prices on the secondary market does influence company behavior. Whether depressed share prices prompt management of a polluting company to move in a new direction or elevated share prices enable a company like Tesla to issue more shares to finance building another gigawatt battery factory, share price is an important feedback mechanism between the public and publicly traded companies.
This can be especially true for investors like us. As smaller investors, particularly those who are saving for retirement, we tend to operate under a long term, “buy and hold” strategy. This means the shares we own tend to largely remain out of circulation on the stock market. While demand for a stock may be dictated by a company’s earnings, the meta-narrative about the company, and herd mentality, the supply of actively traded stock depends on the number of shares looking for buyers.
If long term investors get our fossil fuel stock (or ETFs with fossil fuel companies in them) back into circulation and hold our shares of the companies building climate solutions, we tilt the supply/demand equilibrium in the right direction. Your account may be small, but 37% of the stock market is held by individual investors. Collectively, we make a difference.
Where you keep your retirement (or any other) investments matter. The narrative you tell about a stock impacts how likely it is to come true. Making personal choices that align with your values matter not because they will have an impact every time, but because when they do, the difference is tremendous.
The inverse of all of these is also true. Not making a change, not challenging a narrative with your actions, is a vote for the status quo. Herd mentality is neither good nor bad, just powerful. We want to imagine it turned towards building a sustainable world.
You invest in a retirement account so you can live a stable, comfortable, predictable life after you retire. That investment goal will be much harder to meet in a world with 2º+C of warming.
Invest with your values because it’s a simple way to align your long term financial and ethical goals. Invest with your values because your savings can accelerate how quickly we transition from fossil fuels to clean energy. You should also invest with your values because you may even make more money (Study on how ESG funds have outperformed the market. Study on how “carbon-efficient” companies outperformed the market).
Looking to focus your investments around your values on climate change? We want to help. We help you invest in low-fee, diversified portfolios built for the world where we solve climate change. Let’s divest from fossil fuels to invest in the companies solving climate change.