NSHE Fossil Fuel Divestment Discussion Presentation to Investment Committee of the Board of Regents September 6, 2018 Stephanie Shepherd - NSHE Staff, Wendy Walker - Cambridge Associates and Matt Beardsley - Russell Investments 1 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 1 of 19
Agenda Current Portfolio and Divestment Overview Implementation Considerations Implementation Options Summary and Next Steps 2 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 2 of 19
CURRENT PORTFOLIO AND DIVESTMENT OVERVIEW 3 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 3 of 19
Overview of NSHE Fossil Fuel Holdings % of Endowment Fossil Fuel Exposure Cambridge Associates 45% 3.6% 1 Russell Investments 43% 2.5% 2 Total Endowment excl. Legacy 88% 3.1% Legacy Assets (liquidating long-term Private Investments) 12% 20.3% 1 TOTAL ENDOWMENT 100% 5.2% OPERATING FUND --- 2.4% Environmental Strategies Private Investment strategies focused on environmental solutions 2.0% 3 Public equity manager employing Environmental, Social & Governance (ESG) criteria 1.5% TOTAL ENDOWMENT 3.5% NSHE portfolios have modest exposure to fossil fuel reserves, with the largest exposure in the Legacy Assets Portfolio. The Endowment also has growing exposure to environmental-oriented strategies. 1 Source: Cambridge Associates, MSCI CarbonMetrics as of 31 March 2018. 2 Source: Russell Investments, Trucost, Sustainalytics as of 30 June 2018. 3 When managers fully call committed capital. 4 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 4 of 19
Divestment Landscape According to 350.org, 26 US colleges & universities have committed to full divestment (full list at right). They also cite an additional 16 US colleges & universities that have committed to partial divestment (e.g., coal only). We note that these 42 institutions represent 0.006% of Postsecondary Title IV institutions in the US. Globally, educational institutions constitute 16% of institutions pursuing some form of divestment: Sources: https://gofossilfree.org/divestment/commitments/; https://nces.ed.gov/programs/digest/d17/tables/dt17_105.50.asp?current=yes *No direct fossil fuel exposure Year of # of Years to Name Pledge Full Divestment Hampshire College 2011 ASAP Unity College 2012 5 College of the Atlantic 2013 immediate Foothill-De Anza Community College Foundation 2013 1 Green Mountain College 2013 2 Naropa University 2013 immediate Peralta Community College District 2013 5 Sterling College 2013 0.5 California Institute of the Arts 2014 ASAP Chico State University 2014 3 Pitzer College 2014 1 The New School 2014 ASAP University of Dayton 2014 Phases Brevard College 2015 3 ESF College Foundation, Inc. 2015 immediate* Goddard College 2015 Immediate Rhode Island School of Design 2015 2 Syracuse University 2015 immediate* University of Hawaii 2015 3 Warren Wilson College 2015 3 Pratt Institute 2016 5 Univeristy of Oregon Foundation 2016 Until PI commitments expire University of Massachusetts Foundation 2016 ASAP Northland College 2017 5 Oregon State University 2017 ASAP Lewis & Clark College 2018 5 Fewer than 1% of US colleges & universities have committed to full divestment (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 5 of 19 5
Divestment Philosophies Mission & Values Argument Ethical considerations should be reflected in investment strategy. Divestment could have great symbolic power. Send a signal to policymakers and the general public. Side note - Other dedicated climate advocates such as the Interfaith Center for Corporate Responsibility see a responsibility for investors that care about climate change to instead maintain their holdings to exert influence on corporate management through shareholder votes and resolutions, rather than selling their shares to other investors that may not hold fossil fuel companies accountable for climate action. Many institutions consider questions of institutional mission (and the role of investments in serving that mission) the purview of the full board rather than the Investment Committee. Economic Risk/Return Argument The 350.org 1 campaign contends the market has priced reserves of fossil fuels as if there will be no change to regulation. Companies with these reserves may realize significant valuation declines if government or other factors limit the use of these reserves. Side notes - Many major oil & gas companies are also some of the largest investors in renewable technologies and projects, as they position their business lines for the impending energy transition. Further, NSHE s underlying investment managers are tasked with evaluating regulatory and other risks for fossil fuel companies and other holdings. Assessments of economic risk/return are the purview of the Investment Committee, who may exercise independent judgment or prudently delegate such evaluations to investment managers. It is important for any investor considering divestment to clearly articulate goals/motivations, and establish proper governance. 1 350.org was founded by environmentalist and activist Bill McKibben and calls for institutional leaders to immediately freeze any new investment in fossil fuel companies, and divest from direct ownership and any comingled funds that include fossil fuel public equities and corporate bonds within 5 years. 350.org provides a list of 200 publicly-traded target companies, which hold the vast majority of the world s listed (and proven) coal, oil and gas reserves. 6 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 6 of 19
IMPLEMENTATION CONSIDERATIONS 7 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 7 of 19
Performance Impact of Divestment The MSCI ACWI Energy Index, as a proxy for fossil fuels, outperformed the broad global equity markets over the last 20 years. The energy sector has traditionally performed well late in the market cycle given its linkage with inflation. MSCI ACWI ex Fossil Fuels has outperformed over last five years, however this outcome likely reflects simple change in crude prices. Likely performance impact of divestment will vary widely and depend on measurement period Annualized excess return, ending 06/30/2018 1 year 13.6% 3 years -3.1% 5 years -7.1% 10 years -6.4% 20 years 1.3% Performance impact of eliminating fossil fuels is not conclusive for either short or intermediate timeframes. Need to also consider other opportunity costs of such strategies. 8 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 8 of 19
Investor Responses to Climate Change Efforts outside Investments Partial Divestment Full Divestment Lower Investment Restrictions Greater Investment strategies more widely practiced in institutional investment portfolios (not mutually exclusive with Divestment or each other): Proactive ESG Integration Investments Investment Strategies NSHE needs to determine the following: 1. What is our motivation for adopting environmental objectives mission vs. economic? 2. To what extent do we want to mandate investment restrictions and/or strategies related to the environment? 9 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 9 of 19
Divestment Considerations Full divestment may lead to unintentional reduction or elimination of exposure to renewable energy as well as other valuable areas of diversification. Depending on how strictly fossil fuel elimination criteria are defined, these might include traditional large emitters such as utilities, construction companies, and other energy intensive industries (aluminum, cement, airlines). This may lead to a notable reduction in the investment universe which could lead to foregone return opportunities and potentially reduce overall portfolio diversification. Private industry will ultimately create new technology and fund the transition to a non-carbon based energy economy. Many existing traditional energy companies are leading the charge in this effort. It may make sense to maintain positions in a select group of these companies, rewarding the constructive leadership and governance influence they are having on their industries and globally. Manager limitations Full divestment will significantly reduce the manager opportunity set. Pros vs. Cons and unintended consequences could significantly impact the quality of the portfolio s risk/return profile and may not achieve the environmental benefits the divestment action may be trying to achieve. 10 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 10 of 19
Implementation Challenge: Availability of Managers Stock-pickers have >90% of global stocks available after excluding fossil fuels Of the global equity manager universe: 12% diligenced by C A 3% with screen possible (often with high minimums) 1% explicitly fossil fuel free Impact of Divestment on Universe of Available Stocks 2 8.3 1.1 5.4 Impact of Divestment on Universe of Available Managers 98 91.7 98.9 94.6 482 425 468 476 1 MSCI ACWI ex-coal MSCI ACWI ex Fossil Fuel Sources: MSCI, Cambridge Associates manager database. CU 200 Coal CU 200 Oil & Gas 1 Total Funds 11 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 11 of 19 57 Diligenced by C A 14 6 Screen Possible Only a tiny percentage of fund manager universe is fossil fuel free Explicity Fossil Fuel Free
If not Fossil Fuels, then what? Some of these sectors may not be well positioned for changes to economy such as recession or growth (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 12 of 19 12
Fossil Fuel Elimination Strategies Efforts Outside Investment Partial Divestment Full Divestment Pros: 1. Continues to maximize investment returns 2. May have larger environment impacts Pros: 1. Removes potentially highest polluting reserve holders without completely limiting the investment strategy Pros: 1. If NSHE sets this as policy, this is the most comprehensive set of restrictions. Cons: 1. May not drive an immediate change to the investment policy Cons: 1. Doesn t eliminate all fossil fuel holdings and may not satisfy our activist stakeholders. 2. May limit number of managers Cons: 1. Dramatically limits the number of managers available 2. May also reduce investments in companies that are leading and funding low carbon technologies Net Return Impact = Neutral Net Return Impact = Depends but costs likely Net Return Impact = Depends but costs likely higher Focus on whether investment strategy should lead NSHE in this effort or join with other System-wide efforts 13 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 13 of 19
Reduced Carbon Exposure Strategies Proactive Investment ESG Integration Pros: 1. Deploys capital toward solutions to environmental problems Pros: 1. Future-oriented investment perspective, emphasizes companies with environmental footprints Cons: 1. May invest in less proven technologies with higher risk and returns are less predictable Cons: 1. Doesn t eliminate all reserve holders and may not satisfy our activist stakeholders 2. May limit number of managers Net Return Impact = Neutral Net Return Impact = Depends but costs potentially higher Focus on market drivers in conjunction with environmental considerations (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 14 of 19
IMPLEMENTATION OPTIONS (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 15 of 19 15
Russell and Cambridge Implementation Processes Reduced carbon exposure strategy New customized account (Russell) Reorient the current custom portfolio to reflect mission objectives (Cambridge) Current investment strategies at both will continue even if higher environmentally aware strategies are dictated (both) Implementation timelines vary by investment type: Global equity, public real assets and fixed income (3-6mo) Alternate investments including legacy assets will take years Fees structures may be altered that could result in increases (primarily impacts Russell) Fossil fuel elimination strategy Either a new custom account (Russell) or a reorientation of the existing account (Cambridge) will be required Clear guidance from NSHE on what is and what isn t included in the exclusion Cambridge identified that they will need to terminate 2/3 of the current managers for their portion of the Endowment Managers available have shorter track records and historical lower value add than current manager set Timeline differs depending on investment types. Some could take only 3-6 mo, but for other public equities this could take 5 years in order to limit losses. Private investments would take longer than 5 years. (divestment advocates aware of these challenges) Fees structures could be altered but still might result in increased fees with some of the fee increases at both potentially offset by low fee passive strategies Both strategies have costs and benefits depending on the mission NSHE chooses to follow. Policy guidelines will be critical next steps in order to initiate either strategy. (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 16 of 19
SUMMARY AND NEXT STEPS 17 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 17 of 19
Summary and Next Steps NSHE has small exposure to Fossil Fuels Proactive investments and ESG integration are more widely practiced in institutional investment portfolios (not mutually exclusive with Divestment or each other) Investment committee direction 18 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 18 of 19
Supplemental Reading Fossil Fuel Divestment (2014, Cambridge Associates), which offers a framework for boards to evaluate whether and to what degree an investment portfolio should reflect ethical stances, in the context of the institution s unique mission and objectives. Considerations for ESG Policy Development (2017, Cambridge Associates & the Intentional Endowments Network), which describes how articulating Purpose, Priorities and Principles in a well-designed investment policy can help interested institutions effectively incorporate environmental concerns into their investment portfolios. Commentary by Pomona College president (and environmental chemistry professor) David Oxtoby from The Chronicle of Higher Education, Divestiture Is Nothing but a Distraction which argues for proactive solutions to address climate change, rather than what he calls the symbolism of divestment. Report to the Community from Columbia University s Advisory Committee on Socially Responsible Investing (February 2017) recommending a partial divestment from thermal coal: The Committee is aware that divestment from coal producers would be a form of symbolic speech. Other buyers will step in, stock prices will not directly be affected, and coal producers will not stop producing coal. Nevertheless divestment from fossil fuel producers has become the subject of an international campaign aimed at university endowments and others as a way to signal the seriousness of the climate change threat: a form of self-restraint that is meant to mobilize a broader public constituency The Committee regarded the existential nature of the climate change threat as sufficiently unique to distinguish this case of symbolic-speechthrough-divestment from possible proposals addressing other concerns. 19 (INVESTMENT COMMITTEE 09/06/18) Ref. INV-7, Page 19 of 19