Institutional Investors Embrace Combined Strategy Of Engagement And Divestment To Manage Climate Risks

Institutional investors are increasingly using a combined approach of engagement and divestment to address climate-related financial risks. A recent briefing note from the Institute for Energy Economics and Financial Analysis (IEEFA) highlights how investors are evolving their strategies beyond the traditional debate of whether to engage with or divest from fossil fuel companies.

As investors work to protect their portfolios from the impacts of climate change, they face a challenge. The energy sector, particularly fossil fuels, is closely tied to many climate issues. However, many companies in this sector are not making significant changes to their business practices. This leaves investors with the task of mitigating risks associated with their investments.

Connor Chung, a research associate at IEEFA and co-author of the report, explains that investors should use both engagement and divestment strategies to manage climate risk. Engagement involves working with companies to encourage them to align with climate goals, while divestment means selling off investments in companies that do not meet these goals. According to Chung, using both strategies can complement and strengthen each other. Engagement can be more effective when it is supported by the threat of divestment, and divestment decisions can reinforce overall stewardship efforts.

Traditionally, there have been two main approaches for investors dealing with climate risk: exit or voice. The “exit” approach involves selling off investments in sectors that are misaligned with climate goals, while the “voice” approach focuses on staying invested to influence corporate policies from within.

Recent evidence shows that these approaches are not mutually exclusive. For example, the New York State Common Retirement Fund and the Church of England have both reduced their investments in the fossil fuel sector after their engagement efforts did not lead to satisfactory changes. Despite this, they continue to engage with other companies and invest in climate solutions.

Dan Cohn, an IEEFA energy finance analyst and co-author of the briefing note, notes that as the role of fossil fuels in investment portfolios decreases, investors must reconsider whether maintaining investments in this sector aligns with their long-term financial and stewardship goals. The declining financial performance and uncertain future of fossil fuel companies raise questions about their value in investment portfolios and the broader impact on stewardship efforts.