As the race toward renewable energy and away from fossil fuels to address climate change heats up, more pension funds may look at divestment, willingly or otherwise.

According to a divestment commitment database maintained by Stand.earth, a climate action advocacy group, 1,591 organizations worldwide with a collective $40.51 trillion in assets have publicly committed to some level of fossil fuel divestment. Pension funds represent 11.7% of those commitments, compared with 35.8% from faith-based organizations, 15.7% from educational institutions and 11.9% from foundations.

The pressure on other pension funds, including the $456.7 billion California Public Employees’ Retirement System, Sacramento, and the $307.2 billion California State Teachers’ Retirement System, West Sacramento, to join that list is increasing from legislators in some states.

The boards of both California pension funds oppose pending legislation that would prevent new investments in fossil fuel companies and require divestment from such companies they hold byJuly 1, 2030.

CalPERS officials estimate that the transaction cost of divesting $9.4 billion in current holdings and reinvesting the capital into other investments would range between $75 million and $125 million. They and other pension fund investors also worry that divestment does not translate to better climate impacts, and would make it harder for investors alone or collectively to influence better behavior.

In Vermont, divestment legislation passed by the Senate and now before the House would require the Vermont Pension Investment Commission overseeing three pension funds to divest almost all fossil fuel company holdings by the end of 2030 and produce a divestment plan by Sept. 1, 2024. VPIC Chairman Thomas Golonka warned legislators that since the $5.5 billion Vermont State Retirement Systems, Montpelier, has only $1 billion in direct holdings and the rest in index funds that would have to be untangled or avoided, it would put Vermont at a significant disadvantage, while unwinding the funds’ private market programs would have “a material and immediate impact on state and municipality budgets.”

CalSTRS officials made a similar calculation about the pending legislation there. They calculated that if forced to divest companies getting more than 1% of revenue from fossil fuels — an estimated 159 companies worth $5.4 billion in holdings — it would create deviation from the benchmark, and those potential costs would increase CalSTRS’ unfunded liability and lead to higher state contributions, they argued.

In Maine, where a law enacted in 2021 requires the $18.5 billion Maine Public Employees Retirement System, Augusta, and the state treasurer to divest fossil fuel investments by Jan. 1, 2026, a November 2022 report by investment consultant NEPC LLC found that with 7.63% of pension fund assets invested in fossil fuels through most asset classes, there would be significant transaction costs, including discounts of 10% to 60% for divesting private market investments by the 2026 deadline.

The recent legislative proposals and laws do offer pension investment officials a buffer against immediate divestment: the caveat that such decisions must make fiduciary sense.

Rather than immediate divestment, pension fund investors like New York state Comptroller Thomas P. DiNapoli, sole trustee of the $242.3 billion New York State Common Retirement Fund, Albany, prefer other tactics to get away from the climate and financial risks posed by fossil fuel companies.

Along with pushing companies to set targets to reduce their greenhouse gas emissions and conducting risk analyses of its holdings, the New York pension fund committed $1 billion to funds tracking the MSCI World ex-USA Climate Change index, which overweights companies likely to benefit from a clean energy transition and underweights those at greater risks due to climate change. The pension fund will divest when consistent with fiduciary duty “and where the specific risk posed by a company’s failure to develop any meaningful climate transition plan is extreme,” its climate policy said.

The call for credible transition plans from fossil fuel companies does make it somewhat easier for pension fund investors to consider divesting from companies without them. The Public Sector Pension Investment Board, Montreal, overseeing C$230.5 billion ($172.3 billion), said that by 2026 it will cut in half holdings of carbon-intensive assets at companies without such transition plans.

Divestment vs. engagement

The £25 billion ($31.6 billion) National Employment Savings Trust, London, which in 2020 began divesting from companies involved in thermal coal, oil sands and arctic drilling, will be completely divested by 2025 unless companies “have a clear plan to phase out all related activity by 2030,” NEST policy said.

Officials at the Stichting Pensioenfonds ABP, Heerlen, Netherlands, with €480 billion ($528.9 billion) in assets, are comfortable with their 2021 decision to stop investing in stocks of fossil fuel companies and divest €15 billion of its assets by the first quarter of 2023. In a release announcing the decision, ABP said it did not anticipate a negative impact on returns as a result of that divestment, which it chose because it did not see sufficient opportunity as a shareholder to push for accelerated energy transition at the companies.

Many large institutional investors resist divestment dictates because of a preference for engaging with carbon-heavy companies on ways to improve. That is the case with Norges Bank Investment Management, the in-house manager of the Oslo-based Government Pension Fund Global, which has 14.44 trillion Norwegian kroner ($1.37 trillion) in assets. While NBIM considers risk-based divestment a last resort, by 2025 it said it will use “increasingly granular climate-related data” to inform investment decisions that could include divestment.

For the $1.3 billion Rockefeller Brothers Fund, New York, exposure to fossil fuels plunged to 0.3% from 6.6% in 2014 when it committed to divestment. As more countries and institutions commit to meeting the 1.5 degree Celsius target of the Paris Agreement, fund officials believe that more fossil fuel assets are likely to become stranded and lose value over time. With more institutions deciding to divest, and asset managers increasingly willing to offer fossil fuel-free funds, “we are confident that sound portfolios can be created without exposure to fossil fuels, and our investment performance since 2014 supports that belief,” they said in a recent update.

Asset managers are also feeling the heat. A May 5 report from financial think tank Carbon Tracker said that while asset managers publicly back efforts to limit global warming, they have invested $376 billion in oil and gas companies. That includes 25 members of the Net Zero Asset Managers’ initiative holding equity worth $4.6 billion in 15 of the largest oil and gas companies, according to the report. It warned that those managers “could be misleading clients and putting their investments at risk,” including regulatory risk due to a crackdown against greenwashing. The report also questions the compatibility of the managers’ index products with Paris Agreement goals, for similar reasons.

Engagement then exclusion

The fossil fuel divestment plans announced in 2021 by three out of five pension funds in the New York City Retirement Systems include asking all private markets managers to exclude upstream fossil fuel investments. If engagement with managers or companies whose core business undermines climate goals doesn’t work, the systems will consider excluding them, according to the climate action policy of the New York City Employees’ Retirement System; Teachers’ Retirement System of the City of New York; and Board of Education Retirement System of the City of New York, who together account for 73% of the $243.2 billion in total pension system assets.

Public pressure on private asset owners to divest is also expected to ramp up. A Stand.earth campaign is shining a spotlight on four private hospital systems whose pension funds have $4.6 billion invested in fossil fuels: the Mayo Clinic, Kaiser Permanente, Ascension Health System and HCA Healthcare. As one organizer of Stand.earth’s campaign, First, Do No Harm, put it, “The health sector divested from tobacco in the 90s, now it’s time we do it with fossil fuels.”