New Report: Divestment Would Cost Harvard, Yale, Columbia, MIT, and NYU More than $195 Million Per Year

New Report: Divestment Would Cost Harvard, Yale, Columbia, MIT, and NYU More than $195 Million Per Year

IPAA-commissioned study quantifies real-world cost of divestment for five leading U.S. universities with significant endowments

WASHINGTON, D.C. (Sept. 8, 2015) – As leading universities continue to reject demands from activists to drop their investments in oil and natural gas firms, new research commissioned by the Independent Petroleum Association of America (IPAA) and authored by a researcher from Caltech quantifies for the first time the actual, real-world costs that individual, select schools could expect by divesting.

Led by Dr. Bradford Cornell, a visiting professor of financial economics at Caltech and a senior consultant at Compass Lexecon, the study team analyzed the impacts of divestment on the endowments of five distinguished universities – Harvard, Yale, MIT, Columbia, and NYU. The report finds that the schools collectively could lose more than $195 million by divesting from fossil-fuel related equities – $195 million for each and every year the portfolios are active in the market.

“The fact that divestment has the potential to generate lower returns for schools and other institutions isn’t particularly earthshattering news,” said Dr. Cornell. “But the fact that the projected shortfalls associated with divestment are this significant, and this universal – that is the real critical finding here, and one that schools would be smart to evaluate as part of any discussion on divestment moving forward.”

Drawing on publicly available data and modeling thousands of different proxy portfolios for each school studied, Dr. Cornell and his team were able to approximate the composition of each school’s investment fund, and then analyze those portfolios’ performance under both divested and diversified scenarios. Among the schools evaluated, Cornell and his team found that Harvard would experience the most significant loss if it decided to divest – roughly $107 million per year. Yale’s losses are projected to exceed $51 million year per year. MIT would lose $17.75 million; Columbia would lose $14.43; and NYU would see a reduction of $4.16 million.

“This report adds to the growing body of research and real-world evidence out there showing that divestment is a bad policy based on a bad premise, with the potential to produce really bad outcomes for the schools and institutions that adopt it,” said Jeff Eshelman, senior vice president for operations and public affairs at IPAA.

This Cornell report builds off previous research by University of Chicago Law School professor Daniel Fischel that analyzed the performance of two investment portfolios over a 50-year period: one that included energy-related stocks, and another that did not. The Fischel report found that fully diversified portfolios generated average, absolute returns 0.7 percentage points greater than portfolios that excluded energy stocks — meaning the “divested” portfolio lost roughly 70 basis points relative to the optimal scenario for each and every year over the 50-year period in which the portfolios were active.

About the Independent Petroleum Association of America:

The Independent Petroleum Association of America (IPAA) is the leading, national upstream trade association representing oil and natural gas producers that drill 95 percent of the nation’s oil and natural gas wells. These companies account for 54 percent of America’s oil production, 85 percent of its natural gas production, and support over 2.1 million American jobs. IPAA is also proud to serve as a bridge that connects our members to the capital markets and investment communities through timely events and research, including successful Oil & Gas Investment Symposium events, NAPE summits and expos, and important reports on trends and movements in the financial sector.

Key Findings from the Report:

  • “Consistent with basic financial economic principles, divestment almost always generates long-term investment shortfalls due to reduced diversification, and the shortfalls are typically substantial, given the size and importance of the energy sector being divested.” (p. 3)
  • “The mean risk-adjusted shortfall due to divestment for a weighted average across the five universities is approximately 0.23 percent per year, each year.  This mean shortfall varies across the universities: 0.16 percent (Columbia), 0.30 percent (Harvard), 0.14 percent (MIT), 0.12 percent (NYU), and 0.21 percent (Yale).” (p. 4)
  • “As applied to these schools’ current endowments, shortfalls of this magnitude would translate to annual reductions in endowment value of $14.43 million (Columbia), $107.81 million (Harvard), $17.75 million (MIT), $4.16 million (NYU), and $51.09 million (Yale).  Therefore, these five schools alone stand to forfeit more than $195 million in investment returns each year, without changing portfolio risk.”  (p. 4)
  • “On a gross (not risk-adjusted) basis, the mean annual shortfall due to divestment for a weighted average across universities is 0.31 percent per year, and, for individual universities, the gross shortfall is 0.24 percent (Columbia), 0.37 percent (Harvard), 0.19 percent (MIT), 0.17 percent (NYU), and 0.33 percent (Yale).  Whether risk-adjusted or not, reductions in investment returns of these magnitudes would likely have a meaningful impact on universities’ ability to satisfy their institutional goals of research and education.” (p. 4-5)
  • “Using a weighted average across the five universities, fully 91 percent of these proxy portfolios produce a risk-adjusted divestment penalty over the past 20 years that would generate a shortfall for the endowment fund.  This indicates that, regardless of how successful my attempt to proxy for these schools’ endowment holdings is, it is in any case very likely that the actual endowments would experience a shortfall due to divestment.  Focusing on the five universities individually, the share of constructed portfolios for each university with a risk-adjusted shortfall is never less than 88 percent.” (p. 3-4)
  • “Sizeable declines in the endowment fund … would likely have material impacts on a university’s ability to achieve its institutional goals.  Specifically, endowments fund a material share of the operating budget for all five universities, and reductions in returns specifically harm key institutional objectives, such as funding research and student support.” (p. 10)
  • “Due to the plasticity of the capital markets and the diversity of investors worldwide, basic financial economic theory indicates that it is unlikely the divestiture movement, with or without any specific university’s participation, will have any material effect on the cost of capital of the divested companies or any other relevant outcome.  The history of prior divestment campaigns is consistent with this basic theory.” (p. 13)

New Report’s Findings In-Line with Statements from Experts and Prominent Universities:

  • Harvard Univ. (Mass.): “I also find a troubling inconsistency in the notion that, as an investor, we should boycott a whole class of companies at the same time that, as individuals and as a community, we are extensively relying on those companies’ products and services for so much of what we do every day.” (Letter from President Faust, Oct. 3, 2013)
  • “Divestment doesn’t affect the ability of fossil fuel companies to raise capital: For each institution that divests, there are other investors that take its place. As long as the world still continues to rely on fossil fuels, and consumes them at current rates, the companies that supply them will have a ready market for their products.” (Statement from Professor Robert Stavins, Harvard University, Aug. 10, 2015)
  • “Every bit of economic and quantitative evidence available to us today shows that the only entities punished under a fossil-fuel divestment regime are the schools actually doing the divesting—with virtually no discernible impact on the targeted companies.” (Statement from Professor Daniel R. Fischel, University of Chicago Law School, Feb. 9, 2015)
  • Tufts University (RI):  “Even the most conservative model showed that the endowment would experience a significant loss of return—$75 million in market value over the next five years—in large part because of our investments in commingled funds. o put the projected impact in perspective, $75 million would provide endowment income to fund scholarships for 100 undergraduates or annual stipends for 125 Ph.D. students, or fund the entire 2012 state appropriation for the Cummings School of Veterinary Medicine.” (Statement from President Tony Monaco, Feb. 12, 2014)
  • Pomona College (Ca.): “Far from being a minimal cost, Cambridge’s projections show that divestment would in all likelihood result in a total decrease in the endowment’s performance over a 10-year period of about $485 million. This loss of growth in the total endowment, caused mainly by the need to withdraw from the best actively managed commingled funds, would result in an estimated $6.6 million loss in annual spendable income for such things as financial aid, faculty and staff salaries and program support.” (Statement from College President David W. Oxtoby, Sep. 25, 2013)
  • American University (D.C.): “[D]ivesting from these [energy] companies would require that AU investments be withdrawn from index funds and commingled funds in favor of more actively managed funds. Cambridge has estimated this withdrawal would cause manager fees to double.” (American Univ. “Memorandum on Divestment,” Nov. 21, 2014)
  • Swarthmore College (Pa.): “The documents lay out the College’s estimate that divestment from fossil fuels would cost a total of at least $200 million (cumulative) over the next ten years. The value of the College’s endowment was approximately $1.5 billion as of June 30, 2012.” (“Swarthmore Pegs Cost of Divestment at $200 Million Over 10 Years,” Swarthmore Daily Gazette, May 9, 2013)
  • Univ. of Tennessee: “Last year, 90 percent of the endowment’s payout went to supportive scholarships, instruction, and research. Eliminating a broad segment of the market from investment could hinder future funding of these endeavors.” (Letter from Board of Trustees, Dec. 13, 2013)
  • University of California, Berkeley: “The majority of Task Force members believe that the cumulative benefit from the University’s divestment from fossil fuels would not outweigh the total costs incurred from the divestment of fossil fuels from the University’s $91 billion investment portfolio.” (Board of Regents Task Force on Sustainable Investment, Sept. 12, 2014)
  • Bates College: “In either scenario, the transition would result in significant transaction costs, a long-term decrease in the endowment’s performance, an increase in the endowment’s risk profile, and thus a loss in annual operating income for the college. Such a reduction in resources would affect critical college priorities, including financial aid, faculty and staff salaries, and support for academic programs. In short, divestment would potentially threaten core aspects of the college’s mission.” (Statement from College President Clayton Spencer, Jan. 21, 2014)

About the Author:

Bradford Cornell is a Visiting Professor of Financial Economics at Caltech and a Senior Consultant at Compass Lexecon.  Prior to joining the Caltech faculty, Dr. Cornell was the Bank of America Professor of Finance at the Anderson Graduate School of Management, University of California, Los Angeles, where he taught for 26 years.  He was also the founder of FinEcon, a financial economic consulting firm that merged with Charles River Associates (CRA) in 1999. In his academic capacity, Professor Cornell has published approximately 100 peer reviewed articles on a wide variety of financial topics.  He is also the author of Corporate Valuation: Tools for Effective Appraisal and Decision Making, published by Business One Irwin, and The Equity Risk Premium and the Long‐Run Future of the Stock Market, published by John Wiley.  Professor Cornell is also one of most experienced expert witnesses in the field of complex financial litigation, and has provided testimony and expert analysis in many of the largest and most widely publicized finance related cases in the United States.

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