divestment

On September 9th, Harvard President Larry Bacow provided an update on how the university is addressing climate change, including in its investment portfolio.  In a letter sent to all students, faculty, and alumni, he characterized the issue as "the most consequential threat facing humanity" and briefly summarized three main fronts on which the university is engaging with the problem: investments, research and teaching, and on-campus sustainability practices. If one reads through his letter quickly, it's easy to conclude that the university is effectively divesting from fossil fuels.  

Indeed, much of the press coverage on the letter has framed Bacow's statement as de facto divestment even though that word was never actually used.  Here's a sampling of headlines:  from the Washington Post:   "Harvard, America’s richest university, will divest from fossil fuels"; the New York Times: "Harvard Says It Will Not Invest in Fossil Fuels"; the Harvard Crimson: "Harvard Will Move to Divest its Endowment from Fossil Fuels"; The Hill: "Harvard announces divestment from fossil fuels".

Directionally, it's important to recognize that Bacow's letter is a positive step in decarbonizing the portfolio; and further, that this step likely would have taken much longer to achieve had there not been intense and sustained engagement on the issue by faculty across most Harvard schools, generations of students, and many prominent alumni.  His letter is a formal, top-level statement that the University plans to steer clear of new investments in fossil fuel extraction, and not just in public companies but in its private equity portfolio as well.  Importantly, Bacow also highlights an already growing effort by Harvard Management Company to invest in climate solutions, and indicates this will be a long-term focus in the portfolio.  

Bacow's letter also includes interesting language on investments in fossil fuel extraction and aligning investment decisions with the university mission:  "Given the need to decarbonize the economy and our responsibility as fiduciaries to make long-term investment decisions that support our teaching and research mission, we do not believe such investments are prudent."  People with whom I've spoken view this phrasing as a response, and perhaps a parry, to a recent complaint brought by a variety of Harvard stakeholder groups to the Massachusetts Attorney General.  This complaint argued that fossil fuel investments violated Harvard's original charter from the state (general descriptions of the complaint and its history here and here). 

Unfortunately, as has also been the case with earlier statements and reports by both the University and Harvard Management Company, there's some finessing of language going on as well.  Those missing details matter a great deal in terms of how much pressure Harvard administrators and portfolio managers feel to move expeditiously towards decarbonization, how quickly shortfalls will be discovered, and what leverage others have to encourage mid-course corrections.  Absent additional statements or actions, these omissions mean that the speed of investment restructuring will be slower, and the breadth narrower, than President Bacow's letter implies. 

The remainder of this post goes through the specific wording of the letter, highlighting places where that language creates likely gaps in the decarbonization process. 

Parsing President Bacow's letter on fossil fuel investment

Here are some of President Bacow's specific points, followed by my thoughts:

1)  Commitments are informal statements of intent, without binding language and interim deadlines

President Bacow: As we reported last February, HMC has no direct investments in companies that explore for or develop further reserves of fossil fuels. Moreover, HMC does not intend to make such investments in the future.

• Private equity is clearly placed within the school's domain of action.  Harvard has very few direct investments in publicly-traded companies in any industry, and within that subset (which is reported quarterly to the SEC), we've known for some time that there are no upstream fossil fuel companies.  What is potentially new is the implication that even directly-held upstream producers that are not publicly traded will be excluded from investment, which is an improvement.
   
• Letter includes commitments and promises, but nothing binding.  While the indication that HMC does not "intend" to make such investments in the future is potentially promising, there are no formal restrictions on what they can and can't do.  The investment team continues to have wide discretion to change their investment focus at will. Further, based on current levels of investment disclosure, unless Bacow or HMC told us, we'd never know their intent had changed.  In contrast, Columbia University has formalized exclusions, and has also included a broader array of fossil fuel activities as subject to their new investment guidelines.  
   
• Interim deadlines and timelines have still not been released.  Aside from a 2050 net zero target, Harvard does not have a timeline by which to exit key fossil fuel-related sectors.  It needs one.  Georgetown University, for example, set a five year exit window for publicly-traded investments and a ten year exit window for privately-held firms. 

2)  Included sectors are narrowly cast; many large and important economic sectors, investment vehicles, and asset types appear to remain outside of Bacow's statement 

The exclusionary language in Bacow's letter includes only "companies that explore for or develop further reserves of fossil fuels." Up-stream development of new coal, oil, and natural gas reserves is very much an activity that will contribute significantly to future atmospheric loadings of greenhouse gases, so excluding them is beneficial -- particularly if copied by other large institutions.  However, Bacow's framing follows the carefully crafted language in HMC's first Climate Report earlier this year, which left out a great deal.  As I noted in my review of the Climate Report:

So, what does this narrow definition leave as an allowable investment, untouched and unreported? Apparently:

• These exact types of firms, if held in commingled portfolios such as mutual funds, ETFs, or more diversified private equity, venture, or hedge funds (i.e., investments not "held through dedicated externally managed funds"). 
   
• Other portions of the fuel cycle, such as pipelines, storage, refineries, compression stations, export terminals, or LNG or oil tankers. 
   
• Fossil-intensive industries, including not just energy-intensive industries like cement, but also natural-gas and coal-fired power plants. 
   
• And it even seems to leave in firms that are working their existing reserves of fossil fuels, so long as they are not developing new ones.

All of these issues remain today.

3)  Roll-off period of private equity will be longer, though is not a concern to me; what is a concern are all of the other asset classes that seem to be ignored

President Bacow: HMC has legacy investments as a limited partner in a number of private equity funds with holdings in the fossil fuel industry. These indirect investments constitute less than two percent of the endowment, a number that continues to decline. HMC has not made any new commitments to these limited partnerships since 2019 and has no intention to do so going forward. These legacy investments are in runoff mode and will end as these partnerships are liquidated.

• A slower roll-off of private equity fossil fuel holdings is common across many universities; the actual pace could be faster than expected.  The intention to make no new capital commitments to fossil fuel extraction via private equity partnerships is a notable improvement from past statements. Bacow notes that Harvard's fossil fuel exposure in this asset class will run off over a period of years, which is to be expected given the structure of these vehicles.  Harvard's annual Financial Report lists the remaining duration of its private equity funds of between 2 and 10 years, so this could take a while.  However, I see this as an area where things may end up better than expected in terms of timing.  Because there is a secondary market even for private equity portfolios, it is very possible that HMC will be able to exit the most problematic of these positions on reasonable terms by selling them to other parties, and could implement these sales well before the funds wind down on their own. The University's past holdings in farmland are illustrative:  through sales and spinoffs, HMC CEO Narv Narkemar cut the natural resources share of Harvard's portfolio from 9% in December 2016 when Narkemar arrived to 2.6% in June 2020. 
   
• More problematic is the lack of clarity on other asset classes within Harvard's portfolio.  As of June 2020, the portfolio was allocated 23% to private equity.  Bacow says less than 2 percent of this is related to fossil fuels, though based on my review of past HMC statements, this could refer to the share of all private equity holdings period, or just to the share of energy-focused funds (ignoring more mixed funds that may also contain some oil and gas).  It likely excludes fossil fuel investments outside of upstream extraction.  On the public equity side, the FY 2020 Financial Report notes publicly traded stocks are 19% of the portfolio, but we know from 13F filings with the SEC that less than 2% of the endowment is in the form of directly-held stocks or exchange traded funds.  Public equities outside of the SEC filings may or may not be getting counted in Bacow's statements; if they are not, it implies that as little as a quarter of the portfolio (23% private equity plus 2% directly held, SEC-reported public equities) is directly covered by Bacow's divestment statements -- with the remainder in investment vehicles that are harder to track..
  
  Could Bacow and HMC be including more of the portfolio in their forward-looking commitments to exit fossil fuels?  It is possible.  But absent clearer statements and must better disclosure of holdings, one should be wary about the breadth of what is being culled.  Many other endowment and pension funds already do much better disclosure of holdings in every asset class than Harvard does now or has committed to in the future.  Harvard needs to improve greatly in this area. 
   
• Hedge funds will be a particular challenge.  Indications from the university are that even the investors within many hedge funds have little visibility on the underlying holdings.  Further, these holdings can change rapidly over time such that company- and sector-exposures at the end of a reporting period (when investors have some visibility on holdings) may be quite different from what the fund held in the middle of a reporting period.  Since hedge is the single largest asset class in the portfolio as of the 2020 Financial Report (36.4%), the inability to track and report the carbon impacts or even sectoral holdings within hedge investments is a big problem. 

4)  Green investment is great, but not all that claims to be green really is; transparency on holdings even for climate positive investments is needed

President Bacow:  HMC is building a portfolio of investments in funds that support the transition to a green economy. In addition, the University has made investments alongside MIT in The Engine, a fund that, among other things, seeks to accelerate the development of technologies that promise to address the challenges posed by climate change.

• Hunting strong investment options in decarbonization both alone and with MIT is a good strategy.  The investment in firms involved with greening the economy is a plus, as is the partnership with MIT in identifying and funding some of these initiatives. While MIT and Harvard routinely compete with each other, pooling efforts to identify and fund some of these areas should be beneficial to all.  
   
• But external transparency is needed if claims of progress are to be trusted.  In the same way that disclosing HMC's company-level investments is needed to evaluate whether they are decarbonizing the portfolio in an effective and timely manner, so too is that disclosure needed on the "green" initiatives.  Too many investments claiming to be green end up being mostly greenwashing and move the needle little or not at all on decarbonization.  While sometimes this is the result of deception by investment promoters, it need not be purposefully misleading to be a problem for Harvard achieving its 2050 net zero goal.  For example, some vehicles are trying to fund the "green" portion of a very polluting company overall (e.g., with many green bonds); or an idea seems intriguing until it is scaled to displace existing practices at which point the environmental problems of the "solution" become impossible to ignore (corn ethanol, for example).  In other cases, the initiatives may be well meaning but ineffective -- with little chance to grow at scale within the time frame needed to stabilize atmospheric carbon.  I would put most new nuclear technologies into this camp (though obviously others, including The Engine run by MIT, disagree).  And in others, they are game changing and warrant much larger allocations of capital. 
  
  Obviously HMC will try to separate these categories itself.  But it's staff is small, the vetting is not easy, and external visibility of the decisions made on both decarbonization and green companies is needed to tighten and improve the decisions made over time.  These disclosures can be made with a delay of 12-18 months to protect HMC's competitive strategy, but they do need to be made.

5)  Committing to net zero by 2050 is merely a talking point if not supported by staff, timelines, and transparency

President Bacow:  HMC was the first endowment in the country to commit to achieving net-zero greenhouse gas emissions across the entire investment portfolio by 2050.

• Harvard still lacks formal milestones and adequate disclosure.  This is a great target, but at present lacks interim milestones, a team large enough to carry it out, and virtually any disclosure of investment holdings.  The school is also working to develop it's own brand new method to measure the carbon footprint of these firms.  To the extent this measurement holy grail becomes the enemy of the many, many things Harvard can do with much cruder information, we are in trouble.
   
• Much more on the limitations in Harvard's current net zero approach and how to address them in this publication. 

Earth Track's Earlier Work on Decarbonizing Harvard's Portfolio

Investment Disclosures by Asset Class: Current Practice at Harvard Compared to Other Large Funds (July 2021)

Decarbonizing Harvard’s Endowment:  Reviewing Harvard Management Company’s First Climate Report (May 2021)

Reducing the Carbon Footprint of Harvard’s Endowment: A Review of Information Gaps and Potential Leverage Points (September 2019)

Decarbonizing a large financial portfolio is a complicated task.  Investment managers and their fiduciaries need to ensure that institutional requirements can continue to be met even with greenhouse gas constraints on investment choices.  Selecting what to cull and what to keep is not always straightforward.  Once beyond the most obvious fossil fuel extraction companies, identifying which firms are acceptable investments in a carbon constrained world becomes more gray.  There are greenhouse gas-intensive firms in other sectors.  There are firms that are efficient producers within their sector, but still more carbon-intensive than alternatives once a slightly longer time frame is incorporated.  Lines of business (such as finance or retailing) that appear to have low direct emissions from the consumer-facing portion of the industry, yet be linked to quite substantial emissions once their supply chains, borrowers, or embedded emissions in products (e.g., with refrigeration or air conditioning) are taken into account. 

Read Earth Track's Analysis:  Investment Disclosures by Asset Class -
Current Practice at Harvard Compared to Large Funds

And measuring climate impacts remains an imperfect process, with sometimes wide disparities in how different tracking organizations evaluate carbon impacts of the companies they monitor.  Further, the depth and breadth of coverage and evaluation drops off sharply as one moves from publicly-traded firms to private; from large firms to smaller; and from highly-analyzed developed market firms to developing and frontier countries.  State-owned enterprises, big players in oil and gas around the world, do not always publish reliable and transparent books of account.

Further, if the world progresses as needed to address the threat of climate change, it is clear that many of the firms and industries deemed acceptable in a 2021 portfolio will no longer be so in 2025, 2030, and beyond.  Indeed, the evaluative process will need to be continuous and dynamic.

True, many of these problems will improve over time.  But that time will measure in decades, not years; and each step will be a potential battle.  The Financial Accounting Standards Board, set up to establish standardized rules for corporate financial reporting, is nearly 50 years old.  And yet it continues to grapple with new challenges year-in and year-out.  ESG standards are more wide ranging and often more difficult to quantify.  Further, at least at present, there is less pressure on firms to adopt and apply them.  Consider that with financial reporting, even a small privately-owned firm in a sector with no public-facing reputational risk needs to take on bank loans, and the banks will require audited and accurate financial statements.  The insurers will want reliable financial information, as will many customers.  A similarly-situated firm in an environmentally-problematic industry will not see the same pressure to rigorously adopt standardized environmental reporting. 

Because decarbonizing a multi-billion dollar endowment is a process rather than a statement or an event, one needs to pay careful attention to the checks and balances, the disclosures, and the oversight of actions and procedures that the investment managers and their overseers put into place.  End goals are important, but not without interim milestones that are both concrete and verifiable.  Public commitments are commendable, but not without public disclosure that allows others to see, evaluate, and critique the progress, or lack thereof.  

The good news is that while it is very hard to cost-efficiently pull CO2 out of the air, it is much less hard to establish a robust set of checks and balances on endowments.  These oversight mechanisms can both protect the core (and real) needs of investment managers to move quickly and strategically on their investment strategy, while also ensuring detailed disclosure of those investments over time such that key stakeholders are able to see regular and systematic progress in the endowment's transition to net zero and beyond.

A key element in this oversight is much more extensive disclosure of investment holdings than what Harvard currently does.  Earth Track's review assesses Harvard's endowment asset-class by asset-class.  How big is each category in terms of total holdings?  What has the university committed to do in terms of disclosure and decarbonization?  What should disclosure look like for each asset class, and where are other large investment funds already disclosing much more detail than Harvard does, and yet surviving just fine?

Harvard Management Company (HMC), which manages Harvard University’s nearly $42 billion endowment, released its first Climate Report in February 2021.

As the largest university endowment in the world, decisions Harvard makes to tangibly and materially reduce the climate impact of its investments will garner significant attention around the world and provide space for many other institutions to make similar moves.  Further, the school has the scale and the stature to coordinate with other institutional investors and accelerate the pace of financial innovation across asset classes to more effectively integrate climate-related criteria.  The reverse is also true:  when Harvard does little or nothing, it provides an excuse for other institutions to delay restructuring as well.  

Read Earth Track's detailed review of HMC's Climate Report here

The issue of decarbonizing the endowment has been discussed for years, though with very little real change in investments.  Perhaps as a result, Harvard Faculty of Arts and Sciences (FAS) formally voted 179 to 20 to support divesting the portfolio of fossil fuel assets at their February 2020 meeting.  The vote included an amendment to decarbonize the entire endowment in accord with IPCC climate projections.  Thus, the FAS faculty also voted to decarbonize the endowment. 

At the time, Harvard President Larry Bacow committed to bringing the faculty motion to the Harvard Corporation for consideration.  Bacow summarized the Corporation’s response in a June 2020 written communication.  It read, in part:

Harvard’s endowment should be a leader in shaping pathways to a sustainable future. With this in mind, the Corporation has directed the Harvard Management Company (HMC) to set itself on a path to decarbonize the overall endowment portfolio—a move in step with the final element of the resolution adopted by the Faculty in February. In particular, the Corporation has instructed HMC to develop a strategy for the endowment to achieve net-zero greenhouse gas emissions from the portfolio by 2050. This will require developing sophisticated new methods for measuring emissions associated with the investment portfolio and then for systematically reducing them across the full breadth of the portfolio. We believe that this approach, which considers the investment portfolio as a whole, rather than simply targeting the suppliers and producers of fossil fuels, is the right one for the University to pursue.

The first public step along that strategic process was to be the creation of a public climate report by HMC.  There were some positive elements to, and disclosures in, the report.  However, its scope and depth were underwhelming; so too were the framing and reporting choices made by HMC.  Key changes needed include:

• Convert the Climate Report from an ad hoc policy summary to a rigorous presentation of progress and challenges.  HMC should formalize that the Climate Report will be an annual publication, with a specific release date.  Additional changes:
   
  • Like a financial report, the annual Climate Report should include a standardized set of sections, including both qualitative and quantitative.  This will ensure consistent and comparable reporting over time.
  • Report authors and reviewers should be listed individually all future documents.  Any advance approval by parties outside of HMC and its climate team for data included in the report needs to be disclosed.
  • For each third-party organization to which HMC or Harvard has joined to leverage its decarbonization effort, the Report needs to include the data reported to that organization, which data elements are not made public, specifics on why that data has retained confidentiality restrictions, and options to address those constraints going forward.
  • The Report needs to include a section on the available financial and personnel resourced to achieve the net zero targets, an evaluation of its adequacy, and a plan to rectify shortfalls if they exist.
     
• Robust interim targets.  Harvard needs to set formal interim targets and reporting milestones during CY2021 that map out its path to net zero by 2050.  Milestones need to include not only emissions, but disclosure transparency on holdings and company-engagements as well.
   
• Full transparency on holdings.  Company-level (not fund-level) disclosure of endowment positions across all asset classes should be implemented as soon as possible.  During 2021, HMC should provide a listing of each asset class, what information is already available to others – whether released in financial filings or assembled by third-party data providers like PitchBook and Preqin, and outline a path to present investment-level holdings for all asset classes to the public via the HMC website.  While there may be appropriate guardrails on when something is released or in what form, HMC needs to present a plan to go from no-release to full look-through transparency.
   
• Modernize shareholder committees.  Harvard needs to update its oversight shareholder committee structure, first implemented nearly 50 years ago, to reflect the current investment environment, and to summarize its recommendations in a publicly released white paper.

As the manager of the largest university endowment in the world, Harvard Management Company (HMC) faces significant challenges.  The investment returns are what enable Harvard University to grow, hire top-quality professors, and cover tuition for bright students from all over the world regardless of their financial circumstances.  So there is appropriately a tremendous focus on market-beating returns.  And yet the scale of the endowment brings with it responsibilities to invest morally as well, in alignment with the mission and goals of the school; to focus on long-term sustainable growth rather than short-term returns; and to fund ideas that can make money while also solving complex societal problems.

While most of my work has focused on subsidy reform as a key lever for transitioning economies to a carbon-neutral path over time, the deployment of institutional capital in a climate-responsible way is another important and powerful component of this needed economic transition.  This paper examines the transparency and climate alignment of Harvard's investment portfolio.

View working paper Reducing the carbon footprint of Harvard's endowment

Although Harvard Management Company has signed on to a number of initiatives and networks related to sustainable and socially responsible investment, the visibility on implemented practice and specific investments is very limited.  There may be a great deal of data, discussion, and analysis behind the scenes, but in terms of public transparency and accountability, Harvard's control system is weak.  At present, there is no way for independent parties to review public information and evaluate the specific investments in the portfolio.  Similarly, one can't tell whether Harvard's integration of environment, social, and governance factors in investment review and deployment is robust and effective or mostly symbolic. 

Data needs to be public for there to be a strong system of accountability.  External analysts often ask different questions or vet decisions in ways that HMC may not have thought of or may not wish to do.  And publicity greatly reduces the latitude for practice to lag pronouncements. 

Further, the knowledge that investment decisions within HMC will eventually be public -- even if delayed somewhat to protect HMC's competitive advantage -- ensures that ESG factors are evaluated more completely now.

Data on current levels of disclosure present a fairly stark picture.  More than half of Harvard's portfolio is invested in hedge, private equity, and natural resources -- for which there is no line-item detail.  Only 13% of total holdings have "level 1" prices -- those set through market buying and selling on a frequent basis.  Even more striking is the mandated reporting to the Securities and Exchange Commission (13F filings) of line-item detail on holdings.  Because the rules apply to only a subset of investments (primarily directly-held US equities), and Harvard relies on more complex forms of investment, the reported holdings comprise less than 1% of the investment portfolio. 

One percent is extraordinarily low, but it gets worse.  Fossil fuel divestment proposals, which have been proposed by a number of groups within the Harvard community, wouldn't even apply to this full 1%.  Based on patterns set with Harvard's tobacco divestment in 1990, commingled structures such as exchange traded funds that hold a slice of a basket of stocks would not be affected by a decision to divest.  Harvard's holdings that are both publicly-reported in the 13F and subject to divestment decisions comprised only about 0.7% of the total portfolio.  And within this very small group of stocks listed in the last two 13F filings, there was not a single firm from the fossil fuels sector.

Unfortunately, this doesn't mean that the University has already dealt with climate in its investments.  Rather, it indicates that divestment efforts as they have generally been formulated would leave significant concerns on what was going on in the other 99% of the investment portfolio, and whether and to what degree those other investments were aligned with the University's climate goals. 

The immediate challenge put forth in this paper is how to identify practice and disclosure improvements that create a real system of accountability with respect to climate, while also protecting HMC's ability to act flexibly and quickly on investment opportunities.  The paper suggests this is a solvable problem, and that significant transparency improvements on climate-relevant investments could be implemented quickly.