A financial argument against divestment

On tomorrow’s College Council ballot, students will be asked whether they “agree that Williams College should divest its endowment from the 200 fossil fuel companies with the most carbon remaining in their reserves.” This well-intentioned referendum fails to recognize that the cost of compliance would be far greater than that of simply removing 200 large companies from the College’s investment universe. To make divestment look more feasible than it is, proponents have made misinformed comparisons between the College’s current and past divestment drives, as well as between Williams and other colleges. In reality, divestment is incompatible with the structure of the endowment, and students should reject it on the ballot.

An overview of the endowment is in order. Currently valued at $2.3 billion, this fabled pool of capital supports over 40 percent of the College’s operating budget. To compensate for these outflows, which consume about five percent of the endowment each year, the College puts its money to work in the global financial markets. It does not invest independently, however, preferring instead to allocate its capital among various external managers. These managers serve many clients, and, because they limit the sizes of their funds, still more are waiting in line. The upshot is that the endowment is composed not of individual securities that the College can buy or sell, but rather of several dozen contracts to which the College is an easily replaceable party.

Suppose the College told its fund managers that it would terminate its relationships with them unless they promised not to hold shares of certain energy firms. They would, of course, show the College to the door. Cambridge Associates (CA), a consultancy that advises university endowments, notes in a research report that divestment would therefore “require a large shift of assets and managers.” Rebuilding the balance sheet would be expensive; the College would have to hire additional staff. More importantly, the building blocks of the new endowment would have to be sufficiently green, even though most investment managers are not. This constraint, CA continues, would limit the College’s “ability to diversify risks and opportunities.” For example, “there are few institutional-quality substitutes” for hedge funds, which today manage the majority of the College’s portfolio. In short, divestment would upend the endowment without leaving satisfactory alternatives.

It is instructive to take a closer look at the opportunity costs of divestment. Over the last five years, the endowment recorded annualized returns of 13.4 percent net of fees. Meanwhile, the composite benchmark against which the College measures its investment performance grew by 10.9 percent. (Earlier benchmark data was not available.) The main reason the College has been able to beat the market is that it has won access to lucrative, sought-after hedge funds and private equity managers through its alumni network. If it replaced them en bloc with middling green alternatives, it would lose this edge, which over the last half-decade translated into almost $50 million per year. In a more detailed analysis, CA found that Pomona College, whose $2.1-billion endowment is structurally similar to ours, would forgo an annualized $48 million if it divested. (Pomona decided not to divest.) Our financial aid budget this year was, incidentally, $48 million. Divestment would obviously not bankrupt the College, but it would be enormously expensive.

Proponents of divestment may object that the College has offloaded sinful securities in the past. But when the College sold its apartheid-tainted South African interests in 1980, endowment management was a different enterprise altogether. Comingled hedge funds and private equity partnerships did not factor into the typical college portfolio, which comprised a few domestic mutual funds at best. Divestment would have been relatively easy and inconsequential. Also, the College’s exit from Sudan in 2006 involved only directly held stocks, not the broader portfolio. (It is far easier to sell direct holdings than to extricate oneself from comingled funds.) These divestment scenarios are not comparable with what is on the agenda today.

Other institutions have divested, it is true. Stanford University, for example, recently promised not to “make direct investments of endowment funds in publicly traded companies whose principal business is the mining of coal for use in energy generation.” There are so many caveats here, however, that the holdings in question probably comprise less than 0.1 percent of Stanford’s portfolio. (Stanford Management Company has not disclosed the exact figure.) None of the remaining 18 U.S. colleges that have divested has an endowment in the top 150. This implies that their portfolios are less complex than ours as well as less essential to operations. Their divestment is therefore analogous to the College’s in 1980; Stanford’s is similar in scale and consequence to the College’s in 2006. In short, comparisons with other colleges that have divested to date are not very helpful.

There are other reasons to divest. Climate change will lead to economic and geopolitical turmoil throughout the world, and institutions such as ours have a responsibility to take action. But the benefits of divestment, which are intangible, must be weighed against its opportunity costs, which would accrue to hundreds of millions of dollars in the intermediate term. Over the past decade, the College has drastically raised tuition, reintroduced student loans, curtailed need-blind admission to international students, frozen staff salaries and closed two dining halls. Just as divestment would further the College’s worldly mission statement, so, too, most of these cutbacks run counter to it. Students should reflect on these tradeoffs before voting tomorrow.

Kristian Lunke ’16 is a math and history double major from Oslo, Norway. He lives in Morgan.

  • Michael Nixon

    The demand of the Divestment movement is not that the college snap its fingers and be divested. It will take time. What other schools have done is agree that divestment is the right thing to do, morally and politically, and announce that it is divesting. Then it takes some time to actually get the fossil fuel companies out of the portfolio, first the direct investments, then the indirect investments. The message goes out now, without the harm done by the chaotic rushed process envisioned by the author.