Is full divestment the only path to sustainable investing?

The debate around divestment has been ongoing for years. As investors increasingly focus on sustainability, divestment—particularly from fossil fuels—has become a popular topic. But is it truly the best approach? Or are there alternatives to divestment in sustainable investing that can also achieve impactful outcomes?

Understanding divestment

Divestment refers to the act of pulling investment funds out of industries or companies because you object to their practices, products or services. For example, you might consider them to be harmful to the environment or society. The fossil fuel industry is a frequent target of divestment campaigns with an estimated $40.76 trillion divested to date.^[1] The idea behind this strategy is twofold: first, divestment serves as a moral statement, and second, it aims to financially pressure companies to change their practices by cutting off capital.

The advantages of divestment

1. Moral clarity: Divesting from industries that contribute to climate change or environmental harm offers clear moral ground. Investors send a powerful message by refusing to profit from environmentally destructive activities.
2. Raising awareness: Divestment can raise public awareness. Major institutions, from universities to pension funds, have made headlines by committing to divest from fossil fuels. This visibility helps to spotlight the broader conversation about the role of finance in climate change.
3. Potential financial impact: Advocates of divestment argue that pulling capital from harmful industries could raise their cost of capital, making it more expensive for these companies to operate. Over time, this could contribute to the decline of industries that are not aligned with sustainable practices.

The considerations with divestment

Despite its appeal, divestment has limitations that are important to understand when exploring alternatives to divestment in sustainable investing.

1. Limited financial impact: One of the major considerations of divestment is that its direct financial impact on companies may be limited. While divestment can raise the cost of capital for these companies, it’s unclear whether this effect is solely due to divestment. Broader market forces, such as the growing awareness of climate risks, also contribute to the rising costs for unsustainable industries, making divestment just one of many factors.
2. Lack of engagement: Another consideration with divestment is that it leaves little room for investor engagement. Once investors divest, they lose their influence over the company. Instead of pushing for change from within, they relinquish any potential voice they may have had as shareholders. This can be seen as a missed opportunity to guide companies toward more sustainable practices.
3. Oversimplification of complex issues: Divestment can sometimes oversimplify complex economic and social issues. Entire industries—like energy, transportation, and manufacturing—are deeply embedded in the global economy, providing jobs and infrastructure. Divesting without considering the broader social impacts, such as job loss and economic displacement, can be seen as short-sighted.

Engagement vs. divestment

As an alternative to divestment, investor engagement is an effective way to influence corporate policies. With engagement, instead of taking money out of the company that is considered harmful, an investor keeps their money invested so they can have a seat at the table and directly influence corporate policies. This can be particularly effective in industries where change is possible and where companies are open to dialogue.

Divestment, on the other hand, is a more direct and immediate way to withdraw support from harmful practices. When well-known investors do this, it can stimulate others to follow. A comparative analysis of these strategies can help investors determine the best approach for their specific goals and values.

Engagement and divestment are often seen as opposing strategies, but they can and should be considered complementary. Investors can divest from the worst offenders while engaging with others to drive positive change. This strategy can maximise impact and support the transition to a more sustainable economy. For example, an investor might divest from coal and oil companies with a track record of resisting change, while engaging with oil and progressive gas companies to encourage a shift towards renewable energy.

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Exploring other alternatives to divestment in sustainable investing

While divestment has its merits, it’s not the only way for investors to align their portfolios with their values. Several alternatives to divestment in sustainable investing exist which can drive impactful change without requiring an all-or-nothing approach.

Transition finance

One of the main alternatives to divestment in sustainable investing is transition finance. This strategy involves providing capital to help companies in carbon-intensive industries, such as energy, pivot toward sustainability. Rather than abandoning these companies, transition finance focuses on supporting their evolution, allowing them to invest in greener technologies and practices.

Unlike divestment, transition finance encourages active investor engagement, where milestones are set, and companies are held accountable for their progress. This hands-on approach can push businesses to move toward a more sustainable future, without leaving them behind entirely.

The benefits of transition finance include its ability to directly influence the change needed in carbon-intensive sectors. Unlike divestment, it allows investors to work with companies to ensure they are on a path toward sustainability. However, a key consideration is that it requires active management and regular engagement, which may not appeal to all investors.

Solutions-based investing

Another compelling alternative is solutions-based investing, which directs capital toward companies that are already offering solutions to environmental and social challenges. These might include companies involved in renewable energy, sustainable agriculture, or innovative technologies that reduce waste.

One of the biggest benefits of solutions-based investing is its straightforward impact. By investing in companies that are part of the solution, investors can help accelerate the development and deployment of technologies that tackle global challenges like climate change. For example, investing in clean hydrogen technology, such as that explored in Michael Liebreich’s Hydrogen Ladder,^[2] helps support the growth of future-fit industries.

However, solutions-based investing isn’t without risks. One consideration is that even the most forward-looking companies can face challenges, such as scalability, competition, and ESG concerns. Investors need to be diligent in assessing the long-term viability of these companies.

Combining strategies for maximum impact

When evaluating the alternatives to divestment in sustainable investing, it becomes clear that a combination of strategies may offer the most effective path forward. Divestment can send a powerful message, but in some cases other strategies, like transition finance and solutions-based investing, offer pathways to make an even greater impact.

We believe that understanding where we can have the most influence is critical. For us, that often means focusing on solutions-based investing, where our capital directly supports companies that are working to solve the pressing environmental issues of our time. However, we also recognise the importance of transition finance, especially in industries where transformation is both necessary and possible.

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Conclusion: weighing up both sides of the divestment debate

While divestment offers moral clarity and raises awareness, its financial impact may be limited, and it can reduce opportunities for investor engagement. For investors seeking to make a meaningful difference, considering alternatives to divestment in sustainable investing—such as transition finance and solutions-based investing—can provide more dynamic, impactful options.

By understanding all areas of divestment and exploring other impactful investment strategies, we can make informed decisions that not only align with our values but also contribute to a more sustainable future. Whether through divestment, transition finance, or solutions-based investing, the key is to understand where our influence can be most effective in driving the changes needed for a sustainable world.

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[1] Global Fossil Fuel Divestment Commitments Database

[2] Liebreich Associates. (Nov 2023). Hydrogen Ladder Version 5.0.