02/21/2013 11:49 am ET Updated Apr 23, 2013

Fossil Fuels and Sustainable Investing

The growing student movement focusing on divestment from fossil fuels, along with the work of Bill McKibben and more broadly, have upped the ante in the debate over climate change. While President Obama has promised to address climate change during his second term, McKibben and his student brigades are urging that college and university endowments catalyze the movement by divesting from fossil fuel companies now.

In the sustainable investment community, the student movement has helped re-kindle an important conversation about the role of fossil fuels in a sustainable investment portfolio -- just as the tragedy in Newtown, Connecticut has focused attention on investments in gun manufacturers.

We need to deploy a host of strategies -- as citizens, consumers and investors -- to address the developing catastrophe of climate change, and we must do so with a sense of urgency and resolve. Until now, policy makers have not been listening. The fossil fuel industry is not listening. Large institutional investors, foundations and endowments generally are not listening. This has to change.

As investors, there are essentially three approaches we can take to investing in fossil fuels:

Approach A: Invest in fossil fuels without any regard whatsoever to climate change or other sustainability issues.

Approach B: Fully divest from fossil fuels.

Approach C: Partially divest from fossil fuels by taking a best-of-class approach to investing in energy companies -- favoring those with stronger commitments to reducing carbon emissions and developing renewable energy.

Approach A is unsustainable and irresponsible. It simply continues the status quo and fails to recognize the need for investors and capital markets to play a role in reducing carbon emissions and ameliorating climate change. It effectively aligns investments with those who deny the science on climate change or actively resist efforts to address it. By doing nothing, this investment approach helps guarantee that nothing will be done.

Unfortunately, most mutual funds, pension funds, foundations, endowments and other institutional investors, as well as individual investors, follow approach A, meaning that they -- or at least their investments -- are part of the problem rather than part of the solution.

Approach B is being urged by McKibben's and the growing student movement.

Approach C is embraced by the majority of investors in the sustainable investment community, where many regard a complete divestment from fossil fuels as impractical. Instead, a best-of-class approach -- screening out the worst polluters while investing in companies that have made larger commitments to renewable energy -- is coupled with shareholder engagement to prod energy companies to further reduce their emissions.

My company employs a combination of approaches B and C, taking a partial divestment/best-of-class/engagement approach for most of our funds while also offering one fund that completely avoids investing in fossil fuels.

Why do we generally take a hybrid approach to divesting from fossil fuels?

With respect to Approach B (complete divestment), we have concerns about pursuing it as an exclusive strategy because we are not convinced that these large multi-national companies will miss, or perhaps even notice, the small sliver of capital that is withdrawn. Indeed, when divestment occurs the shares are simply sold on the open market and someone else buys them.

A second concern about divestment as an exclusive strategy is that when you sell your shares you lose your seat at the table and your voice, which can include engaging in dialogue with company management, voting proxies and supporting shareholder resolutions asking companies to disclose or reduce their carbon emissions. The role of activist investors in prompting change should not be completely discounted.

For example, over the past year shareholder resolutions have been filed with companies such as Chevron, Exxon Mobil and Conoco Phillips asking these companies to review their exposure to climate change risk and to adopt quantitative goals for reducing greenhouse gas emissions. Resolutions have been filed with financial services companies such as JP Morgan Chase and PNC Bank asking them to assess the costs and adopt programs to address the carbon emissions related to their lending, investment and finance portfolios. In addition, resolutions have been filed calling on companies in the natural gas industry to address fugitive methane emissions, and companies in other sectors to address water use, electronics recycling and issue sustainability reports disclosing their environmental, social and governance practices.

This is important work, but to file such resolutions, and generally to engage companies in these types of dialogues, you have to be a shareholder. Thus, a complete divestment approach, while a necessary component to a broader strategy, is insufficient as an exclusive strategy. It needs to be supplemented with other approaches as part of a more diversified, multi-pronged investment approach to climate change.

I do believe that a divestment strategy, if widely embraced, could have the effect of shaming companies, putting pressure on them to be more responsive, to embrace sustainability strategies, and to change. So, it definitely has its place within a range of strategies that need to be deployed to marshal investment capital to be part of the solution on climate change.

That said, in addition to advocating for total divestment, students should be engaging colleges and universities to take positive steps that at least begin to green their portfolios in a meaningful way. They can do this by allocating a portion of assets to fossil-free funds embracing Approach B and/or partial divestment/best-of-class investment strategies under Approach C. There are plenty of asset managers and investment options today that employ such sustainable investment approaches.

In this regard, the canard that an endowment's fiduciary duty means that its only obligation is to maximize return, regardless of the consequences or externalities, is utter nonsense. If a university's lawyers or consultants are telling them that, they might want to fire their lawyers and consultants. There is now a substantial body of research underscoring that companies with better environmental performance also tend to enjoy better financial performance. It is ignoring these issues, rather than integrating them, which most likely constitutes a breach of fiduciary duty.

As long as returns on fossil fuel stocks remain high (subsidized by the lack of a price on carbon pollution), they will remain highly attractive to asset managers seeking to maximize short-term gains. But these fiduciaries have a duty to meet the needs of their investors, students and future beneficiaries over the long term as well. Reducing investments in fossil fuel companies could help achieve this balance, protecting investors from climate risk in their portfolios over the long term while sending a clear signal to energy companies that they need to change.

Every college and university, every foundation, every endowment, every institution of whatever kind that claims to be concerned about climate change, can easily take steps to assure that its investments are in alignment with those stated concerns. To accept the science on global warming, and to be committed to doing something about it, but to invest one's resources in a way that wholly ignores that imperative, is the mother of all inconsistencies.

If anyone thinks that the answer is waiting for Washington to act, or waiting for the next international treaty or protocol, or otherwise passing the buck thinking that someone else is going to solve this problem for us, rather than looking at our own energy use, our own consumption choices, and taking responsibility for the way we invest our own money, then again, we are part of the problem rather than part of the solution.

"Be the change," Ghandi said. What students have begun to ask of colleges and universities, we must all ask of ourselves -- so that our investments are no longer in conflict but are aligned with our values. Sustainable investing needs to be a core component of any comprehensive strategy to address climate change. I dare say it needs to be a core component of the way we live our lives.

Joe Keefe is president and CEO of Pax World Management LLC and Pax World Mutual Funds (