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Divestment is a bad idea: detrimental financially, ineffective as policy and unsound ethically. Here is why.
The Meaning and History of Divestment
Divestment means excising certain investments from endowments. Arising in the late 1970s, the first demands for divestment in U.S. higher education aimed to force the South African government to end apartheid. By 1988, about 155 colleges, or 4 percent of all colleges and universities, agreed to do so.
In 2011, climate activists began calling for colleges and universities to divest from fossil fuel companies, with some success. Starting in 2022, a few universities agreed to divest from Russian assets in order to support Ukraine.
Today, pro-Palestinian protesters on campuses have demanded that colleges and universities divest from businesses said to profit from the war in Gaza, including companies linked to Israel. Trustees of some institutions have agreed to consider divesting.
The Importance of Endowment
Endowment comprises the funds, or financial capital, owned by colleges and universities and invested to provide annual income for the institution in perpetuity. This current understanding of endowment and appreciation of its importance emerged in the early twentieth century, as explained in our recent book.
Endowment confers important benefits by strengthening a college or university’s autonomy and flexibility in making decisions. Endowment also increases an institution’s capacity to weather economic downturns or social changes, such as declines in the number of college-aged students.
Endowments are sometimes described as “a savings account or retirement fund … for a university.” But these analogies are misleading because they imply that endowments may be spent, and the constituent investments easily manipulated. But this is not the case.
The Financial Detriments
Divestment exacts significant costs that are often unrecognized.
First, divesting from targeted businesses in response to current events often sacrifices prospective gains or entails financial losses. Investments in natural resources around the world may not yield returns for decades. Selling a lithium mine in Africa on short notice, for example, may incur a penalty or significant loss.
Second, sophisticated endowment portfolios are intricately woven composites of investments, which carefully balance industry type, future prospects, quality of company leadership, geographic locations, political disputes, social forces, and natural events, as the late David Swensen, Yale’s legendary chief investment officer, explained.
Microchip manufacturers in Taiwan are profitable now, but what if China invades? Divestment is not simply swapping one company for another but more akin to pulling threads out of a finely woven tapestry, and the unraveling portfolio cannot be repaired easily.
Third, colleges and universities face what Swenson noted are “enormous difficulties” in recruiting and retaining “superior” portfolio managers who can make more money outside of higher education. These premier managers are evaluated on their investment returns, and they produce the highest returns when they are “operating with few constraints,” as Swensen observed. Divestment requirements constrain investment choices, increasing those “enormous difficulties” in hiring portfolio managers.
Fourth, mid-size and small endowments are often pooled and invested together to increase the investment return and reduce the risk for each individual endowment. A college or university that decides to divest would have to withdraw itself from the pool and sacrifice the higher return.
Environmental, Social and Governance (ESG) funds do not solve these problems, even if their returns are as high as for other funds, which is debated. Investing in ESG funds still entails the cost of divesting retrospectively from the targeted businesses. Furthermore, one would need ESG funds for every imaginable cause to avoid divesting in the future. Where is the ESG fund excluding Israel or Russia?
Finally, demands for divestment are often accompanied by calls for transparency and disclosure of all portfolio assets. The opaque assets are generally what Swensen called “alternative assets,” which include hedge funds, venture capital, private equity and natural resources. These amount to about a third of the largest endowments and yield the highest returns over time.
But alternative assets are by their nature opaque because they are not publicly traded and require extensive research to identify. In addition, they are extremely risky and depend on early investment. Informing other investors through public disclosure would reduce the potential for high returns that justifies the extreme risk.
Given these detriments, any responsible calls for divestment must explain how colleges and universities will cover the associated expenses and lost revenue, or how they will cut expenses to compensate for the lost income.
Ineffective Policy
Apart from those costs, there is no evidence that divestment works. It might appear justified when aimed at a business that violates a college’s own mission and policies. For example, a medical school should not invest in a tobacco company, nor a university in businesses that use child or forced labor. But the effectiveness of such divestment is questionable. Tobacco companies have continued to flourish, and labor exploitation is disguised by supply chains.
Divesting from a company that is indirectly linked to a remote issue or nation is even less effectual. The company’s responsibility and influence are doubtful, and the financial impact of divestment is slight. Only a very small fraction of the some 3,500 nonprofit, degree-granting colleges and universities have ever divested, and the loss in capital for the targeted businesses is even smaller.
Furthermore, even if divestiture succeeded in harming the targeted corporation and depressing its stock price, the divestiture still would be ineffective. This depression simply creates a buying opportunity for other investors, and the divestiture ultimately serves to transfer wealth from those who share the moral obligation to those who do not.
Nevertheless, it is said that the greater impact lies in “stigmatizing” the targeted business and publicizing the social or political issue. But whether that impact outweighs the financial costs of divestment is rarely considered or calculated. And stigmatizing does not require divestment. Protests against the Vietnam War certainly had an effect without demands for divestment.
Finally, there is the policy question of priority: why should a certain kind of divestment take precedence over others? In the 2000s, several dozen colleges agreed to divest from companies operating in Sudan due to the government's campaign of terror. Why not Haiti? Or Nigeria?
In fact, carried to its logical conclusion, the moral argument implies that higher education should divest or expend all endowments in order to rectify social and political ills in the world. Furthermore, once begun, when would any divestment ever end?
Unsound Ethically
The fundamental argument for divestment is that higher education has a moral obligation to alleviate harm and oppression around the world and to do so by expending its financial resources. Proponents urge colleges and universities “to use your investments and your investment holdings to advocate for your values.”
But this “you” typically neglects important stakeholders and their values.
On the one hand, “you” must include donors. Trustees have a fiduciary duty to manage endowments prudently and maximize return, although this duty was somewhat attenuated by the Uniform Prudent Management of Institutional Funds Act of 2007.
But even if the legal obligation is weakened, colleges have a moral obligation to each donor who earned and gave money for a specific purpose aligned with their values. Would a donor who endowed scholarships for Indigenous students in the U.S. want the scholarship income to decrease in order to support an unrelated cause today?
On the other hand, “you” must include future generations as well as the present, according to the principle of intergenerational equity. Those who benefit from endowment today are obligated to preserve its full value for those to come. Doing so will help ensure the existence, autonomy and academic values of colleges and universities in perpetuity.
A century ago, the General Education Board (GEB) codified the first guidelines for managing the endowments of colleges and universities. These guidelines enshrined the principle of intergenerational equity and proliferated subsequently throughout higher education. GEB leaders stated that endowment “is sacred” and “a college has no right, moral or legal, to ‘borrow’ from its endowment … or, in fact, to do anything with endowment except to invest it so that it will produce a certain and steady income.” Following this guideline ensured that American higher education slowly attained preeminence during the twentieth century. It should continue to do so.
