Richard Slocum oversees investments at Harvard Management Co., the U.S.’s largest college endowment, with almost $42 billion of assets as of June 2020. By the time he took over the job in March 2017, he’d managed institutional money for more than 20 years, and before that had worked at some of the top banks in New York helping companies access institutional private markets.
But even in spite of all that experience, he’s starting from square one when it comes to zeroing out the Harvard endowment’s greenhouse gas emissions, which the university pledged last year that it would do by 2050. There is as yet no industry standard for what a net-zero portfolio even means, leaving investors and portfolio managers largely in the dark as to how they should try to get there.
Harvard’s move comes after years of sustained activism from students calling for fossil-fuel divestment and amidst increasingly urgent demands from investors that financial institutions withdraw their support for polluting businesses. But getting out is tricky, and HMC’s portfolio of complicated investments will make the process all the more difficult.
As part of Harvard’s exit plan from greenhouse gas, Slocum is proposing a novel way to turn short-selling within a hedge fund portfolio into a type of offset, combining one aspect of financial engineering with another. An offset is a way to claim credit for eliminating greenhouse gases, typically by paying to protect trees or fund clean energy. Here’s how Slocum explains his idea:
Short-seller A borrows shares issued by a heavy carbon emitter from Investor B, and immediately sells those shares to Investor C. At this point, both Investor B and Investor C enjoy the benefits and bear the risks of owning those same shares. Both have the same carbon footprint—Investor B still has its original carbon footprint, and Investor C now has one as well. Two investors now have a carbon footprint, where there used to be only one, but overall emissions from the operations of the carbon emitter have not been changed.
Slocum’s solution: Allow Short-seller A to deduct the associated emissions from its emissions footprint. This would permit a short position to function similarly to an offset. This, in turn, makes his suggestion contentious, as the value of offsets is the subject of heated debate among various high-profile standards-setting bodies.
While more than a third of the endowment is managed by hedge funds, short positions are a small part of Harvard’s overall portfolio—likely less than 1%, although HMC can’t put a precise percentage on it because its hedge fund asset managers typically don’t report their individual holdings. But it’s a key lever for investors working toward a net-zero world, Slocum said. Short selling not only puts negative pressure on emitters, in his framework, it also allows them to advocate for changes as activist shareholders.
Slocum answered Bloomberg Green’s questions about his proposal, and about Harvard’s carbon-free goals. The interview has been edited and condensed for length and clarity.
Harvard said last year it would create a path for “net zero” greenhouse gas emissions by 2050. Why so long? And how is this different from divestment?
The 2050 timeline was meant to align Harvard’s endowment emissions goal with the Paris Agreement. To get to net zero for the planet, technological advancements will play a crucial role. Carbon capture and clean energy production are two critical advancements that need to happen in order to stem the damage done by high-emitting industries. HMC is investing in new technologies that, if successful, could revolutionize numerous high-emitting activities in the economy to meaningfully reduce carbon in the atmosphere.
We’d say the main difference between a net-zero goal and divestment is that a net-zero pledge recognizes that fossil-fuel consumption is part of our near- and probably mid-term reality. We think that addressing both the supply and demand sides of the equation is a more effective way of making a true impact.
In the hypothetical case of Short Seller A, Investor B, and Investor C, why would both B and C count the emissions attached to the carbon-heavy company? If A is borrowing the stock from B and then selling it to C, why wouldn’t the emissions follow the stock? The stock is only in one portfolio at a time, so where does the double-counting come from?
The number of shares outstanding hasn’t increased. The overall emissions from the operations of the carbon emitter have not changed. The key point is that there is only one carbon footprint in total. A proper greenhouse-gas accounting has to reflect that.
In sharing potential methodologies with our asset managers—such as one from the Task Force on Climate-related Financial Disclosure, which recommends that “gross values should be used”—we’ve found that all three of the parties (A, B, and C) could potentially have carbon emissions counted from a single share of stock, which would distort the real-world accounting. It is logical to add carbon to both B and C’s portfolios because both have made the decision to buy stock in the carbon emitter. But A should have its carbon reduced because it is putting pressure on the carbon emitter’s stock and is clearly not supporting the carbon emitter. [Editor’s note: Michael R. Bloomberg, the founder and majority shareholder of Bloomberg LP, the parent company of Bloomberg News, is the chair of TCFD.]
To the same degree that buying shares helps finance a company’s operations and gives the owner a carbon footprint, holding a short position hinders a company’s finances and gives the holder a negative carbon footprint. We’re trying to raise these types of important issues now to create a standard to allow HMC to be as accurate as possible as it moves toward net zero.
You’re saying these negative emissions would function essentially like carbon offsets, allowing portfolio managers to erase some amount of their direct investments in polluting industries. Offsets are far from a solution to achieving net zero. What makes these offsets better?
This activity would not be a primary goal for any meaningful investor to get to net zero. They will first have to reduce emissions, and then possibly use carbon removal. Investors should be limiting their exposure to heavy carbon-emitting industries like utilities, steel and cement companies, and limiting their exposure to conventional energy companies.
However, we need to distinguish between being an operator and being an investor. An operator adds carbon to the atmosphere. The only way to offset those emissions to become carbon neutral is to actually remove the carbon from the atmosphere. An investor, on the other hand, buys shares in companies, but effectively supports the actions of that company and its inherent climate risks, which is why the company’s emissions may be attributed to the investor.
By shorting stocks of carbon-emitting companies, investors raise the cost of capital for those companies and, in effect, act as a vote against the actions of those companies. The act of shorting carbon emitters also further reduces the climate risk of the investor and should likewise be netted against the carbon risk in the investor’s portfolio. Note that shorting cannot be used to offset the emissions generated by an investment management firm’s own operations. Those emissions, like any operating company, can only be offset by projects that reduce carbon in the atmosphere.
As you mention, there isn’t yet a widely accepted net-zero standard for an investment portfolio. What do you make of the efforts from groups like the Science Based Targets initiative to develop such a standard? What’s the plan for HMC to achieve net zero by the 2050 goal?
Without question, organizations like SBTi and TCFD play an important role in our being able to tackle the challenge. Standardized reporting should minimize excuses around noncompliance due to a lack of clarity on how to account for it.
Netting short positions against long positions not only accurately portrays the carbon footprint, but also will broaden adoption of the drive to net zero among investment managers and asset allocators, and speed its progress. Engagement—as recently demonstrated by Engine No. 1, an activist hedge fund whose candidates were elected to Exxon Mobil Corp.’s board—is a critical tool, and one that we feel must be encouraged as investors seek to reduce carbon in their portfolios. Allowing investors to reduce their climate exposure through shorting will enable them to seek change from high carbon emitters without expanding their carbon footprint.
How could a short seller be an engaged investor? Engine No. 1 took a long position in Exxon Mobil and waged a proxy battle, which is very different from selling short. A short position is at most a passive indication that you don’t think a company is performing as the market is pricing it—and that’s only if you make your position public. Do the hedge funds that HMC invests with reveal their short positions?
No, HMC seeks investors based on organizational strength, track record and investment edge. The individual positions of those asset managers investing in public markets are not often reported to us.
What we’re talking about are two distinct ways that short selling can impact high-emitting companies. In the first scenario, a manager simply shorts a company because it sees the inability of the company to address climate risk as a detriment to its financial outlook, and the short applies additional pressure to its ability to borrow. The manager is engaged in the sense that it is applying financial pressure to the high-emitting company.
The second is an engaged investor who might use short positions to hedge its involvement with a high-emitting company that they are seeking to improve. In that scenario, to go back to the previous example, if Engine No. 1 was applying pressure to Exxon as a shareholder, then they could hedge themselves by betting against its competitors. It would reduce their financial risk in the event that the entire oil and gas industry lost value, but also reduce the carbon footprint on their balance sheet.
Would you use this process as a Harvard Business School case study?
I might suggest a more exciting topic than carbon accounting, though “you can’t monitor what you can’t measure,” to quote [Harvard University President] Larry Bacow.
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