Explainer: What is Divestment?

As ethical investment becomes more popular, you might have heard the term divestment. But what exactly is it, and is this a trend worth paying attention to?

Simply put, divestment, sometimes called divestiture, is the opposite of investment. Any time that you sell an asset, whether it be a stock, a property or a business, you are divesting yourself of that holding.

Why investors divest

People choose to divest for a myriad of reasons, including to realise a gain in the asset’s value, selling off less important assets to focus on a core strategy, or even spinning off a subsidiary as a new separate business.

One increasingly popular reason, and one that occasionally makes the news, is divesting for ethical reasons. These divestments have targeted a range of industries identified as harmful, including tobacco, weapon manufacturing and fossil fuels. This trend has seen pension funds, investment managers and individuals across the globe selling their stakes in industries or companies they consider unethical. In 2016, more than US$5 trillion had been divested from fossil fuel assets alone, representing nearly 700 financial institutions and over 58,000 individual investors.

Source: Diego G Diaz (Shutterstock)

Divestment is not just about environmental causes

Divestment can be motivated purely by a desire to not associate with harmful industries, but it can also be a form of political action. By divesting from a particular industry, investors can help to pressure industries to act more responsibly.

This can even extend to entire countries, universities and businesses around the world. In the 1970s and 80s, to protest apartheid, some investors divested their holdings in South Africa resulting in around $350 million being withdrawn. While divestment wasn’t the only protest against apartheid, it was an effective one that helped raise awareness.

Pros and cons of divestment for ethical reasons

While chiefly done for ethical reasons, there are a few other motivations behind the divestment trend. One is to avoid reputational damage from connections to unethical or unpopular industries; as ethical investments become more popular, funds which don’t divest may be seen in a poorer light and could even be shunned by investors.

Despite the popularity of the movement, it has not been without its criticisms. One of the major critiques raised is that by locking investors out of particular sectors like fossil fuels, divestment will lead to lower returns, particularly in Australia where that makes up a significant portion of the economy.

However, recent evidence shows this may not necessarily be true, with analysis by the Responsible Investment Association Australasia finding ethical investment strategies sometimes actually outperform the market. The reasons behind this strong performance are not explicitly clear by may relate to avoiding uncertainty in the fossil fuel sector surrounding climate change policies.

Another possible factor is that divestment typically requires an in-depth analysis of the assets held. Investment funds that plan on divesting typically develop a socially responsible investment strategy, to help determine if any given investment meets the requirements. This can lead to a better understanding of the entire portfolio, and better decisions made as a result.

Related article: How to Build an Ethical Stock Portfolio in Two Trades or Less

Will this trend continue?

More and more investors are starting to think of their decisions as not simply affecting their own wellbeing, but that of the world as well. Fossil fuel divestment doubles between 2015 and 2016 alone, and the trend shows no signs of running out of steam.

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Header image source: Greyboots40 (Shutterstock)

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