A Primer on Divestment

One tool utilized by impact investors is "divestment," which means to exclude or not own a certain company, industry, or sector. Common targets of divestment have included tobacco companies, gun manufacturers, defense contractors, and adult-media firms, and so on. We believe that there are valid reasons to divest, but also believe that investors should recognize the limitations of divestment approaches.

From an economic standpoint, divestment simply means that there are fewer buyers of a company’s debt and equity. This decrease in the supply of financing increases the cost of capital to the targeted business, all else being equal. While proponents of divestment may cheer that they have made business more expensive for the targeted company, they have also increased the financial returns available to the non-divesting investors.

Investors should consider their rationale for divesting from various companies, industries, or sectors. If an investor wants to dissociate for ethical reasons or because of perceived business risks, divestment can make sense. Institutional investors affiliated with policymaking entities (such as pension funds affiliated with a city or state) may also find divestment is effective in catalyzing changes. However, if an investor wants to materially punish the economics or stakeholders of a business, we do not believe divestment is very effective.

Divestment is one of many tools available to investors and can be appropriate to dissociate or to send a message. However, shareholder engagement may be better suited if the goal is to effect change.