Mechanisms to Incentivize Fossil Fuel Divestment and Implications on Portfolio Risk and Returns

Mechanisms to incentivize divestment strategies, such as divestment schedules, are an important component of carbon reduction strategies. We find that the risk/return profile of divested S&P 500 portfolios is typically indifferent to divestment schedules, but instantaneous divestment benefits management structure. Regarding Environmental Social Governance (ESG) attributes, faster divestment rates are preferred at the expense of higher tracking errors. Rapid divestment by shorting may induce higher management fees and tracking errors. Divesting from energy and utilities sectors reduces carbon footprint, with exchange traded funds (ETFs)' divesting offering more substantial reductions. Investing in funds with low carbon footprints results in lower dividend returns and management fees. Even though the return profile of ETFs is insensitive to divestment strategies, their risk profile is proportionally (to their carbon intensity) affected by such strategies. Our study underscores the importance of considering investors’ demographics, such as dividends, management structure, and carbon reduction targets, on divestment strategies