What are divestments and what is the best divesting strategy?
Increasingly companies, investment funds and individuals are using divestment to ensure their portfolio aligns with their financial goals and ethical viewpoints. But what is divesting, and which divestment strategies can you use?
What does divesting mean?
Divesting is the process of reducing the exposure you have to an asset to achieve specific financial and social goals. This could be done through selling the asset entirely or part closure of the position.
Although divestment is commonly used to refer to the downsizing of a business, more recently the term has been used to describe the strategy of both institutional and individual investors.
Reasons for divestment
The reasons for divesting will heavily vary from circumstance to circumstance – especially if we are talking about the differences between company divestments and individual divestments.
Why do companies divest?
The term divesting is often used to describe a company selling off a business unit or shares in other companies. This can be for a variety of reasons, including:
- To slim down business operations and focus on profit making areas
- To cut out underperforming business areas
- To generate cash by selling off a business unit
- To generate value by breaking one company into two separate entities
- To conform to new regulations
- To meet shareholder demands on ethical or social guidelines
- To align the business to public trends and make it more appealing to new investors
In recent years, more and more companies are divesting for strategic purposes rather than due to financial failure. Instead of simply cutting the deadweight from a balance sheet, companies are using divestment to streamline their operating model and reinvest the proceedings into new products.
Why do individual investors and traders divest?
Individual divestment is often called ‘personal divestment’. It refers to the process of an individual investor moving their money out of certain assets that do not fit with their overall strategy anymore.
This could be closing investments, closing speculative positions or even demanding that fund managers stop putting money into certain areas.
The reasons individual investors choose to divest can vary heavily from person to person. Broadly speaking, there are three reasons why individuals might choose to remove capital from certain companies or assets. Firstly, that they believe that portion of their portfolio no longer has long-term growth prospects; secondly, that the position no longer aligns to their moral standards; and thirdly, the company doesn’t meet the individual’s social impact criteria.
If it is the first option, divestment not only poses the opportunity to reinvest in an asset that does have long-term growth prospects, but to potentially profit from the declining value of the company – this strategy is known as short-selling.
If it is the second or third options – that the positions held no longer meet the individual’s standards in terms of moral and social guidelines – then the process is a little trickier. Not only will they need to divest but reinvest in an asset that meets their self-imposed criteria.
Increasingly investors and traders alike are starting to find ethical and socially responsible means of dealing on financial markets, using filters to assess the economic, social and environmental impact of a company. They would then invest in or speculate on assets that have a beneficial impact on some area of society.
Learn more about ethical and sustainable investing. It is always worth remembering, that if you choose to divest, this does not mean the stock will inevitably fall, as other traders and investors may disagree with your assessment or ethical standpoint.
Best divestment strategies
The act of divesting itself is relatively straightforward: if you have a long position, you are simply closing it. Whether the position is profitable is not necessarily a consideration if the choice is based on ethics rather than financial gain.
However, having a divestment strategy should by no means diminish your opportunity to profit – once you have divested you can then reinvest or speculate on shares instead. There are a few strategies that are commonly used as a next step after divestment, to ensure that a portfolio remains profitable. These include:
Opening a new long position
After divestment, it is common to want to reallocate your newly freed-up funds. There is a way that you could continue to deal on financial markets; speculate on the future price of a market.
To trade shares , you can use IG’s CFD offerings. You wouldn’t own the shares outright or benefit from any dividends, but you would benefit from leverage – this enables you to open a position with just a small initial deposit. Leverage can make capital go further and open up a greater range of market opportunities. It’s important to remember that although leverage magnifies profits, it can also magnify losses.
If you decide to speculate on shares after divestment, you’d need to:
Short-selling a stock
For those that have divested believing that the future of the stock, or even sector, is not looking good, there is always the possibility of short-selling. This is the process of taking a position that there will be a decline in a given market, making a bet against the market and profiting if there is a downturn.
The traditional method of short-selling involves borrowing the physical shares, selling them immediately at the current market price and then repurchasing them later for a (hopefully) lower price. You could then keep the difference in price once you’d returned the shares to their owner.
But short-selling no longer even needs to involve the underlying shares. If you divested in a stock, you could take a position to ‘sell’ the same shares using CFDs. These derivative products take their price from the underlying market, but do not require the ownership of the asset itself – meaning traders can take a position on markets that are declining as well as rising.
For traders, the idea of widespread divestment does pose an interesting opportunity to profit from the withdrawing of funds. Even if you have not divested yourself, going short amid a divestment trend could enable you to take advantage of the trend or hedge a shareholding.
An alternative strategy to divestment
Sometimes, you might feel reluctant to divest because you hold a significant portion of the stock. If you already have shareholder rights, then an alternative strategy can be to become an active shareholder. This is known as an engagement-focused strategy.
There are a number of ways to do so, such as writing a letter to the board or raising questions at an annual general meeting (AGM). But this essentially means that you can raise any issues you have with the way the company is run, and get involved at changing the company internally, rather than simply divesting.
However, if you have an issue with the entire business model – ie the fact that a tobacco company sells tobacco – you’re unlikely to be successful. If, on the other hand, you’d like to encourage a company more sustainable, or more ethical in how it treats its workforce, then this could be a good way to be proactive within the company.
Types of divestment
There have been a range of divestment movements over the years, some of which have targeting specific companies and products, while others have gone so far as to withdraw investment from entire countries. We’ve looked at three of the most common types of divestment to see what opportunities the markets might hold for traders to go both long and short.
Divesting in fossil fuels
Perhaps the most commonly mentioned example of divesting is the movement away from fossil fuels as a response to global warming.
Fossil fuel companies are considered to be a cornerstone of the global financial system, so for many investors it is inevitable that some part of their savings account or share portfolio is invested in the industry. However, with the rise of fossil-fuel-free companies, many investors and institutions are divesting their own money or seeking the option to do so from their financial advisor.
The movement is actually the largest growing divestment trend in history and is led by large activist groups, such as 350.org, who run the Go Fossil Free divestment campaign. The campaign’s message is clear: investing in fossil fuels is morally wrong but also financially risky. As the awareness of climate change spreads, positions held in fossil fuel companies could become worthless.
According to Go Fossil Free, the number of global institutional investors who sought to cut fossil fuel stocks from their holdings increased from just 180 in 2014 to more than 1135 in 2019 – these institutions have committed to divesting approximately $11.48 trillion in total.2
Divesting in fossil fuels has had such an impact, that individual fossil fuel companies have noticed the change to their balance sheets. According to 350.org, Peabody Energy – previously a large private-sector coal company – cited in 2014 that the divestment campaign was one of the reasons for its declining profits. By 2016, the firm had gone bankrupt.
The movement has also fundamentally changed the makeup of many global stock indices. For example, if we look at the S&P 500, in 1980, fossil fuel stocks comprised of more than 28% of the total index – in 2019, this number is approximately 5%.
As oil prices fall and renewable energy attracts an increasing amount of attention, investors and traders are increasingly turning to alternative energy stocks, such as solar and wind.
After divesting it is common for investors to look at how they can reinvest the capital elsewhere to profit from companies that compete with the fossil fuel industry. This could be through speculating on the future of the underlying asset with CFDs. You can speculate on the future of fossil fuel stocks by opening a live trading account.
Divesting in gun manufacturers
Some investors might look to other sociopolitical causes as a basis for divestiture, such as reducing the amount of capital invested in gun manufacturing firms.
Following a series of mass shootings in the US, pressure mounted for investment firms to reconsider their portfolios and remove gun stocks. A lot of individual investors wanted to ensure that their money was not contributing to causing any harm, both domestically and abroad. Divesting from gun manufacturers wasn’t necessarily an easy process – especially for American investors who held a 401(k) retirement savings plan or were invested in the Vanguard Small-Cap Index Fund, as these often hold significant amounts of weapons and ammo shares. With the increasing awareness about divesting from gun manufacturers, a variety of online tools sprung up to ensure that investors would always know exactly how their funds were being used.
In the US, a movement called ‘Campaign to Unload’ was launched in the following of the Sandy Hook shooting, which raised awareness for why individuals should divest from gun companies. And the campaigns have definitely had an impact. Between 2012 and 2016, there was a huge increase in the amount of military and weapons manufacturing companies that were impacted by divestment – with the amount of impacted assets rising from $74 billion to $835 billion.
This divestment has had a big impact on the value of gun manufacturers’ shares. For example, shares in American Outdoor Brands Corp (AOBC) – parent company of Smith and Wesson – fell from an all-time high of $31.15 per share in 2016 to a low of $5.41 in 2019.
Remember, the trend for divestment does not always equate to immediate share price movements – however, the volatility caused by such campaigns can provide an interesting trading environment. It is always important to perform technical and fundamental analysis before taking a position on any stock.
To practise trading the shares of gun manufactures, use an IG demo account.
Divesting in tobacco companies
Tobacco companies are often considered a defensive stock – a category of companies that retain their value, even as the wider market declines. This is due to the historic demand for cigarettes. However, as the awareness of the health implications of smoking has spread, the popularity of the product has declined. This has led to companies and individuals considering whether they want to continue investing in the industry.
For example, in 2016, French insurance firm AXA divested $2 billion worth of tobacco assets – the management team stated that as a health insurance firm, they could not consciously invest in one of the largest threats to public health. Similarly, the UK’s National Insurance Savings Trust (NEST) announced in 2019 that it would divest from all £40 million of its current tobacco investments. This was due to increasing global regulations against tobacco and declining smoking rates, both of which could impact tobacco stock revenues.
These two cases are prime examples of the different reasons for divesting. The first is due to a conflict of interests in terms of ethics, while the second is based on long-term growth and profit expectations.
There are examples of divestment causing companies to miss out on key profit targets. For example, in December 2016, US retirement system CalPERS announced it had lost out on an estimated $3.5 billion as a result of their ban on tobacco stocks.
However, new research has suggested that divesting from tobacco will not negatively impact returns. Genus Capital Management’s report showed that an index portfolio without tobacco didn’t underperform an index with tobacco over a 20-year period.3 They largely attributed this to the severe headwinds the tobacco industry will face from lower consumption, global taxes and regulations.
Both companies and individual traders should always consider the long-term implications of divesting and what the next step in their strategy will be. To take a position on the future of the tobacco industry and key tobacco stocks, create a live trading account. Alternatively, you can practise trading in a risk-free environment using an IG demo account.
Is divesting a good idea?
The answer to this completely depends on why you’re divesting. If it’s for ethical reasons, then it is completely up to you whether you decide to move your capital away from so called ‘sin stocks’.
Even if you’re not that keen on the idea of divesting, it’s still important to keep an eye out on the areas that people are moving away from, because they can provide ample opportunities for going short or even for finding undervalued assets. For example, although these stocks might decline in attractiveness over the longer term, in the short term there could still be significant chances for profit.
Visit our news and trade ideas section for up-to-date market commentary from our in-house experts.
Divestments summed up
- Divesting is the process of reducing the exposure you have to an asset to achieve specific financial and social goals
- It is commonly used to refer to the downsizing of a business, though more recently the term has been used to describe the strategy of both institutional and individual investors
- The process involves investors and traders selling shares of companies that are making a negative contribution to society
- The reasons for divesting will heavily vary from circumstance to circumstance
- Businesses may divest to slim down the company, meet regulatory standards or align to public demands
- Individuals may divest because they believe that portion of their portfolio no longer has long-term growth prospects, or that the position no longer aligns to their personal views
- It is always worth remembering, that if you choose to divest, this does not mean the stock will inevitably fall, as other traders and investors may disagree with your assessment or ethical standpoint
- There are various strategies individual divestors choose to employ to ensure their portfolios remain profitable – these include opening new positions or short-selling
- As an alternative to divestment, individuals might decide to try changing a company from the inside out by becoming an active shareholder
- Over the years, there have been many divestment campaigns that have led to widescale divestment. The largest areas of focus have been fossil fuels, gun manufacturers and tobacco
- Divesting can be a great strategy, but it is also important to keep an eye on divestment trends as a potential opportunity for profit
1 Place 10+ trades on UK shares in the previous month to qualify for a £5 commission rate. Please note published rates are valid up to £25,000 notional value.
2 Go Fossil Free, 2019
3 Genus Capital Management, 2019
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