It’s no secret that a number of state and city public pensions are in crisis. From Puerto Rico to Detroit to Illinois (and many other states, as we will soon come to discover), governments have made promises to their public employees that simply cannot be kept, which has already resulted in financial crises in several localities that have put enormous pressure on governments.
Recognizing this, some analysts have suggested that a switch from fossil fuel holdings to green energy technologies such as solar and wind might be prudent for pension managers, pointing to the strong performance of many of these stocks over the last several years in comparison with traditional oil and gas. Such a transition would also have the benefit of satisfying ethical concerns and social responsibility considerations many of these people profess. The responsibility of any public pension manager should first and foremost be to the shareholders.
It’s worth asking whether these arguments stand up to scrutiny, or if they merely represent wishful thinking on the part of a set of policymakers and analysts whose political and environmental biases trump sound economic policy.
The responsibility of any public pension manager should first and foremost be to the shareholders. How best to accomplish this may be a matter of some debate; a pension manager may privately loathe the petroleum industry and wish for a rapid switch to biofuels, but his public duties demand that he do what is best for the pension holders, not for his conscience.
If we allow pension managers to substitute personal biases for fact-based investing strategies then any number of unintended long-term outcomes may result, with the retirements of public servants being frittered away on investments that might result in good optics, but not actual returns.
But what if more green energy production really does represent the sound actuarial choice? That perspective cannot be resolved merely by examining the recent past: while some green energy stocks have indeed performed well over the short term, it is a far from a conclusive trend, and the reality – regardless of passive investor behavior – is that while our nation’s reliance on petroleum and coal may slightly diminish over the near term it is not going to disappear anytime soon.
Environmentally-driven funds made up 4 of the 9 worst performing funds in the CalPERS portfolio.
For index fund managers and pension fund leaders to push an environmental agenda on the companies they invest in potentially entails more risk and lower returns on the wealth of those whose money they hold. According to a new report from the American Council for Capital Formation (ACCF), the California Public Employees Retirement System (CalPERS) – the nation’s largest public pension fund – has ramped up its focus on such ventures. The result: environmentally-driven funds made up four of the nine worst performing funds in the CalPERS portfolio and represented none of the system’s 25 top-performing funds as of March 31, 2017.
As this focus on ESG-efforts has increased, CalPERS has moved from a $3 billion pension surplus in 2007 to a reported $138 billion deficit today. Yet those who manage the fund remain unwilling to put their own money on the line. The personal investment portfolios of the fund’s Chief Investment Officer and at least two other senior executives report no ESG-related investments at all.
Influence and Risk
There is a very real danger that organizations like CalPERS and other large state and local government retirement funds may collectively become large enough to influence corporate behavior should they choose. One would hope this power is used solely for the good of its retirees – and there is some evidence that they have achieved some tangible improvements in corporate governance using their power in the past – but the political calculus of index fund “managers” investing money for government pensions have a modicum of freedom.
Fund managers motivated in part by political considerations can use their influence to signal their virtue via proxy votes for green investments and bear no cost – just the opposite, in fact. In such a situation, it is future pensioners and future taxpayers who bear the risk and future cost owing to these potentially lower returns.
When people’s careers are on the line, such decisions are carefully considered and thought through.
An example from the real world will be illustrative. With the acknowledgment that tobacco products are hazardous to the health of users, some investors assumed that the share prices in major tobacco companies would decline steadily over time. CalPERS managers concluded as much, and in response they divested their holdings of tobacco companies in 2000, allowing it both to claim the moral high ground while at the same time assuring retirees this decision will lead to higher long-run returns on their investments.
In fact, the decision to divest appears to have cost these pension plans as much as $3 billion in forgone returns. Even things that can appear to be an obvious winning bet can be anything but. When people’s careers are on the line, such decisions are carefully considered and thought through. But if it’s merely the well-being of government coffers at stake, dubious logic can win the day.
It may be tempting to urge public pension managers to take a more proactive role and bet against companies whose products we, for whatever reason, disapprove of, or for those managers to use their positions to influence the business decisions of firms in which they have a stake. However, it would be much better for government workers, retirees, and taxpayers today and in the future if the investors managing the money of public pensions prioritized sound financial policy above all else.