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There's Nothing "Socially Responsible" About Low Pension Returns

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There's Nothing "Socially Responsible" About Low Pension Returns

July 22, 2016

With the California Public Employees Retirement System reporting the lowest annual gain since 2009, it’s time to review the effectiveness of its socially responsible investment policy for California’s taxpayers.

CalPERS grew by only 0.6% in the fiscal year ending June 30, 2016. This follows last year’s below-target return of 2.4%. California pays its pensions on a defined-benefit basis. In order to meet those costs, CalPERS must grow substantially more rapidly than inflation. So California taxpayers are on the hook for paying hundreds of billions of dollars in unfunded liabilities.

In contrast, CalPERS’ average return over the past 20 years has been 7.8 percent. But this year’s disappointing results, driven by the fund’s recent push for socially responsible investing, look set to bring that healthy clip to a crawl.

CalPERS’ 2014 report, Towards Sustainable Investment & Operations: Making Progress, brags about its Environmental, Social, and Governance (ESG) investment strategy. This results in a choice of investments not solely by return, but by a variety of social and environmental criteria. Firms that CalPERS considers to be bad actors for a wide variety of reasons are not selected for the pension fund, even if they generate high returns.

My Manhattan Institute colleague Steven Malanga has written that CalPERS’ foray into what it calls “socially responsible” investing has cost California taxpayers substantially. Not only were the investments imprudent, but CalPERS funneled billions of dollars into politically connected firms.

CalPERS’ slow fund growth calls into question the wisdom of socially responsible investing. An Interpretive Bulletin issued by President George W. Bush’s Department of Labor in 2008 instructed pension plan trustees to act “solely in the interests of participants and beneficiaries.”  Although the bulletin did not technically apply to state and local pension funds, it was used to guide trustees’ fiduciary decisions, according to Boston University School of Law professor David Webber.

In 2015 the Labor Department reversed this with a new Interpretive Bulletin which allowed funds to use social and environmental criteria to pick investments. State and local pension funds can now use the 2015 document as guidance, encouraging more socially-responsible investing. 

To fulfill its social responsibility goals, CalPERS does not invest in tobacco stocks and bonds. Over the past year, the NYSA Arca Tobacco Index increased about 15%. During the same time period, the S&P 500 Index increased only 2%. In 2013, following the Sandy Hook shooting, CalPERS divested itself of $5 million invested in firearms manufacturers. In 2010, it allocated $500 million to HSBC Climate Change Index-benchmarked Global Equity Environmental Index Fund, which CalPERS admits returned half the gains seen from its Global Equity Policy Benchmark since its inception (6.61% compared to 12.79%). It was also co-chair of the UN’s Environmental Programme Finance Initiative, which focuses on reducing energy consumption.  Additionally, CalPERS monitors companies for unfriendly labor policies.

A 2011 presentation by the CalPERS Investment Committee Workshop stated that the pension fund had adopted 111 different policy statements, “including external and internal mandates, compliance with legislation, endorsement of guidelines, capital commitments, engagements and standards on ESG.”

Socially-responsible investing is not the only reason why CalPERS is in trouble. A paper by Columbia University professor Andrew Ang and former founding CEO of the Norwegian sovereign wealth Knut N. Kjaer concluded that CalPERS lost $70 billion during the 2008-2009 financial crisis.  However, unlike other investors, their assets did not recover because they sold equities when prices were low. For instance, CalPERS sold 2.3 million shares of Apple for approximately $370 million, and today these would be worth about $1.7 billion.  

California’s public pension unfunded liability is the largest in the nation, at $754 billion. It needs solid growth to keep CalPERS above water. Otherwise, it will have to raise taxes, cut spending, or cut pension benefits and raising contributions for future retirees. California’s 13.3% income tax is also the highest in the country, and socially-responsible investing is not something that the state can afford.

If CalPERS continues to underperform, both current and future generations of Californians lose. Older Californians will see their pensions at risk. Younger Californians will see their taxes explode with little possibility of a retirement pension for themselves.  Only a self-righteous government would insist on investing CalPERS funds in a manner certain to underperform the market.

Diana Furchtgott-Roth is a senior fellow and director of Economics21 at the Manhattan Institute.

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