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Posted July 12, 2007 The full Governing Management Letter | Subscribe to The Governing Management Letter GIRARD MILLER’S BENEFITS BEAT Bonus columns: Pension Divestment and Fiscal Sanity Needed: Model social investment legislation. Questions, success stories or anecdotes about benefit issues in government? State politicians have returned to the slippery slopes of social investing and pension divestment. In the 1980s, South Africa was the target: Politicians used public pension funds to express their dissatisfaction with human rights policies in that country by forbidding investments in companies operating there. Last year it was Sudan, followed quickly by Iran, and now "all terrorist nations" are on the blacklists in some states. Public officials should be skeptical about the effectiveness of social investing and pension divestment. As well-intended as the idea is, the result is often the famous Law of Unintended Consequences. For example, American divestment policies have helped fuel Chinese geopolitical influence in the third world. 
If more pension divestment legislation continues to pop up — as it inevitably will in a democratic society — we'd best put a system in place to regulate and minimize the domestic fiscal impact of divestment. I propose that the National Conference of State Legislatures, various public pension groups and the finance officers' and treasurers' associations* design model state pension divestment legislation language. That way, future bills will cause the least possible damage to fiduciary funds. Reimburse these unfunded mandates. Pension funds incur the expense of researching their portfolios for blacklisted holdings and selling all those securities. The resultant brokerage fees and transactions costs degrade the fund's investment earnings. Further, the investment performance of the blacklisted companies typically exceeds the market index once the social-selling has subsided, so long-term performance suffers.
Model social investment legislation would require the legislature to appropriate sufficient funds from the state treasury to repay the pension funds for their costs of selling off securities and buying them back once the divestment ends. This is not just robbing Peter to pay Paul. Our children will pay the bill ultimately for weak investment returns, so today's politicians must be reminded that there are expenses and costs to these bills. Requiring a reimbursement of transactions costs would discourage frivolous legislation and force legislators to put their money where their mouth is. Model legislation would also require a fiscal note that the pension plans report back to the legislature annually if these laws have done damage to their portfolios' investment returns. A similar provision just cleared the Pennsylvania house in an amendment to a pending Sudan investment bill. Automatic sunset. One of the lessons learned in the South Africa divestiture movement was that most public plans suffered lower investment returns due to the restrictions. Making matters worse, the legislatures took their sweet time repealing those laws, so even more money was lost after South Africa had itself repealed apartheid. Many public pension plans remained unable to invest in the country once we had declared it investment-worthy. American dollars were unavailable to help people rebuild their country until state legislators changed the laws, which took several years in some states. Model legislation would include an automatic sunset provision that self-repeals the investment restriction once the targeted nation-state leaders change their offensive policies. Empower pension plans to divest smartly. Most of these social-investing bills are written by legislators and staffers who are cause-driven and not cost-conscious or financially sophisticated. So let's help reduce the frictional drag on investment returns. First, all diversified index-fund investments should be exempt from these laws, because the pension funds are not selecting specific companies or favoring specific countries when they buy an index portfolio. They are simply buying an asset class — a share of the overall global financial market. Index funds are amoral and apolitical. In fact, it's possible to construct a synthetic portfolio to replicate almost any broad market index by purchasing futures contracts which are technically immune from these divestment laws, but that imposes another transaction cost. Second, pension funds should be allowed to short-sell and use derivatives that effectively accomplish the same economic result as selling specific stocks from their portfolios. These "synthetic global divestment" strategies would save taxpayers' money and allow the various mainstream active portfolio managers to do the job they were hired to perform, without interference from the legislature. Model language would authorize "any security, contract, hedge fund, short sale or other transaction or process that the trustees in their sole discretion determine to effectively reverse or offset the economic interest of ownership" of the blacklisted country or companies doing business there. In a pluralistic society it's impossible to forbid these pension divestment bills. So let's help lawmakers eliminate as many negatives as possible, provide appropriate tools to pension managers and put a price tag on these bills as they roll through the legislatures. ----- *Participating organizations could include: the National Conference on Public Employee Retirement Systems (NCPERS), the National Council on Teachers Retirement (NCTR), the National Association of State Retirement Administrators (NASRA), the Government Finance Officers Association (GFOA) and the National Association of State Treasurers (NAST). Last month: Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. A reader responds: Divestment and Genocide As the city controller of the city of Philadelphia, I serve as a trustee of the Philadelphia Board of Pensions and Retirement and the sponsor for the Sudanese Divestment Resolution by the Philadelphia pension fund. I would like to provide feedback to the July 2007 article, titled Pension Divestment and Fiscal Sanity, in which Girard Miller criticizes Sudanese divestment and proposes limiting regulations on divestment by pension boards. Divestment is one key strategy to pressure the Sudanese government to end genocide. I am proud to say that Philadelphia is the largest city in the United States to prudently divest from targeted companies doing business with Sudan and confront a tragedy of 400,000 dead and 2.5 million displaced people. Sanctions and divestment do work. South Africa is a vivid testimony to the power of people acting together to stop an injustice. Earlier in Sudan, the Comprehensive Peace Agreement of 2005 was the result of a successful divestment campaign against the Talisman Energy Company of Canada which pressured the Sudanese government to negotiate with southern rebels. In fact, a New York Times op-ed (2/11/07) by Pulitzer Prize- winner Nicholas Kristof stated that five cities, including Philadelphia, have properly and effectively divested “So I’m against economic sanctions in almost every case. But Sudan is an exception, a rare instance where narrowly focused divestment makes practical as well as moral sense.” Initially, we observe that Mr. Miller’s article may confuse the problem with a solution. The problem is the unacceptable risk of public funds invested in companies that directly or indirectly support morally reprehensible acts of the Sudanese government. The solution is divestment from the financiers of inhumanity as pension funds avoid unreasonable risk and financial uncertainty. Mr. Miller’s article seems to show a flippant and caviler attitude to both a human catastrophe and the fiduciary responsibility of pension board members interested in prudent investment by not acknowledging that the social instability from ethnic genocide carries a commensurate financial risk to our investments. Yes, it is technically possible to avoid prohibitions set out by divestment laws, as Mr. Miller stated. However, the reason for divestment is not technical gamesmanship but avoiding undue risks in investment while saving lives. On my watch as a trustee of public funds, I cannot support another Holocaust while risking public funds. In contrast to Mr. Miller’s opinion, Philadelphia properly divested from both directly held investments and indirectly/commingled index funds that owned prohibited companies. Mr. Miller recognizes that companies benefiting from ethically unacceptable practices can make additional profits. Yes, slave labor has lowered the bottom line and increased profits during other genocides as in Nazi Germany. Of course, we reject such business actions and use of contemporary investment techniques such as diversified index-fund investments to fog our understanding, complacency and participation. The focused Philadelphia Divestment Resolution keeps money in companies that provide services clearly dedicated to social development for the whole country of Sudan and shall be excluded from divestment. Such companies include but are not limited to those providing medicine and medical equipment, agricultural supplies and agricultural infrastructure, educational opportunities, journalism-related activities and general consumer goods. Of course, the Philadelphia Resolution encourages timely reevaluation of divestment in accord with federal government policy, changes in Sudan and corporate compliance. Therefore, I maintain that divestiture of holdings in companies doing business with the government of Sudan or in the country of Sudan will send a strong and powerful message — while protecting the value of our pension funds. Alan Butkovitz © 2007, Congressional Quarterly, Inc. Reproduction in any form without the written permission of the publisher is prohibited. Governing, City & State and Governing.com are registered trademarks of Congressional Quarterly, Inc. |
