Earlier this year, even before a gunman killed 12 patrons at a bar in Thousand Oaks, there was a groundswell of calls for California’s two largest pension funds to sell off their investments in gun retailers. But Jason Perez, a Southern California cop, balked. As a protest against “politically correct” investing, he decided to run for a seat on the California Public Employee Retirement System’s board of directors. And it wasn’t just any seat; it was the one held by CalPERS Board President Priya Mathur.
Mathur had been on the board for 15 years. She is a globally recognized leader in the sustainable investment community and holds a seat on the board of the United Nations-supported Principles for Responsible Investment, a network of international investors working to create and promote standards for sustainable investing. She’s worked to apply those standards to CalPERS.
Perez and his union, the Corona Police Officers Association, have routinely criticized the board for spending too much time on environmental and social investment programs. Association members regularly attended CalPERS meetings 430 miles away in Sacramento to urge pension officials to focus instead on making money for the $360 billion pension fund. During his campaign, Perez painted a picture of an investment strategy overrun by politics and emotion, particularly proposals before the board to divest the portfolio of gun manufacturers and retailers and to drop the controversial Dakota Access Pipeline.
Even though the board ultimately rejected both ideas, Perez’s campaign was successful. In October, Mathur was easily unseated when Perez won 57 percent of the vote. While it’s by no means a total repudiation of the board -- fewer than 17,000 votes were cast by the more than 400,000 eligible voting beneficiaries of the fund -- it was the second time in a year a divestment critic ousted a CalPERS board member. The first came last December, when Margaret Brown, an Orange County school district administrator, unseated incumbent Michael Bilbrey.
At issue in California and elsewhere is what’s called ESG investing, a strategy based on an asset’s environmental, social and governance factors. Environmental factors might include a firm’s carbon footprint or its contributions to deforestation. Social considerations would look at working conditions or impact on local communities. Governance covers things like corruption or how a corporate board behaves. The idea is that firms with sustainable environmental practices, who are good social stewards and have strong governance practices, are more likely to produce stronger returns over the long run. While the notion of ESG investing has been around for decades under one name or another, its current form has taken off in popularity as more sustainably minded millennial and Generation X investors have entered the stock and bond markets.
Many governments have positioned themselves as good ESG investments in order to attract these investors. They’ve even generated new vehicles for investments, such as green bonds and pay for success bonds. But as a result, they’re finding themselves awash in controversy, accused of playing politics. As our nation has grown more politically divided, it’s become more tempting for politicians to use pension funds as a political club in the name of responsible investing.
Of course, social divestment isn’t new. It began in earnest in the 1980s as a reaction to apartheid. In protest, pension funds sold off their stakes in companies that were doing business in South Africa. Since then, funds have dumped tobacco stocks and holdings in companies doing business in Darfur because of ongoing human rights violations. More recently, there’s been increasing pressure on state and local pension funds to sell off equity in gun retailers, fossil fuel companies and private prisons. The American Federation of Teachers, for instance, lobbied teacher pension funds this year to cut their exposure to investment firms that funneled money into private prisons used to house migrants whose children had been separated from them at the border. The Chicago teachers fund obliged.
What is new is the extent to which public funds have embraced ESG investing. In fact, it’s a booming business: Assets under management in such portfolios have grown to an estimated $23 trillion globally, an increase of more than 600 percent over the past decade, according to mutual fund researcher Morningstar. Technology has helped increase the overall profile of ESG investing by making it easier for any investor -- institutional or not -- to adopt the approach and filter out unwanted assets.
What’s more, of the seven U.S. pension funds that are signatories to the U.N.-supported Principles for Responsible Investment, three signed on in just the past three years. The overriding point of the principles is that certain factors such as climate change and human rights can affect a company’s performance and should therefore be considered alongside more traditional financial factors. Proponents of the investing strategy say it’s about buying, not selling, bonds. That is, rather than socially divesting, pension funds would dabble in social activism, buying into companies to encourage and maintain sustainable practices.
For many, the crucial question isn’t whether a pension investment does good, but whether it does well: Does it ultimately fulfill a government’s fiduciary duty to earn a healthy rate of return?
The research on whether pension funds are leaving money on the table with ESG investing is mixed. A 2016 paper by the Boston College Center for Retirement Research found that the returns of mutual funds that screen for such investments generally underperformed when compared to unrestricted funds. But that wasn’t always because the investments themselves were underperforming. The center notes that the fees in the ESG funds are roughly 100 basis points higher than their counterparts, which may reflect the additional costs to screen investments.
More recently, Trillium Asset Management, which is one of the major ESG investment firms in the U.S., found that Massachusetts’ pension trust lost an estimated $79 million on its $1.6 billion fossil fuel holdings over a five-year period ending in 2017. If the fund had instead invested $1.6 billion in an anti-fossil fuel index fund, Trillium said it would have paid off $1 billion over the same period.
There’s another way to look at ESG profitability. Ohio State University law professor Paul Rose thinks that evaluating return on investment is a limited view of a pension fund’s fiduciary duty. Rose, who studies sovereign wealth funds, says pensions also have a duty to consider wealth maximization for taxpayers and the broader impact of their investments. While an industry may appear to be a sound investment on paper, it may also be contributing to higher costs for governments in areas like water quality, health care or welfare. While private investors can ignore such negative effects, a pension fund should consider whether it’s aiding something that ultimately costs taxpayers more money.
It’s not uncommon for other investors to consider these impacts, says Rose. He points to revolving loan funds for minority businesses. These may be considered riskier, but such funds can help create long-term wealth and stability for taxpayers. “You could create a colorful argument that [certain types of] ESG investing does help taxpayers over the long term,” he says.
Still, Rose notes, those pushing for or against certain types of investments can’t just say they think the move is good for the long term. “You need to be able to demonstrate that you’ve run the numbers.”
Meanwhile, critics of ESG investing by pension systems contend that fund managers have a fiduciary duty to get the highest returns possible for their beneficiaries at a reasonable level of risk. If investing in a certain fund will add performance, then “do it,” says former Connecticut Treasurer Chris Burnham, who has decried socially responsible investing. But too often, he continues, decisions are based on the desires of “politicians playing politics with the fund’s money.”
Take Illinois. In 2015, state lawmakers voted to require the state’s pension systems to divest from companies that boycott Israel. In a recent paper, the Institute for Pension Fund Integrity noted that the American public is deeply divided over the many issues surrounding the Israeli-Palestinian conflict, making it “all but certain there are members of the Illinois pension systems who lie on both sides of this issue and do not want their funds being used to make this political statement.”
In California, Beth Richtman, managing investment director of CalPERS’ Sustainable Investment Program, couldn’t agree more with taking the emotion out of investment decisions. This year, CalPERS revamped its investment division, created a new one to monitor ESG investing across its entire portfolio and named Richtman to run it. Her philosophy is “not in any way focused on exclusions based on ethical grounds,” she says. Rather, it’s about assessing the fund’s exposure to environmental, social or governance dangers down the road. She is pushing for improving the fund’s research while prioritizing sustainable investment opportunities and using CalPERS’ reputation as a responsible investor to affect what it views as positive change through its investments. “We have long-term liabilities stretching out over decades, so we need to make sure our risks align with that.”
Richtman points to climate change as a classic example. Some investments such as coal might look very attractive in the near term. But decades out, they could be long-term losers. “It’s important we get this right,” she says. “Otherwise, we might end up mispricing investments.”
This approach gets murkier around social issues. While there’s plenty of data to show the benefits of environmental investments or that certain governance practices such as a diverse corporate board are linked with better performance, social issues are steeped in emotion and politics. Richtman says her division is in the process of mapping social issues to determine where CalPERS is at risk.
The most recent anti-gun movement is a clear illustration of the way the ESG strategy of working with companies can achieve results -- better results than a straight-up divestment approach. After the mass shooting last February at Marjory Stoneman Douglas High School in Parkland, Fla., student-led activism put pressure on Wall Street and investors to reevaluate their gun-related holdings. Amid the outcry, California Treasurer John Chiang went before his fellow CalPERS board members to request they divest from national retailers selling guns that are illegal in California. To help make his case, Chiang, who was running for governor at the time, brought families who had lost loved ones in mass shootings to a board meeting to plead with the board to pull its money from gun-related retailers.
Given CalPERS’ divestment history, the idea wasn’t out of line. As recently as 2013, the board opted to sell off the fund’s stakes in two manufacturers of guns and high-capacity ammunition clips. In his argument, Chiang pointed out that gun stocks had plummeted following the Parkland shooting.
Chiang’s original request to divest came in 2017, following a mass shooting in Las Vegas that claimed 58 lives and injured 851 others. In response, CalPERS began pressuring companies such as Walmart and Dick’s Sporting Goods to change their firearms sales. Following the Parkland shooting, more investors did the same. Those companies and others eventually agreed to discontinue the sale of assault-style weapons, cease selling high-capacity magazines as well as bump stocks, and sell firearms only to people who are 21 years of age or older. “I don’t think that would have happened had we just divested,” says board member Theresa Taylor.
In March, the board rejected Chiang’s request to divest, tabling the discussion until 2019. But the discussion was still enough to compel Perez to shake up the CalPERS board by running for a seat. Meanwhile, gun stocks have generally recovered. And most board members believe they took the moral high ground in working with the retail companies to affect firearms sales. “Yes, this conversation involves politics,” says Chiang. “But politics reflects values, and values are important.”