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Public Pension Funds' Anti-Fossil Fuel Activism Raises Risks For Beneficiaries

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In a recent piece, I wrote about the fact that the Divestment movement is now running into headwinds, as federal public policy under the Trump Administration moves further away from the movement’s goal of artificially limiting the production of oil and gas domestically, and as it is becoming increasingly clear that some major public pension funds are finding themselves severely underfunded after years of heavy focus on the movement’s investing priorities.

As it has become increasingly obvious over time that divestment has failed, we’ve seen a new push towards influencing companies directly via shareholder engagement actions. One of the main ways this has manifested itself over the last few years is through the engagement in shareholder proxies by major public pension funds, like CalPERS (California Public Employee Retirement System) and the New York State Common Retirement Fund. Helping that cause, 2017 marked the first year that three giant passive investment funds, BlackRock, State Street and Vanguard, joined with CalPERS in several proxy votes. Taken together, these three large funds hold ownership in most, if not all the companies listed in the S&P 500, and their votes can heavily influence the outcomes of proxy proposals.

In my prior piece, I mentioned that the managers at CalPERS recently admitted that their investment portfolio currently contains just 65% of the funds necessary to meet its future obligations to retirees. A new report published earlier today by the American Council for Capital Formation (ACCF) analyzes in great detail how CalPERS has reached its current point of under-funding. The report lays out how much of the blame for CalPERS current $138 billion funding deficit - it sported a $3 billion surplus as recently as 2007 - can be laid at the feet of “How CalPERS has prioritized relatively poor performing Environmental, Social and Governance (ESG) investments at the expense of other investments more likely to optimize returns (four of CalPERS’s nine worst performing funds as of March 31, 2017 were ESG-focused).”

When running such a large deficit, one would expect the managers at such a major pension fund to focus its shareholder proxy activism on proposals that are designed to increase a corporation’s profitability. Indeed, Belief #3 of CalPERS’ 10 listed “Investment Beliefs” states that “CalPERS investment decisions may reflect wider stakeholder views, provided they are consistent with its fiduciary duty to members and beneficiaries.” Given that four of its nine poorest-performing investments were made based on ESG-related criteria, one might expect to see a de-emphasis on this area of focus and activism by the fund’s managers, in an effort to conform to that specific Belief.

But in fact, 2017 saw the opposite from CalPERS, as the fund sponsored no fewer than 17 so-called “2DS” resolutions. These are proposals that ask targeted companies to assess “the long-term portfolio impacts of technological advances and global climate change policies”, a process that not only does nothing to enhance profitability, but inevitably results in higher administrative costs for companies forced to comply.

Such proposals brought by CalPERS had failed in years past, but in 2017, with the new support from BlackRock, State Street and Vanguard, 3 of the 17 CalPERS proposals succeeded in coming up with a majority vote. In its most recent ESG report, CalPERS boasts that “Sustainability continues to be at the heart of what we do.” But how such successful proxy votes that raise costs to companies in which it is invested help to sustain the fund’s ability to meet its future obligations remains a mystery.

For its own part, Black Rock “explained its votes as a matter of ‘engagement’ with companies, telling the Financial Times that ‘We don’t decide how to vote based solely on our views on the issue under consideration. Our vote reflects our assessment of the company’s response to our engagement in light of the long-term financial impact.’” Life seemed so much simpler when fund managers based investment decisions mainly on anticipated return on capital , rather than some barely-defined notion of “engagement.”

Perhaps the most telling aspect of all in the ACCF report is its analysis of the personal investment decisions made by those who manage the CalPERS fund. It found that, while these senior managers – including CalPERS Chief Investment Officer, Theodore Eliopoulos – own portfolios showing personal investments in a variety of industries, including oil and gas, railways and pharmaceuticals, none have any holdings in the kind of ESG-focused investments into which they have chosen to direct a large portion of CalPERS funds:

“Based on review of California’s Form 700 Statement of Economic Interest for all board members and senior investment officer, it was discovered that none had any personal capital allocated to any environment-focused funds or equities. CalPERS spent more than $1 billion on fees to investment advisors, hedge funds and private equity in 2017. These three people had access to $1 billion worth of investment advice and chose to steer clear of the type of investments they direct pensioners’ money into.”

This sure seems like a funny way to run a railroad. Or a pension fund on which almost 2 million beneficiaries currently rely.

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