California legislature shouldn’t politicize or micromanage public pension investments

California lawmakers are considering two bills that would force the state’s pension systems to liquidate the parts of their investments that may be related to fossil fuels and divest from banks that work with gun manufacturers. Regardless of which side of the political aisle the calls for politically driven pension system divestment come from, these would be bad policies for taxpayers, workers, and retirees.

The California Public Employee’s Retirement System, CalPERS, the nation’s largest pension system, and the California State Teacher Retirement System, CalSTRS, have over $700 billion in assets. Politicizing and legislating their investment strategies is a bad idea. In its opposition to one of the proposed laws, CalPERS correctly noted that the state constitution and the Public Employees Retirement Law say pension plans should act “solely in the interest of, and for the exclusive purpose of providing benefits to, participants and their beneficiaries, minimizing employer contributions, and defraying reasonable expenses of administering the system.”

Supporting the goals of activists is not on that list.

“We also believe that divestment would create a ripple effect on our ability to produce the investment returns needed to fulfill our members’ retirement promises,” CalPERS said in a statement against Senate Bill 252. “Every missing dollar of investment returns must be offset by employer and employee contributions.”

California’s public pension systems have enough financial challenges to deal with without the state legislature making investment and divestment decisions. CalPERS posted a negative investment return of -7.5% in 2022, bringing the plan’s funded ratio down to around 72%—meaning it has about 72% of the money needed to pay for retirement benefits already promised to workers and retirees. Similarly, the California State Teacher Retirement System (CalSTRS) reported investment losses of -1.3% in 2022, bringing its funding ratio down to 73%.

With investment returns failing to meet the plans’ expectations and rising benefit costs, CalPERS has seen a sharp increase in expected contribution amounts. In 2019, the expected contribution amount needed from governments—i.e., taxpayers—to adequately fund the pension system that year was $6.3 billion. In 2023, CalPERS’ annual required contribution rose to approximately $7.6 billion. The rising cost of public pensions means less government funding for education, infrastructure, and other programs today or the accrual of more public pension debt being pushed onto future generations.

CalPERS has been down this road before, with the state’s attempt at divestment after Russia invaded Ukraine. The CalPERS board opposed a bill that would have forced it to liquidate its $195 million holding (originally valued at $765 million) in companies with business operations in Russia. CalPERS rightly argued sanctions would make finding a buyer in the private market difficult. Forced liquidation of assets assumes it is easy to find a buyer to buy at the current market value, and unless that asset is traded on the open markets, that is not a guarantee.

It’s also unclear to what extent CalPERS and CalSTRS would have to divest if the current divestment proposals were implemented. For example, if lawmakers required pension systems to divest from all companies that heavily rely on fossil fuels, that could be interpreted to include countless companies and industries. Forcing apolitical pension funds into political divestment activities is messy, partly because of all the secondary and tertiary connections that are nearly impossible to navigate.

The funding of public pension systems concerns all of California’s taxpayers since they are ultimately on the hook to pay for pension debt. CalPERS has made some reforms in recent years. In 2019, for example, CalPERS fired most of its external fund managers to move them in-house and save more than $100 million in annual investment fees. This aligns with CalPERS’ fiduciary duty and is the type of thing it should spend its time scrutinizing, not sacrificing the security and affordability of its pension benefits by getting involved in politics at the state legislature’s request.

Rather than risking higher costs and more debt by requiring them to make politically driven divestment and investment decisions, CalPERS and CalSTRS must be allowed to focus on their mission of fulfilling the retirement benefits promised to workers.

A version of this column first appeared in the Orange County Register.