Last month, in an attempt to put pressure on gun vendors, the New York City Employees’ Retirement System voted to sell over $10 million in shares of Dick’s Sporting Goods, Cabela’s, and Big 5 Sporting Goods.
This strategy, known as divestment, is employed by shareholders (usually pension funds or university endowments) to take a political stand against disfavored companies or industry sectors or encourage firms to change their business practices. Activists have targeted a number of different industries, including tobacco and gun manufacturers, for divestment. Even United Nations Secretary General Ban Ki-moon has encouraged pension funds to divest from companies that produce fossil fuels.
Despite these pleas for investors to pressure firms in the name of corporate responsibility, it is not wise for public sector pensions to promote social change at the expense of pensioners. As the fiduciaries of public sector pension funds, pension boards have an affirmative obligation to maximize the returns of their respective funds for the good of the pensioners rather than employing these funds to achieve political ends.
Before moving on, it is important to note that divestment is not selling off shares due to anticipated poor performance by a firm or an industry. For example, even if the New York State Common Retirement Fund (NYS-CRF) would have made $5.3 billion by divesting from fossil fuel companies, this could have been achieved independent of a desire to make a statement about alternative energy. An investor could have been completely indifferent to the damage done during the Deepwater Horizon oil spill, but it still would have been wise for them to sell any shares of BP they owned in the wake of the disaster.
In these cases, a savvy portfolio manager and an activist would make the same trades. By contrast, divestment is an attempt to do economic harm to a firm or industry to engender social change. The former is responding to a decline in the price of an asset, whereas the latter attempts to create such a decline.
There are examples of political change occurring alongside divestment campaigns, such as the case of Apartheid South Africa. A 1999 study published by the Journal of Business, however, found little evidence that divestment influenced corporations with operations in South Africa or South African financial markets. Divestment was far from the only measure employed by the international community to put pressure on the Apartheid government. The Comprehensive Anti-Apartheid Act imposed numerous restrictions on trade and investment in South Africa. Perhaps divestment made Apartheid a more salient issue and increased the demand for political action, but divestment is hardly the only way to achieve this outcome.
Even if divestment served as the impetus for change in the past, it’s questionable that these actions will have a significant effect on the bottom line of the firms targeted in today’s divestment campaigns. Dick’s Sporting Goods alone has a market capitalization of $5.7 billion, and while its stock price fell on Thursday afternoon, along with Cabela and Big 5’s, their share prices returned to their pre-divestment levels by the beginning of the following week.
As in the case of South Africa, changing the policies of these firms may require more aggressive action than simply divesting. In the wake of the Newtown shooting and the Chicago pension fund’s $5 billion dollar divestment from gun manufacturers, Rahm Emanuel encouraged TD Bank and Bank of America to stop financing gun manufacturers as well.
Perhaps this more aggressive strategy would work; it would be difficult for any firm to stay in business if major financial institutions refused to provide financing. But this strategy would take pension boards down a rabbit hole. Should they divest from any financial institution that invests in gun manufacturers or oil companies? Walmart is another firm targeted by pension funds eager to divest from gun vendors, but would it be worth punishing a company for only one part of its business model?
While the case for divestment’s ability to produce social change is dubious, one thing is clear: divestment, by definition, weakens the financial position of those who divest. The California Public Employees’ Retirement System (CalPERS), which reported an investment return of a meager 0.61% last year, has lost $3 billion by divesting from tobacco stocks in 2000. These effects are largely due to the risks posed by an improperly diversified portfolio. By selling assets that aren’t highly correlated with the rest of the portfolio, they increase the fund’s sensitivity to economic downturn. The negative effects of divestment are compounded by the trend of funds like CalPERS to increase their share of riskier assets, like equity and real estate, chasing higher gains at the cost of increased volatility.
Pensions funds not only forgo the potential returns from companies they divest from, but also lose money through the rather expensive divestment process. Many university endowments and pension funds make long-term investments in illiquid assets, which means there are high transaction costs to divestment. Additionally, because many divestment efforts target industries rather than specific companies (e.g. “fossil fuel companies” rather than explicitly identifying Exxon, Shell, etc.), the compliance costs for fund managers increase as they try to satisfy the sometimes-vague divestment goals of their customers.
Even if pro-divestment organizations explicitly identify such firms (as in the case of New York’s gun vendor divestment), these funds often do not directly own shares of the companies themselves. Rather, these funds are invested in mutual funds, index funds, and ETFs. This makes it difficult to divest from the targeted companies without also divesting from firms completely unrelated to the targeted industry because their shares are grouped together. One study found that these costs would, for the average endowment of a large university, cost two to twelve percent of a large university’s endowment, a loss of $1.4 to $7.4 billion.[1]
Indeed, many universities such as Harvard and Tufts, decided against divestment because it would “instrumentalize [their] endowment in ways that would appear to position the University as a political actor rather than an academic institution.” While these and other institutions remain committed to promoting positive social change, they choose to do this through the continuance of other university programs. “The endowment is a resource,” wrote Harvard President Drew Faust, “not an instrument to impel social or political change.”
The necessity to prioritize the wellbeing of their investment portfolio is even greater for public sector funds than universities. CalPERS was only 76% funded last year despite using a discount rate consistently above the actual investment returns. At its present course, CalPERS and many other pension funds will face a fiscal crisis that would far outweigh any marginal gains it would make in a quixotic attempt to solve gun violence, climate change, or smoking.
[1] Though the views expressed in this study were Prof. Bessembinder’s, his study was commissioned and financed by the Independent Petroleum Association of America.