Amidst growing pressures from special interest groups, CalPERS—the nation’s largest public pension system—recently confirmed that it no longer has investments in two private prison companies, CoreCivic and Geo Group.
Activists have long targeted these companies over a host of objections, the latest being their partnerships with the federal government in the area of immigration. These moves—ostensibly done as part of a normal recalibration of investment strategy—nonetheless come on the heels of prolonged activist pressure. And big picture, pension boards should recognize that risking lower investment returns in the name of influencing social change does a disservice to the members they represent and to the taxpayers responsible for unfunded pension debt.
CalSTRS—California’s retirement system for teachers—made a move last year to divest from the same companies while openly citing the Trump administration and border crossings. But unlike CalSTRS, CalPERS recently communicated that its decision was purely a decision based on investment analysis, not an attempt to influence change in policy. In fact, CalPERS said, the two private prison companies were among a group of 217 companies that the pension board has decided to jettison as a part of a strategy to reduce investment risk and maximize long-term returns.
As fiduciaries, the guiding principle for public pension boards is to ensure, in full, the retirement benefits promised to their members. Public workers depend on those pension benefits to be there when they retire. In order to keep these promises, pension boards need to achieve certain investment returns over the long-run, and they need to keep a close eye on the risks of long-term underperformance.
There are a couple of problems with pension boards prioritizing social change efforts over these traditional objectives. Firstly, divestment policies can negatively affect the long-term performance of a pension fund, a possibility which CalPERS is likely very aware of since its decision to divest from tobacco stocks in 2000 ended up costing the system a reported $3 billion and it recently balked at divesting from carmakers—despite the pleas from climate activists.
Often, divestment can create a hidden cost if it contributes to loss in diversification, meaning the action reduces the system’s variety of investments, which are an important element in managing risk. This means that divestment policies can unintentionally lead to higher overall risk for a fund, which leaves the assets of a pension fund that belongs to public workers more vulnerable to the volatility of the market.
Secondly, social and political priorities are unlikely to match the opinions and interests of all those who are contributing to the fund. With an active membership of over one million, and nearly 700,000 already receiving benefits, the members of CalPERS are likely a diverse group with varying opinions on all manner of political and social issues. Whenever a pension board takes a political stance on these issues, there are likely members who have contributed their hard-earned money into the fund and who happen to disagree—or not agree entirely—with the position promoted. This raises questions of fairness and again highlights the importance of pension boards not veering from their primary focus of funding benefits.
It is also of note that these pressures present themselves at a rather precarious time for many public pension funds, including CalPERS. The system reported a $138 billion shortfall for its main division—the Public Employee Retirement Fund (PERF)—in 2017, leaving it in a position where it is only prepared to pay around 70 cents on the dollar for the benefits that have already been promised to public workers and retirees. CalSTRS finds itself in a similar position, with an unfunded liability of $107 billion and just 63 percent of the funding needed to pay for promised benefits.
Out of fairness to their members, but mostly as a commitment to their missions, public pension boards should avoid prioritizing political and social goals over maximizing returns and managing risk. Instead of focusing on enacting social change, public pension boards should concentrate on making sure they keep their promises to public servants by fully funding their retirement plans.