The risky political push to force public pensions to divest from China

In recent years, politically motivated management of public pension funds has become a topic of intense debate. Policymakers in several states have turned to the funds that are supposed to be saved for the sole purpose of providing pensions to public workers and directed their use for political ends, be it foreign policy, environmental causes, social change, or any other political interest they seek to achieve. 

The issue has recently arisen in Missouri and Pennsylvania, where policymakers have intervened in the investment strategies of their states’ public pension funds to try to apply pressure or to simply send a message about growing domestic concerns with the Chinese government.

While pressure to adopt non-fiduciary objectives into investment decisions of public pension systems is not new, recent calls to throw public funds into the fray on China-related geopolitical matters are the latest example of political overreach.

In Missouri, this issue reached a critical juncture when the Missouri State Employees Retirement Fund board was pressured into divesting from Chinese-owned companies after it had initially rejected calls to do so.

Until 2023, the pension fund had invested approximately $200 million in China, distributed across three investment categories: equity in publicly traded corporations, stakes in privately owned enterprises, and holdings in funds that diversify into multiple stocks and securities. Liquidating the publicly traded equities is anticipated to result in a loss of around $1.3 million for the pension fund.

The Missouri public pension fund’s financial health is already in jeopardy, with its funded ratio dipping to a precarious 58% in 2023. In an effort to mitigate the impending financial disaster, the pension board voted to ramp up the employer contribution rate—which comes from taxpayers—substantially from 16.97% of pay for all years to 28.75% of pay in the 2025 fiscal year, 30.25% of pay in fiscal year 2026, and 32% of pay thereafter.

Pennsylvania’s story is similar, with its state legislature urging the divestment from Chinese companies affecting the State Employees’ Retirement System, SERS, and the Public School Employees’ Retirement System, PSERS. Both public pension systems already have funded ratios well below the U.S. average, at 61.6% funded for PSERS and 68% funded for SERS as of 2022. The employer contribution rate has already exceeded 30% for the teachers’ pension, further straining government finances.

The politicization extends beyond state pension funds to Congress and the academic world. Rep. Greg Murphy (R-NC) introduced the Protecting Endowments from Our Adversaries Act (PEOAA), which aims to penalize private university investments in Chinese entities through hefty excise taxes. This proposed federal legislation underscores the broader issue at hand—the potential for significant financial repercussions when investment decisions are motivated by politics rather than economic rationale.

The funding of public pension plans is already a massive problem. Total state pension debt has surged to $1.3 trillion as of 2023, with only incremental improvements in funded ratios of public pension systems over the years. From a low point of 63.5% funding in 2009, projections for 2023 show public pensions making a gradual improvement to 76% funding. Yet, this means that most state pension plans cannot fulfill the promises made to public workers entirely. State pension funds being 76% funded means they have the assets to pay only 76 cents of every dollar owed to their beneficiaries.

Some U.S. public pension funds turned their attention to China in pursuit of higher yields as interest rates have remained low in Western countries for a prolonged period. This move aimed to meet the ambitious target rates of investment return of some pension systems, which stood at an average rate of return of 6.93% in 2022, a reduction from the 8.07% return assumed in 2001.

China’s significant presence in global benchmarks makes it an indispensable market for benchmark-conscious investors like pension funds. Holding the largest share in the MSCI Emerging Markets Index and the FTSE Emerging Index at 28.39% and 31.03%, respectively, China offers a crucial opportunity for diversification. 

The core mission of public pension plan management should be to generate robust investment returns that fulfill the retirement promises made to workers without overburdening taxpayers. The abuse of pension funds, using them to achieve political objectives, subverts the primary goal of securing a stable retirement for workers. Such a strategy is irresponsible and perilous, risking both the retirement income of public employees and the tax dollars of citizens who will ultimately bear the brunt of underfunded public pension systems.

This tug-of-war between political agendas and fiduciary duty furthers the worrying trend of using public pension funds as a tool to exercise political leverage. Some blue and red states continue to apply political pressure on their public retirement plans by calling for divestment from industries like fossil fuels or even divesting from companies state lawmakers perceive to be antagonistic to fossil fuels. This politicization only makes it harder for pension funds to uphold their fiduciary duty to make decisions based solely on maximizing the return at prudent levels of risk. Whether the interests are environmental or geopolitical doesn’t matter, any political pressure applied to the managers of public pension funds to shirk their fiduciary duty has a cost.