Last November, the State Board of Administration of Florida (SBA), which invests the pension assets of the Florida Retirement System (FRS) signed the Principles for a Responsible Civilian Firearms Industry. By doing so, SBA (and therefore FRS) joined a coalition of more than a dozen other public-sector pension plans that want to encourage gun manufacturers and retailers (sometimes through divesting, although Florida still refrains from going that far) to support safety measures aimed at responsible use of firearms. But many people question whether this is a sound policy, since actions meant to affect social or political change are generally outside the fiduciary scope of a public pension board. Also, the seemingly honorable gesture puts pensioners’ retirement security at possible risk of lower investment gains that could force them to make higher contributions, which could shortchange employees and increase already-high pension liabilities.
As an investment strategy, divestment means pulling out funds from firms that operate in a “labeled” (read controversial) industry or country, thereby limiting access to liquidity in hopes of making them change their business practices. Increasing a pension fund’s stake, and voting power, in such companies (up to 100 percent) could yet be another way to affect corporate behavior. And firearms policy is only the tip of the iceberg. These days, producers of oil, gas, coal, tobacco, and other politically polarizing goods might find themselves on the blacklists of public pension funds.
In 2013, for example, California Public Employees’ Retirement System (CalPERS) divested its investments in two gun companies. In 2016 the system sold off more than $500 million in tobacco stocks, and CalPERS divested all of its coal investments by July 2017. In fact, just recently, the number of institutions that have committed to divesting from fossil fuels hit the 1,000 mark globally. Similarly, last summer, the New Jersey Pension Fund sold a $1.3 million stake in a private prison company following the actions of two other publicly funded retirement systems in New York and Chicago.
By making decisions that are not based on investment performance, however, pension funds could be foregoing extra investment yields that would help them reach their assumed rate of return targets and properly pre-fund retirement benefits. As Paul S. Atkins, former commissioner of the Securities and Exchange Commission, rightly put it: “…divestment will make it harder for public-sector workers to collect the pensions they expect.”
Overall, divestment strategies have quite a few drawbacks, including:
- Pension plans can’t account for all stakeholders’ opinions on whether any given investment is socially appropriate or not.
- Divesting often means sacrificing investment returns needed to secure promised pension benefits.
- Public pension funds are not appropriate actors to advocate for social change in the ways that advocacy group actors are.
- Few public pension plans seem to have the resources (except perhaps the largest few, like CalPERS, CalSTRS and few other heavyweights) to make a significant impact on corporate activity.
- Thus, the desired effects from divesting on the society are unlikely to materialize and can often be negligible or nonexistent.
While it is true that liability and investment risks often fall on the shoulders of state and local governments, and by extension, of taxpayers, most governments have contractual obligations to law enforcement officers, firefighters, and other public workers—to whom they’ve promised lifetime pension benefits. Given this financial duty, public pension plans are required to maximize the health of the pension systems and retirement security of public employees.
Politicizing asset allocations goes outside the scope of a plan’s “fiduciary duty,” which mandates pension trustees to act in the sole interest of active public employees and retirees, not that of society at large. This generally means minimizing risks and maximizing investment returns of the retirement system, which secures benefits that are generally treated as constitutionally-protected. As such, mixing personal views with the investment decisions made on behalf of thousands of teachers, firefighters, law enforcement officers, and other public servants is typically a bad idea.
Take, for example, the Retirement Systems of Alabama (RSA), which invests more than 15 percent of its assets into “economically targeted investments” (ETIs), prioritizing in-state investments over investments in other states and locations. Not surprisingly, ETIs contributed to RSA’s severe pension underfunding, a 2016 study found. Last year, RSA was $15.3 billion in the red and only 70.9 percent funded. In a similar vein, CalPERS, which has a significant stake in its home state, has missed out on $3 billion in investment returns since its decision to divest from tobacco companies in 2000.
Another significant drawback of divestiture policy is that it can hold public pension plans back from investing in index funds (e.g. S&P 500) and mutual funds that amalgamate holdings in hundreds of different companies. This matters, because such funds help diversify pension portfolios, making overall returns more resilient to market volatility in any one region, industry, or asset class. For example, the Public Pension Management and Asset Investment Review Commission (Pennsylvania) recently published a report that strongly recommends two state pension plans move into fully index investing on all fronts (i.e. in both equities and fixed income).
That is not to say that there couldn’t be exceptions where investments are both risky and morally reprehensible to some extent—certainly, companies that are conducting illegal trading, operating in regions in the midst of ‘brutal civil conflicts,’ or other situations might be worth staying away from. But, in these cases as well, investment decisions are best grounded in evaluating the associated risks of these companies going bust or underperforming financially rather than on their presumably low social standing.
Another important factor to consider is that there is no evidence that cherry-picking based on a social or political stance has any meaningful effect on targeted companies or society at large. In a well-known movement in the 1980s, students across the U.S. protested the apartheid system in South Africa, demanding their universities divest from companies operating in the country. Despite about 150 educational institutions heeding the plea, researchers found that divestment had no effect on these companies’ market values or behavior. Instead, it simply reallocated shares to less passionate investors.
This may be why some states, like Florida, do not seek changes to their portfolios. Notwithstanding the signing of a politically-driven document, the Florida Retirement System (FRS) does not seem to be selling its investments in gun retailers and producers, for example. “Our view is that divestiture is a very inefficient if not completely inappropriate tool for addressing social concerns,” said Ash Williams, executive director of the State Board of Administration, which administers Florida’s pension system. According to Williams, the coalition of investors doesn’t go all the way to call for actual divestment but is meant to influence gun companies to respond in some fashion to safety concerns.
Divestment is mostly an ineffective lever to pull when attempting to influence corporate behavior. History demonstrates that influencing corporate and societal change is best done through other democratic means, such as social movements, awareness campaign, judicial and political actions, and more.
With the next financial crisis potentially looming, and funding challenges increasing, public pension plans can’t afford to undermine their fiduciary responsibilities and leave money on the table in favor of making social or political statements.
For more about public pension divestments, please see our previous coverage: