The Texas Comptroller of Public Accounts recently published a list of 10 financial firms and 348 funds it considers hostile to the fossil fuel industry from which the state’s pension funds must disinvest. Comptroller Glenn Hegar compiled the list in compliance with Senate Bill 13 (2021), a law stating Texas pension funds and government agencies cannot invest in companies that divest from fossil fuels.
It is understandable for state policymakers to want to push back against an environmental governance social investment (ESG) movement that they view as threatening to Texas’ oil and gas industry, but just as some progressive states are wrongly telling their public pension funds not to invest in specific sectors, Texas Senate Bill 13 threatens the cost-effective stewardship of taxpayer funds.
Texas SB 13 instructs the Comptroller to identify financial firms that are:
“…refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalize, inflict economic harm on, or limit commercial relations with a company because the company … engages in the exploration, production, utilization, transportation, sale, or manufacturing of fossil fuel-based energy and does not commit or pledge to meet environmental standards beyond applicable federal and state law.”
The Comptroller’s list includes nine European companies and BlackRock, the world’s largest asset management firm. Disinvesting in BlackRock could impose special challenges for Texas pension funds because it is included in the Standard & Poor’s 500 stock index. Thus, in simple terms, any exchange-traded fund (ETF) or index fund that is based on the S&P 500 holds some shares in BlackRock.
Fortunately, SB 13 appears to provide some flexibility for state agencies that have exposure to blacklisted firms through indirect means—like holding them through mutual funds or ETFs. Specifically, SB 13 states:
A state governmental entity is not required to divest from any indirect holdings in actively or passively managed investment funds or private equity funds. The state governmental entity shall submit letters to the managers of each investment fund containing listed financial companies requesting that they remove those financial companies from the fund or create a similar actively or passively managed fund with indirect holdings devoid of listed financial companies.
So, according to the law’s text, a Texas pension fund or government agency can continue to hold an S&P 500 fund—as long as it asks the fund manager to drop BlackRock from its portfolio. It is doubtful that an S&P 500 fund would follow through and eject BlackRock for various reasons, including because it would introduce a tracking error—a divergence between the index fund’s performance and its underlying index.
Among the mutual funds on the Comptroller’s blocked list are six vehicles that invest in most S&P 500 stocks. Texas is targeting them because the state claims they explicitly exclude companies in the fossil fuel industry and those with low ESG scores. These blocked funds would also diverge from the S&P 500’s performance, but it is possible that ESG-focused investors holding these funds may be more likely to accept any discrepancy. It remains to be seen whether a fund provider could attract sufficient interest in an investment product that mostly tracks the S&P 500 while excluding ESG-oriented firms such as BlackRock.
The European firms on Texas’ blacklist include three institutions—BNP Paribas, Credit Suisse, and UBS—that rank among the 50 largest banks worldwide. The Texas Employees Retirement System or the Texas Teacher Retirement System may hold securities issued by these entities, but this cannot be readily confirmed because neither system publishes a detailed list of investments on their respective websites.
Although SB 13 is relatively clear that pension funds do not need to liquidate mutual funds that include the blacklisted companies, it is less clear whether the Texas pension funds can invest additional, new money in such vehicles going forward.
Most importantly, while the law includes provisions that try to reduce its impact on the state’s pension funds, Texas Senate Bill 13 sets a dangerous precedent for inserting politics and legislating into investment decisions.
It’s also part of a troubling bipartisan trend. In 2021, Maine passed a law requiring the state’s pension system to divest from fossil fuel investments. And similar divestment bills have been proposed in Massachusetts, New York, and New Jersey.
State policymakers and legislators should not limit the flexibility of pension fund managers to maximize risk-adjusted returns. Public pension fund managers should focus on optimizing their portfolios on a risk/return basis, so the pension systems have funding to pay for pension benefits promised to workers.
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