The ESG Threat to California’s Pensions
California’s public pensions are in trouble. While the Pew Charitable Trusts reports that California’s current unfunded liabilities are nearly $170 billion, as I recently reported in my chartbook on California’s pension crisis, the crisis is much worse. Valuing the liabilities using a more realistic market rate, the total pension debt is nearly $1 trillion.
The large fiscal hole leaves Californians with few good choices. If the state raises taxes, it will reduce overall economic prosperity, but if the state fails to adequately fund its pension obligations, then future public sector retirees will suffer greater economic insecurity. In light of these difficult trade-offs, any policy that limits the public pension systems’ investment options, and costs potential returns, worsens California’s pension crisis.
CalPERS’ and CalSTRS’ focus on environmental, social, and corporate governance (ESG) investing is such a policy. ESG investing prohibits the funds from owning specific investments based on the selected environmental or social criteria.
From the perspective of an individual investor, specific ESG criteria can make sense. Perhaps the ESG investment strategy will yield higher returns, perhaps it won’t. Either way, individual investors know the constraints they are imposing, are certain that the investment screens reflect their personal values and bear the consequences from their actions.
These attributes do not apply to public pension funds. Public pension funds represent many individuals who have no other investment options – if you are a teacher in California, CalSTRS will manage your pension, you have no choice.
With such a diverse group of investors, it is inevitable that any specific ESG policy will conflict with the values and preferences of some of the beneficiaries. For example, there is a growing push for CalPERS to divest from fossil fuel companies even though 67 percent of CalPERS members surveyed by the Spectrem Group in 2018 stated that the sector “is an essential element of a balanced, diversified portfolio”.
Beyond the problem of conflicting values, several studies on ESG investing (see here or here) have found that automatically screening out investment options harms financial results. And, California’s public pension funds are not immune from these impacts. According to newly-elected CalPERS Board member Jason Perez, the CalPERS ESG program toward tobacco cost the retirement fund $8 billion! Such investment losses are unconscionable given the funds’ large fiscal holes.
These concerns are also shared by SEC Commissioner Hester Peirce, who, at the 2018 Annual SEC Conference, stated that “problems arise when those making the investment decisions are doing so on behalf of others who do not share their ESG objectives.…When a pension fund manager is making the decision to pursue her moral goals at the risk of financial return, the manager is putting other people’s retirements at risk.”
Creating additional investment risks is the last thing California’s public pension funds should be doing given their dire fiscal position.
Unfortunately, CalPERS and CalSTRS continue to advocate for additional ESG screens. The evidence shows that the more ESG screens California’s public pension funds use, the more insecure the retirement of California’s public employees will become.
Dr. Wayne Winegarden is a Senior Fellow in Business and Economics at Pacific Research Institute. He is also the Principal of Capitol Economic Advisors.