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The biggest comeback of socially responsible investing also took place in the 1990s, when elected officials in New York, Connecticut, Minnesota, and—most notably—California began to dabble in asset allocation decisions based on a growing list of social concerns. CalPERS is the 800-pound gorilla among public pension funds. At its peak value in October 2007, CalPERS and its sister fund, CalSTRS (the state teachers’ pension system), held over $400 billion in assets. Their portfolios have more global influence than the entire economies of most sovereign nations. And during just three months last fall, more than 20 percent of the funds’ combined value evaporated—a horrendous performance for public investments designed to minimize risk and protect retirees. “We have ups and we have downs,” said Pat Macht, CalPERS assistant executive officer, as the fall 2008 massacre unfolded.
CalPERS and CalSTRS began flexing their financial muscles by demanding corporate governance reform, publicly excoriating companies they deemed to be poorly managed. It was an aggressive, almost unprecedented demonstration of the growing corporate transparency and accountability movement. The state’s pension fund meddling went into high gear in 1998 with the election of Phil Angelides as California treasurer. If there is a face to pension fund activism, it’s Angelides’. As political issues go, treasury and pension fund investments are not the sort of hot-button topics that ambitious California politicians usually ride to glory. But Angelides had a vision: to use retirement dollars as a way to change the world, and the state treasurer position became his tool.
Under Angelides’ direction, CalPERS emerged as a leading voice on behalf of shareholder rights, at least as he defined them. To this day, the California funds instigate a dizzying number of proxy fights at the companies in which they invest, focusing not just on governance-related issues like executive pay but on everything from carbon taxes to divestment from companies that do business with Sudan. This social activism has acted as a model for public pension funds in other states. Laws directing funds to scrap investments in companies that invest in disfavored countries have passed or are being considered in 20 states, including Texas, Maine, Tennessee, New Jersey, Florida, and Idaho.
In 1999 Angelides’ funds committed $7 billion to a program called Smart Investments to support “environmentally responsible” growth patterns and invest in struggling communities. As in Alaska and Kansas in the 1980s, however, there were no accountability provisions to measure the impact of the venture, let alone to determine its financial consequences.
Supported by labor unions and minority groups, Angelides argued that the state had too many billions stashed away in so-called emerging markets—Third World nations where democracy is weak and wages are low—and not enough invested at home creating jobs and housing. So in March 2000, he rolled out an ambitious social investing program, dubbed the Double Bottom Line, which included dumping $800 million in tobacco stocks and persuading fund managers to shed investments in countries that Angelides thought had questionable environmental or governance practices. He claimed the initiatives would not sacrifice investment returns, saying at the time: “I feel strongly that we wouldn’t be living up to our fiduciary responsibility if we didn’t look at these broader social issues. I think shareholders need to start stepping up and asserting their rights as owners of corporations. And this includes states and their pension funds.”
How has this social engineering worked out? Angelides left his job as state treasurer in 2006 for an unsuccessful run for governor, but his legacy of politicizing pension fund investing remains. In 2003 CalPERS rejected a recommendation from its financial adviser, Wilshire Associates, to invest in the equity markets of four Asian nations—Thailand, Malaysia, India, and Sri Lanka—based on their alleged misdeeds. That was a costly decision, as their stock markets roared in the ensuing years. Another decision to shun investment in China, India, and Russia cost the fund some $400 million in forsaken gains, according to the fund’s own 2007 internal report.
Under sharp criticism and amid devastating declines, CalPERS last August finally repealed the screening policy, claiming victory in its reform efforts. “Year by year, scores [of countries and corporations that invest in them] are improving, and many countries have responded to our standards for investing,” CalPERS President Rob Feckner said in a press release.
CalPERS’ tobacco boycott was equally disastrous. With the float of most large cigarette companies so large, disgorging even a sizable fraction of one company’s shares has little impact on the stock price; it’s akin to taking a thimble full of water out of the deep end of a pool, only to have it dumped back in the shallow end when the buyer makes his purchase. Since California sold its tobacco shares, the AMEX Tobacco Index has outperformed the S&P 500 by more than 250 percent and the NASDAQ by more than 500 percent. That one decision alone cost California pensioners more than $1 billion, according to a 2008 report by CalSTRS.
Some of the most steadily performing sectors, through both good and bad times, have been the very “vice” stocks that are no-nos for most social investors. When times get tough, the sinners get sinning. “Demand for drinking, smoking, and gambling remains pretty steady and actually increases during volatile times,” says Tom Glavin, chief investment officer at Credit Suisse First Boston. Alcohol, tobacco, and gambling stocks rallied solidly during two of the last three major recessions, in 1990 and 1982. “Many of these industry groups tend to be beneficiaries of the flaws of human character,” Glavin says.
So what stocks did the California funds buy instead? High on the list were financial stocks, which have been given a green bill of health by social investors. CalSTRS recently acknowledged it had lost hundreds of millions of dollars on Lehman Brothers, AIG, and other fallen icons that were recent favorites of social investors.
But those losses may pale when the tab comes due for misplaced bets on the boom-to-bust California real estate market. According to a report released last April, CalPERS had 25 percent of its $20 billion real estate assets in the California market, which has declined faster than the real estate markets in most of the rest of the country.
In the summer of 2007, CalPERS was more than 100 percent funded. It’s now under 70 percent funded and falling, and that doesn’t fully factor in its plummeting real estate investments. Funding levels stand near a dismal 50 percent for Connecticut, where State Treasurer Denise Napier has been a vocal proponent of social investing. Both states are far below mandated minimum funding standards, and they pale in comparison to even the beleaguered ratios of corporate defined contribution plans, which have mostly avoided using social screens.
Large public pension funds have a selfish notion of risk: heads they win, tails you lose. If they gamble on risky investments that pay off, they are heroes, although the predetermined benefits don’t increase. But if those investments go south, tax dollars will have to bridge the gap. “This is adding insult to injury,” says Jon Coupal of the Howard Jarvis Taxpayers Association. “At the same time we’re seeing our own 401(k)s get hit, we’re on the hook to make up the shortfalls for public employees who are guaranteed their full pensions without any risk.”
When public funds slide in value, taxpayers get hit from all sides. The municipalities and school districts that hire firefighters, police, teachers, and other workers have to cut their staffs to recapitalize funds. Last October the Los Angeles County Board of Supervisors learned that the county would have to come up with an extra $500 million to keep its pension fund whole. That means the county may have to raise local taxes and cut services to deliver on overextravagant promises it failed to safeguard.