May Public Pension Plan Managers Use "Environmental, Social, and Governance" Investment Practices?

"[P]olitics has no place in Kentucky's public pensions.... '[S]takeholder capitalism' and 'environmental, social, and governance' investment practices that introduce mixed motivations to investment decisions are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky's public pension plans."

[UPDATE: My colleague Prof. Stephen Bainbridge, who is a corporate law scholar, has more on the subject here; much worth reading.]

From opinion 22-05 by the Kentucky Attorney General's office, handed down a week ago:

Syllabus: "Stakeholder capitalism" and "environmental, social, and governance" investment practices, which introduce mixed motivations to investment decisions, are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky's public pension plans….

There is an increasing trend among some investment management firms to use money in public and state employee pension plans—that is, other people's money—to push their own political agendas and force social change. State Treasurer Allison Ball asks whether those asset management practices are consistent with Kentucky law. For the reasons below, it is the opinion of this Office that they are not….

For years, … the Commonwealth's public pension plans have hovered at severely underfunded levels. According to the Kentucky Public Pension Authority's most recent annual report, the public pension plan for most state employees is roughly 17% funded…. And while the public pension plans administered by the Kentucky Public Pension Authority have shown year-over-year improvement in funding, there is a concern that this trajectory may be threatened by extreme approaches to investment management—particularly those that put ancillary interests before investment returns for the benefit of public pensioners and state employees.

One such approach is "stakeholder capitalism." According to its advocates, "[s]takeholder capitalism is an expansion of corporate management fealty beyond shareholders to include the workforce, supply chain, customers, communities, societies, and the environment." What this means in reality is that investment management firms who embrace stakeholder capitalism propose prioritizing activist goals over the interests of their public and state employee clients.

To achieve this version of "capitalism," investment management firms are adopting "environmental, social, and governance"—or "ESG"—investment practices. ESG investing is an "umbrella term that refers to an investment strategy that emphasizes a firm's governance structure or the environmental or social impacts of the firm's products or practices."

American economist Milton Friedman once criticized an earlier version of this trend whereby one set of stockholders sought to convince another set of stockholders that business should have a "social conscience." As he explained, "what is in effect involved is some stockholders trying to get other stockholders (or customers or employees) to contribute against their will to "social' causes favored by activists. Insofar as they succeed, they are again imposing taxes and spending the proceeds." Friedman found this problematic because "the great virtue of private competitive enterprise" is that it "forces people to be responsible for their own actions and makes it difficult for them to 'exploit' other people for either selfish or unselfish purposes. They can do good—but only at their own expense."

Today, in perhaps an even more pernicious version of the trend, the debate is no longer left to stockholders. In fact, there is little-to-no debate. Investment managers in some corporate suites now use the assets they manage—that is, other people's money—to enforce their preferred partisan sensibilities and to seek their desired societal and political changes.

Investment management firms have publicly committed to coordinating joint action for ESG purposes, such as reducing climate change. For example, the Steering Committee for the Glasgow Alliance for Net Zero ("GFANZ") states: "The systemic change needed to alter the planet's climate trajectory can only happen if the entire financial system makes ambitious commitments and operationalises those commitments with near-term action. That is why we formed [GFANZ], to bring together over 450 leading financial enterprises united by a commitment to accelerate the decarbonisation of the global economy." Similarly, Climate Action 100 "aims to ensure the world's largest corporate greenhouse gas emitters take necessary action on climate change." Climate Action 100 explicitly concedes a mixed motive, stating that its investor signatories believe that taking action "is consistent with their fiduciary duty and essential to achieve the goals of the Paris Agreement." As further suggestion of a political motive, some investment management firms have committed to both advocate for government-imposed climate change mandates, and use their fiduciary role to prevent portfolio companies from advocating against such mandates.

Whether these ancillary purposes are societally beneficial is beside the point when speaking of the duty of fiduciaries. Fiduciaries must have a single-minded purpose in the returns on their beneficiaries' investments.

And this affects Kentuckians. One investment management firm, at one time directing roughly $1.5 billion on behalf of the Kentucky Public Pension Authority, has made a "firmwide commitment to integrate ESG information into [its] investment processes" to affect "all of [its] investment divisions and investments teams." Other investment management firms that direct billions of dollars in Kentucky pension fund investments have publicly made similar commitments to ESG investment practices. There is some suggestion that politically biased investment strategies have real costs and worsen outcomes for pensioners. These harms are significant because companies employing ESG investment strategies are entrusted as fiduciaries to manage the funds in the best interests of pension beneficiaries like teachers, firefighters, and many other public servants who have ordered their lives around promises made and who depend on public pensions to finance their retirements….

State and federal law have long recognized fiduciary duties for those who manage other people's money. The Employee Retirement Income Security Act ("ERISA"), for example, demands that a fiduciary "discharge that person's duties with respect to the plan solely in the interests of the participants and beneficiaries, for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan, and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."

Kentucky law provides similarly demanding duties for fiduciaries. KRS 61.650 provides that a "trustee, officer, employee, employee of the Kentucky Public Pensions Authority, or other fiduciary shall discharge duties with respect to the retirement system … [s]olely in the interest of the members and beneficiaries [and for] the exclusive purpose of providing benefits to members and beneficiaries and paying reasonable expenses of administering the system[.]"This language draws from traditional trust principles requiring a single-minded purpose by fiduciaries that has been summarized as follows: "[a]cting with mixed motives triggers an irrebuttable presumption of wrongdoing, full stop."

Like ERISA, state law also demands that such fiduciaries discharge their duties "[w]ith the care, skill, and caution under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with those matters would use in the conduct of an activity of like character and purpose." The duty of prudence requires more than assuming sweeping government mandates that coincide with an investment manager's policy preferences. Under Kentucky law, fiduciary duty is not merely gift wrapping that a fiduciary may use to conceal a package of personal motivations.

Along with these fiduciary duties, the trustees of the Kentucky Public Pension Authority, for example, have adopted an investment policy that expressly provides that, in "instances where the Investment Committee has determined it is desirable to employ the services of an external Investment Manager," those "Investment Managers … agree to serve as a fiduciary to the Systems." Moreover, the trustees have expressly stated that, "[c]onsistent with carrying out their fiduciary responsibilities, the Trustees will not systematically exclude any investments in companies, industries, countries, or geographic areas unless required to do so by statute." …

While asset owners may pursue a social purpose or "sacrifice some performance on their investments to achieve an ESG goal," investment managers entrusted to make financial investments for Kentucky's public pension systems must be single-minded in their motivation and actions and their decisions must be "[s]olely in the interest of the members and beneficiaries [and for] the exclusive purpose of providing benefits to members and beneficiaries." To do otherwise risks breaching clearly established statutory and contractual fiduciary duties and threatens the stability of already fragile pension systems.

In sum, politics has no place in Kentucky's public pensions. Therefore, it is the opinion of this Office that "stakeholder capitalism" and "environmental, social, and governance" investment practices that introduce mixed motivations to investment decisions are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky's public pension plans.

Comments

[Á àß äẞç ãþÇđ âÞ¢Đæ ǎB€Ðëf ảhf]

This guy gets it. If people want to invest in woke causes, they can do it with their own money. If they have to use other people's money, they don't believe in their cause.

[SimonP]

Here is someone who doesn't understand the industry at all.

"Other people's money." Listen - investment managers don't develop ESG strategies just to pay themselves 1.5% or 2% of committed capital or whatever. They want these to be profitable strategies, and they wouldn't pitch them if they didn't think they could be.

There are plenty of opportunities to make good money in the ESG space. No one gives a shit about being "woke." That's just your idiotic class warfare programming kicking in.

[zztop8970]

https://www.forbes.com/advisor/investing/why-is-esg-underperforming/

[Armchair Lawyer]

They pitch these strategies because they want "woke" investors to invest in them.

[Greg J]

Bullshit

If the strategies were profitable, they'd justify them because they're profitable, NOT because of their politics.

This is people with a fiduciary duty, violating that duty to advance their personal political interests

Anyone who does this should go to jail

[Stephen Lathrop]

There cannot be any reasoned fiduciary limitation on taking into account as financial factors future political prospects which remain colorably reasonable.

Existence of opposing political factors cannot be taken as reasonable proof of fiduciary violation. To do that could lock in particular politics as a fiduciary obligation, and, depending on the unwisdom of the politics, even require bad investment decisions as the only ones available.

[Lee Moore]

I agree. if you are operating in an area where the mob is strong, piously avoiding investment in businesses that refuse to pay off the gangsters is not going to be a high reward investment approach, from a purely financial point of view.

It's a nice business you've got there.

[zztop8970]

More to the point: Assuming that ESG investing is a profitable strategy, there's no need to say you are making ESG a priority or a factor in your investment decisions for ESG's sake. Your duty as a fiduciary is to get the best return for your investors, and you make investments accordingly. If an ESG strategy happens to be one of them, great, but you invest because it makes money, not because it promotes decarbonization, or diversity, or equity or whatever. If you make that a factor, you are not living up to your obligations as a fiduciary.

[Á àß äẞç ãþÇđ âÞ¢Đæ ǎB€Ðëf ảhf]

They absolutely are not concerned about good investment strategies, shown by the fact that they use non-investment strategies to guide their investing. How much plainer does it have to get?!?

[Á àß äẞç ãþÇđ âÞ¢Đæ ǎB€Ðëf ảhf]

Or to make it even simpler, if you have to coerce or trick or mislead people into doing something, you yourself don't believe in it.

[TwelveInchPianist]

""Other people's money." Listen - investment managers don't develop ESG strategies just to pay themselves 1.5% or 2% of committed capital or whatever. They want these to be profitable strategies, and they wouldn't pitch them if they didn't think they could be."

Then they should pitch them as profitable strategies, not as ESG. Some profitable strategies will be environmentally and socially responsible, others won't. The fund manager has a duty to pick the profitable ones.

[Lee Moore]

I find myself in the awkard position of half agreeing with Simon P here. As the AG's opinion itself says :

While asset owners may pursue a social purpose or "sacrifice some performance on their investments to achieve an ESG goal,"

there's a market for selling investment management services to investors who have other objectives besides pure dollars and cents. So there's no reason why profit motivated investment managers shouldn't cater to that market. And in such circumstances it makes perfectly good sense to advertise the ESGiness (or religiosity or whatever) of their investment approach, precisely to attract those investors who want those non financial things.

If you market a fund that says "for religious reaons we are not under any circumstances going to invest in embryonic baby part sales companies" then if you don't consider them, even if they're fiendishly profitable with great growth prospects, and you know it, you're not breaching any fiduciary duty.

However, as the AG explains, in perhaps unnecessarily flowerly language, it's different when your investors have not volunteered for your moral principles. Absent a "waiver" of strict dollars and cents fiducary responsibility by a consenting adult investor, the manager has no right to indulge his moralistic whims, at the expense of the unconsenting investors' dollars and cents.

[zztop8970]

What the AG said was that "Asset owners", i.e, investors, may do that, but investment managers cannot.
If you want to invest your own money using a financially suboptimal strategy to achieve some non-financial goal, have at it. But an investment manager handling other people's money - who have no say in choosing the inventum tmanger (because it is a State pension fund managed by the State) can't do that.

[Lee Moore]

What the AG said was that "Asset owners", i.e, investors, may do that, but investment managers cannot.

Not quite. He referred to :

investment managers entrusted to make financial investments for Kentucky's public pension systems

So there are two different filters here.

1. investment on your own behalf v. investment on behalf of another
2. investment of funds voluntarily supplied v. funds conscripted

The no-no on ESG investing is not for investment managers per se (filter 1) but for investment managers in the Kentucky public pension system, which happens to involve the investment of conscripted funds, ie where the beneficiary does not get a choice (ie filter 2.)

There is nothing wicked, or un-fiduciary, about investment managers running ESG funds advertised as such, and promising to avoid oil companies or puppy-mince manufacturers, so long as all the investors in their funds are putting in their own money voluntarily.

So it's not that investment managers must always eschew non-financial objectives, it's that they may only do so with the money of folk who have agreed to those non-financial objectives by tipping in their own money voluntarily, with their eyes open.

[zztop8970]

yes, that's what I wrote- an investment manager handling other people's money - who have no say in choosing the investment manager (because it is a State pension fund managed by the State) can't do that.

[M L]

"there's a market for selling investment management services to investors who have other objectives besides pure dollars and cents."

Sure but I think pension funds are saying and ought to make clear, "we are not in that market."

[bernard11]

Well, I think the AG is right here, but the political tirade is sort of unnecessary, as is the pious quote from Milton Friedman.

It's also odd to raise hell about this, and "political agendas," and so on when the pension funds 83% underfunded. Wonder if politics had anything to do with that?

[Sebastian Cremmington]

I opposed the Biden stimulus but I don’t oppose spending money—we should have used that trillion to fully fund the pensions of states losing population or paid off some student loan debt or paid reparations to descendants of American slaves. A trillion dollars flushed down the toilet by Democrats and they didn’t even get any political capital out of the stimulus…one of the bigger political miscalculations in recent memory.

[Abdul Abulbul Amir]

States losing population are losing population in large part due to the governance in that state. California is a prime example. It is unfair to pass the cost to innocents.

Public sector pensions should be funded solely by contributions (taxes) from public sector employee pay.

[SRG]

83% is so underfunded that it is basically impossible for no "naughties" to have occurred. Serious underfunding can have come from a number of sources:

1. If the state contribution element were suspended for a while - such "pension holidays" are typically permitted when a PF is overfunded, but I can conceive that in order to keep the appearance of government expenses down, the state simply didn't contribute the due amount each year, possibly getting enabling legislation passed.

(This problem can originate when a state negotiates a generous pension with public sector unions in return for near-term union concessions on pay, benefits, etc. The result is to mask the true cost.)

2. A change of actuarial assumptions of one or more of the following: long-term expected equity returns; long-term expected bond returns; discount rate used for liabilities; changes in life expectancy, Generally these should be rare occurrences and shouldn't lead to a shortfall, but there are political games that can be played - with a new admin, get an actuary to change assumptions (and get a new one if the old one doesn't comply) and then blame the old admin for running the PF into the ground

3. The funds were overinvested in pet private projects that the trustees were happy to go along with, for whatever reason (see "Billions"...)

4. The funds used leverage and the managers got it wrong. In general, leverage has no place in a public defined benefit fund but that doesn't mean that the manages can't use it directly or indirectly

5. The senior fund managers were appointed on political grounds and were basically incompetent swine (tm Rudyard Kipling) if not actually corrupt, and the trustees' oversight was inadequate.

There are other ways, too. I am not saying that any of these actually happened here, but none of this would surprise me.

FWIW I was the CIO of a small-ish ($500mm) union pension fund for a short while, though I didn't have fiduciary responsibilities. I didn't see anything that was outright crooked, but I did see how the opportunities were there.

[YepThatGuy]

Thanks for taking the time to write this out.

[M L]

Good comment.

[SimonP]

State pensions are always fighting with underfunding, because state governments always see their contributions to the pensions of public employees as optional. It's as true in the blue states as it is in Kentucky. There oughta be a law, etc., but there isn't on this. ESG investing has nothing to do with it.

As for the legal analysis - what the opinion leaves out is any space for considering ESG factors as so-called "pecuniary" factors. It is not controversial to say that investment manager fiduciaries cannot sacrifice returns or accept investment risks in order to achieve ends other unrelated to providing for benefits to pension plan participants and beneficiaries. That's the law under ERISA and it at least arguably is the law for most state pension plans. But the opinion bulldozes over the following possibilities: (i) ESG investing may just be good investing in traditional terms; (ii) ESG strategies may provide less return, but at less expense, and with less risk, making the comparison to alternatives more nuanced; and (iii) ESG investing may make sense a time where ESG factors are relevant to investment performance (for example, now may be a good time to invest in companies that specialize in sustainable agriculture or electric vehicles).

Republicans have always been hostile to the idea that institutional investors can have a big influence on financial markets, and have sought over the past several decades to minimize that influence, when it comes to their own parochial interests. The Trump administration, for instance, adopted a rule that made it extremely risky for pension plan fiduciaries to participate in shareholder votes unrelated to business combinations or other issues with clear economic impacts for their interests, and they similarly tried to regulate ESG investment options out of 401(k)s. That's all that the Kentucky AG opinion is trying to do here.

[TwelveInchPianist]

"what the opinion leaves out is any space for considering ESG factors as so-called "pecuniary" factors."

Huh? Nobody is suggesting that fund managers can't do something because it might be socially responsible. They're just saying that that can't be the motivation.

[SimonP]

The distinction you're drawing here is meaningless.

People who understand this area of the law would understand what the AG is signaling here.

[Greg J]

Again, bullshit

You've got high performing investments that happen to be "socially conscious"? Go for it

But in that case you don't have to justify the investment as being "socially conscious", because you can justify it for being "high performing".

An investment manager who's talking about politics is doing that because the investments are worse because of politics

[Social Justice is neither]

As a marketing gimmick I don't really have a problem with this for individual investors. When you come at me for a second infusion of cash because your low performing ideologically motivated investments tank, fuck no.

As long as the fund manager can do this crap while overall not underperforming against their obligations and shafting the public for their ideology, see marketing.

[Brett Bellmore]

But there's no "marketing" component here, because the people whose money it is aren't picking the fund.

[Stephen Lathrop]

Nobody is suggesting that fund managers can't do something because it might be socially responsible. They're just saying that that can't be the motivation.

TIP — You insist that pro bono investing cannot be financially advantageous because it is pro bono? Your converse is apparently that anti-bono investing is required because anti-bono is financially advantageous. Can that make sense?

[Lee Moore]

You insist that pro bono investing cannot be financially advantageous because it is pro bono? Your converse is apparently that anti-bono investing is required because anti-bono is financially advantageous. Can that make sense?

This is not even wrong.

[TwelveInchPianist]

"Wonder if politics had anything to do with that?"

Of course it did. No politician benefits from spending money now to avert future spending that will probably occur when he is no longer in office. That's one reason these types of funds are a bad idea.

[SimonP]

TIP - how secure do you feel about your retirement?

Keeping traditional pension plans funded is not an easy or straightforward question. States treat them like piggybanks. Companies and unions used to, as well - until it was outlawed. But since it was outlawed, they've been phased out, in favor of these 401(k) things and IRAs. And now the course is set for a gigantic retirement crisis in the next couple of decades or so.

Hope you've got your lifeboat handy.

[SomeGuy 2]

Okay but if someone's 401(k) and IRA crashes at least it's their own fault and they were the ones spending the retirement money instead of their employer. This isn't ideal, but it's an improvement.

[TwelveInchPianist]

"TIP - how secure do you feel about your retirement?"

I would like a plan that's politically and economically viable. Defined benefit plans provided by governments tend not to be, for the reason outlined in this thread, among other reasons.

[M L]

Pensions are such a scam. Police officer retires at 40 or 45 and gets paid a comfortable salary for life? That's like a multimillion dollar annuity, far beyond the average taxpayer and would even be rich in the average taxpayer's eyes.

If the pensions are truly "fully funded" in real time, then it's less of a scam in theory. But then, what even is the point of having this system? Why not just pay that money to the employee or into a 401k or whatever?

[Raccroc]

Reads a lot like a typical AG opinion to me and this sort of waxing poetic is seems pretty common.

AG offices are asked all the time to render an opinions on this or that and it is not uncommon at all for them use it as a chance to air a grievance regarding some ancillary issue.

My guess here would be that someone who controls a pension asked for an opinion as a CYA before moving funds to a ESG or, someone complained about a pension which was moved to an ESG and wanted a "can they do that" opinion. The AG simply took the opportunity to chide the other powers that be about the sad state of current funding while issuing its own legal analysis.

[Michael P]

The particular pension fund referenced there seems to be the "KERS Nonhazardous" one, which -- according to the 2021 Annual Report -- has increased from 12.9% funded in 2018 to 16.8% funded in 2021 [p.152].

However, that report also says [p.13] that there are twice as many "CERS Non-hazardous" fund members as "KERS Non-hazardous" members, so "for most state employees" seems odd to me. The CERS Non-hazardous fund is 51.8% funded.

Presumably politics did have something to do with it, but the report credits [p. 6] the recent improvement in KERS Non-hazardous to a bill sponsored by a Republican state legislator.

[Rossami]

This seems so obvious that I am depressed it actually had to be said out loud.

[Rev. Arthur L. Kirkland]

Kentucky seems focused intently on practical performance by state contractors . . . except when it isn't.

What could explain this (other than right-wing politics practiced by bitter clingers)?

STATES RANKED BY EDUCATIONAL ATTAINMENT
(includes territories; 52 entities ranked)

HIGH SCHOOL DIPLOMA
Kentucky 43

COLLEGE DEGREE
Kentucky 48

ADVANCED DEGREE
Kentucky 39

But let's not focus myopically on categories in which Kentucky is ranked near the bottom.

POVERTY RATE
Kentucky 5

Carry on, clingers. As best you can, anyway.

[Raccroc]

I don't know that I've seen anywhere that Kentucky is focused on practical performance; this is just the AG office that is rendering this opinion. I would fully expect the AG to also conclude that any investments made on the basis of any investment portfolio's Palestine or Israel support are also illegal based on the exact same single-minded and no-politics principle they just laid out.

As to the education, that is tough one...

This is a bit of a chicken/egg issue. Better industry begets better paying jobs begets better education begets better industry and so on. Problem is, without having higher levels of education in the populace, how do you attract industry which requires that education? Tax breaks and incentives will only get you so far; any town/area will still need to have enough qualified people in the region for a company to actually hire.

So the question is, what exactly would you suggest they do about it?

[Stephen Lathrop]

So the question is, what exactly would you suggest they do about it?

Borrow heavily, even extravagantly. And spend the proceeds on educating a higher-skilled, higher-income tax base which can afford to pay off the loans. Make every close choice on the side of conspicuous advantage for the educationally inclined. Attract from out of state as many educationally inclined public-money takers as may present themselves.

I mean that sincerely. Of course I recognize the political problem getting that organized in Mitch McConnell's Kentucky. Just another reason to get rid of McConnell, and send his wretched ilk with him.

[Lee Moore]

Borrow heavily, even extravagantly. And spend the proceeds on educating a higher-skilled, higher-income tax base which can afford to pay off the loans.

Ok, then. Let's look at this. Unemployed, poor and even middling folk don't pay much income tax. So we probably need to start with a big ol IQ test to see who's likely to spend their life unemployed or drifting in or out of dead end jobs. And so we spend zip on their education. Then we weed out those who are never going to get a job much past mailman, store clerk, barista etc, and we only spend just enough to get them to readin, writin, rithmetic level, Then it's out to work at the age of 12 or so.

We spend quite a lot on the lower elite - the people who are going to be able to work at a middling to high level in complex businesses. Or who are going to be smart enough to do technician jobs.

And we spend an absolute fortune hothousing the 1% cognitive elite, in their own special schools, from age 4, because they are going to be the star entrepreneurs and inventors of the next generation, they are going to create all the new jobs and they are going to expand the tax base. No expense will be spared ! For these are the potential 10-baggers or 100-baggers of "Investing in Education."

Obviously to save spending money on things that aren't going to expand the tax base, we don't let these folk waste their time studying history, literature, politics. law and other useless parasitical things. Just STEM, maybe a bit of design, that sort of thing.

It's a sort of milchcow farming approach. We select the likely stars early and rear them bountifully so that we can milk them later. The cognitive lower classes we sweep under the carpet.

Maybe we could increase the returns by selective breeding 🙂

[SRG]

I am very satisfied with this decision because I am confident that in the long-term, ESG investment will prove to be effective and in the mean time such decisions will compel ESG advocates to come up with quantifiable economic benefits that will justify such investment.

Take a quasi-hypothetical instance. A fund announces that henceforth it invests only in companies where at least 1/3rd of board members are women. Brickbats are duly thrown and much fulmination takes place. That fund engages researchers who find (consistent with existing research in behavioural finance) that in companies with at least 1/3rd of board members who are women, their earnings grow more consistently, the stocks have fewer price shocks and the returns are no worse than companies with fewer women and which experience greater risk.

That research justifies the ESG fund's policy - but it also leads to funds that are not explicitly ESG also preferentially to invest in such companies.

[M L]

"ESG investment will prove to be effective"

Can you explain this more, and what you mean by "effective"?

Going by your example, am I to understand that if companies are sort of coerced into do things like making sure to get certain genitals and skin colors on their board and in their workforce, supporting abortion rights, Black Lives Matter and other leftwing political issues with their dollars and their speech, environmental factors that presumably include shunning cheaper sources of energy, etc. -- that these things will end up being profitable decisions, even though they were initially made and imposed for ostensibly non-financial reasons?

That is very interesting. What is the reasoning? Is this based on the (perhaps logical) expectation that the ongoing globalist syncretism of all things commercial, political, and governmental will continue apace and ultimately prevail?

[SRG]

I think you misunderstand.

1. "Effective" has only one relevant meaning - gives higher returns than a passive indexed portfolio. Consider that if one preferentially invests in environmentally sound companies, the risk of being sued or taxed for environmental damage is minimal compared to environmentally impactful companies.

2. My point is not that funds should be compelled to ESG investment but that in the absence of compulsion, advocates for it will have to find the evidence which shows the relative benefit of ESG investment rather than relying on political persuasion or appeals to nature, etc. And given my own qualitative knowledge of the subject, I am of the opinion that such evidence does exist.

On being shown the evidence (assuming it can be found), fund managers will have little alternative but to bias their investments towards ESG or run the risk of underperformance and violation of fiduciary responsibilities. Of course, there will always be some managers who will resist the evidence - and in the case of some public funds may even lobby for legislation to protect their resistance to evidence or give them immunity from suit.

I get the distinct impression that you would reject evidence that showed the quantifiable benefits of ESG but (a) I could be mistaken in my impression and (b) you're not running a fund anyway.

[Absaroka]

I'm skeptical. Take three alternative worldviews:

A) 'I'll get a better return by investing in ESG companies (for the reasons you list)'.
B) 'I'll get a better return by investing in rapacious companies because dumping toxic waste is cheaper than proper disposal'
C) 'I will invest in the companies giving the best return regardless of morality'

Both A and B have something in common: they restrict you to a subset of outcomes. C gives you access to the entire universe of outcomes. A (or B) can't outperform C because C can make exactly the same investments as A (or B), but the converse isn't true.

And, theoretical arguments aside, ESG funds have been around for long enough to demonstrate outperformance, and they haven't[1].

Note that I'm not saying you shouldn't invest in an ESG (or rapacious!) fund on moral grounds - just that you shouldn't expect it to outperform a total market approach.

[1]and suppose they did ... even amoral investors would notice and pile into them, driving up the price of ESG companies, which would reduce future expected returns.

[M L]

But traditional investing guidelines already evaluate regulatory risk, civil liability risk, tax burden risk, and so on. What is missing?

Your contention, which I think is the common line, is that ESG is actually nothing more than a purely fiduciary perspective that seeks to maximize returns, rather than what it seems to be -- a "plus" factor that goes beyond profit and into political advocacy, or at least, the adoption of a broader view about social responsibility or "equity" above pure profits. To be clear, I'm not against having values beyond profit.

I'm not running a fund, and you know much more about this than me. It seems to me that part of the problem is this broad sweeping generalization you have -- "the quantifiable benefits of ESG." You are putting this label on a basket of various different things. And the basket seems to change quickly, so it's not just various but also variable. I sense some of it may be more subjective than objective, as well. And who varies it? People do. A very small number of people I think. For example how many people voted on the decision to drop Tesla from the ESG index? A small number of people who have agendas and self-interests and who are fallible like anyone else.

So I am open to evidence that shows quantifiable benefits of specific metrics or factors. But to some extent "ESG" seems more like a cartel.

[Greg J]

May Public Pension Plan Managers Use "Environmental, Social, and Governance" Investment Practices?

No

Not only "no", but "hell no".

The pension managers' sole duty is their fiduciary duty to the pension holders.

Anything that conflicts with that should, at a minimum, be grounds for firing the pension manager

[F.D. Wolf]

We're sorry that your pension check is a little light this month, and you are not able to afford to eat, but you'll be pleased to know that a donation has been made in your name to the Human Fund.

[ReaderY]

Remember, folks, that if a Russian cybertheft ring makes its money by holding hospitals and fire departments hostage for ransom, it is the legal duty of Kentucky pension managers to invest in it if it offers an even slightly better return than an alternative investment. None of this consider the impact of the investment on society bullshit. Fidiciary duty means seek the highest return and only the highest return. By any means necessary.

[Absaroka]

"seek the highest return"

I think that is actually the highest *risk adjusted* return. Most criminal enterprises are high enough risk that the risk adjusted return is pretty low.

As far as the moral implications, do the preferences of the people the money belongs to matter to you?

Would you be happy if the fund managers said 'This is Kentucky, home of tobacco and bourbon, so instead of blindly seeking the best return we are going to invest primarily to support distillers and cigarette companies'? Can the employees object to their money being used to make that statement?

[ReaderY]

Whether or not I’d be happy, I don’t think the concept of fiduciary duty prevents Kentucky pension fund managers from preferring Kentucky businesses, including these, to others. They have to be reasonably financially sound and offer reasonable potential for returns. It can’t be the only consideration. But the concept of fiduciary duty just isn’t so narrow as to require judges, or attornies general, to micromanage the way fund managers invest.

As I’ve often written, people can (and often do) disagree about what constitutes the public good. The question here isn’t simply substituting my opinion on things for the Kentucky Attorney General.

So if a Kentucky fund manager decides to invest in tobacco and bourbon to help support Kentucky businesses, I may or may not like it. But if the businesses are reasonable investments, it wouldn’t be a violation of fiduciary duty.

[Brett Bellmore]

Fiduciary duty SHOULD prevent Kentucky pension fund managers from preferring Kentucky businesses, because concentrating your investments in one region increases risk.

[Absaroka]

I'd be interested in hearing where people think the line should be drawn, e.g. if I am managing your money in a fiduciary capacity, can I[1]:

-invest in my cousin's business, because I like my cousin and his business has hit a rocky patch (clearly no, I'd guess?)
-invest in a stadium in my hometown because I like baseball?
-invest in businesses of a particular state because I like that state?
-for a state client, does that state have to be the client state, or just a state I like?
-for a state pension fund, do I have a fiduciary duty to the retirees who have, say, moved out of state to a warmer/lower cost/whatever state? E.g., suppose I am the trustee of the barely solvent state pension fund, and that state wants me to buy their high-risk bonds to prop up state finances. The retirees who no longer live in the state might want me to look first to their pensions rather than subsidizing further state spending.
-does it matter whether I am running the annuity department of a private insurance company who just feels sympathy for the budget troubles of state X, or a trustee of the state X pension fund? To put it another way, do state X retirees have a special obligation to sacrifice their pensions to support the state they once worked in, relative to, say, retirees that worked in state Y but now live in state X?

etc, etc. I'm curious where people draw the lines on pension fund managers doing things for purposes other than supporting the pension recipients.

[1]in all these cases, let's assume these aren't the highest risk-adjusted returns available; the manager is sacrificing return in favor of some other purpose

[Lee Moore]

I should have thought all of those things were a breach of fiduciary duty, on principle. Though whether State law allows, or even encourages, them in any particular State is a matter for State law.

[ReaderY]

It reads like a Kennedy Supreme Court opinion. Lots of philosophizing about The Nature of Things and How Things Should Be.

Essentially no law.

[Krayt]

'member when the left threw up warnings about NGOs, with their insane money and no democratic control? Good times!

[tkamenick]

Would it be different if the pension fund managers offered an ESG portfolio as one investment option among many, so long as they were honest that they were sacrificing financial performance for these social goals?

[M L]

Imagine how many pensioners, even in blue states, would say,

"Yes, please use my life savings and place it at risk not for maximum security and stability with reasonable returns, but for shadowy political agendas."

Not many, I'd wager.

[Lee Moore]

Perhaps not, but you'd do OK with :

"Yes, please use his life savings and place it at risk not for maximum security and stability with reasonable returns, but for shadowy political agendas."

[M L]

Without a doubt. And that is why, if I understand correctly, ESG is in fact widely popular with pension funds. But that should not be so, if I'm right about what the actual pensioners would think.

[M L]

S&P Dow Jones recently kicked Tesla out of the S&P 500 ESG index. They cited "claims" of racial discrimination. Hmm. It's hard to not see a connection between this and Elon Musk's recent, rather moderate political opinions and the "threat" of allowing free speech on Twitter which leftists apparently find absolutely horrifying. Dropping a company from an index is wielding an incredible amount of economic power, apparently against individuals for far-left political reasons.

[SRG]

S&P Dow Jones recently kicked Tesla out of the S&P 500 ESG index. They cited "claims" of racial discrimination.

This is not the full story. SP& also cited crashes of their autopilot vehicles. And note that Tesla was evidently removed for not keeping up with overall industry improvements.

"Tesla’s overall ESG score has remained “fairly stable” year-over-year, according to S&P DJI. However, an increase in score for the broader industry group in which Tesla is categorized – Automobiles & Components – resulted Tesla's slide." (My bold)

https://finance.yahoo.com/news/sp-removes-tesla-from-esg-index-182259870.html

And of course the ESG index is not the same as the S&P500

[YepThatGuy]

Late add to the discussion, but if you think ESG considerations are out of line, take a look at what "B Corp" certification entails for the companies lining up for that particular brand of virtue signaling. Among other things: "The B Corp Certification legal requirement means that a company must change their fiduciary duties to become legally accountable not just to shareholders, but all stakeholders — including customers, employees, suppliers, communities, and the environment. " I'm not entirely sure how a corporate entity changes its legal obligations with regard to the environment, but hey, why not.

[ArnoldTaylor]

Honestly speaking, we all face these problems and not everybody can solve it. Anyway, I think the law is one of the most important aspects. For instance, a couple of days ago I've found this source https://www.natlawreview.com/article/preparing-record-otr-interview-what-brokers-need-to-know-about-finra-rule-8210 where there is information about what brokers need to know about finra rule. I think this information will be relevant for each investor.