Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

According to Hugh Wheelan ("Prince Charles to propose 'pension plan for the planet'," Responsible Investor, November 17, 2008), England's Prince Charles is working hard to save the rain forests. Since late 2007, His Royal Highness is described as actively encouraging long-term investors such as insurance companies and retirement plan sponsors to buy 15-year bonds "with competitive returns." Issued by companies that are creating "sustainable energy solutions," proceeds of the bonds would likewise be used to make developing companies less dependent on income earned by chopping down trees. The P8, a consortium of 10 (not 8) interested pension funds, is said to include the (1) Universities Superannuation Scheme (2) Dutch giant ABP (3) CalPERS and (4) CalSTRS. (See "Prince Charles lead 'P8' pensions powerhouse finalises climate change report ," Responsible Investor, July 31, 2008.)

Richard Palmer, Daily Express blogger has a different take. In "Prince Charles Wants to Raise Your Taxes to Save Rainforests" (November 4, 2008), eco-friendly investing would get a boost, courtesy of the UK taxpayers as well. Not only would wealthier countries guarantee rain forest bonds, their citizens could pay a utility tax for the alleged benefits provided by tropical jungles - "global air conditioning system, storing its largest body of freshwater and providing a livelihood for more than a billion people."

With the current market situation, one wonders if initiatives such as these will fall by the wayside, for some time, at least. Leaders of developed countries have their hands full as they try to stimulate their beleaguered economies. At the same time, funding status for more than a few pension plans worsens, leaving them with fewer monies to allocate.

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According to blogger extraordinaire and Sacramento Bee reporter Jon Ortiz , the California giant will now invest in "PPP" (public private partnership) deals but with strings attached. According to their policy entitled "Infrastructure Program," posted on "The State Worker" and elsewhere, projects to build bridges, roads and other types of infrastructure should avoid displacement of California municipal workers "provided that CalPERS' fiduciary responsibilities are met." Subsequent text adds that "the investment vehicle shall make every good faith effort to ensure that such transactions have no more than a de minimus adverse impact on existing jobs."

Far be it from me to impugn any group of workers, municipal or private. However, one does wonder if CalPERS and infrastructure fund managers will soon find themselves at loggerheads. If I read the policy correctly, it seems to put an awful lot of responsibility on external portfolio managers to address wage differentials (if any exist) for the express purpose of assessing the cost-effectiveness of labor resources. Employment economics is a speciality in its own right. Should infrastructure moneymen (and women) hire outside experts to undertake a comprehensive study to determine whether private versus public workers are best suited for a particular project? How might such fees, paid to labor economists by money managers but passed along to institutional investors such as CalPERS, erode reported returns? Could returns be eroded by so much that the benefits of investing in infrastructure in the first place are more than offset by CalPERS' mandate to avoid loss of state jobs?

According to Brian K. Miller ("CalPERS Changing PPP Language," GlobeSt.com, August 15, 2008), the California Public Employees Retirement System ("CalPERS") altered its policy so as not to be sued by the Professional Engineers in California Government ("PECG"). The American Council of Engineering Companies of California (the private equivalent of the PECG) countered that threat of litigation does no one any good.

Does this type of allegedly veiled political "intervention" sound familiar?

Just a few days ago, Massachusetts State Treasurer Tim Cahill said "no thanks" to Governor Deval Patrick, when asked to allocate pension assets to bonds issued by the state's student loan organization. In "Cahill rejects student-loan proposal" by Casey Ross (The Boston Globe, August 8, 2008), fiduciary concerns are front and center. In "Massachusetts Pension Plan Urged to Invest in School Loans" (August 8, 2008 blog post), I wrote as follows:

Here's the rub. The state pension trustees have a fiduciary duty to make sure that the plan is in good financial shape. Will statutory investing put those fiduciaries at risk for allegations of breach in the event that MEFA bonds sour or perhaps offer a sub-optimal return?

I think the same principle applies to the CalPERS decision, sending mixed signals about competing constituencies - state engineers versus plan participants. Complicating things, could state workers win now by keeping their jobs (for certain infrastructure projects) but lose later on if infrastructure investments fare poorly due to labor-related cost issues and so on?

What a dilemma!

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According to journalist Casey Ross, Massachusetts Governor Deval Patrick is asking the state retirement system to allocate $50 million to the student loan business by buying about to be issued MEFA bonds. According to their website, the Massachusetts Educational Financing Authority ("MEFA") regrets that it is "unable to secure funding due to increasingly difficult capital market conditions." Harvard University and local colleges are likewise encouraged to do their fair share. (Read "A late try to salvage student loans" by Casey Ross, Boston Globe, August 7, 2008.)

Even if one accepts the premise that granting school loans is a good thing, the issue remains. Should state executives mandate investment policy? The student loan organization cites a low default rate of less than one percent, asserting that the $51+ billion pension plan can thereby avail itself of a relatively safe investment.

Here's the rub. The state pension trustees have a fiduciary duty to make sure that the plan is in good financial shape. Will statutory investing put those fiduciaries at risk for allegations of breach in the event that MEFA bonds sour or perhaps offer a sub-optimal return?

A pension plan is a “trust” that is created to benefit the plan participants (in this case state workers). Legal counsel is likely to confirm that those in charge of the plan should be acting solely in the best interest of the plan participants (duty of loyalty). Additionally, are trustees deemed truly independent if they make a decision that is tied to political exigencies? Unless school loans can be assessed as a suitable investment for the pension plan (and maybe they can), one wonders if trustees "do good" for Massachusetts youth at the expense of retirees.

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In response to our June 29, 2008 post entitled "California Pension Fund Investments in Tobacco," a consultant questioned CalSTRS' claim that the fund had suffered an opportunity loss of $1 billion by divesting itself of $238 million in tobacco stocks.

Sacramento Bee reporter Jon Ortiz sent the following text, excerpted from a CalSTRS report (page INV82, "Performance Review of the Modified Benchmarks"):

<< The performance of the modified benchmarks from inception to December 31, 2007, was
reviewed at the April 4, 2008 Investment Committee meeting. Over the seven and a half years,
since inception, it is estimated that CalSTRS has suffered slightly over a $1 billion opportunity
loss by not investing a market weighting in the tobacco industry. This calculation too is open for
debate, but it remains in Staff’s view that this is a reasonable approximation of the opportunity
loss. >>

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In "UK Pension Fund Goes Green" (June 28, 2008 post), this blogger cites diversification as one element of the decision to allocate monies to "socially responsible" investments. Anticipated performance is another consideration and not just for "virtuous" stocks.

In "CalSTRS wavers on its ban on tobacco investments" (June 5, 2008) Sacramento Bee journalist Jon Ortiz writes that the board of the California State Teachers' Retirement System is mulling over whether to reverse its earlier divestment of $238 million in tobacco company equities. Thinking that the industry is no longer vulnerable to massive lawsuits and/or government mandates, the $169 billion public pension fund estimates it would have earned $1 billion more had it stayed the original course.

An excerpt from its "Statement of Investment Responsibility" puts "preservation of principal and maximization of income" as "the primary and underlying crieria for the selection and retention of securities." The "CALSTRS 20 RISK FACTORS" do not expressly preclude investing in any particular industry. According to "CalSTRS rethinks tobacco taboo" by Jon Ortiz (June 4,2008), gambling and alcohol company stocks remain part of the pension fund's equity portfolio.

While CalSTRS ponders an add-back of tobacco, the University of Toronto announced on April 9, 2008 that it will be dropping its investments for ethical reasons. According to "University of Toronto to Sell-Off Tobacco Industry Holdings," the school will be the "first institution of higher education in Canada to divest from the tobacco industry."

Editor's Note: For articles about tobacco-related investing, visit Tobacco.org. On a related note, and if you appreciate a good satire, check out a movie entitled "Thank You for Smoking." This gal has laughed through the film version of the popular Christopher Buckley novel at least four times.

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According to Institutional Investor ("Buying into Green Investing" by Henry Teitelbaum, June 2008), green is good for at least one large UK pension fund, the Universities Superannuation Scheme Limited ("USS"). Joined by three other organizations (Alliance Trust PLC, SNS REAAL N.V. and Mitsui & Co Ltd), this trustee company with 30+ billion GBP in assets is part of a 56 million GBP financing round for the Climate Change Capital Group, a London investment bank "dedicated to the low carbon economy." Teitelbaum adds that the USS is already sold on the commercial viability of environmentalism, demonstrated by its membership in the Enhanced Analytics Initiative. According to research done by this blogger, the USS is credited with taking "ethical, social and environmental considerations" into account when "assessing the merits of investment in a given company" as early as 2001. (See "Pension funds can get more from 'green investing' - SRI expert" by Nat Mankelow, bfinance, May 12, 2001.)

While few dispute the merits of considering a Socially Responsible Investing ("SRI") component for portfolio diversification purposes, it would be helpful to know how USS determines its strategic commitment to SRI economic interests as a separate asset class. Moreover, how does this pension giant consider "green" or "vice" factors before taking direct equity stakes in oil or tobacco companies? Top 100 USS equity holdings, as of March 31, 2008, include Royal Dutch Shell (position 1 with an estimated market value of 705.8 million GBP), BP (position 3 with an estimated market value of 625.2 million GBP) and British American Tobacco (position 14 with an estimated market value of 194 million GBP). This blogger is not maing a value judgment about investing in the stocks of these or other companies but rather simply thinking out loud about diversification analysis as it relates to SRI exposures.

Valuation is yet another consideration. As pension plans invest in environmental companies, how do (should) they properly determine the probability (and amounts) of revenue realization for start-ups and/or firms that depend on relatively new technologies to generate income? In the absence of accounting rules (across countries) or new regulations that mandate periodic assessments of value, the challenge is significant. Add the time pressures of compliance and these already important questions demand good answers.

Editor's Note: According to the EAI website, membership is "open to institutional investors and asset managers who commit to allocate individually at least 5% of their brokerage commissions to extra-financial research" or said, another way, the assessment of externalities on long-term investment performance. Most members are non-US organizations. The New York City Employees' Retirement System ("NYCERS") is a member.)

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According to "Fighting Climate Change, State by State" by Anne Moore Odell (February 27, 2008), local governments are investing in environmentally-friendly companies for the long-term. Various treasurers from California to Connecticut have collectively committed billions of dollars to clean technologies. Evidence that they mean business, nearly 500 institutions came together in New York on February 14, 2008 to address the "scale and urgency of climate change risks, as well as the economic opportunities of a global transition to a clean energy future."

Progress since the 2005 inception of the Investor Network on Climate Risk ("INCR") includes an agreement to verify if, and to what extent, fund managers and financial advisors have bettered their "capacity to assess climate risk." For mutual funds, this includes an annual scorecard that reflects how portfolio managers vote on various shareholder proposals relating to climate.

To learn more, click to read "Investor Progress on Climate Risks & Opportunities: Results Achieved Since the 2005 Investor Summit on Climate Risk at the United Nations," dated February 2008.

Given statehouse initiatives relating to (a) divestment of certain international holdings and (b) limits on sovereign wealth fund exposure, is the commitment to being a friend of the earth a harbinger of future asset allocation directives or good portfolio diversification?

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With all due respect to Gordon Gekko, replace the "d" (as in "Greed") with an "n" (as in "Green") and we end up with a way to both belately celebrate Earth Day and acknowlege an emerging trend in pension funds' allocation to Socially Responsible Investments (SRI).

Click here to access a nice primer from the UK. Checklists and case studies make it useful to anyone interested in knowing more about the topic. 

Stateside, Mercer Consulting's survey of U.S. pension funds about SRI suggests continued growth. Click here to access the survey.

By the way, it's not just Ayn Rand who rejects altruism. Institutional investors say that opportunities to reduce risk, enhance returns or better align economic interests with socially-oriented values are key drivers behind their decision to invest in SRI funds.

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