Pension Plan Divestment and ESG Investing

In its quest to advise the City Mayor, Boris Johnson, about climate change, the London Assembly recently urged the London Pension Fund Authority ("LPFA") to rid itself of its carbon ("specifically fossil fuels") investments and allocate the proceeds to "responsible funds, which deliver appropriate returns to the taxpayer." They referenced the National Association of Pension Funds ("NAPF") and its recognition that institutions have a role to play in Responsible Investment ("RI") or what the NAPF describes as the "integration of environmental, social and governance (ESG) factors in the investment decision-making process and stewardship activities."

According to Chief Investment Officer, the LPFA, with assets in excess of 4 billion pounds sterling, replied, in a letter to its 80,000+ members, that it takes ESG investing seriously as a long-term vehicle, adding that its "key aim must be to ensure we can continue to pay your pensions as they fall due." Although this jumbo pension plan currently has "less than 1% invested in fossil fuels," it carved out space on the LPFA website to address the topic as follows: "Responsible investment factors, such as low carbon, may be relevant as an additional consideration. However, screening out stocks for investment/divestment on ethical grounds only is in conflict with the Board's fiduciary duty if the decision risks significant financial detriment to the fund."

The concepts of responsible investing and divesting are not new. Pension plans and sovereign wealth funds are a few of the many organizations that have been approached to jettison certain investments. Push back, when it occurs, is based on the notions that (a) entrenched shareholders can do a lot to effect change (b) divestment costs are high and/or (c) selling off a position could violate fiduciary obligations to beneficiaries. In "Selling out of fossil fuels no solution for climate change" (Financial Times, March 22, 2015), Anne Stausboll details the governance stance adopted by the California Public Employees' Retirement System to encompass "advocacy, engagement with companies and investing in climate-change solutions." As its CEO, she suggests that "Walking away by simply selling off assets through divestment will not help."

In 2007, I wrote about my interview with Maria Bartiromo, then CNBC senior anchor, on this topic of whether, how and when to divest. See "Is There Fiduciary Liability Attached to Divestment?" I offered four considerations as repeated below:

  • Selling an investment due to political pressures could end up costing "taxpayers and plan participants in the form of 'unexpected' transaction costs" which in turn could worsen sub-par funding levels;
  • Proceeds from any mandated sales could lead to lower returns than originally projected;
  • Fiduciaries may find themselves accused of breaching their duties unless they can adequately demonstrate the economic rationale for divesting; and
  • Plans, especially those with small staffs, could be overwhelmed with having to spend considerable time and money to get up to speed before making direct ESG type investments.

As with any investment action, there is never a free lunch. Every decision needs to be carefully reviewed.

Interested readers may want to check out the following items:

Longevity Trends and Pension Costs

When it comes to estimating defined benefit ("DB") plan costs, it is critical to use inputs and assumptions that make sense. Longevity is one such important factor that demands attention. Getting good answers to questions about life span differences among age, income and health cohorts is necessary for decision-makers. The assessment of how to redesign a plan, transfer risk and/or modify investment strategy depends on knowing what variables determine the size of the liability.

Studies such as the one just released by the National Association of Pension Funds ("NAPF") and Club Vita (a Hymans Robertson Company) can be helpful to the extent that they shed light about how long participant groups are expected to live. In a November 27, 2014 joint announcement, its "unique" research is described as likely to result in companies having to report higher pension liabilities. Based on an assessment of data about 2.5 million pensioners and one million deaths, authors conclude that "the pace of longevity increases varies significantly within DB schemes and for different groups of DB pension scheme members." One inference is that the life span gap between men and women in the "hard pressed" economic category versus those who are "comfortable" is narrowing. A second finding is that a typical defined benefit plan liability is likely to rise by one percent.

As the researchers correctly point out, access to granular details about the sensitivity of the cost-demographic lever can be utilized by DB plan trustees when deciding if and how to restructure via a buy-out, liability-driven investing strategy or something else. Click to read "The NAPF Longevity Model" (November 2014).