CalPERS board’s divestment dilemmas

California’s Governor Gavin Newsom’s recent executive order calling on the state’s pension funds and endowments to invest more in green energy and less in fossil fuels flags more, complicated divestment decisions ahead for CalPERS 13-member board. The Governor can’t order divestment because fiduciary duty rests with the board, yet his drive promises more handwringing and strife in the giant pension fund’s quest to balance the consequences of divestment’s lost performance and transaction costs with responsible investment.

At least that’s what the future holds if CalPERS December board meeting was anything to go by during which members discussed the thorny issue of its approaching 2021 review of six divestment programs across tobacco, firearms, coal, Iran, Sudan and emerging market equity principles, a program that screens companies from the emerging market portion of its internally managed global equity portfolio that don’t meet ESG standards.

For some board members, the review risks opening old decisions that were reached after prolonged discussions at the time. For others – like board member Jason Perez who said his call to look again at divestment strategy has become a “broken record” – it’s an opportunity to revisit decisions that have cost the fund dearly. For example, CalPERS has lost around $3.5 billion of returns by not investing in tobacco since 2001. A decision based on a view at the time (and reaffirmed in 2016) that the industry was about to hit tough times because of lawsuits and a new awareness among young people of smoking’s dangers.

The merits of tracking divested dollars, and the value of data illustrating what the pension fund has missed out on given it has other pressing considerations, is a cause of consternation for some. Some questioned its use, worried it promotes misunderstanding and pressure to “jump back in.”

But for others examining how divestment performs is an important building block in the reaffirmation process.

Counting the cost of tobacco divestment is “ridiculous”, argued Theresa Taylor.

“To me it just seems silly to look at it as a loss,” she said.

Moreover, few other investors seem to follow the same practice. Daniel Ingram, vice president, responsible investment research and consulting at Wilshire Associates presenting the financial impact of the divestment programs to the board said most asset owners don’t monitor financial gains and losses from divestment according to a recent survey.

“The governance around [this] was probably a bit weaker than what we had expected. Not that many do conduct this kind of an exercise. We picked out one or two examples. Divestment analysis does go on, but not on an annual basis.”

In what he called a “philosophical” comment CalPERS CIO Ben Meng urged the board to “stop chasing its tail” and focus on the sentiments, beliefs and driving factors behind divestment decisions at the time rather than judge with hindsight based only on performance outcomes of divested assets. Similarly, board member Eraina Ortega argued it was “overly simplistic” to look at divestment through an outcome lens and not realise “what was considered at the time” particularly around risk factors. Moreover, she pointed out the pension fund doesn’t list “every other investment it hasn’t made” and the losses therein.

How CalPERS re-invests divested money into the portfolio is another, ongoing concern. Money is re-assigned into the global public equity portfolio according to benchmarked weightings.

“The dollars that come out are spread across the whole fund, so we eliminate [for example] tobacco and everything else gets pro-rated up by its existing weight,” explained Andrew Junkin, president of Wilshire Consulting. Yet members referred to an “incomplete analysis” and not having a “handle” on the process, requesting more light on the benefit derived from re-invested funds.

The board also discussed the frequency of divestment reviews. Some urged against the 13-members “micro-managing” divestment decisions on a more frequent scale than the existing five-year deep dive and one-year high level review. It was one of several nods to the extra toil it brings on CalPERS stretched investment team.

“It does take a big-time commitment from staff,” said Kit Crocker, investment director at the fund. Others also suggested the review process might do better to offer insight into lessons learnt, particularly around impact, rather than “assigning staff to bring a bunch more stuff back” or “second guessing decisions.”

“When organisations such as ourselves divest from an industry, a certain organisation or country, what is the impact on the behaviour of those organisations?” asked Lisa Middleton. “Are we actually producing a positive impact by our divestment decisions or are we not?”

Lastly the board heard how divestment is an active decision that therefore should be re-visited.

“Whether it’s [divestment] forced upon you or whether it’s your choice, it’s an active decision,” said Junkin. “In some cases, you can change your mind. You can’t on Iran and Sudan, but you could re-invest in tobacco. As painful and as long as that process was on the single divestment, that, quite frankly is the process that you need to go through on all of these, on a regular basis to reaffirm yes, we want to stay out of that.”

The fraught reaffirmation of past divestments in the years to come suggests one thing: new divestment around fossil fuels won’t happen anytime soon.