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Divestment Delusions

eye on the news

Divestment Delusions

California Democrats want the state’s overdrawn pension systems to dump their fossil-fuel stocks. June 3, 2015
Economy, finance, and budgets
California
Photo by Max Whittaker/Getty Images

California’s two mammoth public-pension funds—the California Public Employees Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS)—are short a shocking $225 billion that they’re going to need to pay for the retirements of government workers. But what is it about the two pension funds that worries the state’s Democratic Party? Their fossil-fuel investments.

Delegates to the state’s annual Democratic Party convention voted over Memorial Day weekend in favor of a resolution urging the funds to dump oil, natural gas, and coal stocks. The vote follows the introduction earlier this year of state legislation that would require the pension funds to sell all coal-related stocks and study the implications of dropping oil and natural gas stocks. With the resolution, local Democrats jumped on the divestment bandwagon, inspired by radical environmentalist Bill McKibben, which has so far persuaded the endowment funds of about two dozen universities to sell shares in fossil-fuel companies. Yet if CalPERS and CalSTRS’s past social-investing records are any indication, the real losers from divestment won’t be the energy companies, but California taxpayers.

“I’ve been involved in five divestments for our fund,” CalSTRS chief investment officer Chris Ailman told his board earlier this year. “All five of them we’ve lost money, and all five of them have not brought about social change.”

For several decades, California’s pension funds have been subjected to a dizzying array of social-investment prerogatives. A 2011 Mercer Consulting study found that CalPERS investment officials had to follow 111 different investment priorities relating to the environment, social conditions, and corporate governance. Many of these directives have proven calamitous to the two funds’ bottom lines. Eight years after CalSTRS and CalPERS divested their portfolios of tobacco stocks in 2000, a study found that the move cost CalSTRS $1 billion and CalPERS about $750 million in foregone profits. CalPERS also ditched investments in developing countries such as Thailand and India, because board members objected to labor standards in these countries. A 2007 report found that avoiding investments in developing counties cost CalPERS about $400 million.

Considering its investment track record, CalPERS can hardly afford to absorb such losses. A 2012 study ranked CalPERS in the bottom 1 percent among pension funds in rate of investment returns over the previous five years. Only recently has the fund’s investment performance started to improve.

Last year, CalPERS introduced a new policy discouraging divestment. “Fiduciary obligations generally forbid CalPERS from sacrificing investment performance for the purpose of achieving goals that do not directly relate to CalPERS operations or benefits,” the policy stated. “Divesting appears to almost invariably harm investment performance.” The pension fund also argued that divestment is a poor way of achieving social goals.

Advocates counter that the state shouldn’t put profits above people. The author of the Democratic Party fossil-fuel divestment resolution, R.L. Miller, who chairs the party’s environmental caucus, said that the declaration would send a “moral message that California will not invest in those businesses that burn our planet in the name of profit and this resolution is that message.” Delegates compared the action with worldwide divestment in South Africa’s economy beginning in the mid-1980s—a movement intended to isolate the country and persuade its government to dismantle Apartheid. In 2006, Wilshire Consulting estimated that divesting from South Africa had cost CalPERS about $1.9 billion.

The analogy between South Africa under Apartheid and fossil-fuel companies is strained, to say the least. The world was able to isolate South Africa because few major industrialized countries depended heavily on its economy. But fossil fuels are pervasive throughout the world, and the energy they produce drives the economies of most nations. More than 80 percent of the energy the world uses currently comes from fossil fuels, while only 9 percent comes from alternative energy sources (including nuclear). Even under the most optimistic scenarios, it will be decades before countries can end their reliance on fossil fuels, so the demand for them, and the profits they generate, will attract investors around the world, regardless of whether endowments and government-controlled funds divest of their shares in these firms.

More important in the coming years will be technological advances that allow cleaner energy from fossil fuels. The rapid shift in the United States to natural gas—which emits nearly 50 percent less carbon dioxide than coal when burned—has already helped the United States cut its greenhouse gas emissions by 10 percent since 2005. Meanwhile, some 1 billion poor around the world await electricity, and coal will likely fire their dreams.

None of this matters much to California’s advocate-legislators, who always have the state’s overburdened taxpayers to fall back on when their social-investing schemes backfire. California residents already face an enormous bill for unfunded pension liabilities. Last year, Governor Jerry Brown signed legislation more than doubling the annual amount that school districts must contribute to CalSTRS over the next five years. Meanwhile, local governments have been absorbing steep funding increases from CalPERS. An April Manhattan Institute report by senior fellow Stephen Eide found that 25 California municipalities saw their pension costs increase by between 47 percent (Garden Grove) and 537 percent (San Francisco) over the last decade. The report estimated that CalPERS’s bills would increase another 20 percent to 48 percent over the next five years for the largest municipal governments in the pension plan. CalSTRS and CalPERS, meanwhile, will have to take this new tax money and produce above-average investment returns to make up for big gaps in pension funding. If the funds miss their investment targets, taxpayers will be on the hook for additional money.

The proposed legislation mandating divestment offers insight into what California’s elected leaders think of their taxpayers. To assure pension-fund officers and board members that they won’t be blamed for any investment losses generated by divestment, the legislation says that these officials will be “held harmless and eligible for indemnification” in such cases. If only California’s taxpayers could be held harmless from their legislators.

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