STUMP » Articles » Public Pension Assets: Divestments for Everybody! » 3 August 2017, 05:31

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Public Pension Assets: Divestments for Everybody!  

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3 August 2017, 05:31

This is the public pension asset trend that annoys me the most.

In yesterday’s post, I considered shareholder activism by public pension fund managers and trustees, but the divestment push tends not to be coming from those with fiduciary duty.

Often, it’s politicians in legislatures (who can pass idiotic laws to force fund divestment) and most often of all it’s outside activist groups.

At least with the politicians, they may be participants of the pensions they’re targeting with their idiotic laws, and may thereby be later hurt by their idiocy. In most cases of the activist groups, their only stake in the matter is feeling like they’ve accomplished something. If their activism causes harm to the pension funds, it’s usually not their problem.

Heck, is there a pension for professional protesters? They should look into that. And only invest in the virtuous (by their own definition). I wonder who would pass their screeners.

RECENT DIVESTMENT FOLLIES

I last looked at divestment pushes in May, and it’s not even been three full months. So, there can’t be too much extra activity, right?

Oh my chlidren.

Let me dump some stuff on you:

Okay, about those last two — is this really where you want to go with this? Nitpick every little investment in the fund?

TRUMP DIVERSION AND DIVESTMENT

The news item from CNBC:

Advocacy groups are urging two of the biggest U.S. public pension funds to divest from a fund unless it stops paying one of President Donald Trump’s companies to run a New York hotel.

Pension funds in at least 7 states send millions of dollars to an investment fund that owns the upscale Trump SoHo Hotel and Condominium and pays a Trump company to run it.

Advocacy groups launched petitions and sent letters on Wednesday urging two of the biggest U.S. public pension funds to divest from an investment fund unless it stops paying one of President Donald Trump’s companies to run a New York hotel.

Reuters reported on April 26 that public pension funds in at least seven U.S. states periodically send millions of dollars to an investment fund that owns the upscale Trump SoHo Hotel and Condominium in New York City and pays a Trump company to run it, according to a Reuters review of public records.

Two legal advocacy groups sent petitions to half a million of their members and letters urging state officials who oversee the California Public Employees’ Retirement System (CalPERS) and the New York State Common Retirement Fund to reconsider their investments in CIM Fund III, which owns the Trump SoHo.

“The money used for this investment comes from mandatory deductions from the paychecks of public employees. These employees are thus forced to indirectly subsidize President Trump beyond the Constitution’s mandate of a fixed salary,” said the letters from Free Speech for People in Newton, Massachusetts, and Courage Campaign in Los Angeles.

Article II of the U.S. Constitution bars the president from receiving additional payments beyond his salary from state governments. The fees that public pension funds pay CIM may fall into that category, several constitutional lawyers have told Reuters.

Uh huh.

Yeah, you waste your time on that.

…. CalPERS declined to comment, but CalPERS officials disclosed in response to a public records request that the pension fund paid CIM $1,722,418 in management fees for the first three months of 2017.

In a statement, a spokesman for New York State Comptroller Thomas DiNapoli noted that the CIM fund was in the process of gradually selling off the properties it owns and said the New York state pension fund “has limited rights as an investor and does not make or control CIM’s investment choices.”

CIM said in a statement that it “is committed to creating attractive investment opportunities for its investors and then overseeing those investments to produce the best outcomes possible for the funds it manages.”

I am not seeing much in the way of numbers to compare against, but CIM may manage some of the Trump properties… but I imagine they manage several properties.

This is how real estate investment works for institutional investors: many investments aren’t for capital appreciation, but for the rents they bring in. You know, the cash flows that come in as investment income?

There’s nothing particularly nefarious about this set up — it’s little different from an insurance company owning a mall (and some do), paying a property manager to manage the mall for them. The rents from the stores pay the insurance fund.

And yes, maybe the Russian mafia is involved with real estate investment — it would go beyond Trump, I imagine, if that were the case. And public pensions may have a difficult time sussing that out.

Or, maybe, just a thought, U.S. commercial real estate is attractive to legit foreign investors.

THE REPORT ON DIVESTMENT

So above, there is the story (ok, press release) on divestment costing trillions.

The report is here, and yes, it’s funded by petroleum companies.

But let’s see what it says.

The new report, authored by Prof. Daniel Fischel of the University of Chicago Law School, together with coauthors Christopher Fiore and Todd Kendall of the economic consulting firm Compass Lexecon, analyzes 11 of the nation’s top pension funds—including the largest state pension fund, the California Public Employees’ Retirement System (CalPERS) as well as municipal funds in New York City, Chicago and San Francisco – to determine the financial impact of divesting from fossil fuel securities. The results indicate that these funds would lose up to a combined $4.9 trillion over 50 years due to reduced portfolio diversification.

“Our report shows divestment would cost pension funds trillions of dollars, an outcome that likely would significantly harm returns for pensioners,” stated Prof. Fischel. “Given the unique role of the energy sector in the economy, investors who chose to remove traditional energy from their investments reduce the diversification of their portfolios and thereby suffer reduced returns and greater risk. And that’s not all. These costs are further compounded when considering the additional costs of transactional fees, commissions, and compliance costs that are unavoidable when divesting. Divestment may seem noble, but it has real financial implications for pension funds, many of which are already struggling to provide reliable investment returns to beneficiaries.”

In order to accurately calculate the cost of divesting, Prof. Fischel and his coauthors used all available data on the current holdings of each fund to estimate the returns on the same or similar holdings over the past 50 years. These returns were compared to returns over that same period from an otherwise identical risk-adjusted portfolio, stripped of stocks targeted by divestment advocates. The report considers lost diversification benefits due to divestment from coal, oil and natural gas companies, as well as broader divestment including utility companies, which creates a range of possible outcomes.

The report finds that a divestment policy would hit California’s CalPERS fund the hardest, with reductions in returns ranging from $2.3 to $3.1 trillion over 50 years, and up to $290 million annually. New York follows close behind, with the New York City Employee Retirement System (NYCERS) — the largest municipal public employee retirement system in the United States – estimated to suffer between $502 and $692 billion in lower returns over 50 years. The annual impact for NYCERS ranges between $41 and nearly $60 million.

Look, obviously, the “losses” are being driven by the sheer size of the funds.

Calpers is the largest pension fund in the U.S. The only larger pension funds in the world are funds like Japan’s pension fund GPIF — which is akin to Social Security, not a public pension fund covering only state employees.

So obviously if they drop all fossil fuel-related assets, they’re going to see the largest impact.

You can search for yourself, but these are the top ten U.S. public pension funds in terms of assets (FY 2016):

1. California PERF (Calpers, et al) $298.7 billion
2. California Teachers $189.1 bilion
3. NY State & Local ERS $156.3 billion
4. Florida RS $141.8 billion
5. Texas Teachers $134.0 billion
6. New York State Teachers $107.5 billion
7. Ohio PERS $77.1 billion
8. Ohio Teachers $66.3 billion
9. Georgia Teachers $65.6 billion
10. Virginia Retirement System $64.0 billion

The full report can be found here, and I will pull out two tables.

First, the baseline assumption of what returns would be, on average, with or without divestment:

Now, you’ll see some odd things in there — like in some of the cases, the divested portfolio has a higher expected average return… and higher expected volatility. But then when one does risk-adjusted returns, it falls to something lower. Now, they could have just kept the higher return and higher volatility and compared results from a lognormal model (which is what is inherently underlying their risk adjustment).

But in some cases, the expected return, even before risk-adjustment, is lower.

In any case, you’ll see that the final differences range from 9 basis points up to 27 bps. That doesn’t sound like a lot, right?

Those small differences add up to huge amounts over 50 years. The magic of compounding, of course.

And the other thing to remember is that when one recommends lowering public pension rates by even only 25 basis points, some people start screaming about how expensive that is.

Again, that’s because public pensions are for the long haul, and the difference between 7.75% return and 8.00% return can be huge in the long run.

Let me put you some numbers: you invest $1 million and let it ride for 50 years.

At 8% per year: $46.9 million

At 7.75% per year: $41.8 million

A difference of 5.1 million — the second is 11% less than the first.

Yeah, even something as small as 25 bps can add up to a lot over time.

HINDSIGHT SHOWS REAL LOSSES

I did not put this in my list up above, but here is an excerpt from an opinion piece by Mike Posey, mayor pro tem of Huntington Beach, California:

For the city of Huntington Beach, we have less to offer as we are contractually obligated to make up for the lower than expected returns from CalPERS investments. At our May 1, 2017 mid year budget update for fiscal year 2016/2017, we learned that this additional shortage is estimated at between $4.5 million and $6 million per year.

Why are the taxpayers of Huntington Beach being saddled with a budget spending reduction of 2.7 percent? In my opinion, it’s in part due to CalPERS investment policies. Their Investment Advisory Board has embraced an investment policy titled ESG. Environmental, Social, Governance integration. This policy seeks to make investments, on behalf of their members, not based upon investment returns, but instead based upon the pursuit of social justice. Social justice includes carbon footprint reduction, diversity, wage equality, etc. All of which are admirable objectives but should not be the drivers of maximizing members’ returns on investments. The difference between the historical lower return from their current investment policy vs. alternate policies falls on the backs of the taxpayers.

CalPERS divested from tobacco stocks about 12 years ago. This divestment, by their admission, cost the fund about $3 billion. That loss represents about 1 percent of the fund value but $3 billion is still three thousand million dollars. Additional divestures from firearms, (formerly) apartheid South Africa, Iran and others cost the fund almost $8 billion. The fund grew only from about $170 billion to just over $300 billion during the same period that the Dow ballooned from about 6,400 to just over 21,000. If the fund had chartered the same path as the Dow Industrials, the fund would be valued at or near $540 billion rather than just over $300 billion.

CalPERS enjoys the luxury of embarking on investments that mirror social justice values as the shortages of the returns earned are made up by the member municipalities.

As CalPERS CEO Marci Frost reports on CalPERS’ own website, “Financial experts have warned us to expect a lower rate of return on our investment portfolio over the next decade, so the board decided to gradually lower the discount rate from 7.5 percent to 7 percent over the next three years. This was a wise move by the board. It brings more cash into the fund as we move toward our goal of fully funding the pension benefits that have been promised. The action does put real pressure on our employer partners, the 3,000 public agencies, schools, special districts, and the state of California that contract with us to offer you a pension. They will have to contribute more.”

Meaningful pension reform must begin with CalPERS membership holding their investment advisory board accountable. We are in the midst of an economic renaissance unlike any we have seen in decades and must capitalize on it. The opportunity to restore solvency to the fund begins with restoring sound investment strategies prioritizing the growth of members pension values.

The research going forward is debatable. The effect of divestment in the past can be measured.

$3 billion lost in 12 years from divesting from tobacco companies is a very large effect, even for funds as large as Calpers and Calstrs.

Calpers needed to lower its valuation rate for the pension for reasons other than its goody-goody investing pushes… maybe it should have decreased that rate even further for further security.

THINGS CHANGE

But I have a whole problem with this divestment loss measurement and divestment in general. Are the pensions really expecting to hold on to particular stocks for 50 years?

How many companies last that long? And of those long-lived companies, how many are still doing what they used to do?

I found this list of publicly traded companies of at least 100 years in age, one of which popped out at me: International Business Machines, i.e. IBM.

Obviously, IBM wasn’t making computers when it was founded in 1911. What was it making?

The roots of IBM date back to the 1880s. Since the 1960s or earlier, IBM has described its formation as a merger of three companies: The Tabulating Machine Company (with origins in Washington, D.C. founded in 1896), the International Time Recording Company (founded 1900 in Endicott), and the Computing Scale Company (founded 1901 in Dayton, Ohio, USA).8910 However the 1911 stock prospectus states that four companies were consolidated; the three described by IBM and the Bundy Manufacturing Company (founded in 1889).11 Further, there was no merger, no consolidation. The new company, named the Computing-Tabulating-Recording Company(CTR), was incorporated on June 16, 1911 in the state of New York, U.S.A.1213 CTR was a holding company; the now five companies were an amalgamation.

…..
The companies that were amalgamated to form CTR manufactured a wide range of products, including employee time-keeping systems, weighing scales, automatic meat slicers, coffee grinders, and punched card equipment. The product lines were very different; Flint stated that the “allied” consolidation

“… instead of being dependent for earnings upon a single industry, would own three separate and distinct lines of business, so that in normal times the interest and sinking funds on its bonds could be earned by any one of these independent lines, while in abnormal times the consolidation would have three chances instead of one to meet its obligations and pay dividends.17“

I’m pretty sure IBM makes none of those things now, and I’m not even sure IBM makes any hardware any more.

I can’t tell — does IBM make these servers, or just put them together?

In any case, IBM’s business model has changed drastically — from a manufacturing firm (manufacturing precision business machines) to a business IT services provider. It has changed several times in its history to remain profitable (and to keep shareholders happy). Perhaps Calpers has been holding on to IBM stock for decades — the old phrase “Nobody ever got fired for buying IBM.” was actually about buying IBM services, but it also applied to its stock for a long time. It hit a rough patch in the early 1990s, and they had to change their business model in order to survive.

So let’s bring this back to the fossil fuel guys — Many oil, etc., companies know that they may need to diversify — and have become energy companies in general, not merely oil, etc.

Chevron seems to be branding itself that way, ExxonMobil as well.

So one may divest one’s self of dirty dirty Exxon shares… and then, perhaps, it weans itself off of oil revenues and has other business lines that take off — clean energy of some type, let’s say. At which point it’s now “safe” for the pension funds… when the price of the stock is going high.

Sell low, buy high?

I don’t think that will do much for the pension funds.

Companies come and go, business models change, and divestment for political reasons simply restricts choice for pension funds that need returns, even in the short run.

Mathematically, the fewer choices there are, the maximum return one can get is at most what a larger universe of choices can give.

There can be good reasons to reduce exposure to particular sectors, especially if you think they will not perform well… but keep in mind the particular assets you have may change their exposure to those particular sectors as well.

Related posts:

Priorities for Pension Funds: Climate Change or Solvency?

Friday Trumpery: Did You Know Trump is Involved in Real Estate?

Stupid Public Pension Trends: Divestment Expands

A Week of Bad Pension Ideas: Finally, Divestment

Public Pension Follies: Divestment! Divest from All the Dirty Things!


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