The Broader Social Consequences of Investment Decisions

In an essay appearing last month in Institutional Investor ("Avenue of Giants,"July 1, 2017), Ashby Monk argued for a broader definition of fiduciary duty. In polling more than 40 large "pensions and sovereigns," Mr. Monk noted that more than half of those surveyed rejected the notion that their decisions would be guided by the consequences for the community they inhabit. The rationale, it appears, is such considerations are quite simply beyond their fiduciary duties.

Mr. Monk went on to note that narrowly defined notions of fiduciary duty, however rational for individual investors or pension managers fosters damaging consequences for the larger investment community. Monks went on to raise a series of questions:

• Where will the breakout innovations in our industry come from if investors are bound by a prudent-person rule?
• If some investors hide fees paid to external managers, doesnʻt such secrecy prevent boards from understanding the true cost of producing these returns?
• If the price of ʻaccessʻ to a given fund is conditioned by outrageous terms or side letters, doesnʻt this further empower private managers to extract higher fees over time? 

Each of these questions illustrated practices by institutional investors posing a larger problem for pension fund managers. A too narrowly defined notion of fiduciary duty overlooks the negative  consequences for not just beneficiaries, but also the larger society. As mentioned in my earlier postings, these are problems requiring, among other remedies, a radical transparency.

Yet even a much greater transparency is not enough to address what is perhaps the most damaging disconnect between a narrowly defined notion of fiduciary duty and the most threatening of consequences in our time. As Monks notes, many institutional investorsʻ strict definition of fiduciary duty discourages them from considering climate change as a legitimate issue.

It is clearly evident that among the pivotal issues confronting all Californians, is the urgent need to more fully comprehend the true costs of a fossil-fueled economy. Whatever the short-term calculus of satisfying a narrowly defined fiduciary duty at CalPERS, perpetuating fossil fuels and associated industries poses an existential threat to the survival of human civilization beyond the 21st century. As Governor Jerry Brown has noted, for those doubting the magnitude of climate threats, one only has to peruse the consensus statements by climate scientists (e.g. IPCC) to understand the especially damaging role of fossil fuels.

For these reasons, it is important for all voters to understand that the election of public-at-large board members of CalPERS in September is not merely a narrow choice regarding some abstract discussions about fiduciary duties and investment returns; elections of all sorts - from city councils to state treasurers to board members for one of the worldʻs largest pension funds will play an increasingly crucial role in making the urgently needed changes for transitioning to a new economy.

I look forward to posting more on this topic in future posts....and thanks for your readership and commentary.

Radical Transparency

As noted by Bloomberg News some days ago, "a recent Wall Street Journal editorial, hardly a left-wing Donald Trump critic, called on the president to adopt a new strategy on the Russia probe: "radical transparency." The recommended course of action is perhaps also fitting for the members of the Board of Administration at the California Public Employeesʻ Retirement System (CalPERS).

Among the harshest criticisms leveled at CalPERS is the lack of transparency surrounding varied decisions combined with a steadfast refusal to engage in open discussions regarding its policies. Indeed, another candidate as a board member at CalPERS has detailed sustained efforts by staff and current board members to prevent the necessary deliberations regarding specific policies.

The red-flag rising from such episodes at CalPERS is familiar terrain for anyone who has conducted reviews of state agency practices. In various over-sight investigations/hearings I conducted over my years with Californiaʻs Legislature, similar efforts to prevent more fulsome discussions often signaled practices that directors of agencies wanted to remove from public view. Some observers of CalPERS have referred to such issues as a problem of "CalPERS culture." Framing the issue as one of CalPERSʻ culture, however, is unnecessarily vague in addition to obscuring what needs to be done to turn things around at CalPERS.

Others in Sacramento have analyzed the so-called cultural problem at CalPERS more succinctly: "Look," as stated by one of my experts from the world of finance described the problem to me some years ago, "if you walk into CalPERS and talk to one or another of their financial consultants, you readily comprehend that too many of these folks view their jobs as preparing their vita for the next available position at Carlyle, Goldman, or some other outfit." The CalPERS problem, from this perspective, is not an abstract, fuzzy cultural attribute - it more closely resembles a more traditional problem of agency capture by a private interest. Too many in top management positions perceive their job as meshing their responsibilities with large financial interests, including private equity firms, instead of a career defined by serving the beneficiaries and people of California.

As still other critics have written, CalPERS management has become wedded with a system of rewards promoting risky behaviors when it comes to investments. Paralleling the kind of analysis provided by Michael Lewis (The Big Short), the CalPERS organization shares a potentially dangerous trait marked by many other "masters of the universe" from the world of finance - they have no skin in the game. Losing beneficiariesʻ money is simply an abstract risk having little bearing on various other rewards.

This system of rewards and compensation, revolving doors with clients, and critical reviews of management practices requires a much higher level of scrutiny. And these are only the initial steps necessary to ensure that the primary objectives of serving both beneficiaries and the public is on firm foundation requires a transformation from management practices obscuring decision-making at CalPERS. It is a policy premised on what we might term a "radical transparency."

Public versus Private Comparisons

A few weeks ago, while visiting friends at Californiaʻs capitol, a former colleague mentioned the horrible gap that CalPERS faces with respect to unfunded obligations. If you have followed the discussion of public pension funds over recent years, it is a common basis for beginning discussions about the troubling state of finances facing future generations. Not unlike the discussions surrounding social security, the topic typically moves to a linked discussion: why we must turn to ʻless generousʻ retirement benefits.  The fact that the less generous alternatives (401ks) have their own disastrous performance for a generation of retirees relying on such programs never seems to enter the discussion.

Part and parcel of the agenda for ʻdown-sizingʻ pension obligations is the message that public sector pensions quite simply donʻt measure up to private sector performance. The underlying theme is if CalPERS were run more like those plans managed by private corporations, things would be much better. All of which might sound compelling, unless one happens to have come across recent reports published by that hot-bed of radical financial reporting, Bloomberg News.

S&P 500’s Biggest Pension Plans Face $382 Billion Funding Gap

On July 20, 2017 Brandon Kochkodin and Laurie Meisler provided the following on Bloomberg News: 

 

"People who rely on their company pension plans to fund their retirement may be in for a shock: Of the 200 biggest defined-benefit plans in the S&P 500 based on assets, 186 aren’t fully funded. Simply put, they don’t have enough money to fund current and future retirees. The situation worsened for more than half of these funds from fiscal 2015 to 2016. A big part of the reason is the poor returns they got from their assets in the superlow interest-rate environment that followed the financial crisis. It’s left a hole of $382 billion for the top 200 plans."
 
This morning in an updated version of the July article, Bloomberg repeated a similar magnitude of problem facing the retirees for many of the nationʻs largest firms. While many of these same corporations have used revenues to pay dividends to investors, payments to workersʻ pensions are an unmet and growing obligation. As described in Bloomberg: "Companies are eager to get out of the pension business. Most prefer 401(k) plans, where the employee alone bears the risk of falling short at retirement. More are also offloading their pension plans, paying insurance companies to take them on instead."(see "How America Dug a $375 Billion Pension Hole." Bloomberg, August 4, 2017).

The Bloomberg  report does nothing to relieve the deeper inquiry into troubling practices at CalPERS; it does, however, cast doubt on those who would advance the privatization of pensions as some kind of solution.

The record of private sector managed pension funds is not an inspired one for public sector workers. Indeed, the record of corporate managed pension funds underscores the importance of an open and democratic process in the management of pension funds --  a discussion that should be at the center of the upcoming election for Board members at CalPERS.