Stock portfolios at large pension funds had a blockbuster run. Now, managers are cashing out.
Corporate pension funds are shifting money into bonds. State and local government funds are swapping stocks for alternative investments. The nation’s largest public pension, the California Public Employees’ Retirement System, is planning to move close to $25 billion out of equities and into private equity and private debt.
Like investors of all kinds, the funds are slowly adapting to a world of yield, where they can get sizable returns on risk-free assets. That is rippling throughout markets, as investors assess how much risk they want to take on. Moving out of stocks could mean surrendering some potential gains. Hold too much, for too long, and prices might fall.
The Dallas Police and Fire Pension System — which as been severely underfunded for years — still has about 25% of its assets tied up in private investments.
That’s according to pension system official’s briefing during Thursday’s Ad Hoc Committee on Pensions meeting.
Those include investments in an energy fund, natural resources — and assets in real estate. The private investments were deemed “legacy” assets that the pension system still maintains.
It was risky private investments that landed the system in the situation it’s in now — with over a billion dollars in unfunded liabilities.
“Currently we’ve gotten that down to 26%,” Dallas Police and Fire Pension System Chief Investment Officer Ryan Wagner said during the meeting.
Connecticut taxpayers, saddled with a pension system for state workers and teachers marked by decades of underfunding, glimpsed a ray of hope in 2017 when legislators embarked on a path toward accountability and fiscal discipline by enacting “fiscal guardrails.”
Now, state unions under the umbrella of the State Employees Bargaining Agent Coalition are clamoring for the removal of the fiscal guardrails that were constructed to prevent the same unions from driving taxpayers over the cliff. The staggering state debt of more than $80 billion, including unfunded pension debt from the state workers’ and teachers’ pension funds, bonded debt, and health-care liabilities, was the result of years of irresponsibility and political horse-trading with state unions that were all too eager to negotiate benefits without a sustainable funding plan.
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Connecticut has long been a high-income per capita state and also imposes one of the country’s most burdensome tax systems. Yet it still managed to accumulate the highest state debt per resident. The 2017 bipartisan fiscal guardrails constituted a recognition that the previous decade’s cycle of budget shortfalls, followed by significant tax increases, was simply unsustainable.
The guardrails were codified in 2023, and the general assembly unanimously voted to extend them for another five years. Their very effectiveness in slowing spending growth has made them susceptible to attack from state unions.
The Financial Times made its interview with departing CalSTRS’ Chief Investment Officer Chris Ailman its lead story yesterday: Private equity should share more wealth with workers, says US pension giant. The Financial Times was too polite to say so, but Ailman could lay claim to being the best large public pension fund chief investment officer. CalSTRS, which manages the pensions of California teachers, is in the same general size league as its Sacramento sister CalPERS, and regularly outperforms CalPERS by a meaningful margin.
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It’s hard to know where to begin with this. Limited partners like CalSTRS, who are, in Wall Street parlance, the money, have not even been able to get basic disclosures from the general partners like how much in total the private equity firms hoover out in fees and expenses, despite many years of pleading. Mind you, it’s a requirement for a fiduciary to evaluate the costs and risks of any investment, yet these investors have accepted this abuse.
Limited partners don’t get P&Ls of portfolio companies. They don’t get independent valuations even though that is considered to be essential for every other type of investment. So it’s ludicrous to think that general partners will share money with one of the very weakest parties in the picture, mere workers, when they won’t give information to the limited partners.
Someone new to this topic might wonder why limited partners don’t say “no”. The reason is they perceive private equity to be necessary for them to earn enough to reduce their level of underfunding, which in the public pension fund world is typically pretty bad. To make up for the shortfalls, pension funds like CalPERS and CalSTRS have also been increasing the amount they charge to cities, counties, and other local government entities. These pension costs are taking up larger and larger proportions of these budgets, creating concern and anger.
The New York State Common Retirement Fund (Fund) will restrict its investments in eight integrated oil and gas companies, including Exxon Mobil Corp., after a review of the companies’ readiness to transition to a low-carbon economy, State Comptroller Thomas P. DiNapoli, trustee of the Fund, announced today.
The evaluation of the Fund’s integrated oil and gas holdings is part of DiNapoli’s broader review of the transition readiness of energy sector investments that face significant climate risk. With today’s announcement, the Fund will be divesting its corporate bonds and actively managed public equity holdings in eight integrated oil and gas companies that it has determined are not transition-ready. In addition to Exxon, the companies to be divested and restricted in the coming months are Guanghui Energy Company Ltd., Echo Energy PLC, IOG PLC, Oil and Natural Gas Corporation Ltd, Delek Group Ltd., Dana Gas Co and Unit Corp. The value of these holdings is approximately $26.8 million as of Dec. 31, 2023.
DiNapoli also announced the Fund has met its initial goal of committing $20 billion to the Sustainable Investments and Climate Solutions program, and has set a new goal of investing $40 billion in that program by 2035. With the program, the Fund invests in sustainable investments including clean energy generation, energy storage, resource efficiency, and green infrastructure across all asset classes. As part of the expansion of this program, DiNapoli also announced the Fund would increase its climate index investments by 50% to over $10 billion over the next two years, with the longer-term goal of doubling it by 2035.
Publication Date: 15 Feb 2024
Publication Site: Office of the Comptroller of NY State
Activists credit the support of Beck, Maine Rep. Maggie O’Neil and state Sen. Chloe Maxmin for making Maine the first state to require fossil fuel divestment by law.
Passed and signed by Maine’s governor in 2021, LD99 calls for the state’s permanent funds and its pension system, MainePERS, to divest from fossil fuel investments by 2026 and not reinvest going forward.
It prohibits both specific lists of publicly traded companies as well as any whose “core business” is in fossil fuel exploration, extraction, refining, processing or infrastructure. (A separate 2021 law also requires Maine to divest from private prisons.)
Other pension systems, including New York state’s, have made promises to divest from companies whose primary business drives planet-warming emissions, but are not required to by legislation. In 2015, California passed a law to remove public investments in thermal coal, but a move to extend that to all fossil fuel companies died in the Legislature this session.
MainePERS’ assets — about $18 billion at the end of the last fiscal year — are small in comparison to New York and California, but how they manage their legislative mandate will be closely watched as other states face calls for fossil fuel divestment and wider questions of dealing with climate risk in investing.
Leaders at the pension system stressed a key phrase in the legislation, that any MainePERS divestment decision will be made “in accordance with sound investment criteria and consistent with fiduciary obligations” — crucial to a state constitutional requirement to its pension members.
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MainePERS Chief Investment Officer James Bennett estimates about $1.2 billion of the system’s total holdings are in fossil fuel investments, split evenly between publicly traded companies and private investments.
Liquidating private investments will be more complicated, he says. Many of the limited partnerships MainePERS is invested in include fossil fuel assets alongside other infrastructure investments and cannot be separated. They’d need to sell the whole thing, if it indeed is within the financial interest of members to do so.
A Pennsylvania man who stole $194,000 of retirement benefits paid to his deceased father was sentenced today to five years in prison and ordered to pay full restitution, New York State Comptroller Thomas P. DiNapoli, the United States Attorney for the Eastern District of Pennsylvania Jacqueline C. Romero, the Inspector General for the Social Security Administration Gail S. Ennis, the United States Postal Inspection Service and the Federal Bureau of Investigation announced.
From October 2017 through October 2022, Timothy Gritman, 57, stole $110,897 in pension benefits from the New York State and Local Retirement System and $83,188 in Social Security benefits. He pleaded guilty to wire fraud and Social Security fraud charges in February.
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New York state pensioner Ralph Gritman retired from the Nassau County Clerk’s Office in 1992 and moved to Wyoming from Pennsylvania with his son, Timothy Gritman, in August 2017. In September 2017, Medicare records showed he went to a hospital emergency room in Wyoming. This was the last existing record of the father.
The father and son shared a joint bank account where Ralph’s retirement benefits were electronically deposited. Both Ralph Gritman’s pension and Social Security benefits were to cease upon his death, but Timothy Gritman concealed his father’s death in order to continue to receive his retirement benefits. In his attempts to impersonate his deceased father, he used makeup to whiten his hair and eyebrows.
Publication Date: 14 Feb 2024
Publication Site: Office of the NY State Comptroller
The primary responsibility of the $8.4 billion Philadelphia pensionfund is to assure the continuing financial security promised to city workers upon retirement. The welfare of city employees, along with all Philadelphians, depends on the economic and social well-being of the city itself. Therefore, the Philadelphia Public Banking Coalition has proposed that the city pension fund invest $168 million, 2% of its portfolio, in local economically targeted investments to fund projects that benefit Philadelphians.
These investments would address policy goals while achieving returns as high or higher than many of the fund’s current asset classes. Currently, the 2023 pension fund investment policy describes risky investments in options, futures, forwards, and swap agreements. And there’s a precedent for public policy considerations, for example, in limitations on investments in Russian companies, private prisons, and arms manufacturers. The current portfolio exhibits a strong real estate focus but without preference for Philadelphia projects.
Below are just a few of the possible opportunities for targeted investments that would strengthen the health of Philadelphia’s economy.
Author(s): Stan Shapiro and Peter Winslow, For The Inquirer
To appreciate the significance of using inappropriate discounting, consider this example: A 45‐year‐old public sector employee earns $75,000 per year with no pension plan or other benefits. To help secure her retirement, her employer considers changing her compensation to $73,000 in salary plus a U.S. Treasury zero‐coupon bond that pays $5,000 in 20 years. The bond is selling in the market at $2,000. The Treasury bond’s implicit annual “discount rate” is thus 4.69 percent, i.e., $2,000 plus 4.69 percent interest compounded for 20 years equals $5,000.
The total compensation cost to the employer would remain $75,000. The employee, in turn, has three options:
She can sell the bond and be in an identical position as before.
She can accept her employer’s nudge and keep the bond until retirement.
She can sell the bond and invest the $2,000 in other assets, e.g., stocks, in the hope of generating additional retirement income, albeit taking the risk that she may end up with less than $5,000.
Now suppose the public employer decides to be more paternalistic. Instead of giving the employee the Treasury bond worth $2,000, it promises her that in 20 years it will pay her $5,000. To fund this liability, the employer could deposit the $2,000 in a trust and have the trust buy the Treasury bond. The promise would then be fully funded by the trust. In 20 years, the Treasury bond would be redeemed for $5,000 and the proceeds forwarded to the employee. In the intervening 20 years, before the bond redemption and payment to the employee, the value of the future payment would increase with the passage of time, and increase (or decrease) as market interest rates decrease (or increase). But the value of the bond held in the trust would change identically to the liability, and the contractual obligation to pay $5,000 at age 65 would remain fully funded at every instant until paid, regardless of what happens in financial markets. Ignoring frictional costs and taxes, the employer’s cost of those actions would be the same as if it had paid the employee $75,000 in cash. And the employee’s total compensation would still be $75,000: $73,000 in cash plus a promise worth $2,000.
But instead of contributing the $2,000 and using it to buy the bond, the public employer could hire a public pension actuary and invest any trust contributions in a “prudent diversified” portfolio including assets, like equities, exposed to various market risks. The actuary would attest that the “expected” annual earnings of the portfolio over the long term is 7 percent (according to a sophisticated financial model). The actuary would then use the 7 percent to discount the $5,000 future payment and certify that the “cost” to the employer is $1,292, which is 35 percent less than the $2,000 cost of the Treasury bond. The actuary would certify that if the employer contributes the $1,292, its benefit obligation is “fully funded” because, if the trust earns the “expected return” of 7 percent (50 percent probable, after all), the $1,292 will accumulate to $5,000 in 20 years. The public employer can then claim it has saved taxpayers $708 ($2,000 – $1,292) by investing in a prudent diversified asset portfolio.
The question is, does it really cost only $1,292 to provide the same value as a $2,000 Treasury bond? Is $1,292 invested in the riskier portfolio worth the same as a Treasury bond that costs $2,000? Of course not. If it is possible to spin $1,292 of straw into $2,000 of gold, why would the government employer stop at pensions? Why not borrow as much as possible now and invest the proceeds in a prudent diversified portfolio expected to earn 7 percent and use the “expected” gains from taking market risk to pay for future general government expenditures?
The public employer is providing a benefit worth $2,000—a guarantee—and hoping to pay for it with $1,292 invested in a risky portfolio. The $708 difference represents the value of the guarantee that taxpayers will make good on any shortfall when the $5,000 comes due. The cost to taxpayers in total is still $2,000, but $708 is being taken from future generations by the current generation in the form of risk. Risk is a cost (precisely $708 in this example). Its price reflects the possibility as viewed by the market that future taxpayers ultimately may have to pay nothing at all if things go well, or a significant sum if they don’t.
Suppose the employer takes this logic one step further and, rather than promising $5,000 in 20 years, it contributes $1,292 to a defined contribution plan that invests in the same prudent diversified portfolio on the theory that the employee will be breaking even because the $1,292 is “expected” to accumulate to $5,000. The employee would be correct to view that as a cut in pay. The $708 cost of risk is shifted to the employee, reducing her compensation, instead of being borne by future taxpayers as in the case of the defined benefit plan.
The employee might complain. Future taxpayers cannot.
The only way for the employer to keep the employee whole with $73,000 of cash compensation plus a defined contribution plan is to contribute $2,000 to the plan. Whether it is invested in the Treasury bond or in riskier assets in the hope of higher returns, the value of her total compensation would still be $75,000.
Table 1 summarizes all these scenarios. The fourth column is the analog of public pension plans. Both the reported annual cost for the future $5,000 payment ($1,292) and the reported total compensation ($74,292) are understated. Investment professionals are paid well for managing risky assets for which high expected returns can be claimed. The actuary collects a fee. The employee has the value of the guarantee and bears none of the market risk being taken. Along with a happy employee, the public employer gets to report an understated compensation cost, freeing up money for other budget items. It’s good for all involved—except for the taxpayers on the hook for $708 in costs hidden by using the 7 percent discount rate.
“Too few” public pension funds are addressing climate-related financial risk when it comes to proxy voting, according to a report released Jan. 23 by nonprofit organizations Sierra Club, Stand.earth and Stop the Money Pipeline.
The report, “The Hidden Risk in State Pensions: Analyzing State Pensions’ Responses to the Climate Crisis in Proxy Voting,” looked at 24 public pension funds with a collective $2 trillion in assets, including the $241.7 billion New York City Retirement Systems and state pension funds in California, Colorado, Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Minnesota, Nevada, New Mexico, Oregon, Rhode Island, Vermont, Washington and Wisconsin.
The pension funds were graded on their proxy-voting guidelines, proxy-voting records, and data transparency.
On proxy-voting guidelines, no pension system received an A grade, but three of the five New York City pension funds covering city employees, the Board of Education and teachers, earned a B for addressing systemic risk and climate resolutions. Half of the 24 pension funds studied earned an F.
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“The findings of this analysis are clear: Far too few state pensions are taking adequate steps to address climate-related financial risks and protect their members’ hard-earned savings, raising serious concerns about their execution of fiduciary duty,” the report’s executive summary said.
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Amy Gray, associate director of climate finance for Stand.earth, said it is disappointing to see many funds not using proxy-voting strategies to address the financial risks of climate change. “This report is a stark reminder that pension funds can — and must — do so much more to wield their massive investor power,” Gray said in the news release.
A first-of-its-kind report, the Hidden Risk analyzes the proxy voting records and proxy voting guidelines of the 19 public pensions that are in states where a state financial officer has indicated it is a priority issue both to advocate for more sustainable, just, and inclusive firms and markets , and to protect against climate risk.
Ahead of the 2024 shareholder season, a first-of-its-kind report “The Hidden Risk in State Pensions: Analyzing State Pensions’ Responses to the Climate Crisis in Proxy Voting,” from Stand.earth, Sierra Club and Stop the Money Pipeline, analyzes proxy voting records, proxy guidelines, and voting transparency of 24 public pension funds in the USA collectively representing over $2 trillion in assets under management (AUM).
These pensions are based in states where a state financial officer is a member of For the Long Term, a network that advocates for more sustainable, just, and inclusive firms and markets and strives to protect markets against climate risk.
The pensions analyzed include the pension systems of New York City and the states of California, Colorado, Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Minnesota, Nevada, New Mexico, Oregon, Rhode Island, Vermont, Washington, and Wisconsin.
Republican lawmakers in New Hampshire are seeking to make using ESG criteria in state funds a crime in the latest attack on the beleaguered investing strategy.
Representatives led by Mike Belcher introduced a bill that would prohibit the state’s treasury, pension fund and executive branch from using investments that consider environmental, social and governance factors. “Knowingly” violating the law would be a felony punishable by not less than one year and no more than 20 years imprisonment, according to the proposal.
“Executive branch agencies that are permitted to invest funds shall review their investments and pursue any necessary steps to ensure that no funds or state-controlled investments are invested with firms that invest New Hampshire funds in accounts with any regard whatsoever based on environmental, social, and governance criteria,” the bill said.
The New Hampshire Retirement System “shall adhere to their fiduciary obligation and not invest with any firm that will invest state retirement system funds in investment funds that consider environmental, social, and governance criteria, as the investment goal should be to obtain the highest return on investment for New Hampshire’s taxpayers and retirees,” the bill said.
Investors aren’t allowed to consider governance! Imagine if this was the law; imagine if it was a felony for an investment manager to consider governance “with any regard whatsoever.”
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I’m sorry, this is so stupid. “ESG” is essentially about considering certain risks to a company’s financial results: You might want to avoid investing in a company if its factories are going to be washed away by rising oceans, or if its main product is going to be regulated out of existence, or if its position on controversial social issues will cost it sales, or if its CEO controls the board and spends too much corporate money on wasteful personal projects. Obviously ESG in practice is also other, more controversial things:
If you care about the environment, social issues, etc., you might want to invest in companies that you think are environmentally or socially good, whether or not they are good financial investments.
You might incorrectly convince yourself that the stuff you think is environmentally or socially good is also good for the bottom line: You might have a wishful estimate of how quickly the world will transition away from fossil fuels, to justify your desire not to invest in oil companies. You might tell yourself “this company’s stance on social issues will cost it lots of customers” when really the customers don’t care, but you do.
But if you make it a crime for investors to consider certain financial risks then you get too much of those risks.
In particular, I suspect, you get too much governance risk. If every investor tomorrow said “okay we don’t care about the environment,” most companies probably wouldn’t ramp up their pollution: Their executives probably don’t want to pollute unnecessarily, polluting probably wouldn’t help the bottom line, and many companies just sit at computers developing software and couldn’t pollute much if they wanted to. But if every investor tomorrow said “okay we don’t care about governance,” then, I mean, “governance” is just a way of saying “somebody makes sure that the CEO is doing a good job and doesn’t pay herself too much.” If the investors don’t care about that, then a lot of CEOs will be happy to give themselves raises and spend more time on the corporate jet to their vacation homes.
