Politically motivated investments in environmental, social and governance ventures are a key factor in the underperformance of the California Public Employees’ Retirement System, according to a new report by the American Council for Capital Formation.

“The ESG principles that have helped shaped CalPERS’ portfolio over the last four years are truly jeopardizing the retirement fund,” says Tim Doyle, who authored the report and is vice-president of policy and general counsel at the council, a Washington-based non-partisan think tank.

Read: New PSP team aims to ‘integrate ESG’ in all investment decisions

CalPERS’ financial status has evolved from a surplus of US$2.9 billion in 2007 to an unfunded liability more than US$138 billion today, even as the value of the S&P 500 index has increased by more than 275 per cent. As of the fund’s fiscal year end in March, four of the nine worst-performing funds in its portfolio focused on environmental, social and governance factors, while none of the 25 top-performing funds was in that category. Meanwhile, the council report noted the personal portfolios of the fund’s chief investment officer and at least two other senior executives steer clear of environmental, social and governance factors.

In response to an email from Benefits Canada, John Osborn, a spokesperson at CalPERS, said the fund’s investment decisions reflect its “fiduciary responsibility to sustain and pay” members’ earned benefits. “We work to achieve the best risk-adjusted returns possible,” he wrote. “Incorporating environmental, social and governance principles is an important part of our decision-making in our investment office.”

Hugh O’Reilly, president and chief executive officer of OPSEU Pension Trust, believes the position taken by the council’s report is off base. “Saying that a particular fund or type of fund is a non-performer amounts to a mug’s game and produces random outcomes,” he says. “I am persuaded by academic literature that investors’ focus on ESG improves corporate governance and enhances performance.”

Read: How Bâtirente takes ESG reporting to the next level

For his part, Doyle concedes there are some difficulties with the report’s conclusions. “The total amount CalPERS has invested in ESG is not quantifiable,” he says. “So it’s hard to determine the actual overall impact of ESG on CalPERS’ performance, other than by looking at individual companies and drawing some inferences from them.”

Still, as Doyle points out, the funding ratio at CalPERS has struggled to gain momentum since the fund began accelerating its focus on environmental, social and governance factors in 2013. “Despite the strong performance of markets, the funding ratio has fallen from 69.8 per cent in fiscal to 2014 to 68.3 per cent today.”

In 2016, Bloomberg analyzed every equity mutual fund with a Morningstar Inc. rating for environmental, social and governance factors. It sorted the funds into five groups based on the proportion of their assets under management with high environmental, social and governance scores.

“The group with the highest ESG exposure returned an average of 1.1 per cent annually over the last five years and 2.3 per cent annually over the last 10 years,” Bloomberg concluded. “The group with the lowest ESG exposure, on the other hand, returned an average of 7.3 per cent annually over the last five years and 5.6 per cent annually over the last 10 years. The middle three groups fell in line — as their ESG exposure increased, their average return decreased.”

Read: Pension fund assets make up 75% of responsible investing in Canada: report

As reported by Benefits Canada in February, a responsible investment strategy accounted for 38 per cent of assets under management in Canada, up from 31 per cent two years ago, according to a report by the Responsible Investment Association. Pension fund holdings, which grew by $374 billion or 45 per cent over the same period, accounted for 75 per cent of that growth.

“It’s almost unthinkable these days that ESG investing would be an issue on Bay Street,” says O’Reilly. “As for CalPERS, given the constraints imposed by the political system in which they operate, they’re doing a good to excellent job, by any reasonable measure.”

Indeed, CalPERS has no intention of changing its policies. “Any suggestion that we stop engaging with companies on behalf of our members is laughable,” wrote Osborn.

Still, the council expressed concern that other funds are following CalPERS’ lead or will do so despite concerns about the California fund’s performance.

“We’re concerned that ESG investing is a growing trend, largely because of CalPERS’ sheer size and its influence over institutional investors . . .,” says Doyle.

“This will continue as long as CalPERS continues to be run by political appointees, rather than people with investment backgrounds.”

Read: Institutional investors encouraging companies to step up actions on climate change

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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