ALEC Seeks to Protect Pensioners in New Public Comment
On December 13, 2021, the American Legislative Exchange Council submitted a comment to the Department of Labor in opposition to a proposed regulation that allows pension plan managers and proxy advisors to incorporate Environmental, Social, and Governance (ESG) investing practices in investment decisions under the Employee Retirement Income Security Act, ERISA. If finalized, this rule would reverse the rule that ALEC submitted a comment in support of in July 2020.
The ALEC comment stated that the 2020 rule got it right: Under ERISA, pension plan managers must make investment decisions solely on financial considerations. When plan managers allow political causes or social issues to drive investment strategies, pensions could miss out on millions of dollars of foregone investment returns. When investment returns come up short, employers and employees must make up the difference through higher contributions.
The comment contrasted public pension systems that engage in ESG-type investment behavior with states that do not, using research from Unaccountable and Unaffordable, 2020 and Keeping the Promise: Getting Politics Out of Pensions. The data clearly shows that when managers decide to play politics with other people’s money, public pension investments suffer greater volatility, lower returns, and more significant losses when compared to public pensions that invest based solely on financial considerations. The same can be expected with private pension funds as well.
As SEC Commissioner Hester Peirce notes, ESG is inherently vague, subjective, and political. ESG is a constantly changing standard because it is based on what political and social causes are currently popular. This makes prescribing a clear rule on ESG extremely difficult and adds extra constraints on investments.
Research by the University of Chicago Law School Professor Daniel Fischel found that a hypothetical portfolio diversified across all industries outperformed a hypothetical portfolio divested from energy stocks, a popular ESG strategy, over a 50-year period. The divested portfolio produced returns 0.7 percentage points lower on average per year than the optimal risk-adjusted portfolio that did not divest from energy, representing a massive 23 percentage point decline in investment returns over five decades.
These problems have plagued the California Public Employees’ Retirement System, CalPERS, and the California State Teachers’ Retirement System, CalSTRS, for the past two decades, leaving millions of dollars in foregone investments on the table because the funds chose to divest from funds such as firearms, tobacco and fossil fuels.
The constraints on investing in public pension funds lead CalPERS to chase returns elsewhere such as high-risk assets, as well as hundreds of millions of dollars in Chinese companies blacklisted by the U.S. Treasury for ties to the Chinese military.
Volatile investment returns thanks to ESG, along with overpromising benefits without properly funding contributions, have led to California having the largest total unfunded pension liabilities in the country, totaling nearly $900 billion or over $22,000 per capita.
While individuals are free to invest their money however they like, plan managers have a duty to manage retirement funds in a way that provides a secure retirement to the employees that contribute to those funds. If finalized, the rule would allow pension plan managers to put personal political crusades over the needs of retirees.