Fiduciary Responsibility: How far does it extend?

Ken Blackwell

by Ken Blackwell, Contributing Author: There is no greater duty than that of a fiduciary to make sound investments for the best interest of its beneficiary. The California State Teachers’ Retirement System (CalSTRS) has more than 900,000 participants (i.e. beneficiaries) and is the second largest pension plan in the U.S. As such a large plan, the fiduciary responsibility is truly great, and must be at the forefront of all investment decisions.

In late January, CalSTRS voted to oppose AB 33, introduced by State Assemblyman Rob Bonta. This bill proposes that the California Public Employees Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) divest of all holdings in private corrections firms and prohibit future investments in those same companies. The opposition to this bill comes on the heels of CalSTRS voting in October to divest from private prison firms, a move that will negatively impact their retirees due to the nature of divestment. Seems hypocritical, or?

We can’t ignore that such politically motivated divestment goes against their fiduciary responsibility considering that it would be costly for retirees. Private prison stocks have had positive effects for investors so divesting seems counter intuitive. Furthermore, the effects of politically motivated divestment can be devastating. For example, the board of CalPERS, the largest public pension fund in the country, made a decision to divest tobacco stocks from its portfolio. An analysis in 2015 found that the divestment cost the fund $3 billion, and later calculations by Wilshire Associates show the “amount of foregone performance has continued to grow.” Despite the losses, the CalPERS board rejected the advice of its staff in 2016 to reinstate tobacco stocks.

In fact, in a 2016 paper published by Morningstar, Jon Hale writes that “studies focused on the effects of exclusionary screens, particularly sin stocks, also draw negative conclusions. Hong and Kacperczyk find that sin stocks have higher expected returns than otherwise comparable stocks and suggest the reason is they are neglected by norm-constrained investors. Trinks and Scholtens also found that investing in stocks often excluded by responsible investors in many cases results in additional risk-adjusted returns.” These details are important to note around the greater discussion of divestment movements, which continue cropping up across the country. The research and the numbers show that divesting will make the pension fund weaker and reduce returns, going against a fund’s fiduciary responsibility, at a time when public pensions can ill afford such costs.

Beyond the unnecessary costs that AB 33 would cause all California investment funds, CalSTRS makes an interesting point in their reasoning to oppose AB 33. According to Harry M. Keiley, board member and chairman of the investment committee, they voted to oppose AB 33 because it would be an abdication of their authority (or perhaps even their fiduciary responsibility) to allow another entity to make investment decisions for CalSTRS. This adherence to their fiduciary responsibility is positive, but does CalSTRS apply it universally?

CalSTRS relies heavily on proxy advisory firms to inform them on how to vote on corporate proxy issues. CalSTRS must vote their proxies as corporate shareholders on everything from new members of board of directors to the governance structure of the firm, and other major decisions. In theory, getting independent, outside research to inform proxy voting would be important to making smart decisions, and thereby adhering to their fiduciary responsibility.

However, only two firms, ISS and Glass Lewis control about 97% of the proxy advisory market, and both are known to have conflicts of interest and to favor ESG (environment, social, and governance factors) resolutions. If CalSTRS is relying on the information from firms that have known conflicts to inform their proxy voting, is that not also an abdication of authority, and therefore their fiduciary responsibility?

The fiduciary responsibility that public pension plans hold must be at the forefront of all decision making. It is not just something that can be utilized when it’s advantageous to do so, such as when opposing a bill. Instead, it must be a universal consideration for all investment and related decisions.
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Ken Blackwell (@kenblackwell) is a former ambassador to the U.N., former member of the Board of Directors of Fifth-Third Bank and the Fifth-Third Bank holding company, former Domestic Policy Advisor to the Trump Presidential Transition Team, and former Ohio State Treasurer and mayor of Cincinnati. He currently serves on the Institute for Pension Fund Integrity and on numerous boards of conservative policy organizations. He is a senior fellow at the Family Research Council and is a contributing author to the ARRA News Service

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