The Perils of Divestment


Tom Moutes

Retiree Update

By Tom Moutes, RLACEI Director

Recently, the City Council adopted a motion that, among other things, would have LACERS divest from some fossil fuel companies and other companies that “contradict the City Council’s official positions.”

Over the years, divestment requests of public pensions have included things including fossil fuels, guns, tobacco and gambling; countries including Sudan, Israel, and countries threatening Israel; and companies including those that sell guns or provide goods or services to the Dakota Access Pipeline, or the border wall.

While it’s easy to say we should take action regarding some of these causes, as they may be sympathetic, there are a few issues to point out regarding past divestment attempts: First, it is not easy for a pension fund to divest from these things, countries, or companies. The majority of LACERS investments are in index funds, as these funds are cost-effective. Trying to carve out the perceived undesirable investments from these funds would defeat the purpose of being in index funds. You would have to create and track a custom index, and investment expenses would go up.

Second, the LACERS Board does not get to call all of the shots on how its private equity funds are invested. The Board gives its private equity managers latitude to find the best investments within broad parameters. If a fund is invested in an asset that a board wants to divest from, the options basically are limited to selling the whole fund on the secondary market (usually for a discount and perhaps even a steep discount) or waiting for the term of the fund to run out (often many years).

Third, the California Public Employees’ Retirement System (CalPERS) missed out on approximately $3.6 billion due to its divestment from tobacco. The point here is that divesting can cost pension systems investment returns.

Regarding fossil fuel divestment, Ben Meng, Chief Investment Officer of CalPERS, was quoted as saying, “60 cents of every dollar to pay the retiree benefits comes from investment returns … We need those investment returns now and in the future. If the market fails us, or we miss our targets, the hard-working people of California and the employers take on the financial burden.” (Chief Investment Officer publication). In other words, the employees and taxpayers have to pay for the divestment decisions, whether they agree with the decisions or not.

Chris Ailman, the Chief Investment Officer of the California State Teachers’ Retirement System (CalSTRS), was quoted in the Orange County Register regarding potential coal divestment as follows, “I’ve been involved in five divestments for our fund. [On] all five of them we’ve lost money, and all five of them have not brought about social change.”

This brings up the strongest point against asking LACERS to divest from any investment where it thinks it can make good risk-adjusted returns – the City has made benefit promises to more than 48,000 active and Retired City employees, and LACERS currently has only about 70 percent of the funds it will need to pay those benefits. So, any discussion of allowing politics into LACERS investment process, whether in the form of investment “recommendations” or divestment “requests” should start – and probably end – with conversation regarding how the City is going to make good on the retirement benefits promised to the hard-working City employees.

The investment decisions for LACERS should be exclusively for the LACERS staff and consultants to recommend and for LACERS Board to make. The California Constitution and the City Charter give the LACERS Board “sole and exclusive fiduciary responsibility over the assets of its system.” If the LACERS Board determines that an investment’s risk outweighs the potential returns, it should not make that investment. However, the Board should not simply be told what to do by politicians, who do not have a fiduciary duty to the LACERS members.

Even if LACERS was 100 percent funded, it would be dangerous to go down the slippery slope of divestment. With LACERS at only about 70 percent funded, it would be an extremely dangerous slope