CalPERS Decision to Divest from Tobacco Is Costly

A report found CalPERS missed nearly $3.6 billion in investment opportunities from 2000 decision, but other divestments have worked in its favor.

The California Public Employees’ Retirement System (CalPERS) has lost $3.581 billion in investment gains by divesting from tobacco stocks, which amounts to about 1% of current assetsduring a 17-plus-year period ending June 30, 2018, shows a new report by Wilshire Associates, the pension system’s general investment consultant.

The Wilshire report is expected to be discussed at the $345.6 billion pension system’s investment committee meeting on Nov. 17, but it is considered unlikely that the committee would start pursing a reversal of its decision two years ago to continue its tobacco industry stock divestment policy.

After a decision in 2000, CalPERS began to divest in 2001 after investment staff determined that the tobacco industry was due for serious financial trouble as it wrestled with lawsuits over tobacco’s ill health effects and a coverup by companies over disclosure of the dangers of cigarette smoking.

What the investment staff didn’t know at the time was that the lawsuits would be settled, and the tobacco industry would regain its footing. So much so, that the CalPERS investment staff recommended reinvesting in tobacco stocks in 2016 because of the missed investment opportunities.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news.

The move fueled intense criticism from anti-tobacco advocates who argued that it was wrong for the largest US pension system to reinvest in companies that make products that are harmful to individuals’ health.

The advocates said it was particularly hypocritical for CalPERS to reconsider investing in tobacco companies when the pension organization is also the third-largest provider of healthcare insurance coverage in the US. They said that CalPERS would be, in effect, buying securities of tobacco companies, whose products were increasing lung disease and cancer, ultimately driving up healthcare costs.

Investment committee members argued that they were fiduciaries of the pension trust and had to do what was financially responsible for the fund. Ultimately, following the firestorm of criticism, investment committee members in December 2016 voted 9 -3 not only to continue the divestment of tobacco from CalPERS’s internally managed equity portfolio, but to withdraw from more than $500 million in tobacco stocks managed by external managers.

While tobacco divestment has had a negative effect overall on the CalPERS portfolio, other divestments have actually helped the portfolio, Wilshire officials estimate.

A little-known CalPERS divestment program, emerging market principles, has resulted in an overall 0.2% return between the first quarter of 2008 and June 30 of this year, leading to an estimated extra $592 million in returns during a 10-plus-year period, Wilshire said.

Under the program, CalPERS contracts with a service provider to screen companies from the emerging market portion of its internally managed global equity portfolio that do not meet environmental, social, and governance (ESG) standards.

Twenty-two companies were on the exclusion list as of June 30, 2018, said CalPERS spokeswoman Megan White in an email. She said the list is not static and can change throughout the year.

White would not disclose the names of the companies, saying CalPERS and its vendor consider it confidential.

CalPERS used to boycott investments in entire countries like China and Russia that did not meet standards the pension system set for political stability, human rights, market regulation, environmental regulations, and other factors, but changed the approach of its program in 2007.

This followed the disclosure by CalPERS that it has not realized hundreds of millions in investment gains in the four previous years because of the country restrictions.

Other divestments have also had positive impact on the portfolio, though they are relatively small, given the size of CalPERS’s $165.8 billion global equity portfolio.

The California state legislature mandated divestment of companies that do business with Sudan resulting in an estimated $200 million excess return between the first quarter of 2008 and June 30, 2018, by not having the companies in the portfolio, the Wilshire report shows.

Another divestment of companies that do business with Iran resulted in an estimated  $139 million portfolio gain between the third quarter of 2011 and June 30 of this year.

Meanwhile, a CalPERS-directed 2013 divestment of two firearms companies, Smith & Wesson Holding Corp. and Sturm, Ruger & Co., which manufacture assault weapons that are illegal in California, has had no impact on the portfolio between the second quarter of 2017 and June 30 of this year, shows the Wilshire report.

The Wilshire report also analyzed the California legislature’s 2015 mandate that CalPERS divest of thermal coal companies. It found that the divestment resulted in no effect on the portfolio between the third quarter of 2017 and June 30 of this year.

Tags: , , , ,