Commentary: Cal Pers May Not Do As Well By Doing Good

The California Public Employees' Retirement System, better known as CalPERS, is famous for using its massive stock positions to needle malfeasant corporate managers and lazy boards of directors. Demanding changes in corporate governance and other areas has helped the fund post solid average annual returns of 17% over the past five years. Now, however, CalPERS' board is itself facing an internal debate over whether do-good social activism should be a part of the $175 billion fund's investment strategy.

Pushing for a kinder, gentler CalPERS is Philip Angelides, who joined the board in 1999 after being elected treasurer of California. Angelides, 46, a former aide to Governor Jerry Brown, is so ambitious he ran for Sacramento city council at age 20. He lost, but many think he's still gunning for public office. He wants CalPERS to dump its tobacco stocks and investments in nations that don't meet basic political and social criteria. He is also pushing CalPERS to invest 2%, or $3.5 billion, of its assets in California's low-income neighborhoods over the next two years, as part of his "double bottom line" campaign. "I believe you can make money and do good for society at the same time," he asserts.

POOR RESULTS. Maybe so, but using other people's money to do good--especially when there are political overtones--is a risky business. The purpose of a pension fund is to provide income for its members, in this case, 1.1 million state and local government workers. Muddying the waters with a social agenda can mean poor results in both areas. "I'm against making investment decisions based on someone's idea of what is good or bad for society, because I don't know where that train stops," says CalPERS board President William D. Crist, an economics professor at California State University, Stanislaus. "Do we one day ban investments in alcohol, handguns, and rap music?"

This is not the first time the issue has been raised at CalPERS. In 1986 the California legislature banned investments in apartheid-era South Africa. According to a study conducted for CalPERS, the fund lost $590 million in transaction costs and missed appreciation as a result of the divestiture. The CalPERS investment staff figures that selling tobacco stocks could cost upwards of $56 million in transaction costs alone.

Nor is this the first time that politicians on the CalPERS board have pushed their own agendas. In the mid-1990s, former state treasurer Matt Fong promoted Asian investments right before those markets collapsed. In the late 1980s, former controller and now Governor Gray Davis supported a low income housing fund with the AFL-CIO. While the cause was noble, returns on that investment have averaged an unspectacular 7% per year, though another housing fund started in the early 1990s has done well.

While at least six states and dozens of pension funds have already divested or limited investments in tobacco stocks, Angelides' proposal to put social screens on the fund's international investments appears to be a first for a major fund. Sadly, the track record for do-good investing is not great. Some funds like the Domini Social Equity fund, which avoids investments like alcohol, gambling, and nuclear power, have beaten the market. But, according to fund tracker Morningstar Inc., the average socially responsible mutual fund underperformed the average U.S. stock fund in the past year, five years, and in the year to date. And according to a study of eighty pension funds by Cost Effectiveness Management of Toronto, funds whose boards left most investment decisions up to investment professionals had better returns than ones that didn't.

Angelides says he is just doing his fiduciary duty. He says he favors dumping tobacco because the industry faces legal and market challenges that make it a bad investment. He also argues that countries enjoying the same basic freedoms as the U.S. will be better long-term investments.

Rather than mandating divestitures and forcing a percentage of the fund into home state projects, Angelides should leave politics out of CalPERS' investment policy. CalPERS has a 100-person investment staff. Let them decide where the best place to make money is.

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