FOR IMMEDIATE RELEASE: ESG Investing for Public Pensions: Does It Add Financial Value?


Molly Hall


 [email protected]

ESG Investing for Public Pensions – Does It Add Financial Value?

Former Connecticut Treasurer and IPFI President, Christopher Burnham, discusses the current state of the pension system with other experts, focusing on the increased use of ESG investment.

Washington, DC – The Institute for Pension Fund Integrity (IPFI) released its latest research on Tuesday, September 25, 2018. In the wake of the Trump Administration’s renewed guidance on environment, social, and governance (ESG) investing in the April 2018 Department of Labor Field Bulletin, IPFI felt it important to analyze the impact of ESG investing on public pensions. While the DOL guidance applies to private sector pensions, ESG investing is growing in popularity in both the private and public sectors, and it is important to understand the role it plays for public pensions.

Public pensions across the country face more than $6 trillion dollars in unfunded liabilities. Therefore, while some investing strategies are seen as more popular than others, it’s important for public pensions to focus on the returns gained to begin closing the gap. In the latest research by IPFI, the organization details how ESG investing differs in the public sector versus in the private sector. ESG has shown to add value to private investments, but in the public sector it ultimately comes down to the question of if ESG investments add financial value. Much of the research is still undecided on the impact of ESG investing on public pensions given the propensity for ESG investments to be made based on political, not financial, decisions. In the public sector, investment decisions should never be made based on the political impact of an investment.

Christopher Burnham, President of IPFI, recently discussed this new research at a panel discussion hosted by the Pepperdine University School of Public Policy. He joined other pensions experts to discuss this and other challenges facing pensions. Other participants included:

  • Kathleen Kennedy Townsend, Director of Retirement Security at the Economic Policy Institute
  • Wayne Winegarden, Senior Fellow in Business and Economics at the Pacific Research Institute
  • Michael Belsky, Executive Director of the Center for Municipal Financial at Harris School of Public Policy at University of Chicago
  • Joshua Gotbaum, Guest Scholar, Economic Studies at Brookings Institute

At the panel, Mr. Burnham said, “ESG investing is valuable when it adds bottom-line performance to a pension. But it’s not the role of our public pension fiduciaries to make decisions based on what they think is good for society. Instead, they must make investment decisions based on one factor, and one factor only: does it add alpha?” This thinking supports IPFI’s other efforts given its goal to keep politics out of the management of public pension funds.

This research and discussion comes as we reflect on the 10 years since the Great Recession. Considering that public pensions were almost 90% funded before the Recession and on average are now 68% funded, the impact of all investment decisions, whether ESG or otherwise, will be felt by retirees for decades to come.


The Institute for Pension Fund Integrity seeks to ensure that local, state and federal leaders are held responsible for their choices in investment, led not by political ideation and opinion but instead by fiduciary responsibility. IPFI is a non-partisan, non-profit organization based out of Arlington, Virginia, and spearheaded by former Connecticut State Treasurer Christopher B. Burnham.


Fallout from COVID-19 Demonstrated Rose-Colored Perspective on Pension Returns

As of the writing of this article, global markets have experienced the largest drop since the Great Depression as a result of fallout from the COVID-19 virus, erasing all gains from the economic upswing of the last two years. It is likely that with a global quarantine in effect, markets will continue to reel in the weeks and months to come. The global economy will face a daunting recovery, and although we can rest assured that this crisis will pass, it will take years for certain sectors to regain their footing. Fallout and a change in mindsets and habits after the virus may cause some industries to disappear entirely.


In the face of all this, public pensions and the returns that they are supposed to guarantee to retired public servants will undoubtedly face a funding crisis. While an economic disruption of this magnitude may not have been on the radar of investors and public officials, it demonstrates the unrealistic optimism that states have held for pension fund returns on investment. In an effort to compensate for mounting unfunded liabilities, many state officials have pegged future investment growth to a rosy rate-of-return that assumes annual market growth upwards of 8%, which does not account a recession, now likely approaching. For pensions to meet their mark, this would entail a booming economy for years to come. Even a minor economic downturn that slowed growth by a percentage point would cause pensions to drastically miss their targets, possibly increasing liabilities nationwide by as much as $500 billion. What will they look like now in the face of global economic collapse?


This is not the first time that we have seen such fallout. In the wake of strong economic growth throughout the 1990’s (coupled with the Dot Com boom), many state pension funds were in a stable and financially sound position as investments poured in. Unfortunately, many public officials were reluctant to use this increased revenue to take action to shore up pension funds in the long run or establish “rainy-day” measures, instead opting to boost their political standing by increasing pension fund payouts. One major example of this was in California, where in 1999 the state legislature passed SB 400 which increased pension benefits on the basis of an estimated $17.6 billion in state pension surplus. Soon after the benefits were granted, the economic fallout from the 9/11 attacks dragged the pension fund deep into the red – a fund that was now obliged to make larger payouts to beneficiaries. Given that recessions impact government revenue streams across the board, the infusion of additional public money into the pension fund in an effort to shore up losses becomes much more difficult in lean times. One would think that this failure to account for economic fluctuation in the long term would have been a lesson for public pension fund managers, but given our current situation, this does not appear to be the case.


Unfunded liabilities in public pension plans are a problem that has a tendency to compound upon itself. In order to make up losses and ensure that the fund will be stable in the future, fund managers and public officials are faced with several options: increase contributions from workers, reduce expected benefits, or adjust their investment strategy in an effort to boost returns. Because the first two options are politically detrimental to elected officials who will then face the scorn of public employees, the third choice is usually first on the table. Unfortunately, seeking out investments with a higher rate of return by their very nature increase the risk of the fund and makes it much more susceptible to economic volatility. This is a tradeoff that many states have been willing to make, especially coming off of the last decade of strong economic growth. We are now seeing how these decisions can backfire.


What policy changes could be implemented to prevent such pension funding crisis in the future? First, public officials should begin to move toward realistic actuarial assumptions when calculating future pension fund growth and the contribution levels that will be necessary to correct unfunded liabilities. Fortunately, many states and localities have begun to move in this direction in the wake of the record-low interest rates we have seen since the financial crisis of 2008. This trend needs to expand on a more profound scale. Second, when the COVID-19 crisis passes (and it will) and the economy returns to a positive level of growth, public officials must avoid the immediate political gains of using surpluses to fund larger pension payments and must instead think long-term. If history teaches us anything, the next economic downturn is right around the corner.


Ultimately, the failure to realistically project pension rates of return and to adequately re-invest surplus comes down to a failure in political leadership. No governor wants to tell their constituents that a realistic re-assessment of pension investment returns means that their unfunded liability problem is much worse than before. However, the hard-working public employees who have dedicated their careers to public service in anticipation of stable retirement benefits deserve the truth. Our leaders need to get real. Economic disruptions happen. Recessions happen. And yes, major crisis like pandemics, war, and terrorist attacks happen. To simply ignore this reality when evaluating rates of return in an attempt to cover up underlying problems is a dereliction of the duty that public servants swear to uphold. Hopefully, this pandemic will finally bring about some frank conversations and hard decisions to ensure the stability of public pensions for generations to come.

Bucking the Trend to Rescue New Jersey’s Pension

As three of New York City’s five pension funds move to divest from fossil fuels, one state government in the neighborhood is bucking the trend to move away from corporations operating in the carbon-based fuel industry. Governor Phil Murphy of New Jersey has warned against the impulse to sever ties completely with industries or companies when one does not agree with their practices. A spokesman for New Jersey’s investment division laid out the state’s reasoning for staying in the game. Divestment means forfeiting shareholder voice, the New Jersey official said, meaning that they would no longer be able to move the company in a direction more in line with their views. Murphy, a former senior director at Goldman Sachs, understands how the market and corporations actually work, and therefore the negligible impact of divestment.

Further showing the ignorance of the divestment movement, it is major energy companies that have made important breakthroughs in clean energy science since the beginning. Given the kind of change climate activists are seeking, they should be doing everything they can to have a say when Exxon and BP are deciding where to put their money. Nature Conservancy, the nation’s largest environmental nonprofit, has been partnered with Royal Dutch Shell for over a decade.

In the face of criticism, Governor Murphy is taking the right steps to improve one of the country’s worst funded pension systems. His budget proposal includes more than $500 million in increased pension funding in addition to his support of returns-focused investing. Struggling funds cannot afford to play futile political games with average Americans’ financial security. Meanwhile, the three New York City funds are moving a combined $3 billion to appease activists. Mayor Bill de Blasio claims that this move shows that “New York City is taking action,” but really it is the opposite. Taking action means doing something to effect change. Mayor de Blasio is giving up his seat at the table and leaving retirees out to dry in the process.

What the SEC’s Proposed Rule Means for Investors

This article originally appeared on Morning Consult on March 5, 2020.

In the new year, we often make many promises. This time, we must resolve to protect the interests of retail and institutional investors from the meddling of proxy advisory firms. I have always argued for clear and navigable investment voting processes, and this moment is particularly critical. As the SEC’s recently proposed rule S7-22-19, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice makes its way through the public comment period, investors must understand how this rule will bring long-overdue accountability to the proxy voting process, and what that means for bottom-line dollars.

Proxy advisory firms amassed their influence through a series of unintended consequences and a prevailing lack of oversight. Until the SEC issued Staff Legal Bulletin No. 20 in 2014 clarifying that investors were not required to vote every proxy, the misconception that they were prompted institutional investors to disproportionately rely on proxy advisory firms to carry out their voting duties.

During that time, a duopoly flourished. Glass Lewis and International Shareholder Services (ISS) dominate 97 percent of the market, which affords them the ability to dictate the rules of the game with little competition. Proxy advisory firms position themselves as third-party “allies” to investors while wielding enormous power to sway voting outcomes and determine where and how fiduciaries invest others’ money. And that’s cause for concern. 

For one, proxy advisory firms are rife with conflicts of interest. Consider that ISS bases its voting recommendations, in part, on an analysis of a company’s governance performance demonstrated by an ISS Governance Score. ISS also offers a service to companies on how to improve their ISS Governance Score. Hence, ISS collects payment on opposite sides of the same mechanism. 

ISS also sells voting services to investors as well as consulting services to companies considering management-proposed resolutions. This introduces the risk of the proxy firm recommending that investors vote in favor of management when it’s a consulting client. The Ohio Public Employees Retirement System (OPERS) understood the danger this posed to its pension plan members’ long-term financial security and swiftly ended its contract with ISS in the mid-2000s.

Conflicts of interest become even more troubling given the preponderance of automatic voting. On average, investors vote following proxy recommendations 80 percent of the time. A single negative ISS recommendation on say-on-pay leads to a 25 percentage point reduction in support.

As a fiduciary, an investment adviser owes each of its clients a duty of care with respect to services undertaken on the client’s behalf. However, proxy advisory firms provide several different voting guidelines that obfuscate fiduciary duty and skew investments toward subjective goals, including faith-based and sustainability guidelines. By relying on shadow reports, proxy firms offer investors the best of both worlds: the ability to vote how they please while simultaneously recusing themselves of any responsibility by supposedly following the unbiased advice of a third party.

As it turns out, everyday investors are becoming increasingly aware of the many flaws in the existing proxy advisory process. A recent survey found over 80 percent of investors in support of the SEC’s proposed rule at the end of the survey. Additionally, the survey found that the more asset managers and investors learn about proxy firms, their business and what drives their recommendations, the more they support responsible regulation.

Currently, proxy advisory firms provide recommendations based on inaccessible, private data unavailable for public review. S7-22-19 would require proxy firms to ensure their recommendations include dissenting opinions and also allow companies the opportunity to correct inaccuracies in proxy advisory reports.

Proxy voting functions, fundamentally, as an “information production process”. These firms are modern-day factories; their product is information. A proxy firm survives only by maintaining a constant rate of production. By creating reports, data and analyses that tailor to specific political and financial agendas in secret, proxy firms are capable of re-defining public opinion among investors and manipulating large swaths of capital, almost single-handedly.

Though charged with helping investors generate revenue, it seems that proxy advisory firms are only concerned with one bottom-line: their own. The proposed rule rightfully addresses the many transgressions inherent in the proxy advisory process. With the help of the SEC, I believe that we can shift the balance back in favor of investors.

ESG Versus Impact Investing

This article originally appeared in Forbes on February 28, 2020.

There is absolutely nothing wrong with senior management and directors of companies across America reviewing, analyzing, measuring and integrating into company operations, a focus on environmental, social, and governance (“ESG”) considerations. Nor is it a new concept. As one general counsel of a Fortune 200 company told me last summer, “We’ve been integrating ESG into our operations for the past 40 years.”

The reason is, of course, that embracing ESG adds value to companies. This is especially true in the emerging markets, where independent directors, outside audits and anti-nepotism policies all indicate a company’s embrace of good governance. On environmental issues, look no farther than BP or Brazilian-based Vale S.A. to see the damage of what reckless neglect of sound environmental policies can do to the value of a company—BP lost 54% of its value after the oil spill disaster in the Gulf of Mexico, and Vale has plunged in value after the dam holding back mine tailings failed last year, and also faces criminal and murder charges for the more than 250 deaths that happened as a result of the dam failure.

The “S” of ESG speaks for itself. Taking care of your employees, including offering those aspects of 21st century benefits—such as maternal and parental leave, or allowing employees to work remotely, are now essential elements of attracting and retaining good workers. Ten years ago, the consulting world warned us of the impending “war for talent.” That struggle is only intensifying as a new generation is not just embracing but redefining “work-life balance.” Even Goldman Sachs, long known for its brutal work schedule, changed their rules after the suicide of one of their young telecom analysts in 2015. Simply stated, embracing ESG adds value to a company.

Impact Investing on the other hand, does not add value. Impact investing is a nice way to re-label “political investing”—investing with a specific political agenda—be it against the companies that supply our military, coal companies, gun companies and many others. Impact Investing is the antithesis of the utilitarian principles on which, the United States was founded—the greatest good for the greatest number of people—and instead is based on “investing to force change based on my personal political agenda”, and “I certainly know more than you so I will impose my will upon you.”

The absolute worst example of this is allowing politics to undermine fiduciary duty in the management of our public pension funds. From California to New York City, governors and mayors have tried to pad their liberal credentials by forcing public pension trustees to abdicate fiduciary duty to their political whims. However, in the case of California, state employees and retirees pushed back last October when they voted to toss the sitting CALPERS board president in favor of Jason Perez, a Corona, CA police officer who ran on removing politics from the management of California’s public employee pension fund.

In 2001, California stripped tobacco companies from the CALPERS portfolio thereby leaving almost $4 billion of performance (alpha) on the table. More recent proposals have targeted oil companies and private prison companies. One has to assume, that should Mike Bloomberg be elected president, his crusade as mayor of New York against sugar and soda companies will continue. But play politics in the legislature not in our public pension plans.

Now banks and money managers, seeking to appease their own activist clients and shareholders, are trying to put lipstick on the hog by advocating for ESG when what they are doing is advocating for a political agenda. We must not, however, allow them to advance political investing by calling it “ESG.” Again, ESG is used around the world as a way to help both large and small companies increase shareholder value by good governance, being good stewards of the environment and taking care of their employees. ESG is not about forcing pension funds, or banks, to stop funding soda companies, coal companies, private prison companies, defense industry companies or anything else that offends politicians, activists, elitists or scared bank CEOs seeking to impose their supercilious arrogance over fiduciary responsibility.

The Misguided Movement to Divest

At the World Economic Forum in Davos, Switzerland, Greta Thunberg demanded an end to all investments in fossil fuels. While Ms. Thunberg may have good intentions, her demands are indicative of the economic ignorance found in today’s activists. Unfortunately, BlackRock CEO Larry Fink has fallen victim to the same flawed reasoning. Just ahead of the Davos summit, Fink announced that his company would divest entirely from fossil fuels. The head of the world’s largest money manager should know that selling stock is an ineffective vehicle for change. Instead, it provides an opportunity for major oil and gas companies to buy back their stock. In the end, it’s the pension plan members who have committed a portion of every paycheck to funds that invest in these industries that wind up suffering. 

Public servants who hope to one day collect a livable retirement expect that their dollars will be invested based on proven, traditional strategies that yield maximum returns. But many of the industries that can deliver on this expectation now face widespread attacks. The fact is divestment doesn’t work. The large-scale selling of a company’s stock only brings the price down briefly. This makes it more attractive to investors less concerned with the political implications of a particular company. Divestment has little impact on the actual operations of a business. Even AIG CEO Brian Duperreault, who supports impact investing, stated during a Davos conference that AIG is not prepared to cancel business with “low ESG score” companies.  

The dangerous trend of ESG activism compromises returns on the pensions of over 14 million Americans. Divestment movements have become a favored tactic of activists who are unable to effect change in the legislature. In turn, they attempt to circumnavigate democracy by wielding the funds at their disposal in a manner they believe will help their cause, all while attacking investors who employ investment strategies geared toward maximizing returns, their fundamental obligation as a fiduciary. ESG investing, on the other hand, is incompatible with maximum returns.  A recent study by Pacific Research Institute found that ESG funds underperform standard S&P 500 index funds by 43.9 percent over 10 years.  To advocate in favor of an investment strategy that so profoundly limits returns is irresponsible and a violation of an asset manager’s fiduciary duty, and America’s pension funds would be the victims.

Pension funds and other financial assets are amoral entities. They are best served by considering all investment options, not just the ones that fit into a third party’s political agenda. 

The SEC Is Right To Force More Transparency Into Proxy Voting

This article originally appeared in Forbes on January 31, 2020. 

The Securities and Exchange Commission is about to take an important first step in bringing accountability and transparency to the proxy voting world. For far too long pension funds have off-loaded their fiduciary duty to their beneficiaries to proxy advisory firms by outsourcing to them, the review of proxy proposals. These firms, in turn, then make recommendations to plan sponsors but without any oversight and very little transparency. A key point to remember is that fund managers and plan sponsors vote as recommended by the proxy advisory firms almost 100% of the time.

Under SEC Chairman Jay Clayton, the Commission is now trying to “improve [the] accuracy and transparency of proxy voting advice” received from these firms, by focusing on two key areas. If the rule changes are implemented, advisory firms will have to send their recommendations to issuers before they send them to clients. This will allow issuers to review for accuracy, as well as bring a welcomed transparency to the process. Secondly, the SEC is proposing to eliminate frivolous proxy proposals by raising the bar that activist, and those seeking to impose their political view on other shareholders, must reach to force a proxy vote.

What Chairman Clayton is advocating for is not new; the Investment Advisors Act of 1940 required investment advisors to adopt policies and procedures that required them to vote only in the best interest of their clients. What we face today, instead, is an epidemic of supercilious activists who believe they, alone, know what is best for mom and pop investors, and particularly our public pension retirees.

The slippery slope of injecting politics into proxy voting is a clear violation of fiduciary duty. Over the past few decades activists have tried to strip out companies involved in the Vietnam War (almost all of the S&P 500 companies in 1969 sold something to the US Armed Forces) to late last year when the  Charlottesville, VA City Council voted to strip out shares in Northrup Grumman, General Dynamics, and any other company producing systems that protect our country, and maybe, might just bring our children home safely. It can include, cigarettes, energy, guns, sugar and sugary drinks, nuclear energy, and dozens more, depending on your proclivity and personal bias.

In 1995, as the Treasurer of Connecticut, I indexed 75% of the State’s teacher and state employees pension portfolio, which for the previous ten years had been the worse preforming state pension fund in the United States—dead last.  Within six months of indexing, we skyrocketed to the top 10 states in the nation in terms of performance, thereby earning a much higher return for our retirees while decreasing costs at the fund. I also shut down our activist office at the Treasury saving over $1 million a year for the pension fund.

In the past ten years, only six states have outperformed a simple index fund of 60% indexed to the S&P 500 and 40% indexed to the Bloomberg-Barclay’s Bond Index. This means that 44 states waste millions of dollars hiring active and activist managers trying to beat the index, when if they only indexed the portfolio they would beat 88% of the other states. This is pathetic.

In a recent letter to his investors, as quoted in the Financial Times about the new proposed SEC rules, activist hedge fund manager, Dan Loeb, wrote, “Someone has been rigging the public debate and trying to mislead the commission…These endorsements were actually part of a false letter-writing campaign that had been bought and paid for by corporations. This is the ‘swamp’ at its worst.”

No Dan, the real swamp are those politicians who seek to impose their personal political agenda on the retirement accounts of our hard working public employees and teachers. Our fiduciary duty is to ensure the highest return at a reasonable risk, not the highest return after playing politics.

The SEC is about to restore transparency and accountability back into proxy voting and Chairman Clayton should be congratulated for standing up for strict adherence to fiduciary duty.

Case for Proxy Reform Glaringly Evident After Latest Debate

On January 27, the Bipartisan Policy Center hosted a discussion on the SEC’s proposed reforms to the proxy voting process. Tom Quaadman, Executive Vice President of the U.S. Chamber Center for Capital Markets Competitiveness and Pat McGurn, Special Counsel and Head of Strategic Research and Analysis at Institutional Shareholder Services examined the key elements of the proposed reforms and debated their ramifications before an audience that IPFI was privileged to be a part of. 

Mr. Quaadman spoke to how the proposed rule addressed widespread concerns around accuracy, conflicts of interest, and the need for more transparency. Specifically, he cited the 2.5% error rate in proxy reports on companies, which he partially attributes to a lack of communication between proxy advisory firms and companies. Since the 2014 SEC-issued guidance on proxy advisory firms, an annual survey revealed that the level of company-initiated interactions with proxy advisory firms has been steadily declining due to the inability to correct factual errors promptly.  Quaadman added, “A financial analyst who doesn’t interact with the company and just makes industry-wide pronouncements isn’t going to last five minutes on Wall Street.” 

The discussion later turned to automatic voting, or robo-voting as it is commonly known. Quaadman referred to the observation that at least a third of the vote coming in within the first 48 hours, with 95% of those votes following the proxy advisory recommendations. McGurn swiftly noted that the majority of ISS’ client recommendations are based on custom reports tailored to that client. But, by ISS protocol, the term ‘custom’ may indicate a configuration as simple as, “vote in-line with ISS on everything except X.” Unquestioningly following recommendations save for one factor is an insufficient deployment of fiduciary duty. 

Finally, the two keynote speakers explored how conflicts of interest may arise. Mr. McGurn argued the SEC’s reforms compromised the integrity of the firewall between consulting and proxy voting firms. Calling this firewall “leaky” Quuadman pointed to the fact that many companies who receive poor recommendations from proxy advisors are soon after contacted by their colleagues on the consulting side of the business. In other words, their proxy recommendations in some cases can be confused as business development. Quaadman also reminded the audience that proxy firms do not publicly disclose if shareholder or director slate proponents are clients.

ISS clients cast 8.5 million ballots and 3.8 trillion shares annually. Under the current arrangement, rife with factual errors, robo-voting, and conflicts of interest, ISS and Glass Lewis operate as “de-facto standard setter[s] in corporate governance.” The prevailing argument against SEC regulation maintains that it’s simply not necessary. 

McGurn failed to provide any examples to alleviate concerns raised about ISS’ violation of fiduciary duty, need for greater transparency, and their clear conflicts of interest. The discussion summarized here demonstrates that the proposed rules are not only necessary but integral to the performance of our markets and the safeguarding of America’s public servants’ future retirements. 

IPFI Issue Brief: SEC Rulemaking and What It Means for Proxy Advisory Firms

In November 2019 the U.S. Securities and Exchange Commission (SEC) voted 3-2 in favor of proposing two new rules regarding proxy advisory firms. These rules, S7-22-19 Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice and S7-23-19 Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8 build on the SEC’s November 2019 interpretive release, which clarified that proxy advisory firms are subject to anti-fraud rules and outlined best practices investors can employ when utilizing proxy advisory services.

In our latest report, the Institute for Pension Fund Integrity (IPFI) has returned to this topic to assess the rulemaking process and the implications of these two rules, in particular. Proxy advisory firms play a critical role in determining how institutional investors, such as those who manage public pensions, vote on shareholder resolutions. As fiduciaries, these individuals are obligated to prioritize fiscal returns above all else. However, proxy advisory firms compromise that duty through several avenues, such as:

  • Lack of transparency – Those interested in obtaining information on the basis of proxy voting recommendations will find it nearly impossible. Furthermore, proxy advisors provide a technological platform for fund managers to utilize. This encourages compliance with recommendations in a closed system, resulting in a practice of “robo-voting.” This phenomenon disenfranchises public pension plan members from having a say over how their own investment dollars are allocated.
  • Conflicts of interest – Proxy advisory firms advise institutional investors on how to cast their votes. These firms also advise companies on how to obtain a more favorable score as awarded by the proxy advisory firm. Such a practice directly violates the Sarbanes-Oxley Act of 2002, which requires the separation of parts of financial institutions that provide ratings on companies and those that conduct advisory work for those same companies.
  • Politically-motivated voting – In addition to the Taft-Hartley voting guidelines, which prioritize financial returns, proxy firms deploy a range of specialty reports to inform institutional investors on how to vote, including socially responsible, faith-based, and sustainability guidelines. These guidelines allow for third parties to hijack pension funds in an attempt to advance arbitrary political or social causes while providing cover for the proxy advisory firms who have been entrusted with providing independent recommendations. Recommendations that give weight to any of the above considerations are far from independent.
  • Outsized and Unwieldy Influence – Institutional Shareholder Services Inc. and Glass Lewis Co. control 97% of the market. The voting policies of these firms have become so enormous that corporations have adopted a practice of tailoring their policies in advance to avoid lengthy “vote no” campaigns.

IPFI President Christopher Burnham wrote in Forbes, “These firms advise pension plans on how to vote on a variety of corporate issues that impact returns, sometimes with a focus on ‘impact investing,’ meaning they are also advocating for a specific political agenda… Our public plans, politicized, mismanaged and underfunded are a time bomb ticking away.”

IPFI maintains that investment advisers must place the financial considerations above any other factor. The necessity of introducing appropriate proxy reform to a seriously lacking regulatory scheme is apparent. While illuminating the major flaws that need addressing, we hope that this report serves as an accessible reference to public pension plan members when advocating for an unwavering commitment to fiduciary responsibility. No public servant should have to worry about their retirements after a lifetime of contributions.

Read the latest issue brief, SEC Rulemaking and What It Means for Proxy Advisory Firms.

LACERS Must Stand Up Against Divestment Pressure

As the new year begins, fiduciaries must remain vigilant against misguided abuse of our nation’s pensions. Those in charge of California’s retirees have a duty to manage the Los Angeles City Employees’ Retirement System (LACERS) with the sole objective of increasing returns. Forced divestment and politically-motivated financial decisions have been shown to compromise that outcome. Yet Los Angeles City Councilman Bob Blumenfield has irresponsibly ignored past financial research by using LACERS to forward a flawed and uninformed plan to revise his fellow citizens’ retirement funds.

IPFIUSA’s groundbreaking report last April on the faults of restrictive and politically motivated investment strategies seems to never have made it to Councilman Blumenfield’s desk. The report details how ESG-style funds in the style of the Councilman’s suggestion consistently underperform other more responsibly researched and managed funds, if only for a basic explanation: “an investor who is picking stocks from a limited pool of choices will be outperformed by one who is picking stocks from a broader pool.” It is not only a simple and fundamental investment theory that Councilman Blumenfield is ignoring but also carefully compiled data.

The same report details how the S&P 500 — an all-encompassing index fund thought to mimic the general economy — beat the oldest ESG fund in “seven of the past nine calendar years.”  For one five-year period, the S&P beat the ESG fund by more than 0.75%. This margin is significant to any informed investor, and it can especially make a difference to those who rely on pensions for a liveable income after retirement.

LACERS deserves a City Council that prioritizes public pensions over the private political beliefs of its members. Councilman Blumenfield suggests creating watchlists and labeling certain companies (with a demonstrated history of profitable returns that strengthen pensions) as “uncooperative.” This does nothing but harm to the future of Los Angeles. Further, there is no evidence that such a practice alters the behavior of entities deemed politically unfavorable. We are concerned for those who can’t afford to waste their retirement on simply proving a point, and we urge Councilman Blumenfield to leave politics aside to protect the pensions of Los Angeles’ public employees.

COMMENTARY: Senate Banking Hearing with SEC Chairman Must Address Proxy Advisory Firms

This article originally appeared in Morning Consult on December 10th, 2019. 

On Dec. 10, the Senate Committee on Banking, Housing and Urban Affairs will hold an oversight hearing on the Securities and Exchange Commission. Among all of the SEC’s priorities, the Senate Banking Committee should raise the topic of proxy advisory reform. With the public comment period open on proposed rule S7-22-19 Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice, this hearing is an ideal opportunity for Chairman Jay Clayton to address the implications of this rule, which stands to eradicate numerous flaws, distractions and blatant conflicts of interest inherent in the proxy voting process.

Many institutional investors completely outsource their voting responsibilities to proxy advisory firms by automatically agreeing with recommendations in the absence of a thorough review. This practice, coined “robo-voting,” appeared across 175 investment entities surveyed in a Harvard Law study. These entities manage over $5 trillion and follow proxy advisory firms’ recommendations 95 percent of the time. Absent substantive review of recommendations, proxy advisory firms wield disproportionate influence over the outcome of shareholder resolutions. What’s more, these firms receive payment no matter the outcome of the vote, or how it impacts fiscal performance.

To fuel a business model based largely on opinion, proxy advisory firms tailor recommendations based on various points of interest. Institutional Shareholder Services (ISS) offers five different voting recommendation reports that suit multiple agendas. These include Faith-Based Guidelines, Socially Responsible Investment (SRI) Guidelines and Sustainability Proxy Voting Guidelines. How is it that they are allowed to get away with introducing arbitrary, personal morals into the equation while providing cover for those who should be making decisions on a financial basis? This is the crux of the issue that proposed rule S7-22-19 seeks to remedy.

And frankly, corporate board members are tired of becoming embroiled in these battles. As a former member of the National Commission on Economic Growth and Tax Reform, I’m well-versed in how internal boardroom dynamics affect company performance at large. While topics that fall under environmental, social and governance (ESG) objectives raise important issues that should be carefully considered, prioritizing ESG can sometimes undermine a company’s priority to generate optimal returns.

A recent poll outlines this phenomenon in detail. According to PwC’s latest Annual Corporate Directors Survey, 56 percent of board directors say that investors devote too much attention to ESG investments. This is up from 29 percent in 2018. The fact of the matter is that the boardroom is not an appropriate forum for quarreling over which politicized issue merits a company’s financial backing or withdrawal.

Vocal activists repeatedly call for companies to invest here! — divest there! — appoint this person! — remove this one! Cacophonic cries do nothing but exhaust executives, preventing them from meaningfully engaging any particular topic. This badgering has become self-defeating. The slew of demands has weakened corporate executives’ ability to recognize, much less tackle, what’s important.

The institutional investors who direct funds on others’ behalf also have a hard time cutting through the noise. Increasingly, activists have weaponized institutional investment funds to impose an external agenda onto a private, for-profit entity with little consideration for how these moves will affect those who have invested their own dollars. Proxy advisory firms lend power to these demands. Chairman Clayton has an opportunity to highlight this during his testimony in front of the Senate Banking Committee.

Under Chairman Clayton’s direction, the SEC has finally broken ground limiting the influence of proxy advisory firms. The proposed rule stands to affect millions of Americans who contribute to hedge funds, passive index funds, pension plans and other long-term investments. I, for one, hope that it passes.

While I was the State Treasurer of Ohio, I witnessed how nonpartisan, fiduciary duty benefited our resource pool. Why should private entities, that can sway our economy on a national scale, be any more lax with their strategies? Political agendas have proven to be nothing more than a nuisance in the boardroom. Let’s let executives get back to their job, and leave politics to the politicians.

Ken Blackwell is a member of the Institute for Pension Fund Integrity and a senior fellow at the Family Research Council. He was the Ohio State Treasurer from 1994-99 and has also served as Ohio Secretary of State, Mayor of Cincinnati, Undersecretary in the Department of Housing and Urban Development and as an Ambassador to the United Nations Human Rights Commission.