This article originally appeared in Forbes on September 22, 2020.
The time to ensure that pension fund managers are bound by their fiduciary obligation to their beneficiaries and not by any other political motives is now. Prioritizing issues other than pure financial returns may be an acceptable strategy for individuals managing their own money or for corporate board rooms contemplating the future of their company, but for fiduciaries, prioritizing any kind of self-interest or ulterior motive over maximizing returns is a dereliction of duty.
Over the past several months, the Department of Labor has begun to take steps to curb this trend, releasing two new regulatory proposals seeking to re-affirm the responsibilities of pension fund fiduciaries. The first proposed rule examines tax-qualified retirement plans governed by ERISA in order to determine the extent to which Environmental, Social, and Governance (ESG) considerations factor into investment decisions. The question at hand is whether the plan managers, bound by fiduciary duty to their beneficiaries, are sacrificing investment returns or increasing risks to meet ESG goals unrelated to participant’s bottom-line financial interests. The second rule seeks to re-evaluate the outsized role that proxy advisory firms have played in pension fund investment and the associated costs that have been passed down to beneficiaries.
As a former state treasurer of Connecticut, I have personally overseen the management of a public pension system. It is not possible to fully protect the financial security of a plan’s beneficiaries if those charged with managing a pension fund are trying to build an investment strategy around nonfinancial considerations. Decisions on new investment strategies, whether they are driven by political reasons or simply as an attempt to chart a new path forward, must be made in the boardroom. There are many laudable social initiatives that individuals, religious endowments, schools, and other private entities may wish to consider. However, it is never correct to impose personal political motives on pension funds. This principle is even more prevalent given the financial ramifications that the economic fallout of the COVID-19 pandemic has had on pensions.
The Department of Labor should be applauded for taking these necessary steps toward clarifying and correcting guidance on the fiduciary obligations of pension fund managers. As Labor Secretary Scalia noted, these actions aim to “remind plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”
Despite these efforts, public pensions are still vulnerable to ESG strategies. The trend towards “impact investing” has permeated the proxy voting industry, where two firms effectively control significant numbers of shareholder votes in thousands of publicly traded companies. These votes would be an important weapon against ESG policy that does not serve the shareholders, but under the current rules mostly serve an ideological agenda separate from the interests of retirees and public employees. For this reason, the Department’s second proposed rule clarifying the roles and responsibilities of proxy advisory firms and the obligations that fund managers have toward their proposals is of the utmost importance.
SEC commissioner Daniel M. Gallagher acknowledged the problems with the proxy industry as far back as 2013, noting that the current system is not built to increase company value or generally operate on behalf of shareholders, but rather to serve the interests of the proxy advisory companies themselves. While the proposal is a step in the right direction, it is important to think not only about how pension money is invested, but also how the voice that comes with a stake in any given company is used. Until we reform the proxy voting industry, that voice will be vulnerable to the whims of third parties.
One major issue which is not adequately addressed by the Department’s proposed regulations is the issue of “robo-voting,” a practice which has long allowed for the proxy advisory firm duopoly to pursue a personal agenda with limited scrutiny. Under this practice, some fund managers have simply accepted the voting recommendations of proxy advisors automatically, blindly moving forward on proxy firms’ recommendations without consideration of their overall fiduciary impact on the fund. The growth of robo-voting in the industry is understandable given the cost savings that pension plans can accrue as a result, but the desire to implement sound cost-saving measures cannot be upheld if proxy voting is relied upon to determine the course of action on contested issues. In these instances, fiduciaries should end their reliance on proxy voting in order to ensure that all final decisions are truly in the best interest of beneficiaries.
While more work is needed, it appears that the Department of Labor is finally in a position to implement much-needed reforms to a pension system that has for too long neglected the underlying financial security of its beneficiaries. Given the widespread problem of unfunded pension liabilities, the economic fallout from the pandemic, and increased politicization of pension investments, a re-commitment to fiduciary responsibility is a welcome sight. The retirees of this nation deserve as much.
This op-ed originally appeared in TownHall and affiliated outlets on September 15, 2020.
For pension beneficiaries across the country, the recent proposals by the Department of Labor are a positive step towards ensuring that accountability and fiscal responsibility take precedence over any other considerations.
Two new rules are currently being weighed. The first, for which the department is currently in the process of sorting through public comment, concerns the role of environmental, social, and governance (ESG) investments in ERISA-backed pension funds. The second takes aim at “proxy voting,” examining the outsized roles that proxy advisory firms have in investment decisions and examining whether their recommendations are always economically beneficial to pensioners.
These rules rightly reaffirm a fiduciary’s obligation to prioritize financial returns over alternative investment strategies in the management of ERISA-managed pension fund assets. As a former Treasurer of the State of Ohio and Mayor of Cincinnati, I have had firsthand experience overseeing a pension system and I take seriously the responsibility of a fund’s management team to provide financial security to the men and women who rely on their pension or 401K for a secure retirement.
Last November, SEC Chairman Jay Clayton remarked that a chief complaint “was the concern that [shareholders’] financial investments—including their retirement funds—were being steered by third parties to promote individual agendas, rather than to further their primary goals of being able to have enough money to lessen the fear of ‘running out’ in retirement or to leave money to their children or grandchildren.” In putting forth these two regulations, the Department of Labor is taking clear steps to also address this concern.
In the case of the first rule, fiduciary duty obliges pension fund managers to only consider ESG investments when they add value to a fund. When such investments will not improve the financial performance of the fund, or the decision to invest in them is based on political motives, they should be forgone. According to a study by the Pacific Research Institute, ESG funds were “43.9 percent smaller compared to an investment in a broader, S&P 500 index fund,” after 10 years. As ESG strategies become more fashionable, there is cause for concern that financial returns will be replaced by politics at the top of asset managers’ considerations.
The question of pensioner’s financial interests is further addressed in the recent proposed rule by the DOL. The proxy system has long been taken advantage of by outside actors without fiduciary responsibilities, preventing sound advice from reaching the nation’s pension and investment funds and retail shareholders. There is currently a duopoly in the system, in which two companies, Institutional Shareholder Services (ISS) and Glass Lewis, control the overwhelming majority of the proxy advisory market. These firms are not obligated to adhere to fiduciary duty like ERISA plan managers, and abdicating authority over proxy voting in such a way violates fund managers obligation to plan participants.
The proposed rule is a good step in the right direction by the Department of Labor, but more should be done around proxy advisors’ role in a process called automatic or robo-voting. Some fund managers allow proxy advisors to vote their proxies, often without the ability or impulse to consider the recommendation. In other words, fund managers blindly vote the recommendation without consideration of the impact to the fun. Such a practice disenfranchises pensioners and should be curbed. The Securities and Exchange Commission issued guidance on this front to asset managers in June of this year, and DOL should adopt this guidance as a part of the rule.
Pensions should be, and once were, apolitical entities. At the Institute for Pension Fund Integrity, where I sit on the board, we are singularly focused on that objective—getting politics out of pensions and protecting the financial security of America’s workforce. I applaud the Department of Labor’s efforts to further codify the most basic tenet of fiduciary duty: investment decisions should be governed by considering risk and returns, not the political agenda of a third party. As I have previously noted, “public pension funds are already underfunded and underperforming.” Let us not exacerbate the issue by appeasing the special interest groups to the detriment of private sector labor workers and retirees across the country.
Pension fund managers need to be reminded that they are charged with acting on behalf of individuals who sacrificed a portion of their wages every payday with the expectation that their money would be handled with care, not used to promote the interests of political actors. The proposed rule changes are an important step towards fulfilling these obligations.
Ken Blackwell served as Treasurer of State of Ohio and as a member of the U.S. Department of Labor Advisory Council on Employee Welfare and Pension Benefit Plans. He is a trustee of the Institute for Pension Fund Integrity.
Rhode Island Treasurer Seth Magaziner announced that the state plans to stop buying future funds from private-equity firm Leonard Green in the face of controversy over their control of Prospect Medical, a hospital system with facilities in Rhode Island, Southern California, Pennsylvania, Connecticut, and New Jersey. Magaziner controls the $8 billion fund, and cited Prospect Medicals track record of siphoning millions of dollars in excessive fees and mortgage payments from patients and employees in his decision to stop future purchases
“[Leonard Green] has extracted value from Prospect Medical hospitals, including St. Joseph’s Hospital and Our Lady of Fatima Hospital in Rhode Island, at the expense of patients and employees. These actions have left already-vulnerable communities with fewer healthcare resources,” Magaziner wrote in a public letter to Leonard Green. “Under my administration, the Rhode Island pension system has adopted new standards to avoid investment risks associated with socially destructive business practices,” Mr. Magaziner added, concluding that Rhode Island would no longer purchase funds from Leonard Green.
Prospect Medical was bought by Leonard Green in a $363 million deal in 2010. Rhode Island first invested in Leonard Green’s fund, Green Equity Investors V, in 2007. Since that purchase, the Green Equity fund has produced a return of 18.39%, or 2.33 times net return on investment multiple.
Leonard Green has come under fire recently from all sides, with activists and even Congress joining in. The mismanagement of Prospect Medical may be inappropriate, and it’s fair for individuals and lawmakers to call foul where they see it. While this move from Rhode Island may therefore be cheered on by some, it is important to remember that the Treasurer and state of Rhode Island have a fiduciary responsibility to public employees paying into the state’s pension.
Adopting “standards to avoid investment risks associated with socially destructive business practices” may be good politics, but it’s not clear that this is good for retirees who deserve to receive their promised benefits. Refusing to purchase funds from one firm limits the ability of the state of Rhode Island to maximize their overall pension returns by excluding one possible area of investment. This move by Magaziner brings into question the nature of his role as a fiduciary, and deserves more scrutiny.
It is no secret that the U.S. and China have recently experienced diplomatic tensions, but we now see its effects bleeding into the financial sector. The Department of Labor (DOL) recently announced a rule change to the Employee Retirement Income Security Act of 1974 (ERISA) dictating that pensions should not be used to solve the world’s problems through Environmental, Social, and Corporate Governance (ESG) investing. Similarly, Labor Secretary Scalia ordered the Thrift Savings Plan (TSP) to not include Chinese companies in its investment options within the I Fund. It is important to note that the I Fund is an international stock index that tracks the investment performance of Morgan Stanley Capital International: Europe, Australasia, and the Far East Index, also known as the MSCI EAFE.
In his letter, Secretary Scalia states that changing the tracking index from the MSCI EAFE to MSCI All Country World ex USA Index would place billions of dollars “in risky companies that pose a risk to U.S. national security.” In the same fashion, Chairman Clayton of the U.S. Securities and Exchange Commission (SEC) warned in April that Chinese disclosures are sparse and that investors should be cautious when considering Chinese equities.
Although the Employee Thrift Advisory Council has labeled discussions on the I Fund as partisan, members of Congress from both sides of the aisle have argued that investing in China would be a danger to U.S. national security. They note:
“The constituent firms of MSCI ACWU ex-US IMI include military contractors to the People’s Liberation Army, like the Aviation Industry Corporation of China and China Unicom, which supply military aircraft and telecommunications support to militarized artificial islands in the South China Sea. It also includes firms like Hangzhou Hikvision Digital Technology, which was recently added to the U.S. Department of Commerce’s Entity List and produces surveillance equipment the Chinese government currently uses to oppress and detain approximately one million Uighur Muslims and other religious minorities, as well as ZTE Corporation, which was fined last year for violating U.S. sanctions law for business activity with Iran and North Korea and which Congress has enacted a law to prohibit the U.S. federal government from procuring.”
Along with the White House’s decision to end a new China-inclusive benchmark, the Federal Retirement Thrift Investment Board (FRTIB) voted to delay implementing a new index for the I Fund which would give opportunity for foreign investment. The White House is currently in the process of nominating new members to the Thrift Board.
A new Trump-nominated majority on the Thrift Board may be indicative of future U.S. economic policy towards China. These recent moves on the hands of both Democrats and Republicans raise several questions: Should our pension system should be treated as a chess piece in U.S. foreign policy? Is our return on investment greater than threats posed by foreign adversaries? The Institute for Pension Fund Integrity (IPFI) believes that these sorts of decisions, whether or not to keep China out of TSP’s I Funds, must be guided by data-based conclusions around the long term growth of our pension funds.
The Pennsylvania Public School Employees’ Retirement System (PSERS) moved to reallocate $5 billion in assets, moving $2 billion from risky investments made through Bridgewater and BlackRock to more secure stocks, bonds, commodities, and infrastructure investments. This move impacts 8% of the entire funds holdings and will take effect October 1st.
Pennsylvania State Treasurer Joe Torsella praised the decision and criticized the investment firms. “It’s time that more pension funds wake up to the fact that Wall Street has, in many cases, sold them something close to modern-day snake oil. What so many active Wall Street managers have sold our nation’s pension funds on is the idea that—for a hefty set of fees—they can help pensions experience almost all of the gains and none of the losses. We need to recognize that for the fantasy it is,” he said in a statement.
“In so many cases, what ends up happening is that the Wall Street managers do worse than fail to deliver value, they end up delivering an expensive failure,” Torsella said. “This move by PSERS is worthy of substantial praise, and shows that Pennsylvania doesn’t have to be at the mercy of expensive and under-performing Wall Street managers.”
This move comes on the heels of the COVID-19 economic downturn that saw PSERS lose 8.17%, or 4.7 billion, in total assets. This loss outperformed comparative pension funds significantly. On the flip side, the overall rate of return on the risk parity investments only surpassed 4% over the last few years while losing 9% in just the first quarter of 2020. Pennsylvania, along with California, Texas, New Jersey, and Illinois, represent over half of the U.S.’s entire pension fund liability at a moment when pension liabilities are at an all time high, highlighting how important this move is to PSERS overall finances.
“We got as wet as everyone else,” Torsella said, referring to the pandemic and ensuing economic downturn. “And we missed a lot of years that would have had returns. This absolutely, categorically should make us mad,” he concluded.
Although this case is only one example, this move represents a smart shift that will help support and make pensions more sturdy for years and decades to come. As public pensions often are incentivized to make riskier investments to close the gap between their assets and liabilities and make investments look good on paper, PSERS move is a smart decision that will help secure public school teachers retirement funds. Pension funds should not be making riskier decisions for short term bookkeeping over the long term responsibility and fiduciary duty to retirees.
With efforts underway by the Department of Labor and other government agencies to address Environmental, Social, and Governance (ESG) investing in pension plans and other investment products, the topic has garnered significant attention over the past several months. Given its prominence, it comes as a surprise that this investment strategy remains ambiguous and lacks a standardized definition.
In a newly released issue brief, IPFI examines the history behind ESG investment strategies, the variations in how ESG is defined between different firms, and how the financial industry can come together to establish a uniform set of standards.
As noted in the issue brief, “Since the acronym’s first use in 2005, ESG has become a widespread term in the finance world. Although there are over $20 trillion in ESG assets under management, it lacks a standardized definition under which all firms can unite and under which regulators can address legitimate concerns. Most definitions, however, use certain strategies to define ESG on an individual level. Some firms make more of an effort than others to define ESG and demonstrate their commitment to ESG investing.”
This analysis comes at a prescient time, in which the benefits of investment strategies that prioritize alternative goals to financial return are being debated across government, the financial sector, and, most importantly from our perspective, pensions. IPFI has long pushed for the principle that while individual investors should be free to choose whatever strategy best meets their needs, the fiduciary duty which is the cornerstone of pension fund management must always prioritize maximized returns with reasonable risk above any other political or social considerations.
According to IPFI President Christopher Burnham, “ESG investments should be made when they add value to a fund. When such investments will not improve the financial performance of the fund, or the decision to invest in them is based on political motives, they should be forgone.” The first step toward ensuring this principle is to set a common understanding of how ESG standards are defined and put into practice.
This op-ed originally appeared in the Washington Examiner on August 14, 2020.
Over the past decade, a strategy known as Environmental, Social, and Governance, or “ESG investing,” has been pushed to the forefront as a tool by public officials and investment managers to promote environmental or social causes through pension fund investments. This requires special attention to making sure pension fund managers are bound by their fiduciary obligation to their beneficiaries and not acting from political motives.
Prioritizing issues other than pure financial returns may be an acceptable strategy for individuals managing their own money or for corporate officers contemplating the future of their company. But for fiduciaries, prioritizing any interest other than maximizing returns is a dereliction of duty.
The Department of Labor has released a proposed rule on tax-qualified retirement plans governed by ERISA in order to determine the extent to which ESG factor into investment decisions. The question at hand is whether plan managers, bound by fiduciary duty to their beneficiaries, are sacrificing investment returns or increasing risks to meet ESG goals unrelated to participants’ bottom-line financial interests.
As a former state treasurer of Connecticut, I have personally overseen the management of a public pension system. It is not possible to fully protect the financial security of a plan’s beneficiaries if those charged with managing a pension fund are trying to build an investment strategy around non-financial considerations. Decisions on new investment strategies, whether they are driven by political reasons or simply as an attempt to chart a new path forward, must be made in the boardroom.
There are many laudable initiatives that individuals, religious endowments, schools, and other private entities may wish to consider. However, it is never correct to impose personal political motives on pension funds. This principle is even more prevalent given the massive financial ramifications that the economic fallout of the COVID-19 pandemic has had on pensions.
The Department of Labor should be applauded for taking this necessary step toward clarifying and correcting guidance on the fiduciary obligations of pension fund managers as far as ESG investing is concerned. As Labor Secretary Eugene Scalia noted, this rule aims to “remind plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”
The proposal falls short, however, of fully protecting America’s pension beneficiaries from unsound investment practices. Public pensions are still vulnerable to ESG strategies. The trend towards “impact investing” has permeated the proxy voting industry, where two firms effectively control significant numbers of shareholder votes in thousands of publicly traded companies. These votes could become an important weapon against ESG policy that does not serve the shareholders, but under the current rules they mostly serve an ideological agenda separate from the interests of retirees and public employees.
SEC commissioner Daniel M. Gallagher acknowledged the problems with the proxy voting industry as far back as 2013, noting that the current system is not built to increase company value or generally operate on behalf of shareholders, but rather to serve the interests of the proxy voting companies themselves. The proxy voting issue is not one that the rule change at hand would address. While the proposal is a step in the right direction, it is important to think not only about how pension money is invested, but also how the voice that comes with a stake in any given company is used. Until we reform the proxy voting industry, that voice will be vulnerable to the whims of third parties.
The Department of Labor is currently considering the proposed rule. It is my hope that leaders in business, finance, and public policy will continue to voice their support for this initiative. Beyond the scope of this proposed rule, ERISA must be modernized to ensure that fund’s investment strategies remain focused on fiduciary duty and the best risk-adjusted return. The retirees of this nation deserve as much.
Christopher Burnham is founder and president of the Institute for Pension Fund Integrity. He previously served as Connecticut state treasurer, chief financial officer of the U.S. Department of State, and under-secretary-general of the United Nations.
With the comment period recently closed on the newly proposed Department of Labor rule on ESG investments in ERISA-backed pension funds, attention now turns to the evaluation process. Over the next several months, regulators will assess the thousands of comments submitted by organizations and individuals across the country. Attention has also been growing on this issue on Capitol Hill, where both Republicans and Democrats are looking to place their stamp on the eventual final rule.
One prominent individual who has weighed in on this proposal is Alicia Munnell, who served as the Assistant Secretary of the Treasury under President Clinton and currently serves as the director of the Center for Retirement Research at Boston College. In a recent op-ed in MarketWatch, Dr. Munnell voices her support for the rule, noting the downsides of ESG prioritization and need to maintain fiduciary responsibility in pension fund investment.
Munnell notes that:
“Pension fund investing is not the place to solve the ills of the world. ESG investing — which involves environmental, social, and governance factors — is a diversion that enriches financial managers, reduces participants’ retirement investment returns, and makes people think they are addressing a problem without doing anything substantial. No one can seriously think that stock selection is going to fix climate change.”
Noting the history of the Department of Labor’s actions to clarify ESG investment guidelines, she applauds the current proposal as a needed next step. Perhaps most importantly, she also mentions the need to expand the guidelines set forth by the Department for public pension plans outside the jurisdiction of ERISA:
“While the proposed rule is aimed at private pension plans, state and local plans, to date, have accounted for the bulk of the social investing activity. Screening pension fund investments has not been an effective means of achieving social goals, and it distracts plan sponsors from their primary purpose — providing retirement security for their employees.”
As these debates go forward, the Institute for Pension Fund Integrity will continue to press regulators and lawmakers on the need to keep politics out of pension investment. This proposed rule is a key step toward ensuring transparency and accountability in ERISA-backed pension funds, and it is our hope that Dr. Munnell’s comments are given the consideration that they deserve.