After years of criticism, the California Public Employees’ Retirement System made headlines in December when its board voted to lower the expected rate of return on investments from 7.5 percent to 7 percent over the next three years. The move was billed by board members as a responsible reaction to years of unrealistic projections followed by unimpressive returns.

But on another front, CalPERS continues to defy critics who say the giant pension agency should focus like a laser on achieving strong returns instead of using investments to make political statements.

Early last year, the CalPERS board rejected a staff recommendation that it resume investing in tobacco stocks after a 16-year moratorium. The board not only rejected that advice, in December, it broadened the ban to include more companies with ties to the tobacco industry.

Now a freshman lawmaker from Silicon Valley – California’s first Indian-American state lawmaker – is pushing for a bill with the potential to cause billions of dollars in investment losses for CalPERS.

Assemblyman Ash Kalra, D-San Jose, launched his legislative career by introducing Assembly Bill 20, which would require CalPERS and the California State Teachers’ Retirement System to sell all their investments in companies involved in building the disputed Dakota Access pipeline. For CalPERS, this divestment would start with the forced sale of about 1 million shares of Energy Transfer Partners, the pipeline’s primary builder, a Dallas-based Fortune 500 firm.

Divestment would not prevent Dakota pipeline’s construction

The Army Corps of Engineers has given its final approval to the project. As such, critics say Kalra’s bill – if enacted – would amount to a costly gesture of disapproval that achieved nothing beyond signaling the state of California’s allegiance with the Standing Rock Sioux tribe and environmentalists who have protested the pipeline plan.

CalPERS staff strongly opposed Kalra’s proposal, sayings such a forced divestment would yield losses of at least $4 billion. CalSTRS has no estimate of the cost yet.

The toll is so heavy on CalPERS because the ban would be so broad, applying not just to energy firms and their contractors but to the banks that financed the 1,100-mile project. Many of these banks have otherwise excellent relationships with California businesses and government agencies.

Despite staff concerns, last week, the CalPERS board took its first step toward an activist position on the project. It called on Energy Transfer Partners to choose a new route away from Indian land, echoing the concerns’ offered by opponents. A CalPERS statement warned that without a route change, it was possible that there could be “escalation of conflict and unrest as well as possible contamination of the water supply.” This, CalPERS said, could lead to a costly public backlash against the banks.

Kalra praised CalPERS’ statement but said he would continue pushing his bill. He depicted the state government as a “significant investor in the Dakota Access Pipeline” that should take steps to “respect the sovereign rights of the Standing Rock Sioux tribe and raise awareness on the environmental impacts” the project would have on tribe lands.

Trump’s OK of Dakota project could affect state Democrats’ view

CalPERS, which has a portfolio last officially estimated at $309 billion, prefers lobbying the companies it invests in to change their policies rather than make divestment threats. Some coverage of the statement from last week suggested this was just such a measured step, not a first sign of weakened opposition to Kalra’s bill.

But how CalPERS deals with Kalra’s legislation could become caught up in the rhetorical war between state leaders and the Trump administration, which cleared the way for a project blocked by the Obama soon after Donald Trump was sworn in Jan. 20.

State leaders’ eagerness to cast themselves as enemies of Trump has been the target of mockery by Sacramento Bee columnist Dan Walters, who questions how this will help California deal with its many problems.

But Trump’s hardline position on immigration and embrace of fossil fuels continues to infuriate state Democrats. In a state in which Trump lost in November by more than 4.2 million votes, the downside to opposing him at every turn seems minimal.

Advocates for these types of investments often argue that it’s good business to focus more on “socially responsible” companies or to divest from others, but an ongoing debate at CalPERS suggests that isn’t always necessarily true. For months, CalPERS’ top investment officials have been setting the stage for a vote in the investment committee on Monday. They proposed ending CalPERS’ 16-year policy of divesting from tobacco stocks – a decision that analysts say has cost the underfunded system as much as $3 billion over the years as tobacco stocks have soared.

But in a 9-3 vote, the investment committee decided not only to maintain its current ban on tobacco investments, but to expand it further. As the Sacramento Bee reported, the committee’s vote is final because it includes all members of the governing board.

CalPERS depicted its original divestment decision as a financial rather than social one and committee members made the same point on Monday.

In 2000, tobacco companies were facing lawsuits. But as the Wall Street Journal reported in April, “The MSCI World Tobacco index returned more than 309 percent in total returns over the decade from 2005 to 2015, compared with 172 percent total returns for the broader MSCI World consumer staples index, according to FactSet.” And on Monday the committee also argued that tobacco investments still have long-term risks, despite the recent tobacco-stock performance.

Yet despite the financial justifications, there’s always been a strong social element about the divestment strategy. The latest remarks from top state officials and editorial boards makes clear that the tobacco-divestment issue is a social matter as much as a financial-performance-related one.

“Not only is this a predatory out-of-state industry whose child-baiting marketing tactics are disgraceful, but its product is responsible for more than $13 billion in annual health care costs,” said Lt. Gov. Gavin Newsom, in a statement after CalPERS announced a reconsideration of its policy. “Taxpayers will be forced to pick up part of that tab, including CalPERS’ own retiree health benefits. We cannot sell our soul for profit. Investing in death for a return is inexcusable.”

Treasurer John Chiang argued that CalPERS never totally divested from tobacco stocks, anyway. “It is time to end the charade that somehow CalPERS stopped investing in tobacco companies more than a decade ago. Our external managers currently have plowed a sizable $547 million in tobacco-related funds, according to the latest CalPERS staff estimates,” he said. Chiang called for CalPERS to divest from its indirect tobacco-related investments, too.

And the Los Angeles Times editorial board on Monday made clear just how much this fight is about social issues rather than financial ones: “Divestment is a difficult call for governmental pension funds. They have a clear fiduciary duty to maximize the returns on their members’ investments. But in our view, these public agencies also have a responsibility not to support evil, corrupt or destructive forces whose ill effects far outweigh any good they may do. That can take the form of products, like tobacco and firearms, or regimes.”

Those who testified at the committee also made similar social-oriented points. They won the day, as the committee voted to divest of its remaining $547 million in tobacco-related investments – ones invested by outside managers.

Not surprisingly, it’s been CalPERS’ investment staff that has focused more on financial returns. The committee’s investment agenda for its Monday meeting detailed three options. It could have removed all tobacco-investment restrictions. It could have expanded the divestment beyond the current restrictions – i.e., also restrict tobacco investments from externally managed portfolios. Or it could have left the current approach of divestment from internally managed portfolios. It chose option two.

“Divestment, as an active investment decision, represents a form of active risk taking that must be considered, first and foremost, within the context of the CalPERS Board of Administration’s fiduciary duty,” according to the staff report’s executive summary. “As a mature, cash-flow negative system, CalPERS is obligated to seek out and implement the portfolio construction methods that best serve our mission – the sustainable delivery of promised benefits. In efficient markets, however, limiting the opportunity set for investments has generally been shown to have a detrimental effect on performance, and CalPERS’ experience with its tobacco investment restrictions over the past 15 years has been no exception to the general rule.”

As CalPERS investment officials explained in public presentations to its board last month, as a public pension fund managing the assets of the state’s government employees, the agency’s prime responsibility to assure that it makes the best-possible investments to assure that it fulfills its pension promises to current and future retirees.

It’s worth reviewing the basics of how these pension funds operate. Typically in the private sector, employees receive defined-contribution plans, such as 401(k)s. The employee has some money deducted from the paycheck and invested in mutual funds. Sometimes the employer also contributes a portion. If the investments do well, the employee retires with more money. If they don’t the employee has to make do with less.

By contrast, government employees at the state and municipal level typically receive a defined-benefit plan, in which the government agency promises a set pension benefit based on a formula. The government employer pays a large share, with the employee also typically having money deducted to go toward the benefit. The pension fund invests those dollars. No matter what, the employee still receives the promised amount. If investments go sour, the size of the unfunded liabilities, or debt, grows and taxpayers are required to pick up the slack.

Given the potential impact on government budgets, these investment issues take on a highly political tone. CalPERS’ investment returns have been dismal in the past year, which creates pressure for reducing pension benefits or hiking investment returns. With the former a nonstarter in the current political environment, the latter becomes the subject of intense scrutiny. That’s what we’re seeing with the current debate in the CalPERS investment committee.

CalPERS staff had been leading the charge to a) further lower expected rates of return based on those disappointing recent results and predictions of a continued tough road ahead; and b) try to boost return rates by allowing staff to reinvest in soaring tobacco stocks. But the state Legislature apparently hasn’t gotten this message.

New legislation would call for CalPERS and the California State Teachers’ Retirement System to divest any holdings from a North Dakota oil pipeline that has been the source of protest by Native Americans and environmental activists. Certainly, any such divestments would mean little in an investment portfolio (in both funds) valued at $450 billion. But the Legislature is showing its desire to continue a push for more investment based on social concerns rather than strictly financial ones.

That’s always a risk in publicly controlled systems. That’s a tension that will continue, although Monday’s vote shows that CalPERS isn’t likely to soon abandon its current approach even in the face of mounting fiscal problems.

Steven Greenhut is Western region director for the R Street Institute. He is based in Sacramento. Write to him at sgreenhut@rstreet.org.

In 2010, for example, the California Public Employees’ Retirement System faced criticism for “thumbing its nose” at a state law written by Sen. Joel Anderson, R-El Cajon, intended to force CalPERS to divest in firms doing business with Iran.

Calpensions.com explained this defiance at the time:

Consultants have estimated that boycotts of corporate stocks to end racial apartheid in South Africa and reform the tobacco industry cost CalPERS and CalSTRS billions of dollars, with no hard evidence of any results.

Now when pressured to sell or “divest” investments, a new policy adopted by the California Public Employees Retirement System last year gives priority to the “fiduciary duty” to manage money for the benefit of retirees.

Pressure to sell or “divest” investments for other reasons is met by “constructive engagement” with targeted corporations, if dumping the holdings and barring future purchases are not in the best financial interest of members of the retirement system.

CalSTRS more pliant than CalPERS

Now CalPERS and CalSTRS are facing new pressure to take stands on issues. Senate President Pro Tem Kevin de Leon, D-Los Angeles, is pushing a bill that could force the giant pension funds to begin scrapping their coal investments.

CalSTRS is taking a less pugnacious stand than CalPERS did over Anderson’s law. According to Capitol Weekly, “The CalSTRS board directed its staff and consultants last week to evaluate the risk of investments in thermal coal companies, jumping ahead of pending legislation that would require CalSTRS and CalPERS to divest thermal coal holdings.”

But CalSTRS is in a bind over demands from the California Federation of Teachers that it end its investments in gun makers. More from Capitol Weekly:

Last week the California Federation of Teachers led a large and emotional protest of the CalSTRS failure to divest holdings in the manufacturer of an assault rifle used to kill 20 children and six educators at a Connecticut elementary school in December 2012.

“CalSTRS has hundreds of billions in investments,” Jeff Freitas, CFT secretary-treasurer, told the board. “Even if we take a loss in removing this portfolio from our retirement fund, it is the right thing to do.”

CalSTRS quickly sold $3 million in stock of two other gun manufacturers. But its holding in the assault rifle manufacturer, estimated at $8.8 million two years ago, is part of a $375 million investment in a long-term Cerberus private equity fund.

If it broke the Cerberus contract, CalSTRS could suffer a major financial loss and, some fear, perhaps the ability to contract in the future with top private equity funds, which are expected to provide above-market returns.

Investment czar: Divesting doesn’t cause change

While CalSTRS seems more willing than CalPERS to change its investments to take political stands, Chris Ailman, its top investment advisor, isn’t convinced this approach makes sense. He made his views known at the last CalSTRS board meeting:

“I’ve been involved in five divestments for our fund,” Ailman told the CalSTRS board last week. “All five of them we’ve lost money, and all five of them have not brought about social change.”

This observation about divestment being symbolic, not consequential, appears particularly on point with gun manufacturers, given constitutionally guaranteed rights of gun ownership.

But the state Senate has had only Darrell Steinberg, D-Sacramento, as president from 2008 until a few weeks ago. Steinberg left to media accolades this fall. Note this long Q&A in which the Bee reporter’s framing is consistently favorable to the former teacher.

Yet his successor, Sen. Kevin de Leon, D-Los Angeles, is off to the roughest start of any Californian assuming a high-profile office since Lane Kiffin took over as coach of the Oakland Raiders.

De Leon has gotten skeptical to scathing media responses for a relatively long list of things in a relatively short time.

More perceived screw-ups since Walters tore him up

On Dec. 4, Sacramento Bee columnist Dan Walters blasted him for a “series of blunders.”

Walters ripped de Leon for verbal gaffes that proved hugely damaging to a Central Valley Assembly Democratic hopeful; for a self-important, pompous “inaugural” ceremony in Los Angeles; and for gutting many of the Senate’s most experienced policy analysts because of murky budget problems. Insiders said if the Senate really were hurting, the logical thing to do was lay off the political apparatchiks on all Senate staffs, not the people with the institutional memory.

The knocks have kept coming since Dec. 4.

De Leon’s announcement last week that he would pressure CalPERS and CalSTRS to disinvest from coal-affiliated companies — but not those in oil or natural gas — struck a chord in the wrong way with just about everyone.

I talked to one insider who said there was disbelief among lawmakers that 1) this symbolic, hollow gesture was highlighted as an early priority of de Leon’s and 2) that de Leon wouldn’t realize this would seem insubstantial and not worthy of his time. Another Sacramento watcher told me he couldn’t believe de Leon would focus on this trivia instead of grabbing a chance to be enviros’ hero by talking up a fracking ban. New York state’s passage of such a ban last week shows how much it’s where greens want to go.

Oversight office abruptly scrapped

Then de Leon was pulverized last week by editorials in both the Bay Area Newspaper Group and its sister Los Angeles News Group over other actions as well. This is from the Vallejo Times-Herald’s version:

“De León has eliminated a team of Senate aides dedicated to evaluating state government institutions and programs. He declined to renew the Senate’s Office of Oversight and Outcomes, established in 2008 by then-Senate President Darrell Steinberg with a goal “to ensure taxpayer dollars are being spent wisely and productively.

“The four-person staff’s combined salaries of about $379,000 seemed a small price for the good it did.

“Among the reports the office produced just last year were ones on the misuse of student meal funds by school districts, including $158 million in misappropriations and unallowable charges by Los Angeles Unified; about how the state’s system for overseeing substance-abuse counselors failed to flag sex offenders; and assigning blame for problems with the $373 million state payroll system. Among earlier reports was one looking at 10 tax breaks that, over a decade, cost state coffers $6.3 billion more than anticipated.”

Accused of wide range of political sins

What’s interesting is that these criticisms of de Leon don’t just focus on money-grubbing or another particular sin that politicians sometime specialize in. Implicitly, they make quite a sweeping case.

In possibly costing an Assembly candidate a chance at victory, de Leon is accused of poor political acumen.

In staging a showy unofficial “inaugural,” de Leon is accused of grandiosity.

In his Senate shakeups, de Leon is accused in one of a power grab and, in the other, of showing ignorance of the importance of a new but respected Sacramento institution.

In thinking that going after coal while ignoring fracking would make him look good, de Leon is accused of — to be blunt — stupidity.

The Sacramento version of the Stockholm syndrome

That is a pretty sweeping bill of particulars. What’s going on here?

The most obvious problem is that de Leon is politically tone-deaf in a way that’s striking for someone who’s made such a rapid ascent.

But the less obvious problem is that a lot of times it’s not fun to cover politics. It feels sleazy, disheartening, transactional, petty and repetitive. Steinberg made it feel more principled and sincerely, earnestly progressive.

That mattered to a bigger chunk of the Sacramento media-political establishment than people far from the state Capitol might imagine. This establishment didn’t miss Steinberg’s, er, colorful predecessor Don Perata at all.

The scene brought to mind Tom Wolfe’s essay “Mau Mauing the Flak Catchers,” which was published all the way back in 1970, when young Jerry Brown was a member of the Los Angeles Community College Board of Trustees.

Wolfe’s non-fiction essay was set at San Francisco’s Office of Economic Activity, where government functionaries – flak catchers – kowtowed to community activist types issuing one demand or another.

Fast forward to the recent meet-up of the University of California’s Board of Regents at the Sacramento Convention Center.

Outside the meeting room, a few dozen student activists from a group that calls itself Fossil Free UC noisily demanded that the regents – latter day flak catchers – divest the system’s $7.7 billion general endowment fund of fossil fuel investments.

The regents responded to being mau maued by Fossil Free UC’s student activists by expressing empathy with the group’s cause, which regent Norman Pattiz declared “valid.”

Regent Jerry Brown, now the governor of course, went so far as to say he was amendable to “some targeted disinvestment” in fossil fuels, with coal being at the top of the hit list.

Indeed, Brown and his fellow regents tasked managers of the UC endowment fund to prepare an analysis by July of the financial consequences of dumping the fund’s coal equities. Depending on the findings, the regents could act at their September board meeting in San Francisco.

‘Excited’

Fossil Free UC’s organizer, UC Berkeley student activist Ophir Bruck, said his group is “excited about” the prospect that the regents will vote to disinvest in coal. However, he added, the ultimate goal is complete disinvestment in fossil fuels. Or, as the group’s website states, “to remove the fossil fuel industry’s social license to operate.”

This is a common meme among disinvestment groups. For example, urges We Are Power Shift, a climate-change group, “Divestment is an opportunity to expose the real financial liability of investing in a company, country, or industry, and to remove the financial support that enables that them to operate according to business as usual.”

However, the global reality is that fossil fuels are as vital as ever. China and Russia just signed a $400 billion natural gas deal. And since 2010 China, not the Unites States, has been the world’s largest manufacturing economy, a position it keeps expanding. Anything done by the UC Regents might only free resources to be used by China.

Regents

It remains to be seen if the UC regents bow to Fossil Free UC’s demands. According to UC reports, the school’s general endowment has holdings in 67 of the 2,000 largest fossil-fuel reserve firms. If the endowment sold off all those holdings, it almost certainly would incur substantial losses.

As UC regents consider whether to disinvest in fossil fuels, they should consider the last time they made a politically-driven investment decision. It was in 2001, when they voted to sell all of UC’s tobacco-related holdings. As a result of the regents’ decision, UC lost a whopping $500 million in potential gains between 2001 and 2012.

UC can hardly afford to repeat that expensive mistake when it comes to fossil fuels. But if that does happen, the ultimate victims could be the students, who might face higher tuition or, for poor students, a reduction in scholarships.

Some states’ main retirement systems may be in worse shape than the California Public Employees’ Retirement System or the California State Teachers’ Retirement System. But at the local level, there are more government bodies facing ruin in the Golden State than anywhere in the U.S.

And the political influence of the pension status quo-ists is stunning. Gov. Jerry Brown may tout himself as a pension reformer, but the union allies he put in charge of the state Public Employment Relations Board are so militant that they attempted to block a city of San Diego pension reform measure before it even got on the ballot. There are many examples of such reform monkey-wrenching around the Golden State.

Fossil-fuel ‘divestment’ comes with a price

This doesn’t change the basic fact that with all the strain that underfunded pensions are causing cities, counties and school districts, it is more crucial than ever that pension funds focus like a laser on generating healthy returns.

But this is California. Smart, responsible governance is for others, not for us.

And so we see the state’s emergence as Ground Zero for a movement dedicated to pension fund divestment in a consistently lucrative sector of the economy.

The Contra Costa Times has the details:

“In the 1980s, hundreds of American cities, states and universities sold their investments in South African companies as part of a protest against that country’s former apartheid government.

“Now, environmental groups are trying to duplicate that effort, but with global warming polluters in the role of villain. And, just as with South African divestment a generation ago, the Bay Area is at the head of the parade again, prompting cheers from environmentalists and jeers from skeptics who say the whole effort amounts to little more than empty symbolism.

“On Tuesday night, the Santa Clara Valley Water District, a government agency based in San Jose, is scheduled to vote to drop its investments in fossil fuel companies. If the measure passes, as expected, the water district will become the first Silicon Valley governmental agency to join the movement. It also will join Berkeley, San Francisco and Richmond — along with Seattle, Portland and other cities — among a small, but growing group of local governments that have taken similar stands in recent months.”

Bailing on oil, gas firms just as they boom

But what makes this especially ludicrous is that the world is going in the opposite direction — toward expanded use of natural gas and oil — despite fears about climate change. That’s thanks to the stunning technological breakthroughs that have made energy exploration much more efficient. Don’t take that from me. Take that from The New York Times, which devoted a special section to the new energy world on Oct. 26, 2011. Its key takeaway:

“From the high Arctic waters north of Norway to a shale field in Argentine Patagonia, from the oil sands of western Canada to deepwater oil prospects off the shores of Angola, giant new oil and gas fields are being mined, steamed and drilled with new technologies. Put together, these fuels should bring hundreds of billions of barrels of recoverable reserves to market in coming decades and shift geopolitical and economic calculations around the world.” …

“’Use whatever hackneyed phrase you want, like tectonic shift or game-changer,’” Edward L. Morse, global head of commodity research at Citigroup, told the Times. ‘These sources will dramatically change the energy supply outlook, and there is little debate about that.’”

So environmental zealots are trying to force pension funds to abandon fossil-fuel companies just as they approach a bonanza, courtesy of fracking, horizontal drilling and other newly productive exploration strategies. This is crazy.

Most of the world understands that this new era is coming. This spring, I did a 13-part blog series on all the different nations that have jumped on the fracking phenomenon — Germany, China, Russia, Saudi Arabia, Brazil, Canada, Argentina, Mexico, South Africa, Poland, Algeria, Indonesia and Great Britain.

Energy giants won’t suffer — just Californians

But California greens would rather just pretend none of this is happening. And so we’ll see pressure on pension funds to divest holdings in fossil-fuel companies even as they solidify their standing as one of the safest, smartest investments for decades to come. Even as they occasion paragraphs like the following from The Economist:

“Exxon Mobil, with a market capitalisation of $417 billion, vies with Apple as the world’s most valuable listed company. Royal Dutch Shell is the most valuable firm on the London Stock Exchange. Chevron employs 62,000 people; Total operates in more than 130 countries. In BP’s case the big numbers are more calamitous—it may end up paying out $90 billion in fines and compensation stemming from the Deepwater Horizon disaster. But its ability to do so and stay standing is a perverse sign of the company’s underlying strength.”

Losing a few investments from California pension funds isn’t going to hurt these behemoths in the slightest.

Instead, the pain from that decision will have to be borne by Californians dealing with chronic pension shortfalls as a new and near-permanent fixture of local governance.

Great. Just great.