By Ed Mendel.

CalPERS is stepping up its ESG investment program, despite evidence that funds based only on environmental, social and corporate governance strategies have tended to underperform.

The big pension system, an early ESG leader, is half-way through a five-year plan that includes getting companies to report and reduce climate-changing carbon emissions and using ESG factors to help analyze and select its own investments.

Going beyond a narrow profit-loss focus, the wide-ranging ESG movement pushes changes in companies that can benefit the environment and society, while also helping the long-term “sustainability” of investments, needed in this case to pay for pensions.

It’s an international trend. The UN-backed Principles for Responsible Investing network, formed in 2005, now has 2,250 investors managing nearly $80 trillion signed up to use ESG in investment analysis and owner policies, up from 1,750 and $70 trillion two years ago.

Professional acceptance is growing. The CalPERS board was told in March that the Chartered Financial Analyst Institute “encourages all investment professionals to consider ESG factors, where relevant, as an important part of the analytical decision-making process.”

But among some CalPERS members there is an ESG backlash. In a board election last fall with typically low voter turnout, Jason Perez, a Corona police sergeant, unseated Priya Mathur, who became the first female CalPERS board president early last year.

“Mathur has failed CalPERS and put our retirement security at risk due in part to environmental, social, and governance investing priorities, regardless of the investment risk,” Perez said in the campaign booklet given CalPERS members in local government.

He criticized Mathur, a leading ESG advocate, for being “out of touch, believing her role is to fly around the world, ringing the bell of the London Stock Exchange and hobnobbing with United Nations officials.”

Last month Perez was part of a three-member panel that discussed ESG investing at a forum in Washington, D.C., sponsored by the Institute for Pension Fund Integrity, whose concerns include fossil fuel divestment.

Perez is making his presence felt on the 13-member CalPERS board. In March he made an unsuccessful motion, getting votes from two other members, to consider reinvestment in the tobacco industry, reversing a divestment in 2001.

Tobacco divestment, reconsidered by the board in 2016, had cost CalPERS $3.6 billion as of last year, Wilshire consultants estimated. The CalPERS board usually opposes divestment legislation, preferring to engage companies to seek change as it does on ESG issues.

Last week Perez said five months on the CalPERS board have made little change in his ESG views. He said environmental and corporate management issues need CalPERS attention if they affect investment returns, but social issues should remain in the political arena.

“Our duty is to make the maximum amount of return for our members,” Perez said. “Social issues shouldn’t even be considered.”

On the panel with Perez last month was Wayne Winegarden of the Pacific Research Institute, a conservative think tank, who issued an analysis of 18 ESG funds last month that found only two outperformed a broad market index fund over 10 years.

CalPERS, with a portfolio valued at $366 billion last week, recently had roughly $1 billion in ESG global stock funds. After analyzing about 20 ESG strategies and themes, CalPERS selected two last year for an additional $1 billion each, bringing the total to $3 billion.

The two new funds are being internally managed under license from two money managers, Chief Investment Officer magazine reported, and they could serve as models for other parts of the global equity portfolio if they outperform the market.

Last year CalPERS added a managing director, Beth Richtman, and a staff expected to reach 14 members to a Sustainable Investments program that will integrate ESG into investment decisions, research related issues and be an ESG advocate.

Richtman told the CalPERS board in March that using ESG factors (see chart below) to help analyze investments is still a work in progress, requiring different styles depending on the type of investment.

For example, the sustainability staff can consult with a real estate team considering an investment. But applying ESG factors to the more than 10,000 companies with stock held by CalPERS in various funds requires a quantitative process.

CalPERS is working with Wellington Management and the Woods Hole Research Center on quantitative models and other analytical tools to improve the assessment of climate risk and investment outcomes.

In addition to risk, ESG factors are expected to help identify investment opportunities. An example cited by CalPERS is its Energy Optimization program in real estate, which has yielded profits in recent years and reduced energy use.

As a result of staff research on water scarcity last year, Richtman said, “For the first time the investment team has insight into which industries and asset classes in our portfolio are most exposed to water scarcity risk.”

A program that CalPERS helped launch two years ago, Climate Action 100+, has more than 300 investors managing $32 trillion engaging 161 large companies that produce much of the world’s green-house gas emissions.

CalPERS is on track to comply with state legislation (SB 964) directing CalPERS to report on the climate-related financial risk in its investment portfolio by next Jan. 1, but is having difficulty getting private equity information.

An ambitious goal of the five-year ESG plan launched by CalPERS in 2016 is mandatory corporate reporting of ESG by 2036. CalPERS says it’s working with several standards groups and the Security and Exchange Commission investor advisory committee.

In February, CalPERS responded to a letter from eight U.S. senators, including Elizabeth Warren and Bernie Sanders, about the CalPERS approach to deforestation, the industrial-scale loss of trees. CalPERS highlighted the issue in letters to 60 companies.

“Currently, forests are one of the best available ‘technologies’ to sequester carbon,” CalPERS told the senators. Trees mitigate climate change and protect the CalPERS global investment portfolio.

“Therefore, in addition to our focus on palm oil, we are also looking into other drivers of deforestation across various industries and commodities in our global portfolio,” CalPERS said in a letter to the senators.

At the request of board members, CalPERS staff researched economic inequality with two symposiums at UC Davis and a review of 1,800 academic papers but found “no actionable solutions for an investor.”

Noting the risk to investments from income inequality and political unrest, CalPERS is working with other large investors and industry groups on “adoption of frameworks and standards for reporting on human capital topics, including workforce compensation.”

During public comment at the board update on sustainable investments in March about 20 speakers, several from Fossil Free California, urged CalPERS divestment of fossil fuel holdings, arguing they are now risky investments and climate change must be halted in 10 to 12 years.

A lobbyist for the League of California Cities, Dane Hutchings, followed them with an urgent plea for CalPERS to be “laser-focused” on investment returns and leave fossil fuel regulation to the appropriate government agencies.

“We talk about the next 10 to 15 years of our planet. I’m talking about the next 10 to 5 years where cities are going to be going bankrupt,” Hutchings said, apparently referring to soaring CalPERS employer rates.

Example of ESG factors that might be analyzed

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 Originally posted at Calpensions.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 17 Jun 2019