Dubious Investments Further Imperil Calif. Pension Plan
The California Public Employee Retirement System, known as CalPERS, is in crisis. And it sure looks like things are going to get a whole lot worse before they can get a whole lot better.
The system already has a $153 billion unfunded liability, one of the largest shortfalls of any state, and it only has funds to cover 68 percent of promised benefits into the future. And because CalPERS is already cash negative, paying out $5 billion more in benefits to retirees each year than it takes in, there aren’t many scenarios whereby the system would be able to make good on those promises absent outside intervention (read: taxpayer bailout).
Lawmakers and the fund’s board should be considering reforms to improve the system, but California voters and taxpayers faced another setback recently. Overseers of the pension plan—the nation’s largest—passed a funding plan earlier this year that projects shortfalls over the next decade but assumes rosy investment returns in coming decades to make up the difference. Given the high market valuations today, that assumption seems dubious.
When the CalPERS investment committee reallocated its investments recently, it assumed a 7 percent annualized rate of return. While CalPERS has enjoyed some good years—for example, its 2017 return may exceed 11 percent—that’s not the norm. The fund has averaged a 4.6 percent rate over the past decade, and its 2016 rate was an abysmal 0.6 percent.
CalPERS’ strategy -- and to a large extent that of the state in general -- seems crafted first and foremost to advance the interest of public sector labor unions. The high compensation for state government workers and the state’s munificent retirement benefits make it difficult for local government officials to find the money necessary to meet their obligations. Rising contribution rates for local governments mean that municipalities and schools have less money to educate children, build roads or provide other essential government functions.
CalPERS’s school district contribution rates to the pension plan are projected to skyrocket in the near future. The rates have risen to 15.5 percent from 11.8 percent in the 2015-2016 fiscal year, and are scheduled to reach 22.7 percent in 2020. School districts have little power to fight the increases, which are mandated at the state level. The only way to reduce pension contributions is to cut staff. Some layoffs may make sense for districts facing declining enrollment, but they can also harm educational outcomes.
Fund managers should be laser-focused on increasing investment returns for its beneficiaries, which would lessen the fund’s burden on taxpayers. But its board is more interested in pursuing a political agenda. For the majority of California taxpayers who hold a portion of their retirement assets in the stock market, CalPERS’ activism means that some of their money will be used to support a political agenda that hurts their investment returns.
CalPERS has played an increasing role in politicizing annual shareholder meetings in recent years. These elections are on the horizon—a majority of U.S. public companies hold the mandated meetings between March and July—and CalPERS is already planning to force votes on proposals on environmental and social issues.
Traditionally, these proxy votes have been about improving corporate governance with one goal in mind: improving shareholders’ returns. But CalPERS and other activist investors have aggressively pushed proposals irrelevant to companies’ missions that could have a harmful impact on shareholder value.
CalPERS has prioritized relatively poor-performing environmental, social and governance (ESG) investments at the expense of other options more likely to optimize beneficiary returns. As a recent study by the American Council for Capital Formation shows, four of CalPERS’ nine worst performing funds were ESG-focused.
CalPERS responded to the criticism by noting that the plan’s private equity portfolio, which includes the funds, has performed well overall. But CalPERS would serve its beneficiaries—and taxpayers—better if it focused on investment returns and not politics.
Making investment decisions based on social issues has real consequences. Last year CalPERS’ board expanded its ban on investing in companies that produce tobacco products, against recommendations by its professional staff. In an analysis of the cost of divestment produced for CalPERS, Wilshire Consulting placed the system’s total foregone investment gains at more than $3.6 billion.
CalPERS is facing a serious, long-term crisis that could cripple school districts and local governments while forcing tax increases to pay for the pension system. Getting the fund out of politics won’t alone fix the system’s fiscal woes. But it would be a good first step.