Brannon: Investment Funds Don't Prosper When Constrained by Their Political Overseers

Texas’ possbile new ban on investment managers shunning Oil & Gas companies does retirees no favors

By Ike Brannon

WASHINGTON, D.C. (Texas Insider Report) — Public pensions around the country are underfunded, a consequence of increasing longevity and a plethora of bad decisions by governments in previous decades that substituted costly long-run pension increases to stave off short-salary increases.

For many of them the confluence of these forces have left them a huge pension shortfall that has forced them to scale back spending across the board and funnel taxpayer dollars into their pensions, leaving less money to fund the day-to-day activities of government.

To limit this shortfall, such governments need their remaining pension funds to earn the highest rate of return possible, and one crucial ingredient for achieving that is to keep politicians from interfering with investment decisions.

It turns out that interference is a difficult temptation to resist – for both liberal and conservative governments.

In the last few years several local governments – including New York CityWashington home town of Peoria, IllinoisDenver, Colorado – have prodded their retirement systems to divest of stocks in companies that produce fossil fuels. And late last year, the New York State legislature passed legislation directing its pension funds to divest of many fossil fuels in the next five years.

The rationale for doing so is that progressive politicians see climate change as a high priority and justify this as a necessary action in wake of a federal government that has, in their eyes, failed to take sufficient steps to counter this phenomenon.

However, governments often like to aver that this constraint will somehow benefit its public employees and retirees as well, and represents a “win-win” situation.
Thomas Napoli, the New York Comptroller (above right,) praised the state’s legislation (after previously opposing such efforts), saying,
“New York State’s pension fund is at the leading edge of investors addressing climate risk, because investing for the low-carbon future is essential to protect the fund’s long-term value.”

But the notion that elected political leaders are merely helping their investment advisors with such laws is absurd: Investment funds never prosper from constraints imposed by their political overseers, which are – as a rule – completely political. Regardless of the rationale, these decisions are unwelcome, for they – once again – put the narrow short-term interests of politicians ahead of the security of state workers' retirements.

That’s what got many state and local pension funds into their current predicament in the first place.

The Texas House of Representatives is the latest political body to interfere with the investment choices of those who manage the state's pension funds – albeit in a contrarian fashion – when it passed legislation that would force state funds to divest out of investment funds that discriminate against the fossil fuel industry.

While I am somewhat sympathetic to the gesture – I've written several pieces objecting to investment firms pursuing socially conscious investing and asserting it is in their investors' best interests – this sort of political constraint on a state’s pension fund is just as problematic as any other constraint.

And while such a law may very well reduce the prevalence of investment managers that foist the precepts of environmental investing on its unwitting investors, it is unlikely to make much headway nationwide while reducing the investment options for its own state pensions’ investment managers.

To be sure, many investment funds that eschew fossil fuel stocks may be sacrificing returns, but others may be offering a portfolio that provides the Texas pension funds a way to effectively diversify its portfolio to lessen the impact that a long-run decline in the value of oil and gas might have on pension balances.

The House bill contains an amendment which says that the requirement would not apply if the fund determines that doing so would be inconsistent with its fiduciary duties, but that provision would create an additional hurdle for its fund managers, who would potentially have to justify to legislators why they remained in certain “green” funds and discern whether their exclusion of fossil fuels harmed returns.

Texas politicians have a right to be upset at the predilections of other states to play politics with their pensions at the potential expense of a key industry in the state, but the answer isn’t to respond by putting forth its own pointless restriction on their own pension managers and reduce the growth of the pension funds in the state.

Ike Brannon, a former Senior Economist for the U.S. Treasury Department and the U.S. Congress. is a Senior Fellow at the Jack Kemp Foundation.