Divestment ineffective in bringing about social change – CalSTRS’ ESG policy draft

Fund considers formal statement on alignment of interest with external fund managers

A new draft ESG policy from CalSTRS, the California State Teachers’ Retirement System, has underlined its belief that divestment is not an effective strategy for addressing “long-term and persistent ESG risks”.

“Divestment eliminates our rights as a shareholder to engage with management and raise awareness of long-term risks and encourage change,” it says.

“Moreover, divestment has been ineffective in bringing about social change.” The fund’s new Corporate Governance Report (p.33) includes an estimate that the total compounded costs of all its divestments (tobacco, firearms, US thermal coal and geopolitical restrictions) – over time – are $4.8bn compared to a ‘standard’ index return.

A similar view about divestment was expressed by John Howchin, the Secretary General of the Ethical Council of the Swedish AP funds recently. “Historically, the finance industry’s view of corporate governance has been focused on divesting as a way to influence companies,” he said in the panel’s Annual Report. “However, analyses show that this method is not effective. If we do not invest in a company, there are other investors who will.”

Last month Norges Bank Investment Management, which runs Norway’s Government Pension Fund, said “product-based exclusions” (such as tobacco and weapons makers) had reduced the return on the equity index by close to 1.9 percentage points.

The new CalSTRS document was prepared by Director of Corporate Governance Anne Sheehan and Portfolio Manager Brian Rice and approved by CIO Chris Ailman.

“It insures ESG integration into the investment decision and review process across all asset classes, engagement rather than divestment as our preferred approach, and a focus on material impact to the investment portfolio,” they write.‘Material’ is being defined as that which potentially affects an asset class by more than 1%. The draft policy is under review by the two-day Investment Committee meeting currently underway.
The next step is for it to go back to “further revision and refinement” in May before final adoption in June.

It comes as the $202bn Sacramento-based fund is looking at developing a formal statement about its alignment of interest with its external fund managers as part of a wider set of investment beliefs.

“The economic interests of CalSTRS and its external managers and advisors should be aligned, and transparent,” the draft belief states.

“In addition, CalSTRS expects its managers and advisors to recognize the long-term value of CalSTRS’ investment policies relative to best practices, responsible corporate governance and the impact of ESG-related issues on portfolio performance.”

Another belief under review concerns responsible corporate governance.

“As a largely passive long term investor, CalSTRS and enhance the value of its plan assets by promoting responsible corporate governance.

It goes on: “CalSTRS also believes that, in addition to traditional financial metrics, timely consideration of material environmental, social, and governance, (ESG), factors in the investment process for every asset class, has the potential, over the long-term, to positively impact investment returns and help to better manage risks.” Link to CalSTRS meeting notices (See item 12 for new ESG document.)