Investing in SR Companies is a Must for Public Pension Funds

There is no better alternative, according to Prof. S. Prakash Sethi of Baruch College in NYC, who just had his paper published in the Journal of Business Ethics (56:99-129, 2005). I originally saw Sethi (a kindly man in the manner of C.K. Pralahad who wrote The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits) give a verison of this at the AEI seminar in June 2004, hosted by longtime anti-SRI researcher Jon Entine (US Pension funds, Social Investing and Fiduciary Irresponsibility, January 2004 and
The Myth of Social Investing: A Critique of Its Practice and Consequences for Corporate Social Performance Research).

As I was new to the intricacies of US politics and the history of AEI, I realised only over lunch when a horribly researched paper whose name I forget flailed at SRI with all the subtlety of a Rottweiler consuming a hotdog after 2 nights on guard duty. It was a kind of "into the lion's den" for the likes of Tim Smith and Peter Kinder (who gave a fine perfroamnce, provoking some tightly wound Professor to froth at the mouth!). I left D.C> feeling a lot more clear about the political landscape and how that informs SRI. Sethi covers some of this where he discusses the "failed" experiment of economically targeted investments ETI's in the early Clinton years 1993/4.

With US$1.0 trillion in AUM, Sethi points out the powerful place as investors that public pension funds get to play. It is something I have identified as both strength and a weakness for SRI.

The strength comes assets Public Pension funds bring to the argument. The New York State Common Fund ($115.7bn), New York State teachers ($72.4bn), Texas teachers ($76.60bn), CALPERS ($168 bn), CalSTRS ($100.53bn), TIAA-CREF ($307bn) and the funds from North Carolina have all been representative in increasing the heat on corporate governance and SRI issues. In fact it was a coterie of public investment figures that helped push Grasso off his comfortable perch at the NYSE.

The weakness is that the public scrutiny can reverse the positive attitude of trustees to SRI because the funds are so political by their very nature, and a subsequent election can remove a trustee who appears outspoken, with the simple hammer of poor investment performance over the immediate past period. As the funds become more successful as activist investors, so business hypes up any arguments they can, including looking for anti-business (in their eyes anything union e.g. AFL-CIO). They allege Calpers Chairman Sean Harrigan put the screws to Safeway, he was serving as the executive director of the very food workers' union striking against the grocer. Eleven of the 13 Calpers board members had union ties, including Democratic State Treasurer Phil Angelides. Harrigan was fired.

I appreciate that Sethi uses both formal and practitioner definitions as he defines SRI. SRI is dogged by an elastic brand – it is more umbrella than pigeonhole, many sub-definitions can run in and outside of the definition, depending on the positive or negative view of the observer.

Sethi outlines the debate with the 2 oft-cited arguments against SRI:
1. Fiduciary responsibility
2. Financial returns on SR investments
And adds two of his own, namely:
3. Types of SRI included in public pension plans
4. Increased size of public pension plans and the ability to change investment portfolio

Sethi makes the argument first floated by Robert Monks, that large pension funds – especially where they are invested in passive portfolios (which most of them are to reduce expenses and maximize diversification, most definitely need to consider SRI because of the long-term risks and returns; “concerned with long-term survival and growth of the corporation”. Monks wrote in November 1996 about “the need for shareholder activism value added and legitimacy”. He cited a Wilshire Associates study where Wilshire, for many years a consultant to the Public Employees’ Retirement System of the State of California (“CalPERS”), concluded that its principal’s highly publicized activism was value adding.

He demonstrates that the current measurement of future risk assessment “invariably understates, and quite often completely overlooks, these long-term risks because of the inherent bias toward short-run on the part of financial intermediaries whose own compensation depends greatly on short term results”.

This focus on the role of intermediaries is something I tried to identify in last year’s study at Villanova University into pension fund trustee attitudes to social, environmental and corporate governance factors. As a former pension consultant for 6 years in South Africa’s sophisticated $100bn retirement fund industry as the market raced in the 1990’s, I have seen first-hand the pressures to identify performance. Both trustees and consultants are to blame where their agenda is separated from the “greater good”.

The blame goes both ways: the consultant fearing for his appointment and the competition from the next consultant offering “better returns”, feels the pressure to take out the least powerful player at the table – the investment managers actually doing the job. The pressure comes from trustees always driving for returns, and they in turn may feel pressure from their members and the roles of authority to demonstrate actions to protect their position. I have returned to wonder if the wizened old trustee asking point-blank questions of bright young twenty-something market “experts” is not the best model, quite like Warren Buffet’s assertion that he never invests in businesses he doesn’t understand, so insulating him from the market’s biggest bubble of this century.

The most important element that Sethi can help to bring to this debate, aside from the virtues of using qualitative assessment and investor discretion to factor in all risks – including extra-financial risk – is to expose industry practice. While maybe not fraudulent or criminal, it may certainly not be in the best interests of all retirement fund members. Boston lawyer Louis Brandeis wrote in his ‘Other People’s Money” (1914) that “daylight is the best antiseptic” as he argued for securities and banking regulation, which his future position as Supreme Court Justice allowed him to observe as Roosevelt enacted in the early 1930’s.

In this I could not agree more. I hope the debate is joined, for the benefit of all investors.