Anti-Apartheid : Divestment: Risky Times for Pensions

During the last two years, pension fund officials in 20 U.S. states and cities have sold more than $200 million worth of stock in blue chip companies such as IBM, Exxon, General Electric and General Motors in the name of divestment, a form of economic protest that calls for severing ties with U.S. firms that do business in South Africa.

These officials have taken a gamble by shifting pension fund holdings to more volatile investments in a period when the funds face enormous liabilities and must rely increasingly on investment income to pay retirement benefits owed to millions of American workers.

The movement is spreading. With the news of racial violence inflaming American public opinion against the South African policy of apartheid, at least 20 more states and cities, including California and Los Angeles, are seriously considering proposed divestment legislation.

Considered Risky

Even proponents of divestment acknowledge that it can be a risky strategy, both legally and financially, and that it could prove to be more damaging to public retirement systems in this country than it is to South Africa, where American business accounts for only about 3% of all investments.

The question is whether divested public pension funds can meet their legal obligations to beneficiaries while satisfying the concerns of apartheid foes: Can they generate the income they need if they are prohibited from investing in the more than 30% of America’s blue chip corporate giants that do business in South Africa? (Those firms represent nearly 50% of the market value of America’s major corporations.)

Critics argue that elected officials who call for divestment are putting politics before prudence and abdicating their fiduciary responsibility to the approximately 14 million present and future beneficiaries of public retirement systems.

Backbone of Portfolios

“The South African policy hits hardest the very largest stocks that are the backbone of billion-dollar portfolios,” said Boston investment analyst Stanford Calderwood in a reference to the size of pension fund accounts commonly held by states and large cities.

In addition, the impact of divestment on South Africa is not easily measured.

Both supporters and critics of divestment agree that the movement has had some impact on American firms with ties to South Africa. In three cities where divestment laws have been passed--Boston, New York and Washington--nine banks have stopped lending money to South Africa. And since October, 25 more American companies have signed a voluntary code of fair employment practices now subscribed to by 147 of the 300 American firms in South Africa.

But there are other indications that divestment has not slowed the pace of overall American investment in South Africa. In fact, loans from U.S. banks to the private sector in South Africa rose from $608 million in 1981 to $939 million by the end of 1984, according to the Federal Reserve Bank.

In South Africa, black leaders disagree among themselves over the wisdom of divestment as a device for bringing about social change. For example, Nobel Peace laureate Bishop Desmond Tutu has praised demonstrations by American students in behalf of divestiture. But Gatsha Buthelezi, hereditary leader of the Zulu people, has urged American investors not to drop their stake in U.S. businesses in South Africa because he thinks those businesses are an important force for change in his country.

In this country too, skeptics say that public pension funds, which control less than 5% of the stock in all American companies, do not wield enough economic power to make a difference in South Africa.

One response to all the political and economic uncertainties surrounding the divestment movement has been partial divestiture by some states and cities, such as Connecticut and New York City. They have adopted policies allowing them to retain investments in companies in South Africa that follow a voluntary code, known as the Sullivan Principles, that calls on them to practice fair employment and work for an end to racial discrimination.

Pushing for Change

The Sullivan Principles were drawn up in 1977 by the Rev. Leon Sullivan, a Philadelphia Baptist minister, civil rights activist and the first black member of the board of directors of General Motors Corp., to pressure companies to push for social change.

Sullivan himself has said he prefers partial divestment that targets firms believed to be the least responsive to the campaign against apartheid. But he does not criticize those officials who have authorized blanket divestment.

“Divestment has been a great help to me,” said Sullivan, who estimates that 50% of the firms that have signed the Sullivan Principles would not have done so without the threat of divestment.

Partial divestment has found acceptance among investment analysts because it does not drastically narrow the available range of investment choices.

Pension and trust scholar Roy Schotland, a Georgetown Law School professor and one of the nation’s most outspoken critics of divestment, concedes that a “prudent fiduciary” could learn to live with the Connecticut partial divestment plan that would eliminate only 15% of the largest 500 companies.

At the same time, divestment hard-liners, such as Washington, D.C., City Councilman John Ray, say they are confident that total divestment can be accomplished without jeopardizing the integrity of public pension funds.

They base their optimism on the solid performances of some university endowment funds, which have been totally divested for several years.

But many investment analysts disagree, notably Stanford Calderwood, whose firm has one of the best records of managing a South Africa-free university endowment fund.

Calderwood, whose Trinity Investment Management Corp. manages a $10-million endowment fund for Michigan State University, said that comparing most university endowments with multibillion-dollar government pension funds “is a case of apples and oranges.”

Calderwood’s logic goes as follows:

Divestment does more than rule out many of the Standard & Poor’s 500 stocks--the index of major companies traditionally favored by institutional investors. It all but eliminates key industry groups within S&P.; Out of bounds, said Calderwood, are 87% of major office equipment stocks, the group headed by IBM; 88% of auto stocks, including Ford and General Motors; 86% of drugs; 86% of chemicals; 83% of international oils; 74% of electric equipment; 51% of aerospace, and 50% of beverages.

Many Choices Left

What is left allows plenty of choices for a relatively small fund, said Calderwood. But for a typical large pension fund manager trying to invest $100 million or more, it leaves too little room to maneuver within S&P; and means going outside to smaller, more volatile stocks.

One of the most comprehensive critiques of total divestment was published early this year by the Investor Responsibility Research Group, a Washington organization founded 13 years ago to inform churches and foundations about how corporations were responding to social policy issues.

The critique summarizes nine reports by financial analysts on divestment and concludes that for state and local pension funds “divestment will have a detrimental effect over the long term on portfolio performance.”

The conclusion is not universally held in investment circles.

“For larger funds, (those of $150 million or more) disinvestment is harder, no question about it. But it can be done,” said Edward Swan, senior vice president of Franklin Management Corp., a Boston firm with experience managing comparatively small South Africa-free institutional accounts.

Not Going to Extremes

In choosing alternative investments for a large divested pension portfolio, Swan said, “you do have to use more volatile substitutes, but not much more volatile.” And he said that the volatility could be balanced with more stable holdings in real estate, bonds and cash.

Ray, the Washington, D.C., councilman, said that Franklin’s views helped persuade the district’s City Council to vote for its total divestment policy, despite the opposition of its own retirement board.

The campaign for divestment has its roots in a broader trend, known as ethical investing, that 15 years ago saw the Church of England dispose of its interests in a number of companies the church believed to be engaged in immoral practices--including firms that made armaments, gambling equipment, alcoholic beverages and newspapers.

In this country, churches and foundations have taken similar stands against investing in firms thought to be socially irresponsible, ranging from breweries and tobacco companies to the builders of weapons systems and nuclear power plants.

Federal Law Involved

Social investment is a nettlesome issue for pension fund managers because they must abide by a federal law governing fiduciary responsibility. According to the law, pension system assets must be invested for the exclusive purpose of providing benefits to beneficiaries “with the care, skill, prudence and diligence that a prudent man acting in a like capacity would use.”

“A trustee who sacrifices the beneficiary’s financial well-being for any social cause violates both his duty of loyalty to the beneficiary and his duty of prudence in the investment,” wrote John Langbein, a pension law expert at the University of Chicago.

And critics such as Langbein warn that the injection of politics into pension management could backfire on the generally liberal politicians who have backed divestment as a social cause.

“With the rapid rise of social activism on the political right, we can expect social investing advocates to appear who will urge investment managers not to invest in corporations that manufacture contraceptive devices, or publish textbooks that teach the theory of evolution, or do business with Russia,” Langbein wrote in a recent essay on divestment.

Courts are just beginning to grapple with the legality of divestment, but they already have held that certain forms of social investing, done for the benefit of the local economy, do not violate the so-called “prudent man” rule.

For most state pension funds, this kind of local social investment has meant the selective placement of capital to stimulate new business or to increase the supply of mortgage funds for home ownership.

At least 31 states, including California, have aimed a portion of their pension funds at these kinds of investment targets within their borders, according to a 1983 study by the Federal Reserve Bank of Boston.

But South Africa divestment poses a thornier problem. It is being done to affect living conditions in a foreign country and offers no residual economic benefits to local pensioners.

William Josephson, a lawyer representing the New York City public employee pension system, argues that divestment is legal as long it leaves room for investment alternatives of “equal financial merit” to the choices ruled out by divestment.

Geographical Differences

Such a standard may be easier to apply in New York City, which has adopted a policy of partial divestment, than in those places, like Massachusetts, Washington, D.C., Boston and Philadelphia, that have ruled out investments in all firms doing business in South Arica.

(California appears to be taking an even more cautious approach than New York. In Sacramento last week, an Assembly committee voted to halt new investments by employee pension funds in firms doing business in Africa. But the committee did not endorse a stronger proposal that would have required the funds, which have $40 billion in assets, to sell present holdings in firms with South African ties.)

With or without divestment, many public pension systems face an uncertain future.

“During the latter part of this decade, we could have real, severe problems meeting obligations,” said Paul Quirk, executive director of the state’s Pension Reserve Investment Management Board.

Obligations Mount

Nationwide, state and municipal pension systems face estimated obligations 135% greater than their assets, according to recent actuarial studies.

Since pension obligations, like mortgages, don’t come due all at once, most pension systems can meet their yearly demands through employer and employee contributions and investment income.

But as annual obligations have risen, said Georgetown’s Schotland, state and local pension funds have had to rely more on investment income than other sources.

Five years ago, he said, return on investment represented 34% of pension fund income. Last year, investments accounted for nearly 50% of pension income.

The growing dependence on investment income is one of the reasons Schotland prefers the approach to divestment taken by Connecticut, which rules out a comparatively small portion of the stock market.

Under the Connecticut policy, investments are permitted in firms that are rated in the top two categories of compliance with the Sullivan Principles unless the firms provide strategic products or services to the South African government. According to Reid Weedon, a vice president of the Arthur D. Little consulting company, the firm hired to rate Sullivan signatories, the companies that don’t make the top two grades, generally, are ones that don’t pay adequate minimum wages to nonwhite workers, that fail to provide enough training or advancement for the workers or that have done little to improve employee living conditions.

Another Demand

Recently, a demand was added to the Sullivan Principles, one that says U.S. firms there must lobby against apartheid. Weedon said it is the beginning of a push to make American businesses take a leading role in reform politics in South Africa.

In March, U.S business representatives in South Africa responded by making their most forceful statement to date against apartheid. Acting through the American Chamber of Commerce, they formally called on the South African government to end a variety of racially oppressive laws.

Most of the companies, Weedon said, want to stay in South Africa without looking like moral pariahs to the folks back home. Up to now, compliance with the Sullivan Principles has allowed them to maintain that precarious posture. “The (Sullivan) demands will have to be raised to an almost impossible level before American businesses will balk,” Weedon said.

But there are people like Councilman Ray in Washington who support total divestment, in part, because they think the Sullivan Principles are a joke.

“Fairyland,” Ray said. “That’s what they are.”

Doubts About Impact

Pointing out that American companies employ less than 1% of South Africa’s black work force, Ray contends that it is folly to believe that U.S. employment practices can have a significant impact.

Moreover, he said he did not believe that the South African government would tolerate meaningful political activity on the part of U.S firms.

“If GM becomes involved in the political life of South Africa, if it really starts to try to change things, I venture to say it will have to leave the country,” he said.

Ray said he is also confident that Washington’s 20,000 pension fund beneficiaries won’t be any worse off as a result of the district’s total divestment law.

“We looked around to see if we could put our funds in a South Africa-free universe and still make money. We decided we could do it and do it hell of a lot better than we had been doing,” he said.

So far, Ray’s claim has held up.

Investment managers handling $100 million of divested Washington pension funds report that the accounts have been performing well--better, in fact, than the Standard & Poor’s 500 during the first five months of divestment.

One of these managers, Wayne Wagner of Wilshire & Associates in Santa Monica, said he is not surprised by the showing of the district’s holdings so far.

Depends on Market

Wagner has said that divested portfolios, which must make use of smaller, more volatile stocks, do better than the S&P; stocks during an up market and do worse in a down one. By and large, the last five months have been up.

But Wagner cautioned that five months does not make a trend in a business that often requires three to five years to make a judgment about the wisdom of an investment strategy. And he pointed out that even $100 million is a small, relatively easy amount of money to manage, compared with the assets of some funds.

Moreover, Wagner continued to emphasize risk.

In an article in a financial journal, he said: “The alternative universe (meaning the investment choices available to a divested account) will rise or fall, on average, by 8% for every 1% change in the S&P; 500.”

“Retirement plans are not free to take unlimited risks,” he wrote.

In the end, the politicians who bear the responsibility for taking care of the funds must decide how much they want to gamble with other people’s money.

THE SULLIVAN PRINCIPLES The Rev. Leon Sullivan, a black Baptist preacher from Philadelphia and a member of the board of directors of the General Motors Corp., wrote guidelines that seek to improve living standards for non-white employees of American firms in South Africa. Companies that agree to abide by the “Sullivan Principles” promise to:

1. Bar segregation by race in all company eating, toilet and work facilities.

2. Give employees, regardless of race, equal medical, pension and insurance benefits, working conditions and access to unions

3. Pay all employees equally for comparable work.

4. Develop training programs to prepare non-white employees for supervisory, administrative and technical jobs.

5. Increase the number of non-whites in management.

6. Improve the quality of employees’ lives outside of work by a variety of means, including development of good schools, support for changes in laws to provide for the right of black migrant workers to have their families live with them near where they work, and use of firms owned by non-whites as distributors, suppliers and manufacturers.

The companies agree to report their progress annually to Rev. Sullivan and have their efforts audited.

DIVESTING PUBLIC PENSION FUNDS These cities and states are among those that have passed ordinances or legislation ordering pension fund divestment in companies that do business with South Africa or that will not adhere to the so-called Sullivan Principles. “Partial” divestment refers to the practice of withdrawing investments in those companies that have not agreed to abide by the Sullivan Principles.

Amt. Divested/ City or State Full Partial Fund Value Will Be Divested Boston X -- $450 million $6 million Cambridge X -- 67 million NA Charlottesville X -- 10 million 250,000 Hartford X -- 220+ million 2.6 million New York X -- 9 million 850 million Newark X -- * * Philadelphia X -- 1 billion 2.4 million Pittsburgh X -- 16.6 million 40 million San Francisco X -- 1.6 billion 340 million Washington, D.C. X -- 630 million 33 million Connecticut -- X 2.6 billion 79 million Maryland -- X 4.7 billion 160 million Massachusetts X -- 2.3 billion 190 million Michigan -- X ** ** Nebraska -- X 300 million 30 million

* No future investment ** In litigation NA--Not Available Compiled by Times research librarian Tom Lutgen COMPARING INVESTMENTS Although analysts say that it often takes three to five years to judge the wisdom of an investment strategy, cities and states considering divestment do not have the benefit of the wait. Their decisions may be based on such partial data as the performance of this $25-million portion of Washington’s $100-million South Africa-free pension fund. Over five months, the portion of the fund performed nearly the same as Standard & Poor’s index of 500 industrial, rail and utility stocks.