Last week, Fred Buenrostro, chief executive of the California Public Employee Retirement System since 2002, announced he was stepping down. Buenrostro's move came on the heels of the departure of Russell Read, CalPERS' chief investment officer, who told the organization's board two weeks ago that he was moving into the private sector.
Leadership changes at public institutions occur all the time. But the loss of two top officials at CalPERS, the largest public pension system in the country, had financial observers, corporate leaders and politicians speculating furiously about the potential implications. Given the fact that CalPERS has $244 billion to invest on behalf of current and future retirees, and given its cutting-edge investment philosophy, the concern is warranted.
For decades, CalPERS has had a reputation as an "activist" investor. In the world of institutional finance -- pension funds, foundations, mutual funds -- activism can mean a lot of things, from using shareholder clout to change corporate behavior to investing in clean technology companies to refusing to allow investments in countries that violate accepted human rights standards.
As far back as 1985, Jesse Unruh, the legendary California politician and a CalPERS board member, established a national organization of pension funds called the Council of Institutional Investors after a fight with the board of directors of Texaco over its abuse of stock buybacks to stymie a takeover attempt. CalPERS became a founding member, a clear indication that it would not passively watch its investments be subjected to the machinations of corporate titans.
Since that time, CalPERS has pushed the envelope of corporate governance initiatives and socially targeted investing. After the Los Angeles riots in 1992, for instance, CalPERS launched a $375-million initiative aimed at rehabilitation and development in California's major urban areas. By 2005, the effort reached $1.2 billion, with investments in single-family homes as well as the mixed-use and industrial real estate. According to a Harvard Law School study, the return on investment during that period was over 22%. The study concluded that the investments "paid off handsomely for the fund, its beneficiaries and communities across the state."
CalPERS has also taken the initiative in environmental investing. Since 2005 it has committed $600 million to private equity funds that specialize in clean-tech companies and $500 million to publicly held companies that have met a series of environmental standards. Internationally, CalPERS has placed restrictions on investing in countries that violate labor and other human rights standards. In 2006, it stopped investing in companies doing business in Sudan in an attempt to apply pressure to resolve the Darfur crisis.
All of these efforts can be seen as producing socially salutary benefits. But from a narrowly defined fiduciary standpoint -- which considers only whether the pension fund is getting the best risk-adjusted rate of return possible on investments -- CalPERS and other like-minded pension funds have been open to criticism. The only goal trustees should embrace, according to this more conservative viewpoint, is the ability to pay off the defined benefit commitments to current and future retirees.
Benn Steil, director of international economics at the Council on Foreign Relations, wrote recently in the Wall Street Journal that CalPERS' investment policies were "dictated" by legislative and union pressure, thereby ignoring shareholder concerns.
CalPERS' investments mostly do not depart dramatically from the pattern of other large pension funds. The largest percentages of investments are in publicly traded companies and fixed assets such as bonds. But an expanded definition of fiduciary responsibility is also legitimate. By making long-term investments in environmental technology, for instance, our overall economy is strengthened, pollution is decreased and a key new industry is supported. CalPERS only makes these investments, of course, if it believes they have the potential for a competitive rate of return.
According to James Hawley, a professor at the Elfenworks Center for the Study of Fiduciary Capitalism, fund managers and trustees should weigh the effects of investment decisions on the economy as a whole. "CalPERS invests all over the world, in every economic sector and has a long-term time horizon, so they in effect own part of the whole economy," Hawley said. If that is the case, there is a business justification for strengthening the overall economy by including human rights, labor and environmental standards in at least some investment decisions. Moreover, CalPERS' investment returns have been highly competitive with other institutional investors.
It is clear that CalPERS has had to throw some financial elbows to keep corporate America in line. During this year's shareholder meetings, CalPERS has intervened to help straighten out companies that consistently underperformed or had insufficient board oversight. In April at the Washington Mutual shareholders meeting, it joined labor organizations and other public pension funds in pushing a vote against board member James Stever because of issues of executive compensation. And at the Eli Lilly & Co. meeting, it pushed for the right of shareholders to change the company's bylaws by a majority vote rather than the supermajority that currently exists.
With the recent sub-prime lending fiasco, we have been grimly reminded once again that Wall Street cannot police itself. And with all of the presidential candidates receiving millions in campaign contributions from members of the financial services and investment industry, it is wishful thinking to expect dramatic initiatives from Barack Obama, Hillary Rodham Clinton or John McCain.
Pension trustees can keep the pressure on business to take the high road. Henry Jones, a newly elected CalPERS trustee, wants the activist tradition to continue. "We've been a leader in corporate governance for more than a decade," Jones said shortly after Buenrostro's announcement. "We should continue and even expand that investment approach."
With the changes at the top, there will undoubtedly be calls for CalPERS to adopt a more subdued investment and advocacy approach. That's bad counsel. With a clear need for economic and corporate reform, CalPERS needs to remain in fighting shape.