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ESG

New Jersey grappling with role of divesting investments, strategies

New Jersey Gov. Phil Murphy

Executives of the New Jersey Pension Fund, Trenton, are wrestling with the role that divestiture plays in investment management as they deal with mandates from politicians, lobbying from interest groups and debates within the fund's governing board.

"No pension fund has a blanket policy," said Adam Liebtag, vice chairman of the State Investment Council, which sets policies — such as asset allocation —for the $77.3 billion New Jersey Pension Fund. The council advises the Division of Investment, a unit of the State Department of Treasury, which makes the pension fund investments.

"The challenge is do you invest or do you engage?" Mr. Liebtag said. "No one size fits all. We will feel our way."

The council's former chairman, Brendan Thomas Byrne Jr., said divesting is one strategy for the pension fund. "It shouldn't be the initial tactic," said Mr. Byrne, who resigned in June. "If all else fails, then divestiture is an option."

Unlike with some other retirement funds, when New Jersey pension officials and politicians discuss "divestiture," they apply it broadly to environmental, social and governance issues as well as to asset allocation strategies involving alternative investments.

Some recent divestitures include an operator of private prisons, a gun manufacturer, a bank that did business with companies boycotting Israel or Israeli products, and a private equity fund that acquired a payday lender. Compared to the pension fund's total assets, the amount of each divestiture was small.

In late August, the division sold the pension fund's $1.3 million holding in Geo Group Inc., the private prison company.

In March, the division divested the pension fund's $1.9 million stake in Vista Outdoor, which makes rifles and shotguns for sporting and hunting but also makes semiautomatic rifles. Previously, the division had divested an estimated $33 million in publicly traded "civilian or ammunition companies," according to a division report announcing its actions. The company names were not reported.

In February 2018, the Division of Investment announced plans to divest the pension fund's $16 million holding in Danske Bank, which it said violated terms of the state's 2016 anti-Israel boycott law. The division didn't make public specific violations.

And in 2016, the division also sold the pension fund's $23.9 million interest in JLL Partners Fund V, which had acquired the payday lender after New Jersey had invested in the private equity fund. Payday lending is illegal in New Jersey.

The biggest divestiture, however, has been the sharp cutback in hedge funds, from 12.5% of total assets in 2016. A frequent target of criticism by organized labor, the hedge fund allocation was down to 6.32% as of April 30, according to the latest information available.

Divestiture decisions can be made internally between the council and the Division of Investment, such as cutting the hedge funds, dropping the gun manufacturer or ditching the private equity fund with the payday lender.

Other decisions are dictated by state law, such as divesting from the bank that violated the Israel boycott law. Previous laws have required the pension fund to divest from companies doing business with Iran and Sudan. (In the latest legislative session, bills have called for divesting, among other things, investments in the 200 largest publicly traded fossil-fuel companies and in makers of firearms and ammunition. None as been considered by a committee.)

And still other decisions require agreement between the governor and Legislature on policy. For example, in May, the Legislature passed a bill telling the pension fund to divest from companies responsible for Superfund sites in New Jersey that had declared bankruptcy to dodge their cleanup responsibilities.

In July, Gov. Phil Murphy issued a conditional veto, saying a "more effective and legally defensible approach" would be to give the State Investment Council "a variety of options to identify and correct the offending behavior."

Mandating divestiture "exposes the state to significant costs and legal risks," Mr. Murphy wrote in his veto message. The state already has spent more than $23 million monitoring pension fund investments to comply with the Israel-boycott and Iran legislation, he wrote.

The Legislature can agree to the governor's recommendations and then resubmit the bill to him. Or, it can try to override the veto. The Legislature has not yet responded.

One of Mr. Murphy's suggestions in his veto message is for legislation that would "formally institute" an environmental, social and governance policy that will enable the State Investment Council "to use a number of negotiating tools to influence a company's behavior."

The council and the Division of Investment started working on a formal ESG policy earlier this year.

The division "does not base its investment decisions solely on ESG-related factors," Corey Amon, the division's acting director and CIO, said in an email. "However, the Division of Investment believes that effective ESG policies can enhance the value of its investments over the long term. Accordingly, ESG-related factors are incorporated into a comprehensive investment process."

Mr. Amon offered no timetable on when the formal policy, which will require an OK from the state attorney general, will be completed. To bolster ESG efforts, the division is conducting a search for a corporate governance officer who will work with the council's ESG committee.

Messrs. Byrne and Liebtag said a formal policy will help the council and division rely on a more formal framework and enable the division staff to better ask questions of companies about ESG efforts.

Perhaps the best illustration of the multiple pressures applied to the New Jersey Pension Fund is the role of hedge funds. In every legislative session since at least 2008, legislators have introduced bills telling the pension fund to get rid of hedge fund investments. The bills never made it out of committees.

Internally, however, labor members on the State Investment Council pressed for cutting the hedge fund allocation, arguing that these investments produced meager results at high cost.

The showdown came in mid-2016 when the Division of Investment proposed reducing the allocation to 9.5% from 12.5%. Union members on the council wanted the allocation cut to 4%. The council's vote in May 2016 ended in a tie, thus defeating the proposal. In August 2016, however, the council reached a compromise of reducing the number of hedge fund investments and cutting the overall target allocation to 6%. The council also established new terms of engagement for prospective hedge fund managers, telling them the pension fund's fee structure is now 1% management fee and 10% incentive fee vs. the traditional "2 and 20" approach.

"We were proud of that," said Mr. Liebtag, who also is president of Local 1036 of the Communications Workers of America.

Although he agreed the original hedge fund allocation was too high, Mr. Byrne said hedge funds have a place in the pension fund as a "sensible diversification."

New Jersey's hedge fund debate isn't over. When he campaigned for governor, Mr. Murphy, who was elected in November, said the New Jersey Pension Fund should get out of hedge funds and private equity, arguing the returns haven't justified the cost. As governor, he hasn't given a definitive signal to the State Investment Council and division of investment, and neither has state Treasurer Elizabeth Maher Muoio.

The verdict on alternative investments most likely will wait until the governor fills many vacancies on the 16-member council. Governors directly choose eight representatives, usually from business backgrounds like Mr. Byrne, who is founder and managing director of Byrne Asset Management, Princeton, N.J. Like Mr. Byrne, all of the gubernatorial appointees have resigned. Most remaining members represent labor unions.

Mr. Murphy nominated eight members in April, but the Senate Judiciary Committee hasn't held hearings on the nominees and no hearings have been set on the Senate calendar. The council, which meets about every two months, canceled its July meeting. The next meeting is slated for Sept. 27.