When a pension funds investment universe is limited, the potential for harm to performance is great, while the reason for the limitation generally is dubious and usually politically motivated.
That became evident recently at the $236.6 billion California Public Employees Retirement System and at public pension funds in Illinois.
At CalPERS, restrictions on investing in some emerging markets have cost 2.6 percentage points in performance since they went into effect in 2002, according to a staff memo released in February. Because of the restrictions, two of CalPERS three emerging markets managers, running $1.7 billion each, significantly underperformed unconstrained portfolios, the memo noted. These are opportunity costs, but they are real, and taxpayers or state employees eventually might have to make up the difference.
The CalPERS board now is backing away restrictions on investing in some emerging markets. Its new $500 million allocation to corporate governance funds will not be restricted by the policy, and the board might consider reviewing the policy.
Six states have policies on divestiture of companies doing business connected with Sudan: Illinois; California; Connecticut; Maine; New Jersey; and Oregon. At least 22 others have had legislation introduced, or have discussed introducing it.
But Judge Matthew F. Kennelly, of the U.S. District Court, Chicago, on Feb. 23 overturned the Illinois law ordering funds in that state to divest. He wrote in his decision: First, the restrictions on pension funds ability to invest in many equities and mutual funds unquestionably constitutes irreparable injury. Second, the plaintiffs have no adequate remedy at law. Defendants are state officials who have sovereign immunity from suits for damages.
As for relying on the state to make up any performance shortfall caused by investment restrictions, the judge wrote, There does not appear to be any support for defendants contention that the state guarantees the benefits of municipal pensioners.
The effect of the restrictive investment policies on the companies and countries has been in doubt.
Even the Illinois state attorney generals office arguing in court in defense of the Sudan statute stated the law does not impose any substantive economic pressure on the Sudan The act is instead merely moral investment style chosen by Illinois citizens codified into law. Also, it stated, it is difficult to conceive how a single act of divestment would cause the member companies a direct and adverse economic effect.
Taxpayers and plan participants will have to contribute more to make up costs to CalPERS, the Illinois public funds and other restricted funds because of the lower returns caused by investment restrictions.
In Illinois, the Legislature is to blame and ought to reimburse public pension plans in the state for the cost of the divestment law. The $39 billion Teachers Retirement System of the State of Illinois, for instance, estimates the law cost it $2.1 million so far, including transaction costs; the Illinois State Board of Investment, more than $850,000.
But its unlikely the Illinois Legislature would ever do so. It has neglected properly funding state pension plans for many years.
Illinois public plans officials say they are continuing to operate under the law while seeking counsel on the decision. They need assurance they can return to the situation that existed before the law. State Attorney General Lisa Madigan should announce there will be no appeal; state legislators should announce they will not try to rewrite the law.
Illinois should now be free of the misguided law, but, unfortunately, the five other states that have adopted some form of Sudan divestment are stuck with their versions of the law. Fund officials in all states with such laws or considering such laws should speak out about the harm of such restrictions.