Divestment as an ESG Tool: Calpers and Tobacco Stocks (A)

This case uses the California Public Employees' Retirement System (CalPERS) to set the stage for unfolding an analysis of economics and values in the decision to divest tobacco stocks and bonds from the internally managed portion of the CalPERS portfolio. Written from public sources, it offers a discussion about fiduciary responsibility for long-term retirement security and investment policies around environmental, social, and governance (ESG) strategies for the public pension fund. The material includes financial data that further allows calculations and discussion on tobacco investments outperforming the broader market. This A case opens with the CalPERS investment committee having made a decision to recommend removing tobacco investment restrictions. The CIO reflects on whether supporting investment in tobacco firms conflicts with CalPERS's member health and health care mission. Did supporting continued divestment mean CalPERS was putting its own social priority and ideals ahead of its clients' investment goals? The case data should lead most to conclude the fund was breaching its fiduciary duty. Excerpt UVA-F-1948 Jun. 4, 2020 Divestment as an ESG Tool: CalPERS and Tobacco Stocks (A) As he prepared for the December 2016 Investment Committee meeting, Ted Eliopoulos was conflicted. As the chief investment officer (CIO) of the California Public Employees' Retirement System (CalPERS), he oversaw an investment office of over 300 employees and was responsible for investment policies, risk management, corporate governance standards, and environmental, social, and governance (ESG) strategies for the public pension fund. At a time when some worried that the rising numbers of California retirees put significant burdens on pension funds, Eliopoulos was under pressure to shore up long-term retirement security while also staying true to the state's ESG principles. He knew this would require some difficult decisions. California's promise to pay pension benefits in future decades entailed a fiduciary obligation to ensure that as market conditions changed, the balance between risk and return on CalPERS's investments was appropriate. In 2014, CalPERS had initiated an investment strategy review under the Policy Revision Project, and by the spring of 2016, this had led the investment committee to revisit the organization's restrictions around tobacco investments. Over 15 years earlier, tobacco stocks and bonds had been divested from the internally managed portion of the CalPERS portfolio, though they were still permitted in externally managed portfolios. The belief at the time was that the tobacco industry would not survive the heavy regulation headed its way, nor would it recover from the immense litigation against tobacco companies. Despite these threats, by 2016 the tobacco industry had outperformed the broader market substantially, with significant cumulative returns. Outside observers had wondered if the tobacco divestment had been a breach of CalPERS's fiduciary duty. While the divestment had seemed to have no downside 15 years before, it had resulted in a lower return than if CalPERS had not divested. At the end of the day, wouldn't a higher return have been better for California's future retirees than the satisfaction that their pension fund was not promoting smoking? Despite all the positive qualitative factors that favored ESG investing, Eliopoulos wondered if it might not have been worth the forgone gains. . . .