What’s Motivating CalPERS?

Ashby Monk

In June, the State of California managed to stave off fiscal crisis by filling a $26 billion budget deficit with dramatic spending cuts. Fast forward to Monday, when the California Public Employees’ Retirement System (CalPERS) Board announced it would invest an additional $800 million in California infrastructure over the next three years (four times the fund’s current allocation to Californian infrastructure). Coincidence?

I hope so. Because if CalPERS is being directed by state politicians to invest in local infrastructure to make up for spending cuts, then the public pension fund may be experiencing a profound governance failure. Don’t get me wrong, I’m a big fan of infrastructure assets for pension funds, but politically motivated investing tends to be a recipe for disaster in public pension funds.

But before I get too carried away, let’s turn to the official characterization of the investment.

Here’s President of the CalPERS Board of Administration Rob Feckner explaining the move:

“We are prepared to increase our investments in infrastructure with our first and foremost goal being on investment returns, and a secondary goal of supporting essential community services that are crucial to continued economic development, a safe environment, and healthy schools and communities.”

And here’s George Diehr, Chair of the CalPERS Investment Committee, on the investment rationale:

“Infrastructure is an integral part of the CalPERS investment portfolio…We’re looking for long-term economic value by providing safe, reliable, efficient and high quality services that are vital to California that not only meet our risk-return objectives, but that we believe have the extra benefit of creating jobs and ultimately improving the economic climate.

Obviously, these gentlemen strike the right tone in their comments by referencing their fiduciary and ethical duty to maximize returns for the exclusive benefit of the pensioners. However, the sections that I bolded still worry me. Clearly, these comments show that at least part of the decision to increase infrastructure investments in California was motivated by non-financial criteria.

The negative effects of political interference on public sector pension funds have been well recognized in the academic literature and elsewhere. The problems stem from the fact that partisan politicians (motivated by and tied to the reelection cycle) will seek out short-term advantages to the detriment of the institution’s long-term purpose and mandate. So, in the case of CalPERS, there is a concern that the politicians pushing the public pension to invest in California to boost local economic conditions aren’t really interested in the institution’s purpose and mandate.

And, you might say, so what if returns are damaged if jobs are created? Well, I have to admit, that’s a really good question given the state’s high unemployment. But (!) recall that CalPERs is already underfunded, and the state government is banking on high financial returns to prevent an eventual state bailout — a bailout that will require dramatic spending cuts and revenue increases. (Sound familiar?) Also, recall that the legitimacy of the fund is based on paying pensions…not investing in local firms and assets.

In my view, however, the real problem is temporal: The negative impacts of politically motivated investing won’t necessarily be shouldered by the current generation of politicians (or taxpayers), which is why it’s seemingly attractive. They question, then, is whether it is ethical to kick the can down the road to the next generation? I think not. The point of good governance and institutional independence with appropriate accountability is to ensure that the pension fund achieves its long-term objectives, and that the short-term issues arising from political and social crises don’t compromise the fund’s over-arching purpose and legitimacy.

Now, it’s impossible to know what motivated CalPERS decision in this case. Perhaps the fund really does see lots of amazing infrastructure opportunities in California — there must be $800 million worth of good investments in the state! And, moreover, I think the return profile of infrastructure assets offers a great match for pension fund’s long-term liabilities. But I just worry about the sustainability of a long-term institution that isn’t independent from short-term political interests.

4 Responses to “What’s Motivating CalPERS?”

  1. 1 Tim Hodgson September 15, 2011 at 1:48 am

    I think you are right to worry. However there is some growing academic support for the existence of a home (local) return premium – giving some justification to a home bias. The papers I have seen are for equities, but it stikes me as possible (not certain) that there could also be a local premium in infrastructure.
    I don’t think outdsiders will ever be able to accurately attribute a decision between political interference and an enlightened financial decision.

  2. 2 MMcC September 15, 2011 at 6:53 am

    It’s certainly not a pretty picture but I wonder: is there an example of of a SWF with both a 20-year history and a record entirely free from political interference? Even if we can’t see the latter directly, if we infer it from, say, SWFs investing in territories where the government wants closer relationships or trade flows (my money for your pipeline), or perhaps, SWFs abandoning companies around the time regulation of their products’ availability changes at home (large chunks of ethical investing), how many SWFs look interference-free? I suspect it’s an extremely small number.

    • 3 Ashby Monk September 15, 2011 at 7:13 am

      That’s a good question, Mike. How many are entirely interference free? Perhaps the CPPIB and the Future Fund. But you’re right…it’s quite hard to pinpoint. And as Tim pointed out, it’s not necessarily all bad!

  3. 4 Ashby Monk September 15, 2011 at 6:54 am

    Thanks for the comment, Tim. Right you are: The Coval and Moskowitz papers (and there are many more since) do show the boost to equity returns from local knowledge. I guess in this instance I was just focused on the potential for politicization; but you do raise a great point. Thanks!

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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