December 26, 2017

New Report Shows Divestment Would Cost New York State Pension Billions

A new study just released by the Suffolk County Association of Municipal Employees (AME) raises serious concerns about proposals by New York political leaders to divest the state pension from fossil fuels. If the pension were to do so, the report finds that it would lose $2.8 billion over 20 years.  The report’s analysis found that the fund’s energy investments have outperformed other sectors and were responsible for strong returns in 2016.  Eliminating these well-performing stocks would impact the overall performance of the fund and diminish returns on an annual basis and over the long term.

The report is timely, given that New York Governor Andrew Cuomo just last week endorsed divesting the New York State Pension from fossil fuels.  New York State Comptroller, Tom DiNapoli however, has consistently rejected such calls citing his fiduciary duty.   DiNapoli responded to the governor’s call last week by reiterating that the fund had no plans to divest.

The study, commissioned by the Suffolk County Association of Municipal Employees, provides several financial reasons for avoiding divestment.  From the report:

“Given the unique role of the energy sector in the economy, investors that chose to remove traditional energy from their investments reduce the diversification of their portfolios and thereby suffer reduced returns and greater risk. Investor costs are further compounded when considering the additional costs of transactional fees, commissions, and compliance costs that are unavoidable when divesting.   During a period when many pension funds are underfunded.” (emphasis added)

The idea that divestment leads to reduced diversification benefits and higher transaction costs is something that has been well-established in academic studies by respected Professors Daniel Fischel of the University of Chicago Law School and Hendrik Bessembinder of Arizona State University.  They found in their respective studies that when these costs are imposed on pension funds, the losses could top billions, if not trillions of dollars collectively over the long term.  In fact, these two studies helped inform AME’s analysis of how divestment would specifically impact the New York State Common Retirement Fund, with both professors’ work referenced throughout.

Given this financial reality, Comptroller DiNapoli cannot in good conscience divest from the fossil fuel sector. The law clearly requires him to act in the best interests of the fund,

“In fulfilling mandated responsibilities, the Comptroller is legally bound by a fiduciary duty to act prudently and solely in the interest of, and for the exclusive purpose of providing benefits to, the Retirement System’s participants… Investment decisions must be guided by his fiduciary duty and cannot be driven by unrelated motives, no matter how compelling.” (emphasis added)

Further, under a divestment policy, the New York State Pension Fund would be giving up the ability to influence targeted companies when it comes to issues of climate change.  DiNapoli has pointed out in the past that engagement is preferable to divestment.  The report reached the same conclusion:

“Selling shares to other investors who might not share our concerns about these issues or worse deny climate change and support the status quo is not a wise option.”

And what is to gain by ceding influence and taking on lower returns?  Not a whole lot, according to the report.

“It is a venerable concept to think divesting from fossil fuels would provide the “silver bullet” for climate change; however this is foolish and does not take into account the large and generational role this natural resource has had on global markets.”

Instead, pensioners and state governments will be forced to make up for the shortfalls resulting from this empty gesture.  From the report:

“Sector based divestment would adversely affect the New York State Retirement System and result in a significant increased pension contribution by local governments. Divestment losses would jeopardize critical civic services such as public safety, healthcare, and education, which according to the 2018 budget for the State of New York account for 74% of budget spending. The losses from divestment would mean that State and local governments would have to cut critical services or raise taxes to ensure that the pension system is funded.” (emphasis added)

Luckily for New York pensioners, the comptroller is in charge of investment decisions, not the governor.  DiNapoli has maintained an anti-divestment stance and has emphasized the importance of engagement over divestment.  This latest report shows direct losses can be expected if the fund were to heed Gov. Cuomo’s advice and to divest—this would not impact the targeted companies but would negatively impact vital services and force local governments to pay more to make up for the fund’s financial losses.

Hopefully, for the sake of New York beneficiaries, DiNapoli will continue to rebuff divestment efforts by politicians and instead continue to adhere to his fiduciary duties.