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Follow-Up on California Public Pension Law

November 8, 2016

Nighttime Golden Gate Bridge Close Up

We previously blogged about the California State Teachers’ Retirement System (CalSTRS) vote to divest from U.S. companies that produce coal for energy use. This monumental decision is a major step toward widescale adoption of ESG principles in higher-level decision making for pension funds. 

The decision to divest from U.S. thermal coal was somewhat straight-forward for CalSTRS; the decision was only limited to the fund’s passively held equity index portfolio, and active managers had been avoiding U.S. coal sources in recent years. It also coordinates strategically with the already-changing U.S. regulatory landscape, as well as general policies resulting from the recent Paris climate talks. 

California Public Pension System Updates

CalSTRS will now be facing its next set of challenges, as next April it votes on whether also to divest from non-U.S. thermal coal sources. This decision will not be as straight-forward, as the issue of thermal coal consumption is much more complicated at the global level. CalSTRS’s chief investment officer, Christopher Ailman, states that the fund must “consider the human issues as well as the climate issues in emerging market coal.” For instance, in some countries like India, people without electricity must often turn to worse fuel alternatives like wood and dung if coal is not available. 

Since CalSTRS’ vote last February, the fund has taken additional steps to begin implementing these policies. For instance, CalSTRS has committed up to $2.5 billion for low-carbon strategies in U.S., non-U.S., and emerging equity markets. CalSTRS’ passively managed portfolio will:

  • Be invested in an index designed to have significantly lower exposure to carbon emissions than the broad market, and
  • Aim for a near-complete reduction in exposure to fossil fuel reserves

Risk Mitigation Through Hedge Fund Strategies

In addition to its fossil fuel divestment efforts, CalSTRS is also in the midst of introducing additional risk mitigation strategies (RMS) through hedge fund allocations. These aim to smooth volatility as the fund matures by focusing on: 

  • Long treasury bonds
  • Trend following strategies
  • Global macro/Systemic risk premia

Thus, as mentioned in a previous blog, creative use of data would be especially important for CalSTRS in their next steps, as they analyze the various trends and influences involved in non-U.S. thermal coal investment activities.

Additional Pension Plan Fund Activity in the State of California

Assembly Bill 2833: California Gov. Jerry Brown recently signed Assembly Bill 2833 into law. The new law aims to increase the transparency of fees and expenses that are paid to alternative funds. Specifically, every California public pension plan must require all alternative funds in which they invest to make certain disclosures. 

Additionally, the public pension plan must disclose that information in meetings open to the public, along with other requirements and implications associated with the new law. There may still be uncertainties and lack of clarity in the law regarding specific areas like alternative funds. 

Court Ruling: Last August, an appeals court in California declared that public retirement plans could be reduced and that they were not “immutable.” A three-judge panel held that the law merely requires the California government to provide a pension that is “reasonable.” The ruling is now before the California Supreme Court. While some express doubt that the ruling will be upheld, many feel that the ruling could be a vehicle for overall reductions in state and local pension systems, possibly in the amounts of hundreds of billions of dollars.

Overall, it appears California is taking several steps toward reforming the public pension plan situation. Pension funds in other states, like Illinois and Pennsylvania, are facing completely different challenges, such as those associated with fund maintenance. California, on the other hand, appears to be taking the lead with requirements that are going above and beyond those of other states. While these steps may seem incremental, the effects of these new developments cannot be underestimated.

The laws governing U.S. public pension funds are highly complex and are subject to constant adaptations and evolution. If you have any questions, concerns, or disputes related to public pension funds and issues like fiduciary obligations, contact us today at Kessler Topaz. Our team is dedicated to staying on the forefront of breaking developments, which allows us to maximize strategic involvement in important cases.