Cognitive Dissonance At CalPERS

How can a fund that is arguably the global champion for ESG investment policies have a Board of directors made up of ESG skeptics? Let’s investigate...


A few weeks ago I heaped a bunch of praise on CalPERS. Why? Because I was impressed with its ongoing attempt to extend its investment time horizon through the incorporation of a broad array of risks into its decision-making process. And given that holding periods for stocks have dropped from around 7 years to 7 months in the last 50 years, I think it’s a good thing for institutional investors to start thinking more about “investing” and less about “trading”.

Specifically, I thought the California-based public pension fund was being quite innovative with the launch of its “Total Fund ESG Integration” policy. In particular, I liked the way the fund framed the rationale for including ESG risks, focusing on the long-term financial payoffs from the broader decision-making framework. Here’s what I mean:

“Take the example of environmental risk. In the longer term, we recognize that rising demand for food and resources globally, coupled with the likely effects of climate change, will have a potential impact on risk-adjusted returns.”

For a long-term investor, I think that makes a lot of sense. And the fact that the fund has launched this policy underscores the buy-in from the CalPERS Board and Management Team for the role that ESG factors play in risk and return over the long term.

(Pause for dramatic effect) ... Or does it?

As it turns out, the – awesomely transparent – CalPERS has rather mixed views on the subject. In a recent document detailing the fund’s new “Investment Beliefs”, the Board’s views on ESG are not all that positive.

First, a bit of background: A growing number of institutional investors are developing a series of formal ‘investment beliefs’ to help provide direction for the organization in terms of investment strategies, policies, and operations. Here are CalPERS’ seven self-evident truths:

  1. “Strategic asset allocation is the dominant determinant of return and risk.
  2. A return premium is required to take on risky assets.
  3. Premium is required for illiquidity.
  4. Long term investment horizon is an advantage.
  5. Inefficiencies in the market create investment opportunities.
  6. Costs matter.
  7. Risk is multi-faceted and not fully quantifiable.”

That all seems sensible, so I don’t have any problems there. But (!) given the fund’s big launch of its ESG initiative a few months back, you would be forgiven for noticing something missing from this list. And I’ll tell you why it’s missing...
Exhibit A: On page five of the Investment Beliefs report, you can see how the seven beliefs were agreed upon. For an investment belief to be adopted, it seems, the Board required 80 percent agreement.

But when the Board was presented with the ESG belief – “ESG factors impact risk and return over the long term” – only 45 percent agreed. In other words, 55 percent of the CalPERS Board is unconvinced that ESG factors will have an impact over the long term!

(Cue Cognitive Dissonance)

What? How can a fund that is arguably the global champion for ESG have a Board of directors – which ostensibly sets the fund’s strategy – that is largely made up of ESG skeptics?

And this is where I get really confused: It turns out that one of the key investment beliefs adopted by the Board shows that the Board does in fact believe in the power of long-term investing. (93 percent agreed that a “long term investment horizon is an advantage”.)

So the Board rejects ESG as a core belief – which, in my view, is part-and-parcel with long-term investing – but agrees that long-term investing offers unique opportunities?

My head hurts.

I guess – to give the CalPERS board some credit – I understand where the skeptics may be coming from: Being a successful investor is hard enough without adding extra financial characteristics into the max. However, I find it very hard to believe that the would-be champion of long-term investing has a Board for which almost half of the members still seemingly believe in the efficient markets hypothesis...the very foundation of short-termism in financial markets.