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Is South Africa More Progressive Than California?

After gathering dust on a shelf for more than 20 years, it seems the idea of 'impact investing' is being tabled once more at pension funds around the world. Why? And why not?

Let me begin this post by saying that a pension fund exists...to pay pensions. They are special purpose vehicles set up for a singular purpose: to save and invest financial assets to meet future pension obligations. Pension funds are not set up to... bail out banks (as in Ireland); prop up local businesses (as in Connecticut); or serve as piggy banks for governments (as in Argentina). Are we clear? Cool.

With that idea in hand, let’s take a deeper look at the issue of impact investing. (Which, after gathering dust on a shelf for more than 20 years, seems to have been tabled once more.) Indeed, lots of funds around the word – or rather, lots of sponsors of funds around the world – are wondering whether the money accumulated in their pensions can be leveraged in ways that offer economic and social benefits to the local citizenry in addition to the traditional benefits to pensioners. In other words, can a pension fund do more than just make returns...and still make sufficient returns (in reality, not expectation) to meet core objectives?

Interestingly, it depends whom you ask. If you ask California’s CalPERS, the answer is unequivocally, “No!” (And I’m guessing most of this blog’s readers immediately thought to themselves: ‘Bad-idea jeans.’) But not everybody sees it that way. For example, if you ask South Africa’s GEPF the answer to this is unequivocally, “Yes!” So let’s investigate a bit to see if we can unpack the differing views on this issue.

To begin, I’d like to refer you to a nice article outlining some of the GEPF’s investment beliefs (some of which I talked about previously here). In short, the fund takes the position that returns should not be the sole driver of investment decisions; rather, it should also consider ESG factors and seek to generate widespread economic benefits. Why? Here’s a relevant blurb from John Oliphant, head of actuarial and investments, at GEPF:

“We [GEPF] are effectively a third of South Africa’s GDP so what we think is that if the country does not do well then the fund will not do well because we own a slice of the economy...Anything that you care to see when you arrive in South Africa – whether you arrive at the airport, whether you drive on the roads, whether you buy food in the shops, or whether you stay in a hotel – we own a piece of it. So it is critical that the manner in which we invest somehow benefits the economy and benefits the GEPF.”

In short, the GEPF staunchly defends the notion that making money over the long term will require spurring growth in the local economy. In other words, meeting pension liabilities in the long-term requires thinking about more than just pension liabilities today. As such, it takes an active role in supporting local firms and projects.

Now let’s turn to CalPERS, which is currently facing a tough (and common) question from its sponsor about the fund’s infrastructure portfolio. It goes something like this: ‘If you are going to invest in infrastructure, why not look at infrastructure here, in California, before you look for similar deals elsewhere?’ And it seems like a fair, if often dismissed, question. After all, CalPERS has $5 billion to invest in infrastructure. California needs multiples of that to meet its existing infrastructure needs. Why not combine the two for a win-win? And that is what the State Legislature has been considering with a new Bill (SB 955), which would call for the following changes to CalPERs’ investment policy:

“Requires CalPERS to invest in California infrastructure projects over alternative out-of-state projects when consistent with the Board’s fiduciary duties to minimize the risk of loss and to maximize the rate of return...

“Authorizes the Board to invest in out-of-state infrastructure projects only after having considered existing California infrastructure project proposals and determining that investment in the in-state projects would not be consistent with the Board’s fiduciary duties to its members when compared to out-of-state infrastructure projects.”

Interesting idea. But, sorry, Charlie, this isn’t South Africa. And, as such, the CalPERS Investment Committee has formally rejected this idea. And here’s why:

“Requiring the Board to alter its Infrastructure Investment Policy in a manner that could effectively eliminate CalPERS ability to consider out-of-state opportunities and impose several potential risks may not allow the Program to meet the Fund’s investment needs going forward.”

“The requirement to give priority to in-state investments will severely limit the ability of staff to access out-of-state and potentially superior investment opportunities, resulting in lower investment returns and expanded risks not currently experienced by the Program.”

“Effectively focusing all CalPERS infrastructure investments to California projects unnecessarily exposes these assets to geographic risk, including damage and destruction caused by natural disasters such as earthquakes, landslides and wildfires.”

And let’s not forget that the State Constitution says, in Article 16, Section 17, that CalPERS (and other state pension funds) must diversify its investments to minimize risk of loss and maximize returns.

So the answer is clearly, “No.” And there are some very good reasons for this position.

Now’s the part of the show where I infuriate everybody with ambiguity...I think both policies have merit. The CalPERS policy reflects the reality of public investing; these funds fall victim to publicized investments in local jurisdictions that often jeopardizes long-term returns. But I also think the GEPF’s logic is reasonable (with the right mix of governance and independence). Ultimately, these countries are at different stages of development and their institutions will inevitably play a different role. They are both pension funds, but thinking that they have to have the same values and objectives is only something a Chicago-based, financial economist would argue (zing). I think we need to appreciate the local differences here.

For example, one fundamental difference between the two funds is their exposure to their domestic economies. 87 percent of the GEPF’s portfolio is invested in South Africa, while CalPERS only has 8.5 percent. In other words, one fund (GEPF) is completely reliant on the local economy’s vibrancy to pay benefits, whereas the other fund (CalPERS) only views the local economy as one part of a broad and diversified portfolio. In this situation, it might make sense (from the perspective of paying future pensions) for the GEPF to take a more active role in spurring domestic growth; its long-term interests may be served by such a policy. (Let’s leave aside the issue of whether GEPF should be better geographically diversified.) For CalPERs, the local investments are far less meaningful to the fund’s long-term sustainability.

Anyway, unfortunately I don’t have the answers. But I am at least trying to keep an open mind about these different approaches. After all, the last few decades haven’t been all that great for the traditional models of finance. Maybe the South Africans have a model that’s worth learning more about, especially from the perspective of other developing economies.

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