Munnell and Chen: New Developments in Social Investing by Public Pensions

From the Introduction:

Social investing is the pursuit of environmental, social, and governance (ESG) goals through investment decisions. Public pension funds have been active in this arena since the 1970s, when many divested from apartheid South Africa. They have also aimed to achieve domestic goals, such as promoting union workers, economic development, and homeownership. In the mid-2000s, the focus shifted to preventing terrorism and gun violence. This effort included “terror-free” investing in response to the Darfur genocide and to weapons proliferation in Iran. And, after mass shootings in Aurora, CO, and  Newtown, CT, some public funds shed their holdings in gun manufacturers. Most recently, states have renewed the call to divest from Iran and have increasingly targeted fossil fuels to combat climate change.

This brief provides an update of social investing developments and assesses whether, in this changing environment, public funds should engage in this practice. This assessment addresses two questions: 1) can ESG-screened portfolios meet the same return/risk objectives as non-screened portfolios; and 2) are public plans the right vehicle for advancing ESG goals? The discussion proceeds as follows. The first section explores trends in social investing and the U.S. Department of Labor’s guidance on this activity. The second section examines recent state divestment efforts. The third section analyzes the economics of social investing. The fourth section outlines the economic, political, and legal complications. The final section concludes that although social investing may be worthwhile for private investors, lower returns and fiduciary concerns make public pension funds unsuited for advancing ESG goals.

Available for download here.

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