“Fossil fuels make modern life possible.” — William Coaker, Jr., Chief Investment Officer, SFERS

“Well, actually…” — Science

Author’s note: 1/26/2018 — This article appeared in The Bay City Beacon on Jan 23rd, 2018. Since then, the SFERS board has voted to take tentative stepstowards adopting a carbon free policy. Many activists have complained that the SFERS plan for divestment is “vague and non-committal” and does not go far enough.

San Francisco’s Retirement Board and the Board of Supervisors may clash today on whether to free the City’s pension investments to divest from fossil fuels when the pension governing body votes on the issue. Meanwhile, new investment strategies implemented by similar bodies could be instrumental in bringing both sides together.

On January 24th, the Retirement Board of SFERS (San Francisco Employee Retirement System) will vote on a proposal to divest San Francisco’s city pensions from the Carbon Underground 200, the 200 publicly traded companies with the largest fossil fuel reserves.

In an effort to reduce global carbon emissions, public pressure groups have lobbied universities, municipalities, and their investment managers to eliminate their investments in coal and oil companies.

The SFERS vote is significant in that it pressures San Francisco, where significant parts of the city are projected to be flooded by rising sea levels, to join other municipalities such as New York City, New York State, Santa Monica, Washington D.C., and Seattle in their efforts to tackle the risks of climate change. Each of these cities’ pension funds have taken the first steps to align their pension investments with the global need to address the issue.

So far, leading experts have suggested it may be a smart financial move.

Recent research into the performance of investment portfolios that have divested from fossil fuels shows that the risk-adjusted returns of global investment indexes that excluded fossil fuel companies exceeded similar indexes that included fossil fuel companies over a 1 year, 3 year, and 5 year time period. In 2015, an investment research firm, MSCI, discovered that investors who dumped companies with large holdings of coal, oil and gas, earned an excess return of 1.2% per year.

Because of these initial encouraging results, leading investors worldwide have begun to dive deeper into the research and data behind the long term effect of carbon emissions, and low carbon policies on their portfolios. In particular, investors are looking to minimize “stranded asset risk” — or the risk that the value of carbon assets decline as government policies and new technologies reduce demand for fossil fuels.

Fossil fuel divestment is not limited to large institutions. Individual investors have also taken action to reduce the carbon footprint in their retirement accounts.

Using free online tools, such as the fossilfreefunds.org site, anyone can research the carbon footprint of their own mutual funds. Almost 60,000 individuals have already made pledges to divest from the fossil fuel energy industry.

The DivestInvest network estimates that these pledges account for $6 trillion in assets that will be invested into fossil fuel free or low carbon investments. To accommodate this growing demand, investment managers large and small have brought fossil fuel free and low carbon target investment products to market.

Impasse between the Board of Supervisors and SFERS

Despite San Francisco’s strong heritage of progressive policy, the San Francisco Board of Supervisors and SFERS have been deadlocked on this issue for quite some time. SFERS manages the pension plan for 59,000 current and retired workers from the City. The plan currently has about $23 Billion in assets, of which about 2.07% of its assets ($475 million) are invested into coal, oil, and gas companies.

In 2013, the San Francisco Board of Supervisors voted unanimously to instruct SFERS to divest the City’s pension plan from fossil fuel energy companies. In 2015, the Board of Supervisors voted to divest from all thermal coal holdings and reinvest the proceeds into renewable energy. However this mandate has only been partially implemented, following a SFERS staff recommendation to divest from some, but not all thermal coal companies.

The Retirement Board at SFERS and its investment consultant, NEPC, don’t seem to have done their research on divestment. They’ve been repeatedly delaying a vote on the issue for over four years.

Most alarmingly, SFERS’ Chief investment Officer, William Coaker, Jr., and NEPC said that “fossil fuels make modern life possible” and by divesting, SFERS would lose its standing to engage fossil fuel companies on their transition to a low carbon future.

The bulk of a 164 page report, provided as evidence for the board decision, is comprised of BP’s Energy Outlook, pessimistic projections on the future of Electric Vehicles and analysis about SFERS 1998 tobacco divestment. BP, formerly known as British Petroleum, is a global energy producer, and not a disinterested party.

The Retirement Board itself is split, with SFERS board member Victor Makras calling the reports “dishonest” and claiming that no study of the long term investment returns of fossil fuel free investments was ever performed by SFERS or NEPC.

After much frustration, the Board of Supervisors became impatient with the lack of action from SFERS. In October 2017, Supervisor Aaron Peskin authored a second resolution to divest the city’s pension plan from fossil fuel companies. The resolution again passed the Board of Supervisors unanimously, with Supervisor Peskin threatening a ballot measure if SFERS did not take serious action to consider the recommendations from the Board of Supervisors.

Potential Solutions

SFERS has some tools available which may provide a solution to some of Mr. Coaker’s concerns. In 2016, The California State Teachers Retirement System (CalSTRS) had a similar mandate to reduce the carbon emissions in its investment portfolio. CalSTRS was asked to use its investment portfolio to reduce carbon emissions, to actively engage energy and other fossil fuel companies, and to maintain risk adjusted investment performance. To solve this problem, CalSTRS created a “low carbon target” portfolio.

This portfolio reduces investments in companies with higher carbon emissions in all industries, not just the energy industry. Low carbon target portfolios invest more assets into specific airlines, auto companies, banks, manufacturing companies, consumer products companies, and service companies which have lower carbon emissions than their peer companies while reducing or eliminating investments in companies that have higher levels of carbon emissions.

The net result is a portfolio that maintains broad industry exposure with a significantly lower carbon footprint.

A low carbon target portfolio does not mandate a complete prohibition on holding coal and oil & gas companies. This allows the pension plan to maintain small investments in these companies in order to retain its proxy voting stake and to engage other shareholders to further pressure companies to reduce their carbon footprint. By targeting companies across the investment spectrum rather than just fossil fuel energy companies, MSCI estimates that the low carbon target portfolio can maintain its benchmark investment performance and reduce carbon emissions more than a strict fossil fuel free portfolio.

Fast forward to today. SFERS’ Retirement Board is scheduled to debate and vote on the issue this January 24th. The Retirement Board appears split between those who have advocated for divestment and those who remain opposed. The outcome of the vote is uncertain.

While both the investment and activist communities have recognized that exposure to carbon assets is an investment risk, SFERS seems to going its own way and ignoring established research and investment trends. A vote of inaction would place SFERS out of step and lagging behind other large pension plans within California, across the country, and around the world. We hope that SFERS will make the right decision for future generations of city residents and for all global citizens.

Vijay Rao, CFA, FRM is the Chief Investment Officer at Just Invest, Inc., a Registered Investment Advisor and technology firm delivering personalized investment solutions to individuals, families and mission driven organizations. To learn more, you can visit www.justinvest.com or contact Vijay directly atvijay.rao@justinvest.com


This article first appeared in The Bay City Beacon on January 23rd, 2018.