The Evolution Of Sustainable Investing At CalPERS

The California Public Employees’ Retirement System (CalPERS) has 2.2 million members and assets of around $510 billion. It is the largest state pension fund in the U.S. On its website it notes that “Under the California Constitution, the Board of Administration has a fiduciary duty to act in the best interests of its members and employers.” Which means generating long-term returns since it has current liabilities for generations to come. As shown in “The CalPERS Pension Buck,” of the $31 billion in payouts to beneficiaries in 2022-23, 56% came out of investment earnings.

CalPERS is known for being a leader in sustainable investing. This has subjected it to critics on both the left (e.g., CalPERS isn’t doing enough to save the world from climate change and to promote DEI) and the right (e.g., CalPERS is pursuing a progressive liberal agenda on topics like climate change and DEI). What both critics fail to recognize is that the pension fund’s commitment to sustainable investing is based on its constitutionally enshrined fiduciary duty.

In 2012 CalPERS published its first report on sustainable investing, “Towards Sustainable Investment: TAKING RESPONSIBILITY.” This report traces the origins of sustainable investing back to 1984 when it started its corporate governance reform program, 20 years before the UN Global Compact issued its 2004 report titled “Who Cares Wins: Connecting Financial Markets to a Changing World” which coined the now highly politicized acronym ESG (environmental, social, and governance). Page 7 of the report contains a chart (below) which identifies some of the major milestones in the development of sustainable investing at CalPERS as of 2012.

Looking at this chart, two phrases come to mind which explain the evolution of sustainable investing at CalPERS. The first is “field building” and the second is “building internal capabilities.” The former refers to actions in which CalPERS has taken a lead in providing the necessary infrastructure and platforms for sustainable investing. Examples of this include helping to establish the Council of Institutional Investors (CII-1985), helping to found Ceres (1989), being a founding member of the International Corporate Governance Network (ICGN-1995), launching with Ceres the Investor Network on Climate Risk (INCR-2003), helping to found the Principles for Responsible Investment (PRI-2005), helping to draft the Institutional Limited Partners Association (ILPA-2009) Principles for PE investing, and forming the Global Peer ESG Exchange (2010).

Examples of building internal capabilities include initiating the corporate governance program (1984), launching the annual Focus List of underperforming company stocks (1987), launching its International Corporate Governance Program (ICGP-1996), launching its corporate governance website (1999), earmarking $457 million for 11 California emerging private equity firms (2001), Board of Administration approval of its Global Principles of Accountable Corporate Governance (GPACG-2008), and Board approval of the implementation plan for Total Fund ESG integration. (2012).

Field building and building internal capabilities go hand-in-hand. The former is about working with like-minded organizations to create principles for responsible investing and sharing knowledge for how to put these principles into practice for building internal capabilities. As these capabilities develop at CalPERS and others, they can inform the field building work. One example of field building leading to building internal capabilities is being a founder member of ICGN and then launching its ICGP, its corporate governance website, and getting Board approval for its GPACG, now called Governance and Sustainability Principles. Another is forming the Global Peer ESG Exchange and the fund’s plan for Total Fund ESG Integration. One An example of how building internal capabilities contributed to field building is its selection of 11 emerging PE managers and helping to draft the ILPA Principles.

These interrelated actions have continued to the present day as shown in the figure below. Its role in the Task Force on Climate-related Financial Disclosures (TCFD-2015), Climate Action 100+ (2016), the Net Zero Asset Owner Alliance (NZAOA), and the ESG Data Convergence Initiative are about field building. Not on their list but I’d like to add CalPERS’ support for the formation of the International Sustainability Standards Board (ISSB). CalPERS RE Energy (2019), CalPERS Mosaic (2023), its $100 billion Climate Action Plan, and CalPERS Labor Principles (2023-24) are examples of building internal capabilities.

My high level view is that in the first two decades there was more focus on field building which contributed to the development of internal capabilities. This pattern continues through 2021, but the last three years have been largely focused on building internal capabilities. I should also note that some of the field building work in which CalPERS has participated, such as Climate Action 100+ and NZAOA has been subject to Republican attack as the work of “climate cartels.” But that is a story for another day.

What is the state of sustainable investing at CalPERS today? It was nicely summarized by Peter Cashion, Managing Investment Director, Sustainable Investments, CalPERS, in a presentation on CalPERS’ 2030 Sustainable Investing Strategy he gave on July 15 at the most recent CalPERS Board of Administration meeting. CalPERS practices a high degree of transparency and so their board meetings are live webcasted. Mr. Cashion’s tight 15-minute presentation starts at 18:20 with an introduction by CalPERS Board President Theresa Taylor.

Field building and internal capabilities buidling can be seen in the slide on objectives (below). Generating outperformance, increasing portfolio resilience, and implementing a path to Net Zero are examples of building internal capabiliites. Promoting greater inclusion and representation in the finance industry and promoting efficient and equitable financial markets through advocacy and regulatory action are examples of field building.

Not surprisingly, climate plays a major role in CalPERS’ sustainable investing strategy. The foundation of its Climate Action Plan is a commitment to invest $100 billion by 2030 in climate solutions. It has already invested $50 billion. There is also a big focus on engagement with portfolio companies, advocating for decarbonization, exiting investments (subject to fiduciary duty) that lack credible net zero plans, integrating climate risk assessment into all of CalPERS’ investments, and measuring and reporting on carbon emissions for its entire investment portfolio.

Although CalPERS is very clear about how its investment decisions are grounded in fiduciary duty, I suspect that it will continue to be subject to pressures on both the left and the right. I can see some on the left calling for CalPERS to be more aggressive in its company engagements and doing more to exit certain investments, particular fossil fuel companies. Conversely, I can see some on the right accusing CalPERS of politically motivated actions in advocating for decarbonization, exiting certain investments, and integrating climate risk considerations in its investment decisions.

There is no simple solution to this problem. The best that can be done is for CalPERS to engage with its critics across the political spectrum. Given its public prominence and high degree of transparency, it seems to me that CalPERS has the capabilities and willingness to do so. The bigger question is whether its critics want to engage and learn. Or, and more likely in my view, are they simply looking for a platform to push their own agendas, willingly ignoring CalPERS’ constitutionally mandated fiduciary duty when it is convenient to do so?