Minnesota State Pensions' ESG Policy Is Deeply Flawed
Ironically, the only “ills” Minnesota's state pensions are unwilling to address are those within their own halls.
The $146 billion Minnesota State Board of Investment (SBI) has adopted a set of Investment Beliefs for managing the assets of the funds it manages to support the retirement plans of the state’s employees. Included in the Beliefs is the following Environmental, Social and Governance (ESG) Policy:
Utilizing engagement initiatives to address environmental, social and governance-related issues can lead to positive portfolio and governance outcomes. In addition to specific engagement strategies the SBI might apply, proxy rights attached to shareholder interests in public companies are also “plan assets” of the SBI and represent a key mechanism for expressing SBI’s positions related to specific ESG issues. By taking a leadership role in promoting responsible corporate governance through the proxy voting process, SBI can contribute significantly to implementing ESG best practices which should, in turn, add long-term value to SBI’s investments.
In recent years state pensions have increasingly created rules and mandates targeting ESG investment strategies. Nevertheless, ESG investing today is more controversial than ever.
In recent years state pensions have increasingly created rules and mandates targeting ESG investment strategies. Nevertheless, ESG investing today is more controversial than ever. In 2024 alone, more than two dozen ESG bills have been introduced—some favorable to ESG but most oppositional—and six so far are now law.
According to Pew, 2024 has seen an evolution toward a more measured approach—on both sides of the issue—with a greater recognition that strict pro- and anti-ESG investing mandates can lead to unintended costs and administrative challenges.
Public pensions, notes Pew, tend to use ESG factors to illuminate material risks and opportunities—such as a company’s record on employee relations or compliance with environmental regulations—that should be considered as part of any financial decision-making process. That is, pensions use ESG to inform overall investment and risk management strategies. State policymakers, however, have largely viewed ESG through a “social impact” lens, which has prompted policies either prohibiting or requiring certain ESG-related investments. Not only is this view potentially out of alignment with pension systems’ fiduciary role to act in the best interest of its beneficiaries, it also risks leaving money on the table, says Pew.
Pew concludes:
Lawmakers’ and financial practitioners’ differing interpretations of ESG can lead to confusion and politicization. Recent laws governing ESG investing, whether with a favorable or unfavorable view, may intend to mitigate exposure to financial risks for pension funds and other critical state investments, but in practice, some laws are having the opposite effect. These conflicting outcomes make it even more challenging to implement ESG mandates, as evidenced by a recent ruling in Oklahoma that halted the state’s energy law. In her ruling, Judge Sheila Stinson wrote that it was very likely the law’s “stated purpose of countering a ‘political agenda’ is contrary to the retirement system’s constitutionally stated purpose” to act in the best interests of its beneficiaries.
These latest developments underscore the fact that policies restricting investment options often force officials to make immediate and unanticipated changes to investment and borrowing strategies and approaches. The resulting upfront transaction costs and administrative challenges could ultimately mean greater costs to taxpayers to meet states’ retirement obligations.
As noted on the SBI website, at its February 2020 meeting, the SBI passed a resolution concerning ESG initiatives. Consistent with its fiduciary responsibility, the Board determined the following measures be taken:
• Continue to actively vote proxies in accordance with SBI proxy guidelines, policies, and precedents as approved by the Board.
• Continue to participate in ESG coalitions and engage with corporations on ESG related issues.
• Prepare and update a Stewardship Report and other ESG informational materials.
• Develop and implement plans for reporting and addressing ESG investment risks; to evaluate options for reducing long-term carbon exposure; and to promote efforts for greater diversity and inclusion on corporate boards and within the investment industry.
Further, the SBI participates in multiple organizations that address ESG issues including the Council of Institutional Investors and the United Nations Principles of Responsible Investment. Says SBI:
These organizations provide research, engagement opportunities and other resources that enable the SBI to more effectively assess relevant ESG issues. Common issues include, but are not limited to, climate; gender, racial, and ethnic diversity; shareholder rights; corporate governance; and workers’ rights. The SBI continues to assess additional resources.
With respect to Manager Due Diligence, SBI states:
SBI investment staff work with external investment managers to address ESG-related risks within the manager's investment portfolios and within the managers' organizations themselves. Most managers have a documented ESG integration approach and DEI policy. In general, the goal is to assess the quality of these approaches. The team tries to establish consistency in information gathering that will help evaluate managers over the long-term and track changes as they are revealed in subsequent meetings. It is important for managers to both evaluate ESG risks and opportunities prior to making an investment; and add value by improving ESG practices once a company is purchased.
For all the debate surrounding the use of ESG for investing, the “G” or governance is often overlooked.
As many commentators have observed, for all the debate surrounding the use of ESG for investing, the “G” or governance is often overlooked.
In the intricate web of sustainability, where environmental concerns and social impact often claim the spotlight, one critical pillar remains steadfast in its significance: governance, the unsung hero shaping the very foundation of ESG.
Governance is the system of rules, policies and practices by which a company is managed in a responsible, ethical and transparent manner. It involves the relationship between a company’s management and its board of directors, its investors and other stakeholders, to whom it is accountable.
It therefore forms the bedrock of the ESG agenda, as it encompasses not only one-third of the ESG equation but also acts as a prerequisite for achieving all ESG goals. Behind every violation of environmental or social commitments lies a failure in corporate governance, whether it's insufficient anti-corruption measures, flawed incentive systems, conflicting lobbying efforts, ineffective board supervision or unprepared leadership.
In essence, sustainable governance lies at the core of the ESG agenda, and overlooking it can hinder a business’s sustainability progress.
The Minnesota state pensions’ ESG Policies are deeply flawed in that they focus upon external popular environment and social issues but fail to address the funds’ greatest internal governance issues: a profound lack of transparency, failure of board oversight and grossly misleading performance and fee disclosures to the public.
It is ironic that seemingly the only “ills” these two pensions are unwilling to address are those within their own halls.
Indeed, if the funds were committed to operating in a “responsible, ethical and transparent manner” and improving “the relationship between… management and its board of directors, its investors and other stakeholders, to whom it is accountable,” they would never have preemptively, aggressively sought to undermine an investigation by an independent expert commissioned by thousands of state teachers earlier this year into potential mismanagement and wrongdoing.
Most disturbing, improving transparency, board oversight and reporting to the public would have an enormous impact upon the performance of the pensions, potentially improving retirement security for participants and lowering taxpayer costs—objectives clearly consistent with the fiduciary duties of the funds’ boards.
… improving transparency, board oversight and reporting to the public would have an enormous impact upon the performance of the pensions, potentially improving retirement security for participants… Further, there are no costs related to improving governance of the pensions, indeed, better governance through transparency will actually lower costs.
Further, there are no costs related to improving governance of the pensions, indeed, better governance through transparency will actually lower costs. For example, if SBI and TRA required their external investment managers to be fully transparent regarding conflicts of interest and fees, fee competition would be enhanced and any excessive, bogus or illegal fees would be eliminated. Requiring external investment managers to be compliant with environment and social concerns while they operate in secrecy, i.e., ignoring transparency governance, is absurd.
Although governance risks pose challenges, it is a crucial part of ESG. Effective governance ensures compliance, transparency, and accountability while addressing environmental and social risks. It integrates ESG considerations into decision-making, drives sustainable practices and attracts responsible investment. Strong governance builds trust, enhances stakeholder confidence and enables organizations to navigate complex ESG landscapes for long-term value creation and positive societal impact.
In conclusion, improving governance at Minnesota’s state pensions—consistent with the funds’ ESG Policy—should include, but not be limited to, the following:
1. Enhanced transparency through rigorous enforcement of public records laws, including but not limited to, disclosure of all investment documents to the public and any of the three oversight boards;
2. Recording of all board meetings so that active, as well as retired teachers and other stakeholders can access the meetings;
3. Independent investigation into the accuracy of investment performance and investment costs reporting of the funds over the past 30 years.
4. The CIO and/or consultant, who are responsible for designing and implementing the investment program, should not be involved in benchmarking and reporting of investment performance.
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