A New Science of Pension Fund Management

Public pension funds have become powerful and influential players in today's global equity markets, investing trillions of dollars of government employees' retirement nest eggs. Global pension assets are estimated at nearly $30 trillion, and these growing funds are managing an increasingly large proportion of the world's total wealth.

As a counterweight to the short-term mentality that motivates many stock traders, public pension funds have relatively long-term investment horizons. Many operate in the sunshine of regulators, under the close scrutiny of their beneficiaries, and have a fiduciary duty to act in the interests of retirees. That puts public pension funds' investment strategy and performance in the spotlight, and rightfully so. They are responsible for the retirement security of hundreds of millions worldwide, and they are among the largest institutional investors in public companies.

Against this backdrop, many public pension fund managers are evaluating whether their investment decisions should be motivated by the funds' broader role in the countries in which they reside. For example, many pension funds are considering a much larger emphasis on environmental, social, and governance (ESG) factors in their investment policies and practices. These ESG issues cover many topics, ranging from climate change and labor practices to executive pay. This has fueled a healthy debate about how ESG factors should influence how pension funds invest the funds they manage.

At the center of this debate is America's largest public pension fund, the California Public Employees' Retirement System, or CalPERS. The fund manages more than $275 billion and owns significant stakes in many large companies, so it is no surprise that CalPERS is often asked to weigh in on ESG issues. These are hotly contested and politically sensitive issues, and some pension managers might find themselves under pressure to allow politics to guide their investment decisions.

We believe that science, not politics, should guide the way public pension fund managers invest retirees' assets.

CalPERS has taken an important first step toward addressing the ESG debate in the right way: by using hard scientific evidence to determine whether and how ESG should influence how retirees' money is invested. We recently partnered with CalPERS to provide a detailed review and independent analysis of research on the effects of ESG issues on financial performance. Because there is no consensus on how ESG factors influence investment risk and return, improving our understanding of the relationship between ESG and long-term performance is critical for boards of directors, shareholders and everyone who relies upon public companies to be responsible stewards of capital.

Together with CalPERS, we convened a meeting of the minds of top scholars and investment professionals to conduct a rigorous review of the empirical evidence on how ESG issues affect performance. We then conducted an independent compilation of more than 700 research studies and presented our findings to the CalPERS Board.

We told CalPERS that while there is a well-documented link between sound corporate governance and better performance, the evidence so far does not convincingly show that "better" environmental or social practices deliver higher returns for investors. Many on the CalPERS Board remain convinced that ESG factors should inform their investment decisions. But while many in the room held widely divergent views about ESG issues, the Board unanimously agreed the evidence would help them make more informed investment decisions.

Our partnership with CalPERS is an important first step toward ensuring that facts, rather than politics, dictate how public pensioners' money is invested. While the academy is far from perfect, what we do offer is a relatively objective, third party view of controversial claims. Our answers are motivated by the evidence. By subjecting its ESG strategy to rigorous academic scrutiny, CalPERS has shown innovative leadership in sustainable investment.

We urge other public pension funds to bring scientific research to bear on these questions. Like any other investor, these funds should invite, rather than resist, impartial scrutiny of their strategy. That is especially true when the funds at stake are responsible for securing the retirement of hardworking public servants.