Kansas pension investment advisers caution against robust legislative rebuttal to ESG activists

TOPEKA — Investment advisers urged the Kansas Public Employees Retirement System’s board of trustees to adopt a stay-the-course approach to growing demands for modification of institutional portfolios to match political ideas on energy policy, climate change and the carbon economy.

The advisers acknowledged the rising temperature of people on the political left and right, but cautioned requiring or banning investment in certain companies could undermine financial performance of KPERS’ $24.8 billion portfolio. They warned transferring KPERS portfolio management duties from investment management companies BlackRock or Mellon to an in-house model could diminish the state pension system’s bottom line.

KPERS provides retirement, disability and death benefits for Kansas’ state, school and local public employees. The retirement system has more than 325,000 members.

Concern has arisen primarily at BlackRock, the world’s largest asset manager, after the company’s chief client officer, Mark McCombe, publicized BlackRock’s position on energy investments with respect to pension funds. Nearly 20 state attorneys general, including Kansas Attorney General Derek Schmidt, denounced McCombe’s perspective and the so-called ESG movement, in which partisan activists seek to mold portfolios to environmental, social and governance ideals.

Schmidt and the other attorneys general disputed claims by BlackRock to be agnostic on the question of energy and challenged assertions BlackRock was simply marketing alternative investment options in the energy sector.

“BlackRock appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment,” Schmidt and the other attorneys general said of BlackRock. “BlackRock’s past public commitments indicate that it has used citizens’ assets to pressure companies to comply with international agreements such as the Paris Agreement that force the phase-out of fossil fuels, increase energy prices, drive inflation and weaken the national security of the United States.”

The 2023 Kansas Legislature is expected to debate bills comparable to a 2021 Texas law banning most state entities from contracting with companies that banned or reduced investment in the oil and gas industry. The same restrictions could be adopted by lawmakers regarding firearm companies or other types of businesses drawn into political debates.

Fiduciary obligations

Allan Emkin, managing principle of Meketa Investment Group and a general consultant to KPERS, and Bruce Fink, chief investment officer at KPERS, said the black-and-white lettering of Kansas law and the board’s investment policy were bulwarks against political manipulation of the pension system’s portfolio. BlackRock and Mellon were selected by KPERS to handle large chunks of the Kansas retirement system’s portfolio, but the companies operate under the same strategic directives from KPERS despite different public stances on ESG.

Emkin and Fink said BlackRock, which manages $4.5 billion of KPERS’ holdings and has been vocal about the ESG movement, was a fiduciary of the state’s pension system and obligated to comply with state law and board policy governing decisions about the portfolio.

Under Kansas law, no money in KPERS could be invested “if the sole or primary investment objective is for economic development or social purposes or objectives.”

KPERS board policy says the foundational responsibility was to “prudently invest the assets of the system solely for benefit of members and beneficiaries” — not achieve political aims. Board policy also says investments are to be “prudent” and “provide the highest expected return commensurate with the lowest expected risk and are appropriately diversified.”

Jo Yun, a KPERS trustee and vice president of finance and chief financial officer of Reach Healthcare Foundation in Overland Park, put the question directly to Emkin.

“I’m a firm believer of, if the policy is good, let the policy work,” Yun said. “Our mission is to return the best return for our members as we can with the lowest risk. You feel our investment policy lays the process down to let that happen?”

“I think the policy makes enormous sense as does the statute,” Emkin said.

Emphasis on proxy votes

Emkin said the arena in which ESG took on prominence was on proxy voting, in which decisions were made by investors about a company’s board of directors or corporate governance. KPERS delegates to BlackRock thousands of such votes each year.

However, Emkin said lawmakers and others delving into this issue should appreciate BlackRock was the largest holder of ExxonMobile, one of the world’s largest publicly traded international oil and gas companies. He said BlackRock’s approach to ESG activism had more to do with a belief the movement could impact the risk and return of portfolios. He said analysis of BlackRock’s proxy votes didn’t reveal a sweeping declaration of social activism.

“If you look at their proxies, their proxies are all over the place based upon unique facts and circumstances of every company,” Emkin said.

Fink said investment managers were duty bound to vote proxies in the best interests of their clients — KPERS, in this case — and adhere to policies and laws applicable to those clients.

He said establishing an in-house staff to deal with tens of thousands of proxy votes annually would have a cost to KPERS and stepping away from BlackRock or other large institutional management companies was no guarantee of a positive return on investment.

“It certainly could be done,” the KPERS chief financial officer said, “but I would point back to the cost factor. We would have to staff in order to trade this account, manage this account. It’s not without operational risk as well.”

China, Hong Kong issues

Anxiety also has surfaced regarding KPERS’ investments in China and Hong Kong through publicly traded companies and private equities. KPERS documented $486 million in public holdings in China and Hong Kong, or 10% of the system’s international portfolio. There was about $41 million in private equity investments with exposure to China, he said.

During a discussion with trustees of KPERS, Emkin said he thought all his clients were having conversations about the world’s second-largest economy and associated political complications. There are opportunities for investment in China and signals stepping back from China might be best, he said.

“It’s all over the place,” Emkin said. “The challenge is that emerging markets are based on China directly or indirectly as are an enormous amount of American companies who have significant business relationships and whose profits are in no small part derived from either selling to China or using goods and services that come from China.”

He said tension between China and Hong Kong wasn’t as simple as responding to investments held by KPERS in Russia following invasion of Ukraine. In March, the board at KPERS voted to halt new investment in Russian securities.

“It’s not Russia,” Emkin said. “If was easy to address the Russia issue because you had next to no holdings and that market was truly irrelevant. China is relevant on all sorts of different ways.”

Alan Conroy, executive director of KPERS, said he expected issues of China and BlackRock to be topics of conversation among House and Senate members after the legislative session began in January.

He said the Republican-led Legislature, in collaboration with Democratic Gov. Laura Kelly, could adopt laws directing investment decisions by KPERS.

He said one goal of KPERS trustees would be to share with lawmakers information about how global political considerations were relevant to the pension system. That conversation among KPERS’ trustees at a meeting last week was a step toward engaging in comparable dialogue with the Legislature, he said.

“The more you limit the investments out there, there is at least a fair possibility that might ultimately impact the return. As a policymaker, I think they’ll need to be aware of that,” Conroy said.