A Stitch in Haste

In my previous post I remarked on investing in "risky" stocks. Some readers may be familiar with Modern Portfolio Theory, which demonstrates mathematically that holding a portfolio of stocks will generally be less risky than holding a single stock. Hardly a mind-blowing proposition.

But it was not always so. There was a time, not too long ago, when it was considered per se malpractice for a fiduciary to invest a client's funds in any stocks under any circumstances. Only bonds were considered "responsible" investments.

Later, many states eased the restrictions against equity investing by developing "approved lists" or "legal lists" of established reputable firms that paid steady reliable dividends (such as those in today's Dow Jones Industrial Average). I wonder what the "politics of pull" was like back then, as companies vied to get themselves on such lists.

Anyway, in modern institutional investing, fund managers focus on diversification in an attempt to minimize risk and maximize not just dividend yield, but total return (yield plus price gains), constrained only by the objectives and risk tolerance of the client. We don't think in terms of "more risky" and "less risky" stocks, or "good" versus " bad" companies. Today we know better.

Or do we?

California officials on Wednesday voted to oust Sean Harrigan as president of Calpers, naming a former real-estate executive seen as more business friendly to replace the outspoken union official as a board member of the largest U.S. pension fund.
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Harrigan had served as Calpers board president since early 2003, leading the fund into an aggressive corporate governance campaign that drew fire from critics who said it put a political agenda before the interests of the 1.4 million state employees and retirees served by the pension system.
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While Harrigan's allies on the Calpers board -- including state Treasurer Phil Angelides -- vowed the pension system would continue with its activist corporate reform agenda, some said Alvarado represented a more business-friendly voice.

"It sends a signal that the board is becoming more business oriented.... Here's a labor guy being ousted,'' said Bob Stern, president of the Center for Governmental Studies in Los Angeles.

In recent years the pension fund has used its clout to press for reforms ranging from reducing global warming to cracking down on excessive executive pay.

When an individual owns a stock and he is displeased with the company's performance or policies, he sells the stock. If he gives his money to an investment firm, which in turn displeases him, he can withdraw his money and go elsewhere. But a California government employee has no such control, no such autonomy. The money earmarked for him, earned by him, is turned over to bureaucrats who apparently have no qualm about using that money to achieve social objectives that have absolutely nothing to do with maximizing the return for the client.

Of course, it's easier for me to sell 100 shares of stock than it is for CalPERS to sell 1,000,000 shares, and there's nothing wrong with an institutional investor trying to use its substantial holdings as a "foot in the door," to get direct access to management to try to effect change. But once management decides how it's going to run the company, investors should either shut up or sell out (or, in the extreme, attempt a hostile takeover).

But CalPERS and many other government pension funds (including New York State's and New York City's) choose instead to become self-appointed crusaders, pestering companies openly and relentlessly while continuing to hold the company's shares. CalPERS openly boasts about its "Focus Companies," an annual list of "long-term poor performing companies" that CalPERS targets for the investor equivalent of an "intervention." And if the company declines, CalPERS simply turns up the volume rather than cash out.

And of course, this all assumes no agency issues -- that CalPERS' leadership is actually trying to act in the best interests of it members. But as Harrigan demonstrated in his support of striking supermarket workers, such an alignment will be rare in the extreme (remember, these are partisan bureaucrats).

How perverse is it when an institutional shareholder in essence declares war on the company it owns? How can a perpetual pattern of such behavior be beneficial for the company, the government employees or the economy as a whole?

Meanwhile, the Wall Street Journal (subscription site) also reminds us why privatized pension plans for public employees are a good thing by not only empowering government workers, but also by disempowering government pension bureaucrats such as Harrigan:

Nonetheless, state pension plans, with their political appointees and giant hoards of cash, are disasters waiting to happen. When boards use these plans for political purposes, investment returns suffer and that puts pension holders and taxpayers in danger. One good answer is to remove temptation. That is what the Florida Retirement System started to do two years ago when it began offering defined-contribution plans that allow its members to invest their own retirement money. Under the Calpers defined-benefit plan, the pension fund managers decide what to do with the cash, and this is what gives them so much political discretion.

Indeed. Government units are proving to be staunch holdouts against moving from defined-benefit to defined-contribution pension systems. Just like how government is the only sector of the economy where union membership is growing rather than shrinking.

Go figure.