Op-Ed by LOU ALLSTADT
The Freeman’s Journal, Thursday, Nov. 11, 2016
Editor’s Note: Cooperstown Village Board voted Oct. 26 to shift $140,000 in its firefighters’ and emergency squad retirement fund away from fossil-fuel stocks on the advice of Trustee Lou Allstadt, the retired Mobil executive vice president. That prompted an analysis by attorney David Russell, a former pension-fund counsel in the state Comptroller’s Office. This is Mr. Allstadt’s response to Mr. Russell.
I am writing to clarify and respond to several points made in David Russell’s opinion piece in last week’s editions of The Freeman’s Journal and Hometown Oneonta on the Village of Cooperstown’s LOSAP retirement fund.
► What is LOSAP?
LOSAP is the Length Of Service Award Program that provides retirement benefits to firefighters and emergency responders based each individual’s activity level each year. It is a great way to recognize the contributions of these unpaid volunteers and encourage new volunteers to join.
The program is relatively new. It was started with an initial contribution from the village with additional amounts contributed each year as determined by an actuary based on the amount already in the program and the projected retirement payouts over future years.
Those annual contributions will continue for many years and the payouts will stretch out over many years. The latest contribution of about $65,669 brings the total fund to a little over $900,000.
Investment of the fund’s assets is administered by RBC Wealth Management (part of the Royal Bank of Canada), which has an office that specializes on administering LOSAP for a large number of municipalities in New York State. The administrator oversees the distribution of retirement checks and the day-to-day management of investments under guidelines provided from time to time by the village board of trustees.
The Village Board’s finance committee reviews the status of the LOSAP each month and the board of trustees again reviews the status at its monthly meeting. LOSAP is also audited. Village committee and board meetings are open to the public and the investment account statements are public information.
► How is plan administered?
From time to time the finance committee has called in the administrator to discuss the investment mix as well as the fees charged by individual funds. For example, a series of meetings and conference calls early in 2016 resulted in shifting both fixed income (bond) investments and equity (stock) investments from high cost mutual funds into exchange traded funds (ETFs) with similar returns but with low fees – a significant ongoing reduction in costs to the village. That resulted in a widely diversified portfolio including large and medium sized U.S. and international equities as well as a range of U.S. and international bonds.
About two years ago, questions on investments in fossil fuels arose in the finance committee, the economic development and sustainability committee and the full Board of Trustees. Part of the concern was the environmental impact of fossil fuels and part was the growing perception of financial vulnerability among the fossil fuel companies. The administrator was asked to research and discuss alternatives with the finance committee.
At that time, there was no cost-effective way to divest and maintain a widely diversified portfolio, so no action was taken. Later, it became possible to invest in the individual business sectors of the S&P 500, so you can now buy all of the sectors except energy. This was discussed briefly but not pursued because it would rule out all energy, not just fossil fuels, and because it would result in higher transaction fees to buy the ten non-energy sectors.
More recently, it became possible to buy the S&P 500 ex fossil fuel as a single ETF. This fund tracks all of the S&P 500 companies except those that have fossil fuel reserves. Both indexes are calculated and published by S&P Dow Jones. The SEP500 ex fossil fuel index was initiated in December 2011, around the time when many investors started looking for a way to reduce exposure to fossil fuels. Since the initiation of the index, the S&P500 ex fossil fuels index has had higher annualized returns and higher risk adjusted annual returns than the full S&P 500 index. Details can be found at the following link (click methodology).
►What Fiduciary Responsibilities Apply to Investments?
The U.S. Department of Labor has published interpretive bulletins to help fiduciaries in considering what they call economically targeted investments (ETIs) that involve environmental, social or governance (ESG) considerations. The most recent interpretive bulletin IB 2015-1 was issued on Oct. 26, 2015 replacing the previous bulletin from 2008. The 2015 bulletin covers the issue raised by Mr. Russell. Here is the most relevant portion:
“The Department believes that in the seven years since its publication, IB 2008-01 has unduly discouraged fiduciaries from considering ETIs and ESG factors. In particular, the Department is concerned that the 2008 guidance may be dissuading fiduciaries from
“(1) pursuing investment strategies that consider environmental, social, and governance factors, even where they are used solely to evaluate the economic benefits of investments and identify economically superior investments, and
“(2) investing in ETIs even where economically equivalent. Some fiduciaries believe the 2008 guidance sets a higher but unclear standard of compliance for fiduciaries when they are considering ESG factors or ETI investments.”
An important purpose of this Interpretive Bulletin is to clarify that plan fiduciaries should appropriately consider factors that potentially influence risk and return. Environmental, social and governance issues may have a direct relationship to the economic value of the plan’s investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.
Similarly, if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote.
Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors. When a fiduciary prudently concludes that such an investment is justified based solely on the economic merits of the investment, there is no need to evaluate collateral goals as tie-breakers.”
This Department of Labor’s interpretive bulletin (above URL) makes it perfectly clear that the Board of Trustees’ decision is consistent with its fiduciary responsibilities.
Also, to put this in perspective, the change affects only the large capitalization equities portion of the $900,000 LOSAP portfolio. It has no impact on our bond investments that make up more than half of the portfolio, or on other classes of domestic and international equity investments. The change will be phased in over one year, a common method to average the price over time. The net effect after one year will be that approximately $10,000 (1.1 percent of the total) will be moved out of companies that have fossil fuel reserves and into all of the non-fossil fuel companies that make up the rest of the S&P 500. The LOSAP investments will remain a widely diversified portfolio.
On the other hand, I completely agree with Mr. Russell that investments for LOSAP should not be judged by the same criteria used in personal investing. For example, I would not support a LOSAP investment in renewable energy because of the present small size of the companies and the volatility of their results, even though I personally own a number of mutual funds and ETFs that are concentrated in various aspects of renewable energy.
►Fossil Fuel Investment Risks
Mr. Russell’s comments imply that he thinks fossil fuels are a safe investment. I am afraid that he is ignoring a number of serious warnings.
Possibly the most relevant warning for our situation comes from Tom Sanzillo, who like Mr. Russell, used to work in the state Comptroller’s Office. From 2003 to 2007, Mr. Sanzillo was the first deputy comptroller for the State of New York. Among his responsibilities was the supervision of a $150 billion globally invested public pension fund, with significant fossil-fuel holdings. This was probably a better vantage point to judge fossil fuels’ investment than Mr. Russell had during his earlier stay in the Comptroller’s Office. In a recent report for the Institute for Energy Economics and Financial Analysis, “Red Flags on ExxonMobil: Core Financials Show a Company in Decline,” Mr. Sanzillo wrote:
“The oil industry, led by ExxonMobil, the world’s largest publicly traded international oil and gas company, once provided its investors with outsize returns. This is no longer the case. Today annual cash distributions to investors are less than half of the annual average payout for the last decade. ExxonMobil’s future is one of diminished prospects.
“The principal drivers of oil industry profitability have eroded in recent years, and investors – institutional investors in particular, because of their fiduciary responsibilities to their shareholders – are faced now with hard questions about oil industry finances and about the suitability of owning stock in companies like ExxonMobil.
“Fiduciaries for institutional funds have a choice to make. They can ignore the downside and weak outlook of fossil fuels and thwart the world-wide search for alternatives (which is what happened when coal markets began to turn five years ago). Or they can act responsibly, directing their money managers and professional staff to construct investment plans that are increasingly fossil free.”
A few months earlier in July, Mr. Sanzillo and I participated in a press conference and webinar introducing an extensively documented report, “Unconventional Risks: THE GROWING UNCERTAINTY OF OIL INVESTMENTS.” That report lays out the dismal financial results of the major oil companies – reduced profits, reduced cash flow, decreased investments, increased borrowings, decreased bond ratings, decreased share buybacks, decreased dividends. All of which are exacerbated by low energy prices, as well as gradually increasing competition from renewable energy and energy conservation, reduced access to low cost reserves in most of the world, and increasing measures to address climate change.
There are a number of other reports that warn investors of problems now and in the future for the fossil fuel industries. Citing all of them would take far too much space and would be fairly repetitious. One of the most succinct is a recent report from Black Rock, the largest asset management company in the world ($5 trillion under management). Excerpts from the report’s summary are quoted below.
“Adapting portfolios to climate change: Implications and strategies for all investors”
- We start by detailing how climate change presents market risks and opportunities through four channels:
1) physical: more frequent and severe weather events over the long term;
2) technological: advances in energy storage, electric vehicles (EVs) or energy efficiency undermining existing business models;
3) regulatory: tightening emissions and energy efficiency standards, and changing subsidies and taxes;
4) social: changing consumer preferences and pressure groups advocating divestment of fossil fuel assets.
- These factors can play out immediately (often the regulatory variety), in the medium term as economies transition to a lower-carbon world (often technological), and in the long run (often physical). Investor time horizons differ as well – and may require different approaches. The longer an asset owner’s time horizon, the more climate-related risks compound. Yet even short-term investors can be affected by regulatory and policy developments, the effect of rapid technological change or an extreme weather event.
- We then show how all asset owners can – and should – take advantage of a growing array of climate-related investment tools and strategies to manage risk, to seek excess returns or improve their market exposure…
Investors can no longer ignore climate change. Some may question the science behind it, but all are faced with a swelling tide of climate-related regulations and technological disruption. Drawing on the insights of Black Rock’s investment professionals, we detail how investors can mitigate climate risks, exploit opportunities or have a positive impact. Climate-aware investing is possible without compromising on traditional goals of maximizing investment returns, we conclude.
We then reflect on steps that stakeholders in the climate debate are considering, including the use of carbon pricing as a cost-effective way to reduce emissions.
Our overall conclusion: We believe all investors should incorporate climate changeawareness into their investment processes.” (emphasis added)
In my view, the trustees would be remiss in their fiduciary responsibilities not to consider reports like these and many others in evaluating investment decisions in the LOSAP portfolio.
►A Few Minor Points
Mr. Kevlin is notorious among readers of this paper for not getting things exactly right. There is no S&P 475. It is a figment of Mr. Kevlin’s imagination. The ETF in question is the S&P500 excluding fossil fuels, whose symbol is SPYX. There is no 360.org, it is 350.org. And, apparently, a report in The Freeman’s Journal provided some erroneous background information about my investment and tax adviser to Mr. Russell, leading Mr. Russell to incorrectly, and I believe inappropriately, speculate on tax motivations for my selling ExxonMobil stock. Also, I have no idea what advice my adviser might
have given to my former
colleagues. She (not he) would never disclose such information.