In an Opinion article published in The New York Times entitled “More Cities and States Should Divest From Private Prisons,” Scott M. Stringer, comptroller of New York City and trustee for New York City’s Retirement Systems, along with Javier H. Valdés, a community organizer, made the case for divesting from private prison company holdings in public pension fund investments. They argued that “pension funds have a fiduciary duty to make sound investments that grow their portfolios and help fund retirement benefits for their members.” That means, according to the two authors, constantly evaluating the long-term viability and risk of investments across the pension funds’ portfolios, which is what the New York City Comptroller’s Office does every day. Specifically, the authors observe that “investment in for-profit prison companies exposes the system to undue legal and regulatory risks and worker-safety issues that are inconsistent with the board’s risk profile and objectives.”  While the argument has merit on moral, social and potentially financial grounds, the impact of divestment is unclear and open ended, its application has limitations as well as financial consequences and, in the end, there may be more effective ways to address these and similar concerns both on the part of the City as well as other institutional and retail investors.

This is not the first time in recent years that one or more of the five funds that make up the $194 billion New York City Retirement Systems have promoted a divestment strategy. In January of this year, it was announced that city officials have set a goal of divesting some of New York City’s pension funds from fossil fuel companies within five years.  According to the accompanying press release issued at that time, it was noted that the City’s five pension funds have about $5 billion in fossil fuel investments.  And earlier, in January 2016, it was announced that a resolution had been submitted to the NYC Police Pension Fund to analyze gun divestment, the first step necessary to ensure that no public pension funding flows to gun manufacturers who produce assault weapons and high-capacity ammunition magazines and market these wartime products for civilian purchase. This followed several high profile shooting tragedies involving assault weapons.

While the merits of the concerns expressed around the operation of private prisons, in in terms of their moral, social and potentially financial dimensions, are valid, divestment actions taken by New York City and other public pension funds raise a number of important questions that apply more generally not only to public pension funds but also institutional as well as retail investors. For starters, these include the following:

  1. What is the ultimate objective of divestment and what are the trade-offs that the New York City’s Retirement Systems are making? On the one hand, the City’s actions make a political statement and send a loud and clear message. On the other hand, the effectiveness of divestment campaigns remains unclear and, in any case, their application at the portfolio level may be limited. That is to say, such actions are typically restricted to direct holdings or do the actions extend to index fund holdings, pooled fund accounts as well as REITs that may hold such investments? At the same time, the actions risk sacrificing investment performance and compromising investment strategies at a time when at least three of the city’s five pension funds are underfunded[1] and emphasis should be placed on maximizing risk adjusted financial returns.
  2. The City’s pension funds have already considered three divestment initiatives in the last three years. Where does the city draw a line since divestment may be a slippery slope without an end in sight? For example, what about companies that provide financial, logistical support or administrative support to private prisons? Or thinking about divestment more expansively, what about support for companies and their investors that offer ride-hailing services that siphon riders away from public transportation and are responsible for a significant increase in CO2 emissions, particularly in large metropolitan areas? To that end, has the City of New York’s pension funds adopted a broad divestment policy, perhaps like the one applicable to economically targeted investments, within the context of its Corporate Governance and Responsible Investment policy?
  3. Are there more effective ways for the city to carry out its fiduciary responsibility? For example, engaging with companies more actively, proxy voting initiatives, or, to the extent justifiable, taking legal actions and exercising additional governmental oversight over private prisons, to name a few options, that are already aligned with the pension system’s current practices.

Alternatives to a divestment strategy that may better serve investors and potentially have greater net impact include, but are not limited, to the following: (1) advocating for the proactive integration of relevant and material environmental, social and governance (ESG) risks and opportunities in investment strategies.  Applying this to private prisons, as an example, the decision on whether to buy, hold or sell the stocks and/or bonds of private prison companies such as CoreCivic (CXW), and Geo Group (GEO) should take into consideration any relevant and material risk exposures faced by these companies, such as the consequence of political and reputational risks, direct and indirect financial consequences on the firm’s operations, and legal liabilities, to mention just a few. Alternatively, to the extent these private prison operations modify their operations, investments in these companies could lead to opportunities, (2) taking a more active role via corporate engagement as well as proxy voting initiatives, either individually or collaboratively, in an effort to alter the behavior and strategies of these companies, and (3) for individual investors, at least, seeking to maximize risk-adjusted financial returns from their portfolios and allocating a portion of the gains to advocacy groups aligned with their environmental social, moral or ethical preferences.

[1] Source:  Milliman 2017 Public Pension Funding Survey discloses that two of the five NYC public pension funds, namely the Police Pension Fund and Employees’ Retirement System have a funding ratio of 69.4% and 69.6%.