BILL ANALYSIS
SENATE PUBLIC EMPLOYMENT & RETIREMENT BILL NO: SB 1433
Adam B. Schiff, Chairman Hearing date: 4/13/98
SB 1433 (Hayden) as introduced
FISCAL: yes
PERS AND STRS: DIVESTMENT OF TOBACCO STOCKS
HISTORY :
Sponsor: author
Prior legislation: AB 3445 ( Knox) 1996
died Assembly PER&SS Committee
AB 1679 (Perata) 1998
AB 1744 (Knox) 1998
passed Assembly PER&SS 4/1/98
SUMMARY :
Would:
a) prohibit the Public Employees Retirement System (PERS)
and the State Teachers Retirement System (STRS) from making
new or additional investments in any tobacco company on or
after January 1, 1999,
b) require a phased divestment of those investments
beginning January 1, 2000 and continuing until January 1,
2003, at which time PERS would have zero holdings in
tobacco companies, and
c) provide legislative declaration language citing health
related illnesses and conflict with California's
anti-smoking education programs as reasons for the
divestment, and questions related to the future
profitability of tobacco investments and potential high
risk of such investments.
BACKGROUND :
1) The committee is advised that Proposition 162, "The
California Pension Protection Act of 1992," was adopted by
the voters in November of that year. Prop. 162 amended the
California Constitution, Article XVI, Section 17, to require
that the PERS and STRS Boards of Administration have the
following mandates:
a) to exercise sole and exclusive "plenary" authority to
administer the system in a manner that will ensure prompt
delivery of benefits and related services to the
participants and their beneficiaries,
b) to discharge their duties with respect to the system
policy in the interest of, and for the exclusive purpose of
providing benefits to participants and their beneficiaries,
minimizing employer contributions, and
c) to discharge their duties with respect to the system
with care, skill, prudence and diligence under the
circumstances then prevailing that a prudent person acting
in a like capacity would exercise.
ANALYSIS :
1) Existing state Constitutional law , pursuant to Prop. 162,
provides that all investment standards and procedures for
the PERS and STRS Funds are derived from the fiduciary duty
to ensure that trust assets are used for the exclusive
purpose of providing benefits to PERS and STRS participants,
as described above.
2) This bill makes legislative declarations that:
a) the cost to the State for healthcare services for
persons with tobacco-related illnesses is $630 million
annually; and that 19% of deaths in California are
attributable to smoking,
b) more Americans die each year from tobacco-related
illnesses than from alcohol, cocaine, heroin, fires, car
accidents, homicides, AIDS, and suicides combined,
c) California spends $50 million annually on anti-smoking
education programs,
d) PERS holds investments of close to one billion dollars
in tobacco companies; holdings which create an interest
that conflicts with the aims of California's healthcare and
anti-smoking education programs, and
e) the value of PERS tobacco-related equity holdings
declined by 4.31% in June, 1997, when the major tobacco
companies reached a settlement which would require those
companies to pay $368.5 billion to private litigants and
state governments.
3) This bill requires that:
a) on or after January 1, 1999 PERS and STRS would be
prohibited to make new or additional investments in any
"tobacco company," defined in the proposal as a business
entity involved in the production of cigarettes or
tobacco-related products,
b) beginning January 1, 1999 PERS and STRS would reduce
existing investments in tobacco companies,
c) by January 1, 2000, no more than 0.65 percent of either
fund's total market value shall be invested in tobacco
companies,
d) by January 1, 2001, no more than 0.35 percent of either
fund's total market value shall be invested in tobacco
companies,
e) by January 1, 2002, no more than 0.15 percent of either
fund's total market value shall be invested in tobacco
companies, and
f) by January 1, 2003, PERS and STRS shall hold no
investments in tobacco companies.
COMMENTS :
1) The committee is advised that the PERS Board-approved
analysis of this bill includes the following statements:
" Constitutional Mandates
By imposing investment restrictions, this legislation would
significantly impede the Board of Administration's
constitutional authority to make investments on behalf of
its participants and beneficiaries. This proposal would
directly infringe on the Board's fiduciary duties to
maximize investment returns on behalf of its membership and
meet its benefit obligations.
This legislation also imposes arbitrary restrictions that
would negatively impact a significant portion of the trust
fund holdings. Eliminating all tobacco investments from
PERS investment universe reduces the opportunities to
maximize risk-adjusted equity returns, reduces the
diversification of the fund, and contributes to increased
portfolio risk.
Investment Holdings
As of December 31, 1997 PERS domestic and international
tobacco-related equity holdings amount to $884.5 million
and $178.5 million, respectively, The total
tobacco-related equity holdings amount to $1.1 billion.
This amount is 1.3% of the total domestic and international
equity portfolio of $81.5 billion. The fixed income
holdings amount to $167.3 million or .55% of the total
domestic fixed income portfolio of $31.1 billion. Total
tobacco-related holdings for both equity and fixed income
in the PERS total portfolio are $1.2 billion, or .96% of
the total fund of $128.2 billion.
Opportunity Costs
Similar legislation was passed in 1986 and restricted
investments in South Africa. The impact of this
restriction caused a cost of $590.2 million in investment
opportunities according to a Wilshire Associates study.
This conservative estimate includes the commission cost
incurred to sell the stocks of companies doing business in
South Africa, the market impact associated with those
sales, as well as an estimate of the "opportunity cost"
caused by that restriction against any future purchases of
stocks of companies doing business in South Africa.
The impact of divestiture to PERS equity returns will
entail transaction costs to liquidate the investments and
reinvestment risks in choosing alternative investments for
the proceeds. The pension fund would incur higher annual
costs from constructing a unique index devoid of tobacco
stocks. Reducing the investment universe of available
equity investments will provide less opportunity for
potential capital appreciation in the future.
Index Investment Strategy
PERS utilizes a custom benchmark index provided by the
consultant Wilshire Associates to manage the passive
internal domestic equity portion of the Fund. At December
31, 1997 the internal domestic equity portfolio was valued
at $49.0 billion. The benchmark is defined as the 2,500
largest capitalized companies domiciled in the United
States, and accounts for nearly 97% of the total
capitalization of the U.S. equity market, thus providing
broad market exposure. The index is capitalization
weighted, that is, each company in the index has a
portfolio weight equal to the market capitalization of the
particular company divided by the total market value of all
2,500 companies in the index. PERS Internal Equity Unit
manages the portfolio in a passive manner using
quantitative optimization methodologies to control risk.
Therefore in managing an index fund, one does not forecast
the returns to securities nor apply social criteria. When
a segment of the market is restricted from investment, this
can result in lost return opportunities. Restricting a
segment or industry such as tobacco from investment is an
"active" decision, contrary to the "passive" approach of
index fund management. Passive index fund managers do not
make this judgment. Forecasting that tobacco stocks will
under-perform is an active decision. Active divestiture
contradicts our basic index strategy to buy and hold."
2) SUPPORT :
California Professional Firefighters
American Federation of State, County and Municipal Employees
(AFSCME)
California Teachers Assn. (CTA)
American Lung Assn.
American Cancer Society
American Heart Assn.
Calif. Public Interest Research Group (CALPIRG)
various individuals
3) OPPOSITION :
Cal-Tax
Calif. Public Employees' Retirement System (CalPERS)
The Tobacco Institute
Calif. Retired Teachers Assn.
various individuals
David Felderstein SB 1433
April 1, 1998