Not that long ago, state legislators of various stripes told their state pension systems they must immediately divest of any portfolio investments tied to companies doing business in South Africa. The apartheid debate was front and center for nearly every public pension fund in the country.

Several funds went along with the political demands, but most did not. Pension officials took the view that bowing to divestment demands would be a complete surrender of their independent, fiduciary responsibilities owed to the beneficiaries of the fund. In truth, political interventions like these are primarily about individual politicians seeking headlines to bolster their profiles by suggesting that the massive pools of public pension cash are being improperly invested. Quite simply, tactics to politicize pension investments are never initiated in the interest of pensioners.

Fast-forward to 2023 and the scene once again repeats as political actors attempt to strip away investment decisions from the fiduciaries legally responsible for investing pension fund assets. In the process, they are usurping decisions on asset allocation, risk management, and portfolio diversification.

In the case of climate change, the partisan intervention can run in both political directions. Most recently, attorneys general and legislators in several states have entered the environmental, social, and governance investing fray. They are saying “halt” under the assumption that they know better, and it’s their right to direct pension officials as to exactly what they can and cannot do when it comes to investing pension-fund assets in fossil-fuel companies or in ESG-focused assets.

Their analysis is simple. Politicians, not pension fiduciaries, define what is material for proper investment and risk analysis by the state pension fund when it comes to climate-related matters. In essence, pension officials who invest in fossil fuels or use ESG factors or who hire managers that do, will be injecting their own social beliefs on climate change into pension management, thereby violating fiduciary duty. Pension trustees and professional investment staff will be forced to sanitize their investment portfolios from any fossil-fuel or ESG considerations—depending upon the particular political actor’s mandate.

To be fair, in the case of ESG at least, some state pension officials have gone all-in on this mode of ESG factoring and investing. They consider it not simply a risk-reduction and alpha-generating strategy for the fund, but, importantly to them, a matter of allocating capital to companies and investments that are concerned about society and stakeholders. In essence, they seek portfolio companies that are strong corporate citizens.

There are now several hundred products and investment firms featuring this more comprehensive approach to financial analysis and risk management in the marketplace, addressing an ever-increasing demand from investors, including public pension plans. Staying with ESG for a moment, these pension officials say this is an important part of their comprehensive and holistic approach to better risk management and preservation of best risk adjusted returns for the pension.

The distinction here is that proper investment analysis is determined by the pension fiduciary, not politicians.

Importantly, the financial analyst profession has long acknowledged in its standards of practice that proper financial analysis must factor all material information into their investment process, including material ESG or climate-related matters. What is in the best interests of the pension beneficiaries in pursuing best risk-adjusted return must be the exclusive domain of pension boards of trustees. It is their legal duty and oath to act with prudence, loyalty and care, thus rejecting periodic attempts at political intervention or misinformed legal analysis that undermines the fiduciary responsibility of pension trustees. History is full of these examples.

Over decades of experience at major U.S. public pensions, politicians have made dozens of attempts to direct investment decisions through legislation or public pressure, including how public funds should be invested. Political issues have ebbed and flowed around pension investments. On the hot list have been investments linked to social and labor matters, promoting state employment, firearms manufacturers, defense firms, tobacco companies, infant formula, and others.

Pension trustees, for the most part, have weathered these political storms, remained independent, and neutralized the constant flow of political dictates. If they did not, pension funds and their beneficiaries would face asset-allocation chaos, endure higher risk, and earn weaker returns. And taxpayers would face greater pension costs.

What should worry all states is that this era seems much more intense than political interventions of the past, where pension officials were generally successful in maintaining fiduciary control. Something has changed in the back and forth contest over fossil fuels and ESG. Social media has made for a much more aggressive and deeply partisan debate supported by the bickering of competing narratives.

Unfortunately, extreme politicization of pension investment management may help re-elect an officeholder, but it could easily destroy retirement security for many and injure local economies across entire states.

State citizens and pensioners beware. Politicians make extremely poor asset managers.

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