Not All Forms of Russian Divestment are the Same
By Anthony Randazzo
One of the fallouts of the Russian invasion of Ukraine was a furious wave of calls for U.S. state pension funds to “divest from Russia.” Several state legislatures have passed statutes requiring divestment, while other state pension boards have voluntarily opted to sell their stakes in Russian-related assets or freeze future such investments. These sentiments may seem patriotic — or even amusing, what with the governors of Utah and North Carolina ordering any Russian-made vodka off the shelves of state liquor stores. But without careful thought, the general orders of divesting from Russia could lead to financially damaging mistakes since not all forms of divestment are the same.
State pension fund divestment from Russia over the past two months has typically come in one of three forms:
- Compliance with sanctions on specific Russian companies, as directed by the federal government. For example, Colorado’s Public Employee Retirement Association announced it would be selling $7.2 million worth of equities in Sberbank, the largest banking lender in Russia.
- State legislatures, governors, or pension boards deciding to sell stocks or bonds in non-sanctioned Russian companies out of a sense of solidarity and alignment with American political feelings toward the invasion of Ukraine. Ohio’s State Attorney General wrote in a letter to all five state pension funds that there was a “moral imperative” to divest from any equity related to Russia and the state’s Governor issued an executive order to divest “any investment in… a Russian institution.”
- State officials ordering that pension funds sell anything that is related to Russia, including index funds that contain some exposure to the Russian market. New Jersey adopted a law in March that says “no assets of any pension or annuity fund” are allowed to be “invested in a company with an equity tie” to Russia or Belarus. The only exception in the bill is related to humanitarian aid.
There is little question that compliance with federal divestment requirements related to sanctions should be followed. But it should not be taken as a simple given that the right thing to do is for state pension funds sell anything related to Russia — certainly coming at a loss.
It is not hard to see the political logic in adopting a bill that would show “solidarity with Ukraine.” But the underlying requirements from these political moves could be fiduciarily irresponsible.
State pension funds are held in trust on behalf of the public employees who are members and who will be drawing future retirement checks from the fund. The duty of any trustee of these funds is to maximize the investment returns, safeguard the assets, and keep the financial interests of the fund beneficiaries first.
No matter what the politics are, public employee pension funds are not supposed to be used as pawns in political games. Put more bluntly, government pension funds are designed to make money to support their members, not to save the world.
In practice, this means that state legislatures and pension board trustees should not be rushing to demand their pension funds divest from anything related to Russia, unless required by sanction.
There could be reasonable economic reasons to sell a Russian-related asset now — such as an argument that selling for pennies on the dollar now is likely the most a given investment could earn back. There also can be concerns about the appropriateness of investments in companies that have corrupt or discriminatory practices, which in turn could reduce a company’s future financial success — the Russian government is considering making it legal for its companies to steal intellectual property. But whatever analysis the divestment needs to come from investment strategy reasons, not “moral reasons.”
So what is the right approach?
To start with, any divestment decisions should come from the fiduciaries and trustees managing state pension fund investments. Executive orders from governors or state legislation demanding the sale of Russian-related assets carries too much risk of establishing a blunt instrument to accomplish a political end, while at the same time threatening to force pension funds to break their fiduciary duties.
If legislatures insist on getting involved — as they are prone to do — at a minimum they should provide exclusions for the sale of index funds or mutual funds that might contain some Russian-related exposure. For example, Minnesota adopted divestment legislation at the end of March aiming to “show Ukraine we stand with them in joining an ever-growing number of democracies in standing up to the atrocities happening in the Ukraine.” However, the divestment targeted “directly held” equities in Russian and Belarusian companies while excluding a requirement that state pension funds divest from “indirect” holdings, such as indices or mutual funds.
This approach is consistent with some of the general divestment legislation that states have adopted, such an Illinois law that bans investment in companies that boycott Israel, that are based in Iran or Sudan, or that shelter migrant children for profit. Direct investment in such companies by state pension funds its not allowed, but indirect investment through index funds is permitted. (Legislation adopted by the Illinois House in April, but still pending in the Senate would add Russian companies to this list.)
Such exclusions are likely the most important for ensuring pension funds don’t lock in maximum investment losses. There is very little in direct equity investment in Russian from U.S. pension funds, so any forced sale of such assets is not going to create significant financial losses. (Assuming such divestment sales are even possible, given restrictions on foreign institutions accessing Russian markets at the moment.) On the flip side, there is every reason to think that global index funds or energy market exchange-traded funds will rebound over the long-run. And requiring the sale of such index funds would effectively lock in investment losses that don’t need to happen.
Taking a cautious approach with index fund divestment is also warranted given the probability that Russian-related elements will be replaced over time. The financial services company MSCI Inc. is already moving to remove Russian equities from one of its popular index funds.
Ultimately, there are plenty of investment related reasons to not be invested in Russian companies — most of those reasons existed long before this invasion, which escalates a conflict that has been particularly tense since the 2014 annexation of Crimea. But state leaders and pension fund trustees could make a mistake if they let emotionally driven, politically focused logic to drive their behavior. Divesting based on social duty is a violation of fiduciary duty.
