Should large institutional investors divest or engage if they have an issue with a company? Harvard Business School professor Vikram Gandhi discusses why and how CalSTRS, the $200 billion pension plan for California public school teachers, chooses to engage with gun makers and retailers in California in his case, “CalSTRS Takes on Gun Violence.”
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BRIAN KENNY: 2017 was a milestone year, but for all the wrong reasons, because that year marked the first time that more people were killed by firearms than in car accidents. It was also a record breaking year when a shooter in Las Vegas killed 58 people and injured hundreds more, setting a new record for death toll in a mass shooting. And in 2017, 2,500 school children died from gun-related injuries. A report released in September of 2019 by Congress’s Joint Economic Committee found that teens and adults in the U.S. are 50 times more likely to die by gun violence than they are in other countries. The report highlights the fact that, in addition to the staggering human toll, gun violence carries substantial economic costs that include lost income and spending, employer costs, police and criminal justice responses, and healthcare treatment. In the five states with the highest rate of gun deaths that year, the report estimates the economic toll to have been $17.5 billion dollars. Today, we’ll hear from professor Vikram Gandhi about his case entitled, CalSTRS Takes on Gun Violence. I’m your host, Brian Kenny, and you’re listening to Cold Call, recorded live in Klarman Hall Studio at Harvard Business School. In addition to teaching at Harvard Business School, Vikram Gandhi is the founder of Asha Impact, an impact investing platform. He also spent 23 years in investment banking, so you know a thing or two about economics, I’m guessing Vikram? Thanks for joining us today.
VIKRAM GANDHI: Thank you. Thank you Brian.
BRIAN KENNY: Great to have you here. This is sadly a case that’s sort of ripped from the headlines. We’re reading about this every day. People are experiencing it far more often than they should, the episodes of gun violence in our country. I think they will be able to really relate to this case, and it does give a sort of a glimmer of hope about maybe another way to get at this problem that doesn’t rely on a political system that just seems completely mired and unable to move on it. I’m going to ask you to start the way we usually do here. Can you just sort of set up the case for us? Who’s the protagonist and what’s on his mind?
VIKRAM GANDHI: CalSTRS is the California Public Teachers Retirement System. It’s the largest pension plan in the US for teachers. It’s based in California. Essentially, they have assets under management of a little over $225 billion, and so from their perspective, they are a diversified financial services firm. But beyond the fiduciary obligations of generating financial returns, they do view themselves, given their position, given their size, of having a broader objective and what we call more conscious capitalism, if you will. The stage here really was in a context of the course that we’ve developed and teacher at the Harvard Business School, which is investing risk return and impact, then in addition to the traditional metrics of analyzing investments from a risk return standpoint, how do large investors, whether it be in the public markets or the private markets, bring in impact into the equation? For large institutions, shareholders like CalSTRS, having influence on the companies that they invest in is important, and the influence takes two forms. One is a values, it’s an expression of values. But equally if not more importantly, it’s value. So, if they feel that there are things that companies should do to improve long-term value, to reduce long-term risk, they will be much more active in the investment process. The case is really set about the fact to kind of get this across to students, which is the whole objective of large institutional investors could do two things when they have an issue with a company. They could divest or they could engage. This case is about a large investor like CalSTRS choosing to engage with an industry, even though they were getting a lot of pressure within California, as teachers, they’re the pensioners, the actual employees. As you rightfully said at the start here, all the shootings at the schools. There was quite a bit of pressure from the teachers to kind of sell all these stocks and get out of them. CalSTRS view was that by just divesting, are we actually going to achieve anything or should we engage? That was the big debate. That’s a debate that happens not just in gun control, it’s happening. It’s a massive debate happening at fossil fuels. It’s happened in the past in tobacco and there’s still a debate around that. That’s the broader context of the case.
BRIAN KENNY: We’ve had you on the show before, so thank you for coming back. I guess it wasn’t too bad the first time. That’s good.
VIKRAM GANDHI: It’s my pleasure to be here.
BRIAN KENNY: I’m curious as to how this case relates to your research. Why did you decide to write about CalSTRS?
VIKRAM GANDHI: The research that we have is the engagement by large institutional shareholders. As I said, the key issue here in terms of our research on the course is that should big pools of capital have an objective of generating returns, which is their fiduciary obligation, but also making a difference. As I said, making a difference, not just from the point of view of values, but a point of view that if you are a long-term shareholder like CalSTRS is, you have to influence outcomes, which would reduce risk over time. So as far as gun manufacturers and gun distributors go, there is a big risk over time, a societal risk, the risk of all the things that you’ve mentioned at the start of the program. They could either just get out of it and not deal with the issue, but they chose to engage.
BRIAN KENNY: We here being in a higher education environment as we are, we feel the same kind of tension for Harvard and where it invests.
VIKRAM GANDHI: That’s right. I mean, just at the Harvard College commencement at the speaker’s day in May, I was in the audience, and Vice President Gore within five minutes was making a case as to how the Harvard endowment should sell fossil fuel stocks. That’s a big debate. Just last week, Bill Gates basically as an interview with the Financial Times said, “Well, by divesting, you’re not changing anything. But by engaging or investing in new energy related technologies, you may be able to actually make a difference.”
BRIAN KENNY: And that’s at the heart of this case.
VIKRAM GANDHI: The pros for the divestment case though, just from the other side, is that if enough people sell stocks that there would be pressure on companies to justify the existence. A big example that’s given is apartheid. There was a huge push on the part of both investors and there were obviously broader issues to get out of stocks that companies that did business with South Africa. I think that was a large component. People will use that as an example that if there’s enough pressure put on by selling and through various other sources, that could make a difference in behavior.
BRIAN KENNY: And that’s kind of come up a little bit later in our discussion, too. Just for people who aren’t familiar with CalSTRS. I was surprised at just the sheer size of them. California is a big state, but boy. Can you describe them a little bit?
VIKRAM GANDHI: CalSTRS is a, as I said, about 225 billion. It’s a diversified, professionally-run investment organization, but that governance structure is such, because they are a public pension plan, is that they’ve got some teachers’ representatives on the board, they’ve got political representatives on the board, some of the ex-officio members who work there on the board. It’s a governance structure which is complicated and with a lot of different people with a lot of different objectives. Essentially, the CIO, Chris Ailman, doesn’t have an easy job. He’s got to keep on balancing a whole bunch of different things. But the fundamental issue is they’ve got to generate enough return to pay the pensioners from this deal.
BRIAN KENNY: Got to pay the bills, right?
VIKRAM GANDHI: Got to pay the bills.
BRIAN KENNY: They’ve got almost a million pensioners that they represent?
VIKRAM GANDHI: That is correct. Yeah. Yeah.
BRIAN KENNY: Many of whom I would assume, being teachers, being in the educational space, would probably be sympathetic to this notion, but they also want their returns to be good on their pensions.
VIKRAM GANDHI: The gun issue has come kind of to the forefront the last few years, but tobacco has been an issue for a long period of time. The California pension plans had divested off tobacco for the reasons I said. But they did do an analysis recently, which is in the case, that as a result of not investing or basically having divestment strategies for tobacco, and some things they have to divest because legislation requires them to divest. I will not invest in companies, and it’s by legislation. You know, companies doing business in a certain which the US don’t want to do business with. Was the last year of returns was like $6 billion and a big chunk of that would have been tobacco stocks. The question then becomes, well, all right, that money, by divesting off tobacco stocks, you underperformed by few billion. But from a long-term risk-management perspective, you shouldn’t own those stocks. But now I know one of the other pension plans, CalPERS is also evaluating whether they should have divested off tobacco stock and whatever they should get back into them.
BRIAN KENNY: It’s complicated, like you said.
VIKRAM GANDHI: It’s very, very complicated. Then some of the politicians will have one perspective. The teachers that have another perspective. The people who are professionally running the organization from a money management perspective will say, “Hey look, I need to generate a return to pay you guys.” It’s all much more complicated than just running a regular asset management company.
BRIAN KENNY: How does it perform overall? Historically how has it gone??
VIKRAM GANDHI: So, their target over time is to have a return of 7% or more, and on average they have outperformed that.
BRIAN KENNY: Okay. They manage a lot of funds. I’m sure they work with a lot of fund managers and doing that. How much clout do they have in sort of engaging in those relationships?
VIKRAM GANDHI: They are big investors, so size helps. They have a lot of clout and they’ve been very active, for example, in the whole issue of engagement. They started off with things like transparency in reporting in climate, impact on climate. They’ve had a big push on board diversity. They had in 2017 a campaign around disclosure of climate data, and engaged with the hundred most companies they felt were not disclosing the information. Nearly 30, 40% of them as a result of that engagement started disclosing. I think they have a lot of clout in the market.
BRIAN KENNY: They’re one of these firms that we would look at as an ESG. The last discussion that you and I had was around a similar kind of fund. For people who aren’t familiar with ESG, can you describe what that is?
VIKRAM GANDHI: ESG stands for environmental, societal, and governance factors. This is bringing in ESG the environment, the impact on society in different ways, as well as good governance into the investment equation. Again, if you were to step back and just think of it logically. If you’re a long-term investor and you don’t factor those things in, you probably are making bad investment decisions. But until now there really has not been that much data that’s been kind of supplied by companies to evaluate that, and there’s a big push around that. That’s where the transparency should come in. But also, there’s more and more evidence that companies that focus on the four or five ESG things that matter to their business. ESG factors in financial services are different than technology or different in consumer product companies. But if you focus on the ESG factors that matter to their business, they do outperform within a period of time. And so, incorporating these factors in is become quite an important initiative of the asset management industry.
BRIAN KENNY: You look at organizations like this a lot. I mean, I wonder how many people think about ESG as sort of a, “Oh, this is the soft, squishy side and they’re not looking at returns, they’re concerned about morals and values,” and probably write it off as a result of that. Is that a tension that exists here?
VIKRAM GANDHI: I think that used to be a tension. I think we’re moving away from that for a few reasons. One is that, first of all, there’s a lot of demand on the part of investors to push this. There have been studies done on millennials and how millennials are much more focused on ESG issues. There’s now more and more data which suggests that if you don’t include ESG analysis you probably are not making good investment decisions. I think while there are still a lot of skeptics that this is the flavor of the day, I think we’re kind of beyond that. It’s moved from being a due diligence, “tick the box” issue. If I talk to a lot of the large institutional investors like CalSTRS, they have incorporated ESG into that core risk management, long-term risk management, which is part of this engagement with the gun companies. But they’ve also started to think about incorporating ESG to find alpha, so actually to outperform the market. There are a couple of other instances of asset managers who have been using ESG to find undervalued companies, and as a result of generally consistent alpha over the last five, ten years.
BRIAN KENNY: So, returns, results will really make the case for this.
VIKRAM GANDHI: Results, exactly.
BRIAN KENNY: Let’s go back to CalSTRS for a minute. When they chose to divest of tobacco that was probably a very controversial decision at the time. We mentioned that they took a financial hit as a result of that. Did that give them trepidation kind of going into this next decision that they had to make?
VIKRAM GANDHI: I think it did. The pension plans also just given their size cannot be seen as being too off the index. So, if they divest of companies, which as they say, that reduces the tracking error or increases the tracking error or the index, then that causes them problems. Maybe tobacco was one of those. But then tobacco when it happened, was really a political thing. I think somebody was running for governor at the time and basically had them divest tobacco stocks and then use that as a platform to promote health, his health objectives, et cetera. Then I think they didn’t really change that. There was a debate. I think there were some public hearings where a lot of the pension has said, “Why are we in gun stocks? Why does our pension plan own gun stocks, whether it be manufacturers or distributors? They came to the view that a gun manufacturer, that’s what they do. By not being there to engage with them, they’re not going to go away, unless everybody stops buying gun stocks. The cost of capital doesn’t go up, nothing goes up. And so, a gun company is going to be manufacturing guns. For the distributors, this is a big source of revenue. And so by us divesting, that’s not going to change, so why not engage in a way that could make the gun industry safer?
BRIAN KENNY: What were they hoping to achieve? How were they hoping to do that?
VIKRAM GANDHI: It’s really through the proxy process and through engagement with senior management to the extent they’re willing to engage. But it’s the proxy process. And so what CalSTRS did was they said we don’t want to be the only ones doing it, so they brought together 14 large investors, which together with CalSTRS represented $5 trillion worth of assets. A lot of those discussions happened here at the Harvard Business School. We had actually helped initiate that. In fact, it was one of our students, Christy Wood, who was a senior executive of CalPERS. She was at the Advanced Leadership Initiative at Harvard and she wasn’t in our investing for impact class when we were talking about this, this was in 2017. That’s where she took the lead along with Sean Cole, myself, and a few others, and worked with Chris Ailman on this. We were kind of the convening agent, if you will, to get it going. Then they brought the 14 investors in and have come out with these principles of a responsible civilian firearms industry.
BRIAN KENNY: What are the principles?
VIKRAM GANDHI: There are basically five principles which deal with the whole supply chain of the industry. A couple of them are for the manufacturers of essentially focusing on safer guns, improving the technology and improving the R&D, making them safer. Reducing gun manufacturing, that is more on the automated side in terms of civilian distribution. Then on the distribution side is to educate employees on improving background checks. Basically if you go through the five, it’s around either improving the technology of guns to make them safer or it’s about educating and actually implementing. Because the gun companies can’t change the regulation. That’s a separate discussion in the legislature. But what the gun companies can do is implement what is their right now, which is educating employees, doing the right kind of background checks. Because most of these cases, which at least is my understanding, is that most of the cases where guns have been used in these cases, the background check wasn’t done correctly or something happened. Which would not have happened if things had been done correctly. There are some very practical suggestions and there are five principles. The idea was, and they have been doing it this proxy season, the last three or four months, of engaging with the companies through the proxy process or directly with managements on those principles.
BRIAN KENNY: How do the gun manufacturers react to this?
VIKRAM GANDHI: In the case, we have a couple of situations. This is before the case, while the case was written, but in the last proxy season in 2018, we have two gun manufacturers there which had proposals from shareholders which talk about disclosing what the gun manufacturers are doing to make gun distribution safer and technology safer, and to just report that on a more broad basis.
BRIAN KENNY: That’s them reporting out what they’re doing?
VIKRAM GANDHI: Them reporting what they’re doing and also putting out actions that they plan to do, et cetera. These were shareholder proposals, not management proposals. Both the proposals at these companies had got a majority vote, but the companies still are not bound to do it and they didn’t do it. Right? Because of the US shareholder proposals. That’s partly what triggered them to say, “Okay, we need to have lots of investors coming together, come up with some principles, and make things happen.”
BRIAN KENNY: Because they have the leverage.
VIKRAM GANDHI: They have the leverage. So this last season, still the proxy season hasn’t completed, but my understanding is that both the distributors and the gun manufacturers in certain situations are focusing on the five principles and working towards them.
BRIAN KENNY: They’re coming around, it sounds like?
VIKRAM GANDHI: They’re coming around, but this is a slow process. Changes through proxy and by large institutional shareholders, it took a long time for the energy companies to start disclosing what their impact on clients is. It took maybe four or five years. The hope is this will just be a shorter process.
BRIAN KENNY: You referenced apartheid earlier. There was a sort of a playbook for them to refer to when they developed their own principles. Can you describe that?
VIKRAM GANDHI: The playbook is that investors have a big influence as you said, but the fact is that there will be other investors who don’t really bother by these things. If they think it’s a good financial investment, they’re going to make the investment. What the hope here is that when combined with large investors doing this, combined with, as you know, there’s a lot of debate in Washington about this, just the public coming behind this, that there will be bold behavioral change on the part of companies. I mean, you’ve seen the recent announcements by Walmart and some of the other distributors, that people will come around to this, and that collectively, as it did in the case of apartheid, things will change.
BRIAN KENNY: Is this a situation where a CalSTRS could reach out to places like Walmart, the people who are actually selling the guns, and try to enlist them in the same effort?
VIKRAM GANDHI: When I say manufacturing and distributors, the distributors are the Walmarts of the world, right? That’s where the guns are sold. It’s about improving point of sale checks, point of sale background checks, basically educating employees that when someone comes in and if you feel through various questions, et cetera, that this person perhaps we should be careful about selling a gun to them, they should alert the right people within the sales process. There are things like that. They have been very focused on improving some of those metrics.
BRIAN KENNY: I’m just curious, how do you keep something like this from becoming politicized and particularly in the current climate that we’re in?
VIKRAM GANDHI: I think it’s very hard. Where the investors are coming from is that they’re not expressing a political point of view here. I mean, they’re not saying we shouldn’t have gun manufacturers. They’re not saying killing the distribution to distribute guns. They’re saying within the context of the industry as it exists today, long-term risk management of these companies, there’s a long-term risk that if things are not done correctly, that those industries, there could be a massive backfire on those industries, both from a legislative perspective and a public perspective. Therefore, they should proactively as long-term management be thinking about making these changes. They’ve been very, very careful of, this is not a question of we are against the gun industry.
BRIAN KENNY: The case doesn’t get into this at all, but I’m wondering has the NRA had any kind of a role in this?
VIKRAM GANDHI: No, they have not. They have not.
BRIAN KENNY: Okay. Have you discussed this in class before?
VIKRAM GANDHI: We taught this case in our last class, because we finished writing it in October last year. We taught it in November just after the principal. The principals came out in November, 2018 and we taught the case, and Chris Ailman came to the class.
BRIAN KENNY: I don’t want you to give away any big secrets, but were there any insights that you didn’t expect?
VIKRAM GANDHI: Yes and no. I mean, it was interesting that the class, while you make the case for engagement, there was quite a few people who felt that we should divest. And if all investors came behind and divested, you would actually have more of an immediate impact. I was surprised by the number of people who felt that way. As I said, there was Vice President Gore making the case over here. But the point really, what I think we didn’t come to a conclusion was, again, which one is better, because both of them take lots of time. Both of them actually involve large pools of capital coming together to work together towards a common objective.
BRIAN KENNY: And if you assume that the gun industry is going to continue to operate, whether you divest or not and they’re going to continue to be people who want to buy guns, then engaging seems like a more effective stance to take.
VIKRAM GANDHI: That’s what a lot of folks who are against… the other big hot button right now is fossil fuel, sale of companies that have fossil fuel. As I mentioned before, Bill Gates and others have come out well by selling fossil fuel stocks, are you changing behavior? Especially since a lot of actual investment buy into renewables can actually come from those companies. As they change, they’re the generating focus. Would it not be better to engage in that discussion?
BRIAN KENNY: Do you think this is kind of the next phase in the evolution of ESG? I’ve been hearing our faculty talk about this for more than a decade now, and it started out as kind of a reporting thing, and let’s be transparent. This feels to me much more significant as a way to apply leverage than just reporting.
VIKRAM GANDHI: Absolutely. I think people have realized that this is long-term risk management, and that there is opportunity to generate alpha. As a result, there’s a lot more focus on this. That’s coming from the suppliers of capital, the asset owners. It’s coming from more better data, et cetera. And it’s also coming from more tangible evidence that being engaged in these topics does produce risk and potentially increase returns.
BRIAN KENNY: To your point earlier, it addresses the sort of values sensibility of this millennial generation who are going to be the majority of our workers in no time at all.
VIKRAM GANDHI: We are also seeing activists. CalSTRS for example, they wrote a letter to Apple, which we also have another case on, early last year. They weren’t being hostile or anything, but it was a public letter. They laid out all the evidence which shows that child addiction to screens is becoming a big medical issue both in terms of physical and mental health of children. And that for a company like Apple not to do something about controlling screen time is a long-term risk to the stock.
VIKRAM GANDHI: I don’t know if you recall, but last summer suddenly you found that there was an update on the app, and you had screen time limits, and you could actually adjust.
BRIAN KENNY: Yes. That was a result of that? Oh?
VIKRAM GANDHI: They never promised that was a result of that, but that letter went out in January. Again, it wasn’t anything about, well, we are here for the health of the people, et cetera. It was pretty hard-nosed. At long-term, if you don’t do something about screen addiction, it’s going to come back and bite you. I think as a result of that, now you go on and parents can control the amount of time, they can track which app is being used the most, and why, and the apps shut off after a couple of hours if that’s how it’s programmed on the phone.
BRIAN KENNY: It’s a different way of sort of getting at this is the right thing to do, not just because it’s the right thing to do morally, but it’s the right thing to do from a risk management perspective.
VIKRAM GANDHI: Correct. The pension plans particularly and the endowments have to be very focused on that because they have a fiduciary obligation, so they cannot be actually investing or doing things or not investing because of values. What they can be doing is bringing in ESG, because long-term it’s a risk management issue, which is an important fiduciary obligation of the pension plan.
BRIAN KENNY: Vikram, thanks so much for joining us.
VIKRAM GANDHI: Thank you, Brian. Pleasure.
BRIAN KENNY: Thanks for listening to Cold Call. I want to let you know about the newest podcast from Harvard Business School, Climate Rising. It’s about what businesses can and should do to confront climate change. In each episode, host David Abel of the Boston Globe gleans insights from HBS faculty, business leaders, and policy makers who are pioneering new ways of doing business in the age of climate change. It’s produced by our Business & Environment Initiative and you can find it on Apple Podcasts or wherever you listen. I’m Brian Kenny and you’ve been listening to Cold Call, an official podcast of Harvard Business School, and part of the HBR Presents network.
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