The testimony below was submitted to the Texas House Committee on Pensions, Investments, & Financial Services on August 25, 2022, by the Texas Conservative Coalition Research Institute (TCCRI).
Texas Conservative Coalition Research Institute
House Committee on Pensions, Investments, & Financial Services
August 25, 2022
Regarding the Committee Interim Charge:
Review the impact of investments by public retirement systems of their endowment and other trust funds in businesses and funds owned or controlled by the Russian government or Russian nationals, and determine the need for investment restrictions. Consider the impact of any proposed investment restrictions on fund performance.
Russia invaded Ukraine on February 24, 2022. Leaders around the globe immediately condemned this unjustified aggression,[i] with President Biden calling it "needless act of aggression against Ukraine and global peace and security."[ii] Russia has compounded the injustice of its actions by consistently failing to respect the lives of Ukrainian civilians.[iii] According to a mid-July estimate by the United Nations, more than 5,000 Ukrainian civilians have been killed in the war.[iv]
The U.S. government has helped lead a movement with other nations (including those of the European Union) to impose sanctions on Russia as punishment for its aggression.[v] These sanctions include freezing Russian assets, removing Russian banks from participation in national banking systems, and banning the importation of many Russian exports.[vi] Although Russia’s exports of oil and gas still finds a welcome market in some countries,[vii] the Ukraine-related sanctions have severely damaged its economy. The International Monetary Fund (IMF) in late July predicted that the country’s economy will contract by six percent in 2022.[viii] One study, released that same month by a Yale academic and other scholars, noted that the foreign companies that have ceased operations in Russia account for 40 percent of the country’s gross domestic product.[ix] That study concluded that: “Looking ahead, there is no path out of economic oblivion for Russia as long as the allied countries remain unified in maintaining and increasing sanctions pressure."[x]
In early March, Senator Bettencourt wrote a letter, signed by all Texas senators, to Lt. Gov. Dan Patrick, proposing an interim charge to study the feasibility of state entities divesting from any company that invests in Russia.[xi] Sen. Bettencourt stated that “We have to underline all of this with the fact that we simply cannot do business, we simply cannot be an investing party as the state of Texas in the Russian Federation under its current leadership as long as they’re conducting an absolutely aggressive war.”[xii] Texas is just one of many states who have joined in the response to Russia’s unjust war.[xiii]
The interim charge before this House Committee concerns the investments of these seven state retirement systems:[xiv]
· Texas Teacher Retirement System (TRS);
· Texas Employees Retirement System (ERS);
· Texas Permanent School Fund (PSF);
· University of Texas/Texas A&M Investment Management Company (UTIMCO);
· Texas Municipal Retirement System;
· Texas Emergency Services Retirement System; and
· Texas County & District Retirement System.
Investments by Texas’ State Pension Systems in Russia
Even with limited publicly-available data on Texas’ investments in Russia, two points are clear. First, as made clear from the data below, the pension systems’ total investment in Russia comprises only a tiny percentage of their overall investments.
Second, the vast majority of the state’s investments in Russia are through third parties.[xv] These third parties may consist of stock or bond index funds. These funds accept investor funds and then allocate them to obtain a globally diversified portfolio. Russia is classified as an “emerging market,” signifying that it has strong potential for growth but carries political and economic risks that are greater than those of developed countries such as the U.S. and Japan. As of January 2022, investments in Russia comprised about 3 percent of Vanguard’s passively managed emerging market stock index fund (ticker: VWO).[xvi] The same percentage was held by Fidelity’s actively managed Emerging Markets Fund (ticker: FEMKX).[xvii] Notably, Russian companies have since been removed by prominent stock market indices,[xviii] which will dramatically reduce the inflow of capital to these companies.
Alternatively, these third parties may consist of active private managers who receive money from the state’s retirement systems and then direct it as they think best, which could target specifically Russian investments (e.g., a shopping mall in Moscow).
TRS has stated that, as of February 25, 2022, 0.2 percent of its more than $200 billion in assets was invested in Russia.[xix]
The value of the PSF’s assets as of the close of its 2021 fiscal year (August 31, 2021) was $55.6 billion.[xx] At the close of calendar year 2021, the PSF had approximately $260 million in assets (or less than 0.5 percent of $55.6 billion) invested in Russia. As of April 2022, however, the value of that $260 million had declined to approximately $14 million due to the economic and political conditions in Russia.[xxi]
As of mid-March 2022, the Texas Municipal Retirement System had less than $4 million of its $36 billion dollars in assets (about 0.01 percent) invested in Russia.[xxii]
In its most recent comprehensive financial report, the Texas County & District Retirement System reported that, as of December 31, 2021, it had reduced the value of its (former) $73 million in Russian investments to zero due to the situation in the country and the related international sanctions against Russia.[xxiii]
Data on ERS, UTIMCO, and the Texas Emergency Services Retirement System’s investments in Russia is more difficult to obtain. However, UTIMCO’s financial report as of March 31, 2022 indicated that eight percent of its assets (which stood at approximately $69 billion as of the close of 2021) are invested in public stocks in emerging markets,[xxiv] and (as noted above) Russia up until recently comprised a small percentage in prominent emerging market stock indices. In addition, another 3.7 percent was invested in emerging markets through private equity.[xxv]
Because of limited data, the total amount of the pension systems’ Russian-related investments is not clear. However, Chairman Anchia stated in early March that, ““So far, the pension funds that have responded to our request have identified about $660 million worth of financial exposure to Russia …[a]nd we think that number is going to grow.”[xxvi]
The Comptroller’s chief investment officer stated in May that by then it had become a common financial or accounting practice to “zero out” investments that state entities have in Russia to reflect the near (or even literal) worthlessness of those investments.[xxvii]
The Legislature faces the following two key issues in divesting from Russia:
1) Even if the Legislature overwhelmingly approves a policy of divestment, the actual process of divestment is not possible at the moment due to the collapse of Russian financial markets.
2) Once actual divestment is possible, promptly liquidating all Russian-related assets will likely result in a “fire sale” scenario, in which the state sells those assets at prices far below the prices at which they were purchased.
Regarding the first point above, Russia shut down its public stock market on February 25th,[xxviii] and there are very few prospective buyers in the private market. With no way for prospective buyers and sellers of Russian assets to interact, current owners of these assets cannot dispose of them.[xxix] This difficulty in divesting is a problem faced by pensions funds all around the United States who wish to join in sanctioning Russia.[xxx]
Relating to the second point above, Politifact published an article[xxxi] in April that highlighted the difficult balancing act in divesting from Russia: on the one hand, withdrawing assets from Russia furthers the morally just cause of weakening Russia while it wages war against Ukraine. On the other hand, assuming the relevant markets do open up in the future, the state could find itself as just one of many parties desperately seeking to immediately sell their Russian-related assets. In purely financial terms, this may harm the state and its pension beneficiaries because then there will be no chance to benefit from the presumed rebound in the value of such assets (if and when Russia ends its aggression). A finance professor quoted in the Politifact piece pointed out that “"The issue is mainly one of timing … Institutions know that if they rush to sell, the average price will not be as attractive as when they are more patient." This concern perhaps explains the approach of the New York state comptroller, who stated that that state’s divestment from Russia would occur in a "prudent manner and time frame."[xxxii] If pension funds and other investors choose to wait for a rebound in the value of Russian investments, they may have to wait a while: in mid-March, a news article reported that all of the various economic and investment professionals consulted for the piece believed that sanctions against Russia would still be in place three years from now.[xxxiii]
In any case, even assuming that Texas did participate in a fire sale of its assets in Russia and received exactly zero dollars for them, the Russian-related holdings of the seven relevant public retirement systems are so small as a percentage of their total assets that the results of divestment should be anything but catastrophic. To put the loss of a fraction of a percentage point in context, it is instructive to compare that to the outstanding 2021 fiscal year returns that the pension systems enjoyed. TRS, for example, saw its assets grow from $165.4 billion to $201.8 billion during that year, an increase of 22 percent.[xxxiv] That said, the Legislature prides itself on being a good steward of taxpayer dollars, and a potential loss of several hundred million dollars is difficult to ignore.
Recommendation and Questions for the Committee to Consider
Policy Recommendation: Russia’s aggression must have consequences. The Legislature should move forward with a Russian divestment strategy once it has the information necessary to minimize financial harm to the pensions systems as much as possible.
The Committee should strive to obtain answers from resource witnesses to the questions below at the hearing on August 25th. The answers to these questions are necessary to craft the optimal divestment policy.
1) What percent of the pension systems’ Russian holdings are publicly-traded, and what percent are privately held investments? There is no evident way under current conditions for the pension systems to sell their publicly-traded Russian investments.
2) Generally speaking, do the pension systems have the ability to sell or liquidate their privately held investments in Russia? Aside from the lack of a ready market for such assets, there may be legal considerations which pose obstacles to selling or liquidating such assets (e.g., a pension system’s status as a limited partner in a partnership and its related lack of voting power).
3) Is there a meaningful distinction between the pension systems withdrawing cash from Russian investments, and selling Russian stocks and/or debt to a third party at fire sale prices? The former clearly harms Russia’s economy, but the latter might result in the pension systems selling at a drastic loss and allowing third parties (e.g., hedge funds specializing in distressed securities) to benefit from fire sale prices, with an unclear and perhaps minimal effect on Russia.
4) If and when Russia ceases hostilities and withdraws from Ukraine, what would be a reasonable estimate of the time it would take for markets for Russian assets to re-open so that divesting transactions could proceed? Is the state willing to wait five years or more for Russian assets to rebound in value?
5) What would be the effect on the long-term health of the pension systems if they sold their Russian investments in a fire sale environment? As noted above, the numbers suggest that the pension systems could easily weather this drawback, but insight from mangers of the pension systems’ investments would be welcome.
[i] E.g., https://www.cnbc.com/2022/02/24/leaders-of-us-uk-eu-and-canada-condemn-russian-invasion-on-ukraine.html. [ii] https://www.npr.org/2022/02/24/1082749522/biden-condemns-russias-attack-on-ukraine-which-he-called-unprovoked [iii] https://www.nytimes.com/article/russian-civilian-attacks-ukraine.html [iv] https://www.bbc.com/news/world-europe-62179136 [v] See, e.g., https://www.whitehouse.gov/briefing-room/statements-releases/2022/04/06/fact-sheet-united-states-g7-and-eu-impose-severe-and-immediate-costs-on-russia/ [vi] See, e.g., https://www.bbc.com/news/world-europe-60125659 [vii] See, e.g., https://www.bbc.com/news/world-europe-60125659 [viii] https://www.cnbc.com/2022/08/02/russia-faces-economic-oblivion-despite-short-term-resilience.html [ix] https://www.axios.com/2022/07/26/russia-sanctions-economic-impact [x] Id. [xi] https://senate.texas.gov/members/d07/press/en/p20220302a.pdf [xii] https://www.dallasnews.com/news/politics/2022/05/04/texas-has-millions-invested-in-russia-but-ukraine-war-has-set-off-scramble-to-back-out/ [xiii] See https://www.stateside.com/sites/default/files/2022-07/Simplified%20Russia%20Divestment%20Report%20All%20Actions%207.27.22.pdf listing actions taken against Russia by various U.S. states as of July 2022). [xiv] See, e.g., https://comptroller.texas.gov/application.php/pension/search (listing public state retirement systems under the “State Plans” search option). [xv] This point was made to the House Public Education Committee on April 26, 2022 by the Chief Investment Officer of the PSF. See https://tlchouse.granicus.com/MediaPlayer.php?view_id=46&clip_id=23209 (starting around the 3:11:10 mark). [xvi] https://www.cnbc.com/2022/02/28/heres-how-us-investors-may-have-exposure-to-russian-stocks.html [xvii] https://www.cnbc.com/2022/02/28/heres-how-us-investors-may-have-exposure-to-russian-stocks.html [xviii] See, e.g., https://fortune.com/2022/03/03/russia-firms-erased-msci-ftse-russell-stock-indexes-putin-ukraine-invasion-uninvestable/ [xix] https://www.trs.texas.gov/Pages/TRS-statement-on-Russia-holdings.aspx [xx][xx] https://tea.texas.gov/sites/default/files/PSF_Annual_Report.pdf [xxi][xxi] https://www.gainesvilleregister.com/news/local_news/russian-invasion-of-ukraine-costing-texas-school-fund/article_ab1c75bc-c73c-11ec-82bc-4793e87ba398.html [xxii] https://www.pionline.com/pension-funds/us-funds-remain-vigilant-over-exposure-russian-securities [xxiii] https://www.tcdrs.org/globalassets/library/reports/2021-annual-report.pdf (p. 44) [xxiv] https://www.utimco.org/media/3779/board-book-06102022.pdf [xxv] Id. [xxvi] https://www.wfaa.com/article/news/politics/inside-politics/bipartisan-group-texas-lawmakers-calling-on-state-use-economic-power-punish-russia/287-0f79cdb2-7401-4fda-8154-5e50368b623c [xxvii] https://www.dallasnews.com/news/politics/2022/05/04/texas-has-millions-invested-in-russia-but-ukraine-war-has-set-off-scramble-to-back-out/ [xxviii] https://www.sacbee.com/news/politics-government/the-state-worker/article263749188.html#storylink=cpy [xxix] See, e.g., https://www.wsj.com/articles/divesting-from-russia-proves-complicated-for-pension-funds-11646193559 [xxx] Id. [xxxi] https://www.politifact.com/article/2022/apr/07/fact-checking-fried-desantis-claims-about-floridas/ [xxxii] Id. [xxxiii] https://www.cnbc.com/2022/03/14/putins-invasion-of-ukraine-will-knock-the-russian-economy-back-by-30-years.html [xxxiv] https://www.trs.texas.gov/TRS%20Documents/popular-annual-financial-report-2021.pdf