To determine which companies qualify as politically connected or active, the study constructed measures to weigh the extent that a given fund invests more with firms making political action committee (PAC) contributions to home state politicians or engaging in lobbying.
Misallocation
The finding was that state pension funds will tend to overweight their holdings of local firms that make PAC contributions by 23 percent and those that lobby by 17 percent relative to their neutral weight in a market portfolio.
Interestingly, the only local companies that displayed significant positive outperformance were non-politically connected local firms. Perhaps if you are good enough to overcome a biased, politically influenced system your company might actually be a winning investment.
As well, state pension funds tend to hold on to the stocks of politically connected companies longer. They are also poor at making decisions about when to buy and sell these politically connected stocks: selling winners too soon and riding losses too long. This phenomenon is not present for non-politically active stocks, according to the study.
Unsurprisingly, the degree of political bias in state pension funds is linked to how they are governed. Local political connection bias - the tendency to own the shares of politically connected local firms - is stronger in state pension funds with a higher percentage of politically affiliated trustees.
And while having an influential member of Congress in your home state might help bring home some political bacon in government spending, it is a drawback for pension governance. States with more influential politicians in Congress tend to invest more in politically connected local firms, suffering the underperformance that that implies.
Pension fund managers and trustees have an obligation to the members of their funds as well as taxpayers who ultimately might be called on to make good any shortfall. This trumps any woolly local economic development that might come from providing capital locally.
While it would be good to see a larger sample, a responsible state pension fund ought to be doing this analysis for itself and making changes in the holdings based on what they find.