The complaint that trustees must act as ‘moral policemen’ misses the point, says FairPensions’ Christine Berry.
Robin Ellison, in his reaction to the recent Bank of International Settlements report, made two important points: one, that trustees’ duty is to their beneficiaries, and two, that fulfilling that fiduciary duty is a “question of balance”. But he went on to imply that the systemic impact of trustees’ decisions should not weigh in that balance: “Trustees are not moral policemen, nor have they the skills to decide which of their investment policies can reduce world financial volatility.”
The “moral policemen” tag seems an odd one. It’s surely wrong to equate concern for the systemic impacts of one’s investment decisions with a moral decision to, say, avoid pornography or arms companies. This characterisation reflects the general tendency - which Ellison himself explicitly warns against - to equate “beneficiaries’ interests” solely with next quarter’s risk-adjusted returns, and to dismiss anything else as motherhood and apple pie.
Trustees do have reason to think about the systemic impact of their investment policies - not because it’s the ‘moral’ thing to do, but because it will clearly affect their beneficiaries. In the 12 months following the financial crisis, the OECD estimated that pension funds lost an average of 17% of their value - with much greater losses in more risky portfolios. It’s hard to deny that this constitutes a fiduciary issue. More generally, the increasing evidence that asset allocation determines the bulk of variation in pension fund returns points to the importance of beta exposure over alpha. If what matters most is the performance of markets themselves, then surely funds should be looking not only at their level of exposure to those markets, but also to their own impact as market participants.
Of course, addressing those impacts is another matter, and a difficult one at that. As Ellison rightly points out, most trustees do not have the skills to assess the systemic impacts of their decisions. As Lord Myners recognised a decade ago, the level of trustee expertise raises much bigger questions about fiduciary responsibility - but that’s another issue. Even if they did, the existing tools available to them may no longer be enough to protect their beneficiaries. It is in the nature of systemic risk that it cannot easily be avoided or hedged using traditional risk management strategies. The only sure-fire way to protect beneficiaries from the impacts of the next global financial meltdown is to tackle the risk at its source: to try and reduce its likelihood, and, if and when it happens, reduce its impact. That potentially takes trustees far outside their comfort zone, into the arena of collaborative engagement with other investors, companies and even regulators. At a minimum, it does suggest that they should seek to ensure their own actions as investors do not escalate that risk.
The events of recent years have starkly demonstrated that trustees can no longer fulfil their fiduciary duties by considering their investment policies as if they exist in a vacuum. But this is not the first time fiduciaries have faced such challenges: fiduciary duty has always evolved and will continue to do so. In the 19th century, fiduciaries were effectively barred from investing in equities, which were considered risky and therefore imprudent. In the 20th century, modern portfolio theory led to the development of the duty to diversify. In the 21st century, with commentators already muttering dark warnings about the next crisis, trustees should be asking themselves how they can get a handle on the range of risks facing their beneficiaries.
Exploring the implications of this new reality was one of the key aims of FairPensions’ recent report on fiduciary duty. We don’t pretend to have all the answers - but we do believe there’s an urgent need to start asking the right questions.
Christine Berry is policy officer at FairPensions