The SRI debate, with its new jargon and new investment philosophy, may be seen as yet another complication that trustees just do not need! But let me try to simplify the debate about why some pension funds have taken up this issue, what we have learnt, and what this might mean for the future of ‘socially responsible investment’.
Pension scheme members want to know that they will have a reasonable pension when they come to retire. For the average UK pension fund member, that means about 20 years from today. And if we think of the world 20 years ago, it is clear that there can be considerable progress and improvements in living standards over such a timescale. These changes will benefit all pension fund members – defined benefit (DB) and defined contribution (DC) alike – when they come to retire.
So an important question for pension funds is: ‘are we doing what we can to encourage companies to make the decisions that will maximise this long-term progress and quality of life?’
Consider the reverse: ‘which of us would like to think that our pension funds were undermining our future quality of life? And for those of us who are parents, who would like to think that our retirement savings are undermining the quality of life for our children?’ This is not a political issue. It’s not even an altruistic issue. It is basic common sense.
This was one fundamental reason why the University Superannuation Scheme (USS) in the UK decided to take up SRI through the engagement route. One of the things that we have learnt is that the business world – and of more direct relevance to us, financial markets – could be doing more to promote economic, social, political and environmental stability, and progress more generally, without straying from the fundamental purpose of generating wealth.
The gap between what is happening and what needs to be done is of importance to pension funds because we (and the multinationals in which we are heavily invested) have a shared strategic assumption – that globalisation will be successful. The pension fund contract – between different generations of workers – will increasingly become a contract which is not only inter-generational but which is also international. ‘Our’ retirees will in the future increasingly depend on the influx of retirement savings from successful workers and on the profitability of successful companies in what are now considered the emerging markets.
Yet this process is under growing risk from, to name just three things, international debt, HIV/Aids and climate change. The ‘symptoms’ are most obvious ‘over there’ – economic instability in Latin America, Aids in Africa, the impact of climate change in South Asia. We, ‘over here’, may think that we are secure. But as Kofi Annan said at the Johannesburg Summit: “Either we now help the outsiders in a globalised world out of a sense of moral obligation and enlightened self-interest, or we will find ourselves compelled to do so tomorrow, when their problems become our problems in a world without walls.”
Looking to the future, therefore, and if trustees are to act with the best interest of our members in mind – balancing the short term with the long term – we need investment consultants and fund managers to help us have a more rational and ideally evidence-based discussion about these urgent issues.
One concern seems to be that doing this work may reduce the net performance of the fund because fund managers will have to ‘tool- up’ or sub-contract these services because costs will go up. But what does this mean in specific terms and how will these new costs relate to other fund management costs (for example, marketing costs)? With this kind of data, we can together work out how we can move forward.
Another concern – perhaps more important – is that by pursuing this SRI and corporate governance work, fund managers and company managers will be unable at the same time to deliver growth sufficient to satisfy investors and clients. We need, therefore, some analysis of the pros and cons of the options available. Is it true that we are, inadvertently, fuelling “the modern obsession with beating the benchmarks” which “means that fund managers need rising share prices and out-performance to satisfy their clients – and are prepared to prod and push companies in which they are invested towards measures that produce the desired result”?1 Several informed commentators have highlighted the fact that whilst a pragmatic focus on shareholder value can often deliver useful efficiency savings and help to keep management accountable, a myopic focus on short-term share price movements can cause companies to mortgage their futures, to damage their relationships with their employees, customers, suppliers and society in ways which, ultimately, cause investors more harm than benefit and stands in the way of the progress.2 The new complicating feature is that senior management can now be so incentivised through stock options to consider the short to medium term, such that they, too, may not be focused on these longer-term downsides. Thus another question on which we need specialist advice is: ‘as long-term investors, would our members be better off if we went for lower volatility rewards, even if this meant accepting real return rates which are much more modest than those which we experienced in the 1980s and 1990s?’
At the heart of this debate is the concern that fund managers cannot deliver on this ‘new’ agenda in a systematic manner whilst simultaneously beating the benchmarks that we, their clients, have set them. But, with the benefit of 20/20 hindsight, have those benchmarks really served us well? It is generally accepted that pension fund trustees believe they are not focusing on short-term performance and that fund managers think we are! Now surely is the time to stop having this sterile debate!
What we need are creative and talented specialists to suggest alternative measurement methods and performance systems that would address the short-termism problem and simultaneously have a welcome effect on these corporate governance and SRI concerns as well. After all, which pension fund trustee would be wedded to a benchmark if it was going to fuel the next bout of ‘irrational exuberance’ with the boomerang effect on schemes members and sponsors that we can now predict?
Finally, I’d like to touch on a point which is so fundamental that it is easily ignored. No progress will be made as a result of a few pension funds and investment managers acting alone. The task is just too big. Even more important, without greater collaboration, companies face competing and contradictory priorities from different ‘responsible investors’. USS’s experience is that currently the factors driving collaboration are not adequate to overcome the resisting forces. As with many of the things that I have covered, what we have is a systemic problem – no one is particularly to ‘blame’ and no one player can change the system alone.
Clearly the best solution is to work together and, with public/consumer opinion, to create the catalysts that we need to create the positive outcome that we all want without what could be unnecessary intervention from government. This is a challenge that our trade associations are ideally suited to respond to.
Clearly SRI and corporate governance has come a long way and, given that you are reading this supplement, I will take it for granted that you are aware of the major progress that has been made. But let us not gloss over the telling criticisms that those who monitor developments have highlighted:
q Corporate governance and, even more so, SRI, is still a niche product. Fund managers would seem to be doing what they think is needed to ensure they get through any selection hurdles and integration between SRI activities and mainstream fund management decision-making can be pretty patchy – a matter not unrelated to the question of benchmarks I discussed earlier.3
q Most pension funds that have signed up do not appear to be monitoring, either directly or through their investment consultants, whether fund managers are doing what they really should be doing, although it must be said that the situation in the UK appears to be much better than, say, in the US.4
At this time many pension funds face major challenges to their core business as a result of weak equity markets. They face possibilities of further sudden drops in market values if things go wrong in Iraq, Korea or Japan. They face weak positions vis-à-vis their liabilities. One investment consultancy has described this as the riskiest position pension funds have been in for 30 years. Is now the right time to be asking their fund mangers to taking this ‘extra’ agenda seriously?
The answer to that question depends on what we, as scheme trustees, think is the change that needs to take place. If we think the need is to find the ‘right’ asset allocation and the ‘right’ fund managers to ride out this storm and wait for the next bull market, clearly the issues raised above will not be of major relevance.
But as pension funds, should we not be taking a longer-term perspective? If the learning from our collective experience is that our money is inadvertently being managed in ways that are not in the best long-term interests of either the companies in which we invest, and in all probability, our members as well, then the answer to the question ‘should we embrace this agenda now?’ must be a clear and unequivocal ‘yes’.