Public understanding of long-term investment can be limited. Repeated exercises in the Netherlands have shown that when pension fund members are asked about their investment-risk tolerance, they say they want a higher return and no risk. In the same way, Californians repeatedly vote for low taxes and high-quality public services.
The two cannot be squared in either case. Leaving California’s finances aside, in pensions this means a communication exercise is necessary to explain to beneficiaries the income shortfall they will face if they take a low-risk strategy.
Lots of factors affect public understanding of pensions. In the Netherlands, experience is tainted by the recent pension entitlement cuts, while in some countries pension funds are linked in the public mind with the bad practices of other financial institutions. Sometimes retail pension funds have contributed to this poor perception over the years through excessive fees.
There has been considerable scrutiny of investment at pension funds in various European countries of late, with advances on cost disclosure in countries like Switzerland and the Netherlands. In the UK, the industry is awaiting with interest the outcome of the Financial Conduct Authority’s review of asset management.
As the focus on transparency has increased, some pension funds have struggled in recent years to justify their hedge fund investments, mostly on the grounds of cost. Indeed, some large funds, like PGGM and now NYCERS, have divested completely from the hedge fund sector.
Following the revelations of the Panama papers in various media around the world, there is a risk that the legitimate offshore structures of hedge funds will be contaminated in the public’s mind. This might lead to more member pressure to divest from hedge funds, even though this may not be in their overall interests. Wise pension fund trustee boards might want to consider how to counter any such pressure before it arises.
Communication is also important on the cost of internal staff and investment capability. It is widely known, for instance, that the large Canadian public pension funds pay their internal staff well. Other pension funds, like ATP in Denmark, have a special agreement to exempt them from public sector pay constraints.
Leaving aside the debate on in-house resources per se, it is important to note that these decisions on remuneration were made through informed deliberation and were the product of conscious decisions at board level.
The common ingredient is to take a consistent approach to governance and long-term investment beliefs and to communicate it effectively. As funded pensions take on a wider role in many parts of the world, public understanding needs to keep up with the growing complexities of long-term investing if trust is to be maintained.