While corporate practice is often in the firing line, the pension funds investing workers’ life savings are generally given a free rein. That may be about to change
Pension fund trustees are among the UK’s biggest investors, but a lack of meaningful connection with the assets they hold and the beneficiaries they are meant to serve has hampered accountability and transparency. An individual saver often knows little about the pension amassed in his or her name other than its annual value.
At the same time, the environmental, sustainable and governance (ESG) agendas espoused in many boardrooms today are too rarely reinforced by the powerful institutional investors who could be making a difference.
Now, however, campaigners and market analysts are calling for closer alignment between corporations and their pension funds in order to promote better sustainability. This, they argue, would ultimately drive up long-term financial returns without threatening the legal separation that has always been a necessary cornerstone of the relationship.
Mike Clark, director, responsible investment, at Russell Investments, argues that there are four key players in the pensions chain of investments.
First are “citizen savers”, or beneficiaries, who are those paying into a pension scheme. They are giving money to the second link in the chain, the asset owners – the pension fund trustees who are aggregating savings. They in turn give it to, thirdly, the investment managers (such as Russell). “And we pass it to the companies in which we invest.”
The challenge is to make interaction between these groups richer and better informed, he says. Although Clark accepts that disengagement between citizen savers and their underlying investments is an issue that needs to be addressed, he points to some positive moves in this direction.
For instance, the Green Light campaign by the NGO ShareAction helps beneficiaries email pension fund trustees to challenge them on matters linked to climate change. This has been effective in raising awareness among fund managers, Clark says, and in turn can be fed back to the company in question.
“It’s a smart initiative and works towards joining up the system,” Clark says.
The notion that an ESG focus is somehow incompatible with strong financial returns is completely misguided, he says. “Many investment managers already incorporate a range of ESG-related risks in their investment process without, in the past, attracting that label. This approach to generating long-term value is distinct from a ‘values’ approach which typically excludes some companies or industries [such as arms or tobacco].”
Seb Beloe, partner and head of sustainability research at Wheb Investments, says the main issue is not really about “ethical investment” in the sense of screening out certain stocks – though that might sometimes have its place – but rather integrating ESG issues into decision-making. A sensible way of doing that is to frame the debate in terms of risk management, he says.
“There have been many cases where individuals have been involved with their company’s sustainability programme then thought: hang on, where’s my [pension] money being invested?” Beloe says. “Then they discover that it is being invested in a way that pays no attention whatsoever to sustainability.
“Now corporate pension funds are increasingly being exposed to external campaigning but are also becoming engaged by their own beneficiaries as well. It is sporadic, but gathering pace.”
Pension fund trustees are accountable to the beneficiary, not to the corporation, an important legal principle that ensures the pension fund’s independence.
In practice, however, most corporate pension funds are in deficit and require the funding stream to come from the company. “Often this can become a good conversation around how the corporation is dealing with sustainability and how that can be used to inform what the pension fund does,” Beloe says.
“So the legal separation is not necessarily, and should not be, a barrier to this dialogue.”
He cites the example of Unilever, the food and consumer goods conglomerate, which has adopted the high-profile Sustainable Living Plan under chief executive Paul Polman. This is just starting to embrace its £25bn pension fund, too.
“Unilever doesn’t have a sustainable plan because it is necessarily trying to be ‘ethical’,” Beloe argues. “It has a sustainable plan because that’s how it’s going to be successful 10 years from now – it’s about being an effective business.”
In other words, if a corporation considers sustainability important to its core business, then it also makes sense to try to ensure that its pension fund is thinking about sustainability in a similar way.
This satisfies twin needs: practical and reputational. Conversely, just because a company is producing, say, solar panels doesn’t make it an ideal target for investment: it could be exploiting its workforce and poisoning the local environment, Beloe argues.
Tomorrow’s Company, a London-based global business thinktank, is calling for an overhaul of the whole concept of value that informs pension fund trustees. It wants a comply-or-explain requirement to apply to trustee boards when they set their mandates.
“The best way of securing the long-term interests of beneficiaries is by forming a new view of value that promotes the long-term interests of people, profitable companies and the planet,” says Tony Manwaring, Tomorrow’s Company chief executive.
At the end of April, Tomorrow’s Company is launching a guide for pension fund trustees on how to achieve financial returns over the short, medium and long term in ways that are compatible with this approach.
Some of these issues were touched on by the government-backed Kay Review into the financial crisis, published in 2012. Reactions to the review have raised the question whether fiduciary standards should be applied to more people within the investment chain. Anyone who manages or advises people on how to invest their money should be required to put the client’s needs first, this argument goes.
However, several analysts have been critical of Kay for its relative silence on the role of asset owners – ie pension fund trustees themselves – rather than fund managers.
The UK Department Business, Innovation & Skills (BIS), which formally responded to the Kay report last year, is currently consulting with the Law Commission to legally define fiduciary duty, with a response not expected until June 2014.
The traditional view is that the fiduciary duty is to maximise returns for beneficiaries, but that has been measured over the short term, perhaps every quarter or six months. Many experts hope it will be redefined to cover a longer span while also recognising the shorter-term obligations that trustees face.
“If you only hold [a company’s shares] for six months, the performance of those shares isn’t really going to be dependent on the company’s ESG stance, for instance on emissions or employee benefits,” Beloe says.
“But when you think about it over five years those things become much more central to how that company is going to perform, so it becomes worthwhile to push it to improve the way it operates.”
The most progressive pensions funds are already selecting asset managers who are considering ESG factors in the way they pick investments, analysts say. Or the fund managers might be engaging with companies they already hold to try to encourage higher ESG standards.
This can have much more impact than just avoiding tobacco or arms manufacturers. Certain thematic funds, for instance, are aligned with sustainability stocks such as clean energy.
The UK Financial Reporting Council’s Stewardship Code, which aims to get investment managers focused on responsibilities rather than profits, is also being reviewed. The FRC has already implemented some of the recommendations into the code and is now considering further changes.
Most major asset management firms investing in UK equities have already signed up to the code, according to the BIS, and asset manager signatories to the code now manage about 40% of the UK equity market.
However, Tomorrow’s Company insists the fundamental change has to start with the pension fund itself, as the principal in the relationship.
Manwaring says all boards of pension fund trustees should have a view of value that is consciously considered and is one that they own. They should be clear about their own fundamental investment beliefs, but this may go against established practice that has been built up over years.
“Trustee boards tend to behave in ways whereby the view of value is in practice established by their suppliers, such as investment consultants and asset managers. Contrast that with corporate boards: it would be absurd to think a board should rely on their auditors to determine investment policy,” Manwaring says.
He adds: “We may be at a tipping point. The steps are not that difficult to take – it’s the changes in behaviour and mindset that are most challenging.”
Tomorrow’s Company has had dialogue and consultation with many pension funds. For some it’s a very new argument and they are largely content with the existing approach. Others are more open, and a minority are starting to actively engage.
The thinktank insists that when making investment choices, trustees need to ask themselves questions such as: has the company in question done an integrated report? Does it have a supply chain of conduct and is it being monitored? These and other factors should be of crucial consideration.
“Kay wanted to shine a light into the very complex and fragmented financial system and argued that until you knew exactly what was going on, you couldn’t intervene,” Manwaring says. “He was relatively silent about the role of asset owners but the system can’t operate properly unless they fulfil their responsibilities.”
Manwaring says the issue has global relevance, and cites positive developments in overseas pensions funds, including North America, South Africa and Canada. Major pension funds in these countries are actively putting this wider concept of value at the heart of their investment beliefs.
In the UK, the move towards automatic enrolment and defined contribution pensions schemes, away from defined benefit, has been shifting the ultimate liability for retirement incomes from employer to employee.
UK chancellor of the exchequer George Osborne’s 2014 budget, announced in March, also gave millions of savers more freedom to cash in their pension pot early.
These changes present both a potential threat and an opportunity, according to Catherine Howarth, chief executive of ShareAction.
“Auto-enrolment is bringing millions more people into the system. In a way this is good because people need to save to avoid poverty in old age,” Howarth says. “But given that most people are not confident about investment decisions, we need a pensions system that has strong accountability, transparency and standards of governance.”
Many more employees, including quite vulnerable people on low incomes, are now exposed to the ups and downs of financial markets. Their quality of life and standard of living in retirement depend on a fair system that is fit for purpose, she says.
Passive tracker funds are the cheapest and most popular option in auto-enrolment, and these funds contain “the good, the bad and the ugly of the corporate sector”.
Pension funds using these passive products must challenge – through dialogue and use of shareholder votes – the corporations that perform worst in terms of ethical and sustainability performance, Howarth says, adding: “And the best pension funds are doing that.”
A small number of pension funds are urging FTSE 100 companies to become living wage employers, for example. On this issue, an outright ethical exclusion policy would not be practicable because so many companies would fall foul.
But most pension funds have been slow to challenge excessive pay for executives. The voting record of UK pension funds (usually not disclosed openly to fund members) shows they overwhelmingly vote in support of pay deals for company executives put forward by the company’s board.
Most savers will accept that “it’s not possible to have a squeaky clean portfolio”, Howarth says, but you should be able to expect active stewardship of those funds so that companies are nudged to be sustainable in every sense of the word, including financially.
Transparency and accountability
ShareAction is campaigning for the same level of transparency and accountability from pension funds as these in turn demand – or should be demanding – from corporations.
“It’s a natural and logical parallel: the real shareholders of course are all of us, the pension savers, but the money is held in trust on our behalf by large institutional investors.”
To this end Howarth welcomes the decision by a large new pension fund, Legal & General Mastertrust, to open its first AGM, in September 2014, to all of its members.
And she praises the Environment Agency Pension Fund for putting out a lucid responsible investment review each year, which addresses fiduciary duty in a much broader way than just maximising return. The fund aims to explain how beneficiaries might retire on a good income from a pension that does not invest in ways that degrade the environment.
Likewise, ShareAction has singled out Heineken for the way its pension fund trustees have successfully communicated with fund members, thereby achieving active engagement by more than 90% of employees in the fund.
“This example shows that the oft-cited idea that members are completely apathetic about their pension is more a reflection of how poorly most pension funds have communicated with members,” Howarth says.
That may finally be starting to change. But the results will be seen over years and decades rather than months.
Global pensions – fast facts
The 13 largest global pension markets held $29.8tn of assets at the end of 2012, an 8.9% rise on 2011.
The US has the biggest pension market (56.6%). Japan is the second largest (12.5%) and the UK is third largest (9.2%).
- In 2012, 89% of pension assets in the UK were held by private sector companies. In Canada, this figure was 43%.
By 2018, nearly all workers in the UK will be automatically enrolled into a workplace pension scheme.
The UK state pension deficit is £7.1tn (2010, still lower than EU average, according to the Office for National Statistics).
The UK private sector final-salary schemes deficit was £244.7bn at the end of December 2012.
- There are more than 6,000 defined benefit schemes in the UK.
Source: Tomorrow’s Company
Asset classes – where’s the money?
- At the end of 2012 the average global asset allocation of the seven largest markets was 47.3% equities, 32.9% bonds, 1.2% cash, and 18.6% other assets such as alternative investments and property.
- In 2013, the UK had equity allocations of 45% (down from 61% in 2002), 37% invested in bonds, 1% in cash and 17% in other assets such as alternative investments and property.
Source: Tomorrow’s Company
Case study: Pensions Trust
In 2010 the Pensions Trust (a trust-based multi-employer scheme for the third sector) surveyed 15,000 members across its funds and commissioned Queen Mary University to analyse the results. The survey focused particularly on members’ ethical preferences.
Issues that often dominate ethically screened products, such as gambling and alcohol, ranked relatively low in members’ list of priorities, while child labour, human rights and environmental factors ranked highest.
The Pensions Trust has used the findings to inform the “themes” which they have directed their asset managers to focus on. Funds may therefore be able to re-engage members who feel alienated by the idea that their money is invested in “unethical” companies by explaining how these issues are addressed through voting and engagement activities.
Case study: PKA
Danish healthcare sector fund PKA operates a system of elected member delegates who attend and vote at AGMs and scrutinise the board on behalf of the membership at large. Delegates get two and a half days’ intensive training to help them understand pensions and investment, so that they can ask questions and engage with debates about fund policy. They participate in discussions with both members and fund decision-makers.
Delegates also take part in role play to explore the merits of “voice” versus “exit” when faced with unethical behaviour by investee companies. PKA reports that this has helped to build understanding and support among delegates for the fund’s engagement-led approach.
The process did identify a core of unacceptable investments – at first involving weapons, then later also tobacco – which the fund now screens out. It also showed that delegates were particularly interested in protecting labour rights and socially and environmentally positive investments.
Case study: Heineken
Heineken’s contract-based defined contribution UK pension scheme, launched in July 2011, before auto-enrolment, achieved a 95% sign-up rate. Of these, 97% made an active investment choice – in most schemes roughly this proportion join by default. The initial development of the scheme had also included a formal 60 day consultation process involving the Heineken UK Employee Council.
Part of the brewer’s strategy was a statement of investment principles (SIP) setting out its investment beliefs and objectives, and explaining how investment options are monitored. Although a legal requirement for most trust-based occupational schemes, SIPs are not required of contract-based ones.
Former Heineken pensions manager Carol Young says the SIP is “an opportunity to provide investment information to members in a transparent way”.
asset managers ESG fiduciary duty fund trustees Kay report pensions