Pension Funds Online

The Future of Pension Funds: Sustainable Investment

Pension funds need a future economic recovery that lasts. To achieve that, they must take greater responsibility as asset owners to create a low carbon, resource efficient and socially sustainable world, working with insurance companies and other major investors. Thoughtful commentators increasingly recognise that this is the only way to deliver the sustained profits that pension funds require to meet their liabilities in the decades ahead – and even arguably to survive.

The current economic crisis offers a major challenge to pension funds. There is an emerging view that they and other asset owners have given too much emphasis to short term returns at the expense of holding corporate management to account to protect asset value. The Walker review of the corporate governance of the UK banking industry, due to report in Autumn 2009, is considering “the role of institutional shareholders in engaging effectively with companies and monitoring of boards”.

Mark Goyder of Tomorrow’s Company has said “The crisis is a failure of ownership and we have to learn the lesson”[1]. The Board members of the United Nations-backed Principles for Responsible Investment Initiative (PRI) represent some of the world’s largest pension funds from five different continents including France’s Fonds de Réserve pour les Retraites, PREVI in Brazil and the UK’s BT Pension Scheme. They take a similar view. Donald MacDonald, Chair of the PRI Board, has said ““As clients and part owners of the financial institutions at the core of this crisis, institutional investors should accept some shared responsibility for the behaviours that led to the crisis.” and “We believe this current crisis could have a catalytic effect of shifting the mainstream investment sector towards more responsible investment practices.”

Recently, the National Association of Pension Funds (NAPF) and the Association of British Insurers (ABI) have both re-emphasised their support for responsible ownership and investment.

Others have also highlighted its importance. For example, the International Corporate Governance Network’s “Statement of Principles on Institutional Shareholder Responsibilities”, adopted in 2007, states “The ownership of equity carries important responsibilities, particularly due to the voting rights that can influence the way in which a business is conducted. Ultimate owners cannot delegate these responsibilities. Even when they employ agents to act on their behalf, it is up to beneficial owners to ensure that the responsibilities of ownership are fulfilled by those agents.”

Because environmental, social and governance (ESG) issues can have a material financial impact on portfolios, lawyers Freshfields Bruckhaus Deringer, in a report on fiduciary responsibility produced for the United Nations Environment Programme Finance Initiative (UNEP FI) in 2005[2], warned that failure to integrate them in investment decision-making could represent a breach of trustees’ fiduciary duties. They argue that the application of a responsible investment policy is consistent with fiduciary duty and should not be thought of as a cost but as an investment to improve returns.

Government has also given greater emphasis to responsible investment. Speaking in the House of Lords during the passage of the 2008 Pensions Bill, government spokesman Lord Mackenzie said[3]

… In the statement of investment principles, trustees of pension schemes must already state to what extent social, environmental or ethical considerations are taken into account. That is an obligation on trustees—not simply a right or an option.

There is an emerging recognition that the central reason for pension funds to consider long term responsible investment is financial risk and opportunity. ESG issues can affect the performance of investment portfolios. Appropriate consideration therefore needs to be given to them to deliver the highest risk-adjusted returns for scheme members.

In addition, major pension funds are ‘universal owners’. The financial performance of a universal owner’s investments depends on the performance of the economy of the whole. Companies or industries which profit from passing on the costs of negative externalities to other sectors of the economy do nothing for the universal owner’s overall portfolio performance. As such in order to meet its long term financial liabilities, major pension funds need both sustained corporate profitability and global sustainable economic growth. Both are only achievable if companies have sustainable business models and practices.

As an asset owner, pension funds must consider their ownership imperative. There are both fiduciary and financial reasons behind this. Owners have a duty to hold directors accountable for governance and corporate responsibility. And active ownership can protect financial value. The 2001 Myners Review and subsequent Investment Governance Group, the Institutional Shareholder Committee and the NAPF all recognise this.

As major actors in society, pension funds also need to protect their licence to operate by being responsible institutional citizens.

For public sector pension funds, there is a further consideration. Responsible investment is becoming the international norm for public pension funds and buffer funds. This is evidenced by the number of public pension fund signatories to the UN-backed PRI. There are a range of risks that public sector pension funds may be exposed to by opting out of such global best practice, not least its confidence and reputation amongst potential members and other stakeholders.

In summary, pension funds need to practice responsible investment for three reasons:

• To enhance and protect the long-term financial value of their portfolios;
• To contribute to and benefit from sustainable economic development
• Because they are part owners of corporations and important actors in society

There are several positive developments to build on.

Launched in 2006, the PRI network has extended within three years to over 500 financial organisations worldwide.

The UK’s new Personal Accounts system could play a significant role as a beacon for responsible investment in the UK. Early in 2009, the Personal Accounts Delivery Authority (PADA) held a consultation seminar on responsible investment as the first part of their consultation process on the system’s investment strategies. Announcing the consultation, PADA CEO Tim Jones commented that “the single most important debates will be responsible investing across the whole of the investment area, and the structure of the default fund”.

Since 2006, UKSIF’s Sustainable Pensions Project has supported UK occupational pension funds to respond to these challenges. Under the oversight of an advisory board of industry leaders, it provides a range of online resources for those developing and implementing responsible investment policies. The Advisory Board is chaired by pension fund trustee Michael Deakin, a former Chief Investment Officer, and includes leading pension fund trustees, pension fund managers and investment consultants.

The free resources include:

Sustainable Pensions Library
An online library that provides trustees and advisers with an overview of key responsible investment documents and initiatives.

Quarterly E-newsletter
A short update email giving summaries of key developments in responsible and sustainable pension investment over the previous three months as well as new resources available.

Self-assessment template for local government pension funds
Developed with the Chartered Institute for Public Finance and Accountancy (CIPFA) Pensions Panel and the Local Authority Pension Fund Forum, a self-assessment template which takes trustees through key responsible investment issues. This was published in Local Government: Responsible Pension – Assessing responsible investment leadership by Local Government Pension Schemes (November 2007).

Bi-annual survey of corporate pension funds
This survey seeks to encourage the pension schemes of the UK’s Corporate Social Responsibility (CSR) leaders to consider ESG issues in their investment decisions. For example, they might align their investment policies more closely with their plan sponsor’s CSR, Climate Change and sustainability policies. It focuses specifically on the pension funds of UK companies listed in the FTSE4Good and the Carbon Disclosure Leadership indices. The results were first published in Autumn 2007 in the report Responsible Business: Sustainable Pension – How the Pension Funds of the UK’s Corporate Responsibility Leaders are approaching responsible investment. The results of the second bi-annual survey will be published in Spring 2009.

Our work suggests a framework for action for pension fund trustees that includes the following steps:

Step 1: Build Knowledge and Understanding and take Professional Advice

As well as the support above, the plan sponsor’s sustainability or corporate responsibility departments may provide useful insights – or even a suitable employer-nominated trustee. The major investment consultancies have responsible investment teams with specialist knowledge and experience in the field.

Step 2: Collaborate and Consult

Collaborative forums include the Institutional Investors Group on Climate Change (IIGCC), the Local Authority Pension Fund Forum (LAPFF), the Carbon Disclosure Project (CDP) and the UN-backed Principles for Responsible Investment (PRI). Some pension funds may also wish to consult their beneficiaries to gauge their views.

Step 3: Define Policies and Implementation Strategies

Consider which asset classes should have responsible investment strategies and which techniques should be used. Techniques may vary from building criteria into voting strategies to investing in specialist mandates.

Step 4: Implement and Assess Impact

Effective implementation is key. Many investment consultants are able to help funds select managers with relevant expertise and suggest ways to hold them to account for their performance.

Step 5: Disclose

Finally, pension funds should communicate on their responsible investment policies and implementation so that beneficiaries and civil society can respond. Commentators are increasingly calling for the same level of transparency from pension funds as that practised by the plan sponsor or expected from the companies owned by the fund.

Today’s financial and economic crisis and tomorrow’s looming threats of climate change and resource scarcity make unprecedented demands for leadership by occupational pension funds. Through responsible ownership and investment strategies, they can play a pivotal role in building the low carbon, resource efficient and socially sustainable world needed to meet their liabilities and act in the best interests of their beneficiaries. There are now many resources to help them. It is in their own enlightened self-interest for pension funds to rise to this challenge.

www.uksif.org

Penny Shepherd has been Chief Executive of UKSIF, the sustainable investment and finance association, since May 2005. She has assisted the organization to refine its mission and strategy to address advancing sustainable development through financial services; and launched UKSIF initiatives including the Sustainable Pensions Project, National Ethical Investment Week and the Finance Network for Sustainable Energy (a joint programme with the Renewable Energy Association). Previously she was the first Chief Executive of the London Sustainability Exchange (LSx) (2001-2005) and a member of the London Sustainable Development Commission (2002-2007).

As UKSIF Executive Director from 1997-2001, Penny played a leading role in championing the government's pioneering SRI disclosure regulation for occupational pension funds. Her leadership in socially responsible investment was recognised in the Queen's Birthday Honours List in June 2000 with an MBE for “services to sustainable economic development and socially responsible investment".

Prior to that, she was responsible for new business development at Business in the Community, the corporate social responsibility charity (1995-1997). Penny started her career in IT and business consultancy at IBM (1976-1994), working with financial services and retail clients and in quality management.

About UKSIF

UKSIF, the sustainable investment and finance association, aims to ensure that the UK finance sector is the world leader in advancing sustainable development through financial services. To achieve this, it seeks to:

• Grow customer demand
• Ensure access to high quality supply
• Ensure that the operating environment for the UK finance sector encourages and enables leadership in sustainable and responsible finance

[1] FTfm, 8 December 2008

[2] http://www.publications.parliament.uk/pa/ld200708/ldhansrd/text/81007-0011.htm

[3] http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf