Pension funds: how to awaken the sleeping giant of ethical investment

7 Oct 16

Council pension funds can do more to help promote ethical behaviour in the companies they invest in, which would benefit members as well as local residents.

Pension funds are something of a sleeping giant in the world of ethical finance. According to the latest data from the Office for National Statistics, pension funds held 3% of the value of the UK stock market in 2014. Although this may not seem like a huge chunk of the investor market, the investments of some pension funds are significant, especially if we talk about the public sector.

For example, the Local Government Pension Scheme (LGPS) is one of the largest public sector pension schemes in the UK with 4.5m members and a total £217bn of assets under management, of which 36.8% are invested in public equities. Such figures only go to show the potential that local authority pension funds have for influencing the social and environmental behaviour of investee companies.

As Labour’s shadow chief secretary to the Treasury Rebecca Long-Bailey has called for pension scheme members across local government to be given a greater say in what investments are made, including on ethical grounds, it is time to consider what could be done.

Local authority pension funds can use their influence as investors in companies in order to initiate a change towards better stewardship. One way could be for them local authority pension funds to divest sell stock (basically sell) considered to be at odds with their principles (i.e. a tobacco company or an arms manufacturer). Alternatively pensions could engage with investee companies through letters, dialogue, meetings, voting at AGMs, among others – an approach known as shareholder activism.

Recently, local government pension funds have been targeted by Fossil Free UK and other campaigners to divestment from fossil fuels. Their investments in coal, oil and gas companies – BP and Shell being prime examples – amount to £14bn as revealed by FOI requests sent by campaign groups. In response to these calls for divestment, a spokesperson for the council with the highest percentage of fossil fuel investments (Merton Council in London) pointed out that, by law, fund managers have a fiduciary duty, they are duty bound to maximise the financial returns from their stock portfolio.

Such a response is not an isolated case. There are, of course, local authorities who are using their investment influence in a responsible way – for example, in July 2014, the London Borough of Croydon divested from the tobacco industry. However, there is a perception in councils that according to the law their fiduciary duty (the legal obligations pension fund trustees have to the people whose money they are managing) instructs them to maximise the financial return for their scheme members, regardless of wider social and environmental factors. There is also the added complication, or should that be pressure, that public sector pension funds are facing increasing deficits. And so cold-hearted economics takes precedence over ethics.

And yet ethics and the economics of investment are not necessarily at odds. Pension funds have a clear duty to take account of the long-term risks in their investments in order to ensure a sustainable future and steady and reliable income for future pension beneficiaries. Climate change, the risk of a carbon bubble and environmental disasters such as the Deepwater Horizon oil spill are only a handful of the factors which have created a dent in shareholders’ pockets and put the long-term financial sustainability of their investments in this jeopardy. Fiduciary responsibility can be seen as a convenient excuse on the part of fund managers to avoid the work necessary to screen potential investments for their ethical sustainability /and engage with investee companies.

In addition, there have been recent changes in the way fiduciary duty is interpreted. The Law Commission published a report in June 2014 on the fiduciary duty of investment intermediaries that concluded: “Trustees are required to balance returns against risk. When investing in long-term equities, the risks will include risks to the long-term sustainability of a company’s performance. These may arise from a wide range of factors, including poor governance or environmental degradation, or the risks to a company’s reputation”.

Despite this, there are misconceptions about fiduciary duty. The positive news is that pension savers are, as Long-Bailey stated, slowly beginning to get more engaged in how their money is being managed, asking questions to their pension funds and demanding their voices be heard. The problems pension savers face are lack of transparency and accountability (i.e. pension funds not disclosing information on their voting and engagements). Also pensions, and the wider world of investments, are often perceived to be complicated and daunting for the would-be campaigner.

Another question to ask is whether divestment is really the best course of action for local authority pension funds as they lose their investor rights and cut their communication channels with management, while at the same time their shares are bought by another investor who is not necessarily concerned with the ethical practices of the company. But the public ethos of local government is about improving the life of people and building resilient communities, both now and in the long-term. The decisions made by local authorities impact on our wellbeing, on the quality of education, transport and economic opportunities. As such, local authorities can, through their investments, serve as an example by initiating a positive change in companies’ behaviour. Such a change could happen through taking a proactive role in creating the future they aspire to, via engagement with poor performers, rather than a quick selling of shares.

  • Mila Ivanova and Mike Marinetto

    Mila Ivanova is a post-doctoral research fellow at Cardiff Business School. She holds a PhD in business ethics and her research interests lie in the area of corporate social responsibility, responsible investment, and non-governmental organisations.

    Mike Marinetto is a lecturer at Cardiff University Business School. He has a long standing interest in shareholder activism and ethical investment. He is currently writing about 'idle scholarship' and the role of investigative journalism in business research.

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