The obligations of pension funds to society

The dust has barely started to settle on the government’s last review of the investment arrangements for the Local Government Pension Scheme (LGPS), and already – due to one authority (out of 89 in England and Wales) with a high-profile investment representing less than 0.01 per cent of total Scheme assets – there are top-down calls to throw everything up in the air again.

Much of the costly work undertaken by the eight new LGPS asset pools, created to both improve governance and reduce costs, is now being threatened with a compulsory move to passive management.

 

One would have thought that if any pension schemes might take into account the wider view of what investment ought to achieve for society, it would be those that are linked to the government. Surely the government, more than any other entity, relies on productivity growth and wealth creation in the economy to generate the tax revenues that are required to meet welfare and state pension obligations for decades into the future.

 

How is wealth created? By the deployment of capital into companies that improve efficiency for existing industries and activities, or those that create entirely new goods and services which improve standards of living and wellbeing. It is not created by simply parking gigantic quantities of capital into the entire stock market.

True active managers should not worry about share prices but whether companies are achieving their goals in a way which is sustainable for their clients as shareholders.

The latest clamour for a move to passive investments is a gross over-simplification of the challenges we face. It may well be the case that the average active fund manager doesn’t achieve anything very worthwhile, but that is to conflate the hugely important task of capital allocation and stewardship of assets with the short-term market speculation that has come to be equated with active management. These are two different topics and should be treated as such.

 

It is not an active manager’s job to defend the pointless and expensive system of speculation on share prices that dominates stock markets. However, it is their job to provide capital to companies that are bringing about much-needed wealth creation in society.

 

As long-term responsible owners of these companies, true active managers should not worry about share prices but whether companies are achieving their goals in a way which is sustainable for their clients as shareholders, and more widely for pension scheme members - as citizens who want to retire in a world worth living in.

 

In achieving these goals, companies which are operationally successful in the long run, achieve a disproportionate amount of wealth creation and have share prices that eventually follow. Well-run companies are a huge benefit to society, not just their investors. By focusing on what matters, active managers can achieve over and above what they would have received by investing generically in the stock market. And that wealth created pays a lot of pensions. This is value generated by actually investing for the long term, not out-speculating others or slashing costs.

The vast majority of wealth that is created comes from a tiny number of companies. The stock market is not a single entity that goes up and down in a nice neat group.

Why would the Government set out to shoot itself squarely in the foot with respect to future economic growth in the UK? Somebody has to be the actual investors. Of course, we know the answer – it’s because most active managers aren’t paying the slightest bit of attention to the fundamentals of wealth creation and capital deployment, which is a disservice to our industry.

 

And why is it ok for pension funds to incur huge costs elsewhere in ‘alternatives’, which in some cases have even less chance of serving a useful purpose for society, such as hedge funds that in some cases actually set out to destroy companies? Or private equity funds that are only valued occasionally, so they give the illusion of low volatility, thereby gaming the government’s own pension funding rules? 

 

Admittedly, some private equity funds are pretty good value creators, but not all of them. These funds can’t be replicated passively, so does this mean that the 1 per cent (or higher) annual management fees that accompany these investments are acceptable?

 

The vast majority of wealth that is created comes from a tiny number of companies. The stock market is not a single entity that goes up and down in a nice neat group. It is high time the real issues around the dysfunctionality of capital markets are aired. What we don’t need is a pointless debate about whether the average active manager adds value relative to a stock market index, which is the completely wrong reference point.

 

 

This article first appeared in the Financial Times, October 2019.

 

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Piers Lowson

Director

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