A global pension fund culture that has encouraged investors to employ “copycat” investment strategies based on a “lemming-like” fixation on short-term returns needs to be put under the regulatory spotlight lest it escape the necessary scrutiny that could help financial markets recover fully from the credit crisis, according to a report by two former senior pension fund advisors. The report titled: “Modernizing pension fund legal standards for the 21st century” was written for the Network for Sustainable Financial Markets (NSFM), the web-based ginger group on sustainability issues, by Keith Johnson, former chief legal officer at the State of Wisconsin Investment Board and Dr. Frank Jan de Graaf formerly an advisor for responsible investment at PGGM Investments in the Netherlands. The report suggests pension fund trustee boards may also be failing in their fiduciary duty by favouring short-term return goals that benefit older scheme members over younger beneficiaries who, it says, would be better served by longer investment horizons. It said that despite pension funds now making up a massive part of the global financial system – US institutional investors, with over $10 trillion in pensionfund assets alone, now own up to 76% of the equity of US Fortune 1000 companies – there had yet to be any real scrutiny of the role of this ‘central plank’ of the economy in contributing to industry-wide investor pressure on the managers of companies to deliver short-term investment results. Short-termism is cited as one of the main reasons why companies such as banks geared up their businesses to maximize quick returns and meet annual performance targets prior to the credit crash. Citing a survey from the Social Science Research Network (SSRN), it said short-term pressure from investors had become so strong that nearly 80% of a sample of corporate managers asked by SSRN said they would sacrifice future economic value to manage short-term earnings and meet investor expectations. Johnson said: “This is an incredibly destructive force and has contributed directly to the collapse of financial markets, as financial institutions and operating companies take on excess leverage and engage in financial engineering to meet short-term revenue expectation.”
Conversely, Johnson said pension fund performance was directly tied to stability and growth of the corporate
sector and the broader economy: “Companies need investors with a more balanced approach to the markets and pension funds need sound companies that can deliver sustainable results. As major market players, pension funds now have to look at systemic risks to investments that lie outside of what has traditionally been quantified by the industry. This includes risks to the wider economy in which they operate. That means how the economy as a whole is working, as well as long-term factors like climate change.” The report also suggeststhat pension funds could increasingly merge in order to increase professionalism and cut costs. The authors conclude with six policy suggestions they say would enable pension funds to promote sustainability in the future economy. These include a reappraisal of fiduciary duty, better intergenerational balance between pension scheme members and its impact on investment, and partial fee allocation to fund managers and advisors based on economic sustainability and systemic risk.
The full paper is available from Link to NSFM site