The discovery – or rather the rediscovery – of fiduciary duty will be central to the effective provision of pensions. Indeed, it is central to the effective operation of any complex financial system. There are three reasons why this is so. First, it is what people want from the financial system. Second, in many roles, fiduciary institutions are considerably more efficient than those whose operations are based on contract. Finally, without a broad sense of fiduciary duty, it is difficult to see how many of the most central questions facing our financial markets can be addressed. These include the sustainability, not only of our financial system, but also the broader social and environmental and challenges which our global world faces, and which our economic institutions can do so much to exacerbate or resolve. When we established our private pension system in Britain last century, its founders were very clear about this. Pensions were established under trust law. After all, pension promises might last 80 years; the beneficiary would give away their money and require that it be properly stewarded by agents with much greater expertise. Those agents needed to be trusted to act always in the beneficiaries’ interests, otherwise, as Adam Smith reminded us, “negligence and profusion” would prevail, and savers would be unable to trust that their pension would be paid.
Those principles remain as important today as they did then. And people know it.A couple of years ago, as part of the RSA’s “Tomorrow’s Investor” programme, we undertook a number of “citizen juries”, to help understand what sort of financial system ordinary pension savers wanted. In the past, government and industry policy in this area had focussed on providing choice, and as a result there are literally thousands of pensions and savings products to choose amongst. Choice is fine. But it isn’t the main thing people wanted. Here is one comment which summarised the citizen jury judgement of how the system ought to work. It is, in common language, what we want from a fiduciary system.
“You sign up, and you hand the money over to someone who knows what they are doing, and you trust them to do a good job”
If you don’t trust your agent, you won’t hand over the money.
Which brings me to my second point. Without trust, the system requires costly regulation and limitation. And that ultimately leads to inefficiency. Let me give one example. In Britain, we have a highly regulated, often contract based, individual, fragmented system for savings for our pensions. In Holland there are large, collective fiduciary institutions. If today, a typical Brit and a typical Dutch person were to save exactly the same amount for their retirement, the Dutch person would receive an income which was 50% higher. That is not to say the Dutch system is perfect. But boy, does it do a better job
than the one we have in the UK. Imagine that we could recreate such a system in Britain, where we spend 6.5% of our annual GDP on private pensions. That would be an extraordinary boost to national productivity and to a healthier and wealthier retirement.
Third, if we want to address the serious issues which face the financial world, it is difficult to see how these can be done, unless the agents who manage our money always think about the broad interests of their clients, and use their judgement in reaching conclusions. For example, if I am a pension saver, who owns bank shares, I would want to encourage the banks to lend with prudence, not to make the money while the going is good, and risk bringing down the economy. But if you try and write a contract with a fund manager to steward the banks in this way, it’s pretty difficult to do so. It’s even more difficult if you want to encourage companies to address environmental or social concerns. The only thing you can do, is to give broad discretion to your agent, and tell them to act as they think you would act, if you had their knowledge and expertise. So trust is what consumers want. It’s what the system needs. And it’s the only mechanism by which we are likely to be able to address global problems. It should therefore be of some concern that the trust law under which our pension system was established has been under pressure. Too often, trustees defer to advisors. Too often those advisors advocate that trustees use minimum discretion. I have even been told by trustees that their advisors have told them that they may not take environmental, social or governance issues into account when making their investments. That is simply not true, as the Fair Pensions document so clearly shows. But if trustees believe this tobe the case, that is how they will act. And if they all do so, we are in real trouble. Indeed, let me go further. We need to reinforce trust law so that trustees are obliged to consider the options available to them. Trust law is not there so that trustees are instructed to act, letter by letter, in everything they do. It is there to allow them discretion within a framework of trust. Equally, we need to find some way that the playing field between trustee institutions and commercial ones is made a bit more even. Here is an extraordinary statistic from the WM company, an institution which monitors the performance of British pension funds. They reckon that pension funds which do their own fund management, (i.e. who have trustee operations in-house), make higher returns that those who farm it out on contract to “experts”. That is a fact of profound importance to anyone thinking about how to structure pension investments. But it is not well known, because the trustees of in-house funds have little incentive to advertise their success, since they can only consider the interests of those whose pensions they already manage.
Harvard Emeritus Professor, David Landes, wrote a masterpiece economic history entitled “The Wealth and Poverty of Nations”. In it, he suggests the characteristics of a society which was likely to generate prosperity. He says, “This ideal society [would be] honest. Such honesty would be enforced by law, but ideally, the law would not be needed. People would believe honesty was right, (also that it pays), and would live and act accordingly”.
They would, in other words, behave as fiduciaries.
David Pitt-Watson is the founder and Chair of Hermes Equity Ownership Service.
This article first appeared on the blog site of Fairpensions: Link