Can pension funds act for the public good

Pension schemes’ overall purpose is to deliver retirement income so that members can enjoy later life. Open pension schemes are long-term investors deploying patient capital. It is in this role that they make their wider contribution to the economy and society.

Long-term investment horizons are crucial if the existential challenges of climate change and related social and economic risks are to be successfully addressed. Pension capital is better placed than most to play this role. Overall, our financial system is focused on short-termism and that can lead to inferior return outcomes for pension scheme members while also being an obstacle to sustainable economies and societies.

This may be evidenced through lower returns across the portfolio over the long term, as well as elevated short-term volatility which can further influence short-term thinking, leading to a continued pattern of poor decisions.

Many large pension funds can now be considered universal owners, i.e. institutional investors that have become so large they own a slice of the whole economy. They can’t stock-pick their way out of climate change and other social issues that challenge sustainable outcomes. And they can’t swerve systemic issues that affect the entire economic system – and beyond – such as inequality and biodiversity loss.

These risks are impossible to diversify away from; only active engagement by long-term motivated owners can effectively meet this challenge.

How can pension schemes support climate-awareness and social regeneration?

There is a concern that current mark-to-market securities prices may not adequately encompass the financial risks of climate change. This reflects externalities which are hard to quantify ‘in the price’, e.g. the cost of carbon emissions in the absence of effective global carbon pricing.

Pension capital, as long-term investment on behalf of successive generations of citizens, looks beyond the short-term vagaries of markets to the longer-term risks, such as that of stranded assets in a disorderly transition. Calibrating these risks is a role that pension schemes can perform, but they can also use the wider market short-termism as an opportunity to outperform on behalf of their members.

Equally on the social side, evidence is growing that sustainable value creation is enhanced by, for example, fair work practices. In knowledge economies, nurturing human capital is critical to long-term success.

Potential unintended consequences?

There is a possible danger that too much is expected of pension schemes, whose purpose is to deliver retirement incomes and who must therefore always have long-term financial returns in the foreground. Pension trustees play a crucial role here in ensuring a sustainable investment strategy.

Impact investing is an interesting area in which doing well and doing good are aligned. The challenge can be in measuring success or otherwise. Protecting long-term future investment outcomes involves taking on systemic issues, such as climate change. And this, in turn, involves pursuing real-world impact to nurture the health of fundamental systems.

Consciously pursuing impact means active ownership, investing in solutions, engaging with policymakers, and working jointly with other institutions to bring about change. Part of this change should also include working with the stewards of pension assets on providing greater data transparency which can help quantitatively evidence the financial benefit of effective socially-aware investing.

Luba Nikulina will be taking part in the Pension Funds Acting in the Public Good panel debate at 10am on 8 June at the PLSA’s Investment Conference 2023.

Socially-aware investing – more information

Worthwhile workforce reporting: good practice examples from the UK’s biggest companies
Find out more about what constitutes good working practices and reporting methods in this joint report from Railpen, the High Pay Centre, the CIPD, the PLSA and Board Intelligence.

Investment relationships for sustainable value creation
Read the PLSA’s stewardship recommendations for managing each stage of the relationship between investment managers and asset owners, to help deliver better returns for savers.