Pension funds as owners - a view from the beach

Here's a brief bit from a much longer paper I wrote on a beach on holiday in Greece about 2 years ago when I was a bit sceptical about the prospects for pension fund activism. It's a bit dated, as the National Pension Saving Scheme is now called Personal Accounts for example, but I haven't changed my views substantially.

Pension funds’ ownership function in the future

The role of pension funds going forward will involve some contradictory themes. It is clear that some pension funds have responded to the impetus provided by Government interventions such the requirement to disclose voting and SRI policies, and the shareholder engagement thread within the Myners review process. A small but growing number of trustees are using the opportunities such interventions provide to have more interaction with their fund managers over ownership issues.

Practically this will for the most part continue to be limited to interrogating service providers over how they exercise ownership on behalf of clients. A number of initiatives have sought to formalise the provision of such information from service providers to clients. As such this is a trend that can be realistically be expected to increase.

As more pension funds clear or reduce the deficits they have incurred in recent years this might provide more breathing space for trustees to explore these issues. This will be in contrast to the past five years or more when the agenda of most trustee boards has been dominated by deficits.

However there are factors that may limit this. The recent experience, for employers, of large deficits and associated significantly increased pension contributions has likely terminally damaged the inclination for many to play a significant role in pension provision in the future. The closure of most defined benefit schemes to new members is just one element of this. As pension funds clear their deficits there might be closures to all accrual, as employers seek to completely lock down their pension liabilities.

The implications of the closure of DB schemes are twofold. First, closed schemes will inevitably become increasingly mature and as such will move out of equities into bonds and other assets. The proportion of shares held by DB schemes will be in long-term decline.

Secondly, the structure of the defined contribution schemes that are being established will become increasingly important. Many employers, believing themselves scarred by experience of playing an active role in pension provision, may opt to set up contract-based DC schemes where responsibility lies largely with the service provider. In such funds there will be even less oversight of the ownership function, if any at all. This will further reinforce the trend of the transference of ownership from pension schemes to fund managers.

A potential countervailing trend is the impact of the Government’s pension reform agenda, specifically the role of the proposed National Pensions Savings Scheme. The structure of the NPSS is still under discussion, however the model outlined by the Pensions Commission envisaged something close to an occupational DC scheme with a committee playing a role similar to that of a trustee board.

This scheme would seek to provide pensions for the many working people currently without provision. In addition it is likely that many employers may see it as a no-hassle way to provide pensions for their staff, they need simply pay in a contribution. As such it is expected that the NPSS would grow rapidly in terms of assets. The role of a national DC scheme with large assets has already attracted excitable comment, being described variously as ‘Stalinist’ and ‘nationalisation through the back door’ .

The influence the NPSS actually has will depend on how ownership issues are addressed. If responsibility is delegated to fund managers appointed by the scheme, or by the employer or carousel if an alternative model is introduced, this will mark a decisive and arguably final shift away from the notion that pension schemes or their members are in any real sense owners.

In contrast, if the scheme is established as envisaged by the Pensions Commission the governance body responsible for oversight could set an ownership strategy for the fund which mirrors the expectations set out by the Government set out in the SRI disclosure regulation and Myners. If the NPSS does adopt this role it should be expected that there will be significant criticism from some quarters on the grounds that it represents political interference in the capital markets and British business.