Trustees should think about ‘doing good’, even in some cases where this could reduce returns says Ralph McClelland
When discussing social investment, the question of “what is social investment?” may be the hardest. The FCA offers a neat but slightly pat response – a social investment is one which does well while at the same time doing good. Of course, in a pension scheme of 100 people one might expect to find a number of divergent definitions of what “doing good” means; probably 100 of them.
Complexity, however, may not be an excuse for inaction. The minister for civil society has asked the Law Commission to investigate whether there are any legal barriers to social investing, presumably on the assumption that the minister thinks he already knows what doing “good” means, which may or may not be a cheering thought. The Law Commission is now considering responses to its call for evidence on this topic and we consider some of the legal issues below.
Pension trustees have a fiduciary duty to invest pension trust assets in the best interests of beneficiaries
Pension trustees have a fiduciary duty to invest pension trust assets in the best interests of scheme beneficiaries. This is usually taken to mean the best financial interests, but this is not necessarily to be equated with simply maximising financial returns. Schemes need risk-adjusted returns and should balance reward with risk over the long term. Wider factors, including environmental, social and governance factors can legitimately be taken into account from a financial perspective. An example might be considering employment practices to determine whether higher standards correlate to a more sustainable business and more reliable returns in the longer term. Where trustees can characterise a social consideration as a financial factor, they may be able to treat social investment as suitable for the scheme on purely financial grounds.
However, there are also scenarios in which “doing good” may come at a price from an investment perspective. To adopt the Law Commission’s terminology, such factors are “non-financial” and should ordinarily be disregarded. For example, a manager that identifies opportunities to develop affordable housing while taking into account the potential for positive social impact may not be able to offer the same returns as one which has a narrower financial focus. The trustee’s fiduciary duty will ordinarily be to disregard the social objective and to focus solely on the fund’s investment merits, which might suffer by comparison to a fund without the social slant. This will probably preclude making the investment if the trustee can make a better risk-adjusted return elsewhere.
Trustees must offer an appropriate range of suitable funds, but they are entitled to include funds with a social objective
However, while this generally holds true for trustees who choose how the member’s assets are invested (i.e. DC default funds or DB schemes), different considerations apply where a member actively chooses to invest their assets in a social fund. In the context of member-chosen funds, the member can reasonable be assumed to have prioritised that fund’s objectives. Trustees must offer an appropriate range of suitable funds, but they are entitled to include funds with a social objective. It is important that trustees are very careful in how they label such options. Members who opt for such funds need to understand and accept the possibility of lower returns in the knowledge that the fund is committed to a broader social objective.
There are, however, some structural factors to consider. Pension scheme members have a statutory right to transfer their pots. They may also need to bring pensions into payment earlier than their planned retirement age, for example on early retirement after the age of 55 or even earlier should they suffer ill-health. In the DB world, assets are held in aggregate for the scheme membership as a whole. There is therefore a buffer to provide liquidity to pay member pensions or transfer values when they are required. By contrast, where members’ benefits are related to their DC pot, the pot needs to be made-up of assets which can be disinvested and turned into cash quickly enough to pay the pension.
Some evolution is necessary before DC platforms are set up to accommodate the needs of managers and members
Social investment funds we have seen tend to be illiquid. With sufficient scale, it may be possible to build sufficient liquidity into the structures available on DC platforms. However, at the moment it appears as though some evolution is necessary before DC platforms are set up to accommodate the needs of both the managers and pension scheme members.
Ralph McClelland is an associate director at Sackers