Ethical investment is fine – but Pension Fund trustees need freedom to manage their investments

The major divide in occupational pensions is between the Defined Benefit (DB) schemes, which Oliver Kamm is mainly talking about in his piece on ethical investment in The Times today, and so-called Defined Contribution (DC) or money purchase schemes which are really savings schemes without the security of a predictable pension that DB gives. We can exclude DC from this debate because to include it would require the same environmental investment rules to be applied to any portfolio investment (Trust or otherwise) – which ain’t going to happen! If you want ethical investment there are funds that do this – but you can’t make it the norm.

DB Pension Funds are substantially “heritage” schemes these days looking after pensioners and those employees lucky enough to join the scheme before it was closed to new entrants. That said they are collectively a huge national asset providing millions of retirees with a sound basis for their retirement years. The trustees of these funds have a multiplicity of duties but above all they must protect the financial security of the fund now and for the future. It’s a complex and quite technical task. The overriding requirement is to try and ensure that future liabilities are matched by assets.

There is a range of asset classes available to trustees to try and ensure a good Asset/Liability balance for the long term (most funds, despite being “closed”, have a prospective lifespan of at least thirty years). Many funds these days pursue a Liability matching policy – that is they try and order their investments in such a way that their future pension payment obligations are met. This may involve an increasing percentage of Gilt type investments which give a predicable and guaranteed return rather than the higher risk (but potentially higher return) equity investment classes.

Every Pension Fund is unique with a different current Asset/Liability ratio. The more positive this is (the more Assets exceed Liabilities) the more Liability matching makes sense. The nirvana of certainty in the future capability of the fund to meet its obligations is within reach for some well run Funds. The key point is that the focus of every fund changes over time as will the asset mix they choose. For example shrewd investment in equities in a time of stock market growth may allow a Fund to grow to the point that it can switch almost entirely to a Liability matching portfolio.

In sketching out the priorities for Pension Fund Trustees in this way I am emphasising both that the task of constructing the right asset class mix is complex and that it changes over time. That funds should consider the ethical component of their portfolio (particularly for Equities of course) is reasonable but I would argue not to the extent that it takes away from their overriding obligation to underpin their future capability to meet their pension payment obligations.

Finally it’s worth remembering that there are millions of retirees and employees in the public sector with Final Salary pension benefits (or future benefits) covered not from a pension fund but by the Treasury out of taxation and borrowings. Society as a whole guarantees the pensions of nurses, teachers, civil servants and the rest. Whether society should also place constraints on the freedom of the generally well-run private sector Pension Funds to make their own choices on investments is a moot point. Pension Fund Trustees have many masters to serve, but first and foremost their obligation is to serve the needs of current and future pensioners.