Saving for retirement is the primary investment objective for most individuals. Yet the ability to meet this objective depends not only on the investments made, but on the system on which retirement income provision rests. Put simply, how well a pension system is designed, including the level of benefits it provides, its sustainability, and its governance, has a critical bearing on the ability to meet one’s retirement goals.

Pension funds, as some of the biggest institutional investors in financial markets, play an influential role in capital allocation and the generation of wealth and well-being for individuals’ retirement. The framework in which they operate provides the key infrastructure supporting pension system effectiveness.

An annual examination of 39 different retirement income systems around the world rates the strengths and weaknesses of different pension systems. The findings, published in the Mercer CFA Institute Global Pension Index, provide accurate and comparable data on retirement systems covering approximately two-thirds of the world’s population.

The index is comprised of three sub-indices that measure the adequacy, sustainability, and integrity of pension systems, respectively. The adequacy sub-index includes certain core features such as the design of the system and level of benefits it provides in retirement. The sustainability index examines factors such as demography, public expenditure, government debt and economic growth, while the integrity sub-index evaluates the governance and regulation of the pension system, including transparency, costs and investor protections. The index covers all the pillars of retirement income provision, namely state pensions, personal and occupational pensions, and additional private savings or assets held outside of a pension.

The Netherlands is ranked as the top retirement income system, followed by Denmark, both of which received the coveted A-grade in the index. These systems provide very good benefits and have good pension coverage in the private sector, as well as having a significant level of assets (more than 150 per cent of GDP) set aside to meet future liabilities.

But in most markets, pension provision is challenged by increased life expectancy and the low growth/low interest rate environment, which may reduce investment return expectations and increase the present discounted value of future liabilities. The Covid-19 pandemic has created an additional challenge for retirement systems that has accentuated strains in funding levels.

The pandemic has led to large-scale fiscal support measures, funded by increased government debt levels, the servicing of which adds to pressure on future pay-outs from the state.  Moreover, in many markets, the recession induced by the closure of large segments of the economy, together with reduced employment, may lead to lower individual contributions.

In some countries, workers who have lost employment have been permitted to access a certain (limited) proportion of their pension savings, which may provide temporary income support but at the expense of lost future retirement income. The impact of reduced contributions generally, as well as early access to pension assets, results in leakage from the system, which may impair future benefits.

The index identifies a number of recommendations to strengthen pension provision in each of the markets covered. All else equal, the more individuals save and the longer they work, the higher the benefits in retirement and the more sustainable the system. But the recommendations also identify important areas for reform, including expanding pension coverage to all types of workers, making improvements to pension scheme governance and transparency, reviewing the level of public pension indexation, tackling the pensions gender gap, and reducing the leakage from retirement income systems.

The macroeconomic consequences of the pandemic may have long-term effects on the adequacy and sustainability of retirement income systems around the world. Investors, pension plans, and public authorities will need to work together to address the potential build-up of an accrued trust deficit in pensions among individual savers. Among other things, this will require a re-examination of asset allocation, including the dependence of defined contribution schemes on public markets, as well as ongoing improvements to pension scheme governance, costs, and coverage.

The path to a more robust pension system will require continued dialogue and collective action among policymakers and industry stakeholders. The promise of a secure retirement depends on it.

 

Rhodri Preece is senior head, industry research at CFA Institute.

In a move that will help solidify a global system of ESG reporting standards, the Sustainability Accounting Standards Board and the International Integrated Reporting Council will merge to create the Value Reporting Foundation.

The merger helps progress the vision of a single, coherent system of corporate disclosure, an essential ingredient for investors and corporates serious about ESG reporting.

Chair of SASB, Robert K Steel, said the merger was an important step in enabling investors to communicate with clarity and ease about the issues that matter most to financial performance. Importantly it helps to eliminate the fragmented reporting landscape that currently exists in ESG.

The merged entity – which will be headed by the current CEO of SASB, Janine Guillot – will maintain the Integrated Reporting Framework, advocate integrated thinking, and set sustainability disclosure standards for enterprise value creation. The organisations said that the merger directly responds to calls from global investors and corporates to simplify the corporate reporting landscape, providing the market with a clear solution for communicating about the drivers of enterprise value.

The Value Reporting Foundation could eventually integrate other entities focused on enterprise value creation, and the Foundation and Climate Disclosure Standards Board have jointly signalled interest in entering into exploratory discussions in the coming months.

“Sustainability disclosure is at the top of the agenda for many, creating incredible momentum towards simplifying the corporate reporting landscape.  By merging two organizations focused on enterprise value creation, we hope to clarify the field. We stand ready to engage with the efforts of the IFRS Foundation, IOSCO, EFRAG, and others working towards global alignment on a corporate reporting system,” says  Guillot.

The merger will advance the work of CDP, CDSB, GRI, IIRC and SASB in the Statement of Intent To Work Together Towards Comprehensive Corporate Reporting, which outlines a vision for a comprehensive corporate reporting system.

 

Listen to Janine Guillot in conversation with Amanda White

In this Fiduciary Investors Series podcast Amanda White talks to chief executive of the Sustainability Accounting Standards Board, Janine Guillot, about stakeholder capitalism and the role investors can play in shifting the dial. We discuss the value SASB can play as a tool for decision making and how stakeholder issues can impact performance. SASB standards identify the issues most likely to impact financial performance in 77 industries.

Guillot says the key lever to help re-establish trust between business and society is that companies measure, manage, and reward environmental and social issues the same way they measure, manage, disclosure and reward on financial issues.

New Zealand Super has completed the latest five-year review of its reference portfolio, with currency risk hedging a hotly debated topic by the internal investment committee.

The NZ$50 billion fund eventually decided to leave its reference portfolio fully hedged, but the discussion went to the board which is an unusual situation for the fund.

“We had a lot of discussion around currency. In New Zealand there has been a benefit to hedging and there has been a currency hedging premium for a long time,” Stephen Gilmore, chief investment officer of fund, said. “We thought a lot about whether that premium would still persist in an environment where rates are low. We eventually came away thinking there would continue to be a currency risk premia but it would be a bit lower.”

Gilmore said there was a lot of very intensive debate over the decision to remain fully hedged with the internal investment committee evenly split.

“Normally the internal investment committee would go to the board with a clear recommendation. In a rarity in this case we weren’t sure, so we presented that situation to the board, that was quite novel and the board also debated it. It was fascinating that we decided to present the nuance of the discussion in the internal investment committee and discus that with the board, the board found that quite helpful.”

The team also came away thinking that foreign currencies would be diversified which Gilmore said was important in an environment where it is harder to find diversifying assets.

In looking at the next five years Gilmore said the biggest change in the assumptions in assessing how to set the reference portfolio, related to rates.

“If we think of the last five or 10 years the one thing we have really underestimated, like many others, is how low rates could really go and how long they would stay low,” he said. “So our assumptions around real interest rates came down, we are now looking for real interest rates to be around 0.5 per cent over the very long term, which is quite a bit lower than before.”

The assumptions around the equity market remained quite unaffected with the assumptions of the equity risk premium “nudged up” marginally.

NZ Super’s most recent five-year reference portfolio review was completed in June, and while it remains largely unchanged – 75 per cent global equities, 5 per cent NZ equities and 20 per cent bonds – the process involved a lot of debate.

“The outcome almost looks like no change, but it hides a lot of detailed thinking and discussion,” Gilmore said. “Some of those discussions were challenging because we were sitting in an environment where we had the COVID shock, and we were trying not to think about the short term but the very long term.”

Gilmore said the reference portfolio review, which takes place every five years, is the most important investment decision the fund makes because it sets the risk appetite.

“And it also helps us get the right perspective, it’s an equilibrium concept.”

The fund’s actual portfolio deviates from this reference portfolio due to active risk decisions.

The biggest area of active risk has been the fund’s tilting program which takes advantage of the fund’s time horizon and strong governance arrangements – it is not expected to make material contributions to the budget until 2050.

The fund has also taken active risk via its exposure to timber, the credit space and through factor exposures.

New Zealand Super incorporated a low carbon approach into its reference portfolio in 2016, and that has added about 60 basis points per annum to performance since it was brought in.

The victory of Joe Biden over Donald Trump in the US general election is a “double repudiation” not just of Trump but of the “democracy in crisis crowd” who thought American democracy was under threat, argues historian and author Stephen Kotkin, the John P. Birkelund ’52 professor in history and international affairs at Princeton University.

The US system was not designed for good-hearted politicians, but to check the power of venal politicians and force consensus and coalition to get anything done, Kotkin said, speaking at a Conexus Financial event last week.

“The US system worked and the institutions are strong,” Kotkin said. “The genius of our system is that even with bad people we can sometimes get good results.”

Kotkin said the last time an incumbent president was beaten by a challenger with such a large percentage of the popular vote was when Franklin Roosevelt toppled Herbert Hoover in 1932.

Biden won because women in the suburbs swung massively in his direction, not because he increased his vote with traditional Democratic constituencies.

The result was also a backlash against racism, he said, with Americans increasingly mixed and in inter-racial marriages and no longer identifying racially the same way they used to.

“Trump’s vote among black people increased this time since the last time, 2016,” Kotkin said. “We know that 25 per cent or so of Americans are liberal, and 28-29 per cent are conservative, and 40 per cent are moderates. That’s the electorate and they repudiated the extremes. And give them credit, there was a kind of genius in that.”

With Biden having presented himself as someone who can unify both sides of politics, voters have “called Joe Biden’s bluff” by electing him with what is likely to be a Republican senate, although this won’t be confirmed until January, Kotkin said.

But deep divisions remain in American society and Biden will need to focus on possible areas of bipartisan consensus.

This could include providing broadband access to rural communities which are the base of the Republican Party, better funding community colleges and vocational education which educate more people than universities, and going after monopolies which dominate the economy and hinder new entrants.

“A deal can be made,” Kotkin said. “It requires Biden to govern from the centre and it requires Republicans to be cooperative, not obstructive. It remains to be seen, but I’m optimistic the option is there if both sides want to exercise it.”

Biden will also need to show he can build a working relationship with majority Senate leader Mitch McConnell, build a better working relationship with China, and manage the passions of the leftist wing of the Democratic Party, Kotkin said.

Stephen Kotkin will speak at the Fiduciary Investors Symposium on December 8.

The lines between sustainable investing and investing in general are blurring and will soon disappear. Yet there remains an important barrier to fully integrating a company’s sustainability performance into investment analysis—the lack of reliable, relevant, and comparable data on the different dimensions of a company’s sustainability performance. Today we have a plethora of NGOs working to set sustainability measurement and reporting standards, as well as ESG data vendors whose ratings are poorly correlated with each other.

Fortunately, there is now a very real possibility to solve this problem. The IFRS Foundation (IFRS) has issued a “Consultation Paper on Sustainability Reporting” proposing a Sustainability Standards Board (SSB) which would be a parallel body to the International Accounting Standards Board (IASB), with both being under the direction of IFRS.

One of the issues discussed in the paper and for which comments are requested is the important, complex, and controversial concept of materiality. It proposes that “If established, the SSB would initially focus its efforts on the sustainability information most relevant to investors and other market participants. Such information would more closely connect with the current focus of the IASB.”

We support this approach while at the same time recognizing that there are sustainability issues that are important to the world even if they currently do not have an impact on investor returns.

A good analysis of materiality is presented in another September paper “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting (The Statement)” written by CDP, the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB) and facilitated by the Impact Management Project (IMP), Deloitte, and the International Business Council of the World Economic Forum (IBC/WEF).

The report provides a conceptual “three-box” framework which is very useful for the proposed SSB. The smallest box represents financial reporting standards, the traditional work of the IASB (and the Financially Accounting Standards Board in the U.S.). It sits inside a box of sustainability issues that are material for enterprise valuation creation, the focus of CDSB and SASB. Here the unit of analysis is the company, just as it is with financial accounting standards. The work of the SSB will be focused on the second box with the IIRC contributing a framework for integrating both sets of standards.

This box, in turn, sits inside one representing the total range of sustainability issues, which include the positive and negative externalities of a company’s operations, products, and services that make the world a better or worse place, such as through the lens of the Sustainable Development Goals. This is the domain of CDP, the GRI, and IBC/WEF. This is a system-level unit of analysis and is outside the boundary of work for the SSB, thus making its remit clear.

While some have argued that the SSB should include all sustainability issues and even extend to developing standards for reporting on science-based targets, we think that would be a mistake. One must walk before one runs. Simply establishing an SSB will be a major challenge in terms of funding and establishing the necessary capabilities. It also needs to move quickly, starting with climate and related environmental issues and then swiftly moving on to critical issues such as human capital and diversity & inclusion. Here it can rely on the work done by the authors of The Statement report and their public commitment to harmonize their efforts and, for climate, the Task Force on Climate-related Financial Disclosures.

Asking the SSB to take on a broader remit beyond the sustainability issues material to enterprise value creation would be impractical since it would greatly delay the needed global standards for sustainability reporting. A much better solution would be for the SSB to coordinate its work with those organizations that are focused on sustainability issues that are broader than enterprise value creation but very important to the world.

Over time, these issues can indeed became material from an SSB perspective through the concept of “dynamic materiality.” An issue that hasn’t been material to companies can become so for many reasons including system-level effects on all companies regardless of industry (e.g., climate change and inequality), changing social expectations of employees (particularly the Millennials) and customers, and laws and regulations (e.g., carbon taxes and minimum wage rates). When this happens, it will fall in the domain of the SSB.

The SSB is being established to meet the sustainability information needs of investors. Please help the IFRS Foundation help you by submitting a response to the Consultation. Oxford University’s Saïd Business School has submitted a letter that might provide some helpful guidance. Responses are due by December 31, 2020.

Richard Barker is Professor of Accounting and Associate Dean of Faculty , and Robert Eccles (pictured) is Visiting Professor of Management Practice at Said Business School, University of Oxford.

Bob Eccles will be speaking at the Fiduciary Investors Symposium online on December 8. For more information click here.