The idea of referendums setting the agenda for institutional investors may be a frightening pipe dream in much of the world, but Switzerland’s unique brand of direct democracy is set to revolutionise its funds’ priorities.

Swiss funds are due to be anointed as no less than the country’s official guardians against “rip-off” executive salaries. That is according to a referendum that received the overwhelming backing of the Swiss electorate in March.

Funds do not appear to be hugely thrilled at their boosted future responsibility, however – enhanced by binding annual votes on executive pay and appointments at all publicly listed companies in Switzerland. Some grumbles about cost implications have made their way from investors into the local media.

Referendum reaction

The Swiss pension fund association, ASIP, says it does support greater shareholder rights “but not at the expense of members”. Director of ASIP, Hanspeter Konrad, says funds felt a less stringent government counter-proposal would have been more effective in advancing the underlying principals behind the referendum.

Sabine Doebeli, Zurich-based vice chair of the Sustainable Investment Forum of Germany, Austria and Switzerland (FNG), believes the referendum result is likely to prove a shot in the arm as “the culture of being an active investor is not well anchored in Switzerland”. sabine_doebeli

That challenge centres on the introduction of mandatory voting for pension funds at annual general meetings. It is an obligation funds would definitely not be advised to ignore though as the text of the referendum – championed by the head of a family cosmetics company – envisages jail terms and hefty fines for violations.

Doebeli, pictured right, says that “with existing legislative challenges in Switzerland and low funding ratios at many funds, the commitments add an additional complex aspect to the strategy of time-pressured investors”.

Stephan Skaanes of investment consultancy, PPC Metrics, says the reactions of funds to the results have been more mixed. Nonetheless, he explains that the first shock to the country’s unengaged investors may come as temporary regulation is introduced within a year to pave the way for full implementation of the referendum’s terms within around five years.

Doebeli believes that pension funds will likely wait for votes on executive pay to become mandatory before they assume all their new voting rights.

Naturally, the largest investors should find the task of becoming permanently active shareholders easiest. A spokesperson for the CHF21-billion ($23-billion) BVK fund for civil servants in Zurich, says that given “the scale and scope” of the fund’s organisation, it is “very well positioned” for the new legislation.

Within days of the referendum gaining the approval of the electorate, BVK began publishing the results of the shareholder votes it casts, thereby revealing that it had rejected a controversial remuneration scheme at pharmaceutical giant Novartis in February.

Disclosing the votes they make is another responsibility that the referendum is to hand pension funds, although Skaanes explains there is plenty still to debate as to how and to what audience disclosure is made.

Other Swiss funds to demonstrate engagement include the 90 pension funds, such as the $10.25-billion Basel Stadt pension fund, that are party to the Ethos Engagement Pool – an initiative that seeks shareholder dialogue with the largest companies in Switzerland. That grouping, however, is a small minority of all Swiss funds.

Doebeli says that a likely scenario as the initiative is implemented is that stretched funds will increasingly look to turn an ear to proxy shareholder voting advisers like Swiss firm Ethos or ISS. There has been a wave of activity in that space in recent months, with a new voting advisory firm Swipra launched just days after the referendum, Inrate announcing a new product range ‘for active shareholders’ in January and Ethos reportedly due to go on a post-referendum hiring drive.

Another requirement of the measures approved by referendum is, however, that pension funds vote in the interest of their members. Skaanes says that could place a block on fund’s controversial reliance on proxy advisors while the Swiss parliament interprets the referendum result into legislation. Doebeli says this could instigate some interesting broad-based dialogue with members on investment priorities – “a new element in the Swiss pensions landscape”. Konrad says that as funds are already structured to fully heed the interests of their members, this won’t need to go as far as polling members on their opinions prior to shareholder votes.

Will it work?

The radical new rules will surely boost the workload associated with domestic equity holdings, which averaged 11 per cent across the country’s pension funds in 2012, according to Mercer.

Skaanes says he would be “very surprised” if a drive out of Swiss equity holdings results, even though the tough regulations are not set to apply to overseas equities.

“There might be a switch from direct investing into domestic equity funds if the government decides that collective investment schemes are exempt from the mandatory voting requirements”, he adds.

In the ideal world of the sustainable investment business, perhaps Swiss equities will also gain added outside appeal for the stringent shareholder checks imposed on executive pay?

Leaving aside the obvious objections from the business community to that reasoning (they fear such strict rules will drive investment out of the country), the initiative must first prove it can perform in its chief task of checking pay. Critics point out that with domestic pension funds making up a tiny fraction of domestic share ownership (6.5 per cent according to ASIP), their potential to transform the country’s boardroom culture is limited.

Beda Dueggelin, a spokesperson for Thomas Minder, the businessman who proposed the referendum, agrees that Swiss institutional investors can only do so much on their own. “Foreign pension funds and investors are in the position to have a say on pay due to their voting power,” he says. “If they exercise their increased rights, something will change.”

The current regime was, after all, sufficient to persuade Novartis to recently drop a planned $78-million payment to its outgoing chairman. Credit Suisse and UBS have both also faced shareholder rebellions on their executive compensation plans in the past two years.

While determining “correct” rates of pay is something for newly empowered shareholders and boards to wrangle about in the years ahead, the new rules might not have such an obvious limiting impact on pay. Doebeli says that the experience in the UK shows that increased transparency on executive pay does not necessarily curb it as the keenest observers of salary reports could be rival executives hoping for a raise, although the clout of binding shareholder votes mandatory for pension funds “should definitely make it easier to prevent exaggerations”.

Skaanes adds that funds might be able to simply have a default position of voting in favor of the board under the new rules – perhaps in cases where they currently decide not to vote on a company, as they have no desire to closely monitor it. Should this indeed be a common pattern, the referendum’s impact would seemingly be limited.

Coming to a boardroom near you?

Doebeli says that “the strong international reaction” to the referendum has been noted with interest in Switzerland. Being home to several giant multinationals, particularly in finance and pharmaceuticals, makes the radical changes globally important.

Dueggelin says the proponents of the referendum “are sure that you will see more similar actions like the one in Switzerland in the foreseeable future”.

The European Commission is known to favour legislating for EU-wide binding shareholder votes on executive pay later this year. Days after the Swiss referendum result, the German government also announced that it will look to empower shareholders before then – most likely with binding votes. That is despite Germany’s Industrial Federation warning against “rash conclusions from the Swiss debate” and arguing that Germany’s tradition of employee and shareholder representation on supervisory boards makes new legislation unnecessary.

Gary Lutin, head of the Shareholder Forum in the United States – a group that moderates between boards and shareholders – says “that whether it works well or not, the Swiss adoption of binding compensation votes will certainly encourage others to try it”.

The US enforced the holding of advisory votes on executive pay at large public companies as part of the 2010 Dodd Frank Act.

Speaking on whether there would be demand for binding votes in the US, Lutin says: “You can expect the views of US fund managers on binding votes to be as mixed as they are on everything else. Some will see it as an opportunity to increase their influence, and others will see it as an imposition of increased burden that adds nothing to their portfolio’s performance or to their ability to compete for assets.”

In any case, there might not be a straight path to increased shareholder power.

Before the radical new corporate governance framework takes shape in Switzerland, militant funds might have to confront a growing academic backlash against increased shareholder power emanating from the US. Critics such as Lynn Stout, author of The Shareholder Value Myth, contend that shareholder pressure is actually a major driver of the short-termism in corporations that has spawned the kind of result-linked compensation schemes the public dislikes.

Increased rights should also logically bring increased responsibilities. Lutin poses one of the questions that he feels would result from a Swiss-style radical shake-up of corporate-shareholder relations. “If shareholders now have the kind of real authority to approve compensation that had traditionally been assigned to corporate directors, do they also have the same kind of fiduciary duty as directors to make informed decisions?”

Pension funds can face a lot of turbulence in the course of their investing journey and many funds thrown into shortfalls have found the need to de-risk their portfolios.

There might be a few investment officers at those funds casting an enviable eye upwards to the pension fund of Dutch flag-carrying airline KLM. Toine van der Stee, director of the €16.5-billion ($21.2-billion) group of funds says: “We want to take more risk when we can… the way solvency has to be managed in Dutch pension funds, the poorer you are, the less risk you can take on board and the more chance you will stay poor. As the rich can afford to take risk, the rich get richer.”

It is clear which side of that divide the KLM fund finds itself on. While many pension funds around the world are still unable to match their liabilities – figures from JLT suggest there was still a $75-billion combined deficit at the end of 2012 across the pension funds of UK FTSE 100 firms – the KLM funds have healthy coverage ratios of 127 per cent for its largest fund (for cockpit staff) and 116 per cent for the other two major funds (covering ground staff and cabin crew).

Van der Stee says a high level of contributions have helped those coverage ratios.

Furthermore, he can trace the positive results across all the funds (14.8 per cent for the ground staff fund and 13 per cent for the pilots fund) to a decision to up their risk by underweight bonds and make the plunge into overweighting equities in 2011. Equity holdings varied between 34 and 44 per cent of the individual funds at the end of 2011 after the top up, and delivered in excess of 16 per cent last year, allowing KLM to keep its risk-seeking portfolio intact.

Knowing where the break is

Despite their appetite for risk, the KLM funds remain checked by the kind of hedging instruments typical for Dutch funds. Some 75 per cent of the equity risk is covered by equity put options for instance. These dragged results down with a minus 1.2 per cent performance in 2012, but naturally also offer breaks when markets go sour.

Currency hedges also lost the funds a little in 2012 but these reverses were compensated for by a 1.7-per-cent yield from interest rate hedges, covering between 45 and 55 per cent of risk in two of the three main funds.

The absence of interest rate hedges in the $9-billion cockpit fund shows that unlike some multi-fund investors, which replicate a single investment strategy, KLM is happy to tinker slightly different approaches to each fund.

Van der Stee explains that the less risk-seeking stance of the cockpit fund, with the lowest equity share and highest real estate holdings (13 per cent at the end of 2011), means there is no need to shackle it with the same level of hedging. “Also, we can afford to take the risk as it has a substantially higher solvency ratio than the other two.”

He also argues that a rise in interest rates “that we don’t want to get hit by”, together with future inflation, are greater risks to the KLM portfolios than even lower interest rates. He is confident that a reduction in government bond holdings as part of the switch to equities in 2011 will help to mitigate that.

Some 20 per cent of the fund assets, around $4 billion, are also held in global inflation-linked bonds.

Should KLM’s real estate holdings continue the 15-per-cent returns they achieved in 2012, they will surely more than cover any remaining inflation risk. The 25-per-cent returns on public real estate (about half KLM’s total in the asset class) were “very nice” says Van der Stee, congratulating his external managers for delivering them. His assessment is that the real estate managers “seem to have picked the right funds – meaning mostly international ones”.

Just a fraction over half the KLM fund’s real estate exposure is European, so there is little exposure to the struggling Dutch real estate sector. The sight of empty buildings from his office in Amstelveen, a usually thriving town just to the south of Amsterdam, suggests Van der Stee does not have to look too far for evidence of its woes.

Beyond hedging and real estate, the KLM funds have resisted the allures of other alternative assets up to now, but Van der Stee says they are “looking into infrastructure, which seems very attractive as a hedge.”

Cruise control

The KLM funds will keep their asset strategy “more or less the same” for the foreseeable future, according to Van der Stee. “We don’t expect a rise in inflation or interest rates in the short term, but it may happen in the medium term, which threatens returns on government bonds,” he says.

Otherwise, Van der Stee confesses to being “moderately optimistic. Of course there are some risks in the European financial markets, but these can be contained to quite some extent.”

The KLM funds’ fixed income strategy appears to have paid off handsomely in 2012, with 14-per-cent returns. Allocating some 20 per cent of the fixed income assets to emerging market and US high-yield debt has worked well, but Van der Stee cautions that there are “two faces” to the good return figures, with liabilities rising last year as interest rates and government bond yields declined further.

Van der Stee oozes contentment when he talks about the funds’ external management. “We have active management in emerging market, small-cap and mid-cap equities as well as emerging market debt, as you need it there, but the rest is passive” he says.

On being asked about his relation to the member base, Van der Stee says “managing a pension fund is very different to flying planes”. The KLM funds anyhow seem fully under control for now with their tried and tested asset mix guiding them.

As the world and companies globalise, George Siguler, managing director and founding partner of private equity firm, Siguler Guff, has a simple recommendation for investors.

“My recommendation for stock investors is to look at great global companies,” he says. “Look at companies like Johnson and Johnson, Unilever or Boeing. They all have great balance sheets and are great businesses. They are unique businesses.”

Siguler, who is also on the board of MSCI, serves on the pension advisory committee of the International Monetary Fund and is on the board of overseers of the Hoover Institute at Stanford University, says the current environment can “justify good quality companies”.

“Warren Buffett doesn’t need Riskmetrics to understand his portfolio,” he says. “If Buffett was running a pension fund he would buy good companies like Amex, Coke or McDonalds, and hold them forever.”

Siguler says that despite the recent crisis, the US is in recovery, and points to the considerable growth among small companies, of which there are 40,000 in the US where, as a private equity firm, Siguler Guff invests.

“We have 250 small companies in private equity and they grew through the crisis. We had 45,000 jobs at the beginning of the crisis and 55,000 at the end,” he says.

He believes the US economy is in recovery.

“The US economy is still a mess, but it is in recovery. It is slow but moving in the right direction,” he said. “It’s been a rough ride.”

It is not only the US federal debt, which at $17 trillion is equal to the debt around the time of World War II, but the social security unfunded liabilities are also around $17 trillion.

“There are only four ways a government can fix this. They can tax, spend less, grow or inflate,” he said. “Can we effectively make this happen? We have to.”

Similarly, on the upside Siguler said the US is going through a revolution in energy, with its natural gas at a quarter of the world price and a newfound self-sufficiency in oil.

His experience tells him that the current crisis is nothing new and points to the fact the purchasing power of the Harvard Management Company declined by 80 per cent from the mid 1960s to the early 1980s.

Siguler, who wrote the business plan, strategy and team structure for the evolution of the Harvard endowment, says its recent private equity problems are more perceived than real.

But Siguler is also adamant the players in the financial services good chain need to take some responsibility and that there has to be some criminal punishment for the “creativity of Wall Street”.

“There was a time when your investment banker was your partner, your fiduciary. Now every transaction with a financial services firm is adversarial. If the word fiduciary was introduced in legislation that would solve the problems of Dodd Frank – people need to behave ethically,” he says.

Siguler Guff, which has a number of multi-manager funds including distressed opportunities, BRIC and small buyout as well as direct funds, was an early investor in Russia. It also has a strong presence in Brazil and China, where Siguler describes its reported demise as exaggerated, and recently made its first investment in Turkey. The next frontier for the firm is Africa.

In terms of industries, Siguler says “we really like healthcare.”

The area surrounding the British city of Wolverhampton, near Birmingham, is still called the Black Country although the polluting coal mines and steel mills that sprung up during England’s nineteenth-century explosion of wealth have long gone. Today there is little evidence that Wolverhampton was the cradle of an industrial revolution and the 300-odd public sector and private employers in the area from which the local government pension scheme, the £9.8-billion ($14.93-billion) West Midlands Pension Fund, draws its contributions are involved in new and modern employment. The defined benefit occupational scheme set up in 1972 has earned a reputation among its peer group of local authority schemes for its growing size and innovative, diversified investments. However, now it could have to adjust its strategy to meet the challenges and shifting circumstances of what you might call a mid-life crisis.

Black-Country-1872-200x150

Of the pension fund’s 253,000 members, less than half are now contributing members, and Geik Drever, head of pensions at the fund, notices more of the scheme’s small-member employers are closing their pension funds. It’s a maturing profile hastened by the UK government’s austerity policy forcing public sector cuts. The response among many local government authorities has been to encourage voluntary retirement, triggering an early shift in maturity for many of the pension schemes these employees have paid into. “We are open to new members, the profile of the scheme isn’t too bad and auto-enrolment will definitely help,” says Drever, who joined last year from Scotland’s Lothian Pension Fund where she was head of investment and pensions. “We’re not de-risking, but we are maturing and there has been a huge reduction in headcount.”

How to meet maturity?

Results of an actuarial review this year will inform any shift in investment strategy to reduce risk and prioritise protecting funding levels once they improve from current levels of around 75 per cent, “symptomatic of the current climate,” or whether to continue the push for income and total returns. It could be that West Midlands joins a de-risking trend evident for a while among UK and European schemes, such as Dutch funds in which the deficit crisis is the most severe in the industry’s history, but also cropping up in Canada and the United States. Here some of the largest corporate pension funds, including General Motors and Ford, have pursued de-risking strategies in recent years.

Drever is still unsure which strategy West Midlands will follow to meet its growing maturity. Options she is considering include running lower, medium and higher risk strategies to suit the scheme’s different employers, although she says “we won’t be able to manage too many strategies – three or four at most”. Employers will have to gauge their own appetite for risk according to their liabilities and cash profiles. “Each individual employer has a different profile.” It’ll be down to them, she says, to decide whether they can afford to pay more in contributions and reduce their risk or to “not close down risk.” Low risk strategies will comprise the usual “bond-like” allocations; the fund has no liability-driven investment strategies yet, unlike other schemes using the increasingly popular fixed-income-derivative strategies to reduce interest-rate and inflation risk.

Although a maturing scheme will need more cash to pay pensions, Drever is not convinced trading out of illiquid assets like infrastructure and private equity is necessarily the answer. West Midlands has a long track record of infrastructure investment and was one of the first schemes to leap on board the government’s Pension Infrastructure Platform. She says the fund has “ample cash,” particularly through its large quoted-equity allocation. Moreover, the scheme’s well established private equity and infrastructure investments have matured beyond the tendency for negative returns these assets have in their early years and provide a good cash yield. “We’ve got cash coming in from our infrastructure investments,” she says. “In private equity our investments are also paying out, so we’re less worried about our J Curve.” In another indication of the fund’s continued risk appetite, she welcomes the government’s decision to increase the cap placed on the amount local authority schemes can invest through limited partnerships, a structure though which many access property, private equity and infrastructure, from 15 per cent to 30 per cent.

Diversity now

Whatever the future holds, for now strategy at West Midlands is still based on diverse allocations set after the financial crisis. The scheme follows a customised benchmark that targets a 7-per-cent beta return, from assets in quoted equities and alternatives primarily, and a 2-per-cent alpha return from private equity and alternatives, including infrastructure and an absolute return allocation. In the 10 months to January 2013, the fund made an absolute return of 8 per cent. “It hasn’t been too bad, but we’re not shooting the lights out,” says Drever, adding that the pared-down 45-per-cent global equity allocation, where the biggest allocations are to stalwart mining and resource groups, has actually bought the fund its best returns so far. “Overall equities have done tremendously well. If we’d had an extra 15 per cent allocated to quoted equity, we’d have done even better.” A 10-per-cent private equity allocation “hasn’t done too badly,” infrastructure (3 per cent) and property (9 per cent) have “been fine” but commodities (3 per cent) have been “dire.” West Midland’s 20-per-cent fixed income allocation is split between stabilising assets and an allocation to return-seeking fixed income including high-yield and corporate bonds and unsecured loans. A 10-per-cent opportunities allocation includes catastrophe bonds (with which investors cover insurers’ extreme losses from natural disasters), a growing asset class for pension and sovereign funds and endowments seeking a truly uncorrelated market. “Hurricane Sandy put a spanner in the works, but you have to take the good with the bad,” says Drever.

It’s a strategy born from the need to diversify after 2007 when the fund wracked up paper losses of 18 per cent at one stage during the crisis. Drever says West Midlands was able to come back from the lows because it didn’t have to sell anything and crystallise losses; not concentrating assets in any one area became the new mantra. In house, the fund directly manages $4.57 billion in low-risk passive allocations, mostly equity. Another third is actively managed in LP structures, with the remaining third managed externally – the fund uses around 30 managers altogether. The portion managed externally has crept up as the scheme has increased its push into alternatives requiring specialist management, although the pension fund also uses specialist managers in mainstream assets where inefficiencies or market opportunities exist. It’s a strategy for growth that doesn’t acquiesce to the demands of its growing maturity – just yet.

It is easy for long-term investors to avoid short termism, and the solution lies in avoiding momentum and conducting risk analysis using cash flows – not market pricing.

“Diversification is a joke. Diversification and risk analysis relies on pricing, but pricing is distorted because it’s driven by momentum,” says Paul Woolley, chairman of the Paul Woolley Centre for Dysfunctional Markets at the London School of Economics.

Woolley, whose centre has set out the not-so-small task of rewriting finance theory, says the efficient-market hypothesis rests on the premise that prices are always right, no matter whether the time frame is short or long.

Rethinking models

But Woolley and his team, led by centre director, Dimitri Vayanos (pictured below), can show for the first time in a formal model that the long term is not equal to a succession of individual short terms.Vayanos-Dimitri-150x150

“We’ve cracked the issue of the short term in a formal model. We can show that it is optimal to use momentum or ride the trends if your horizon is short, but if it is long term then use fundamental values and look at cash flows,” he says.

Woolley says that if markets have momentum then maybe it does pay to ride that in the short term, but investors should recognise they are forgoing long-term returns by taking that course of action.

“Anything designed to make you concerned with minimising risks and maximising returns in the short term will drive you to momentum because fundamental value investing requires patience,” he says. “It is better for long-term investors to ignore the index.”

Instead he says the benchmark for the whole fund should be real global GDP plus local inflation.

Momentum is growing

Woolley’s career has spanned academia and the private sector, but while living through the tech bubble as a partner of GMO the question around momentum played on his mind.

“The tech bubble was a big turning point for me. Everyone was acting in their own best interest, it was a disaster.”

He retired from GMO in 2006 and still had many ideas to pursue so funded and formed the centre at the London School of Economics, with affiliates in Sydney and Toulouse.

“I had spent a lot of my career exploiting the mispricing of markets, and I wanted to spend time explaining them, the causes of them, and mitigating what I thought was dysfunctional,” he says.

Since then Woolley and his team have been challenging academic theory and the strategy implications of that.

“The prevailing finance theory is why the world’s economy is such a mess,” he says.

While there has been some resistance to the challenge of looking at an alternative paradigm, particularly by academics, ironically “momentum” is growing and the centre will hold a summer school in June for PhD students in dysfunctional finance.

It has also had some intrigue with policy makers and, he says, the theory has had traction with the IMF, Bank of England and the Department of Business, Innovation and Skills in the UK government.

It can’t explain

Perhaps one of the more significant advancements of the argument came from the G30 last month which said in its paper, Long-term finance and economic growth, that national regulators and international bodies such as the IMF and Financial Stability Board should draw up best-practice guidelines for investors with long-term liabilities or horizons.

If this is acted on, it will have “profound implications” for the investment industry and for investment returns, Woolley says, highlighting that the main obstacle is one of terminology and definition.

It is important to recognise, he says, that short-termism is not just a holding period and that long-termism does not equal buy and hold. Rather, the distinction is the investor’s choice between the two basic investment strategies of momentum trading and fundamental investing.

The problem for investors, he says, is that the damage this can cause has not been fully explained, because the theory doesn’t allow it, hence his mission to rewrite the very basis of the discussion.

“The rewriting has to come first. The prevailing theory of efficient markets is a dangerous core belief which is misleading everyone. That competition ensures prices are always right and markets are self-stabilising is not a good starting point to explain why prices are distorted,” he says.

By way of contrast, he points to the natural sciences: in physics, for example, there are assumptions of zero gravity or friction but to build machines, you assume situations when those conditions are not met.

“In finance the theory translates directly to practice and working with, for example, perfect competition, is useless and dangerous. The efficient-market theory can’t explain, for example, momentum – it’s the unexplained anomaly.”

“ShareAction has become the premier organisation to give voice to those who wish to invest their values as well as their assets,” enthused former vice president of the United States Al Gore, speaking to a packed audience at ShareAction’s annual lecture in London’s Guildhall last week. ShareAction is only a tiny pressure group but Gore’s ringing endorsement reflects its growing clout when it comes to galvanising pension scheme members and other asset owners to make sure their views are taken into account by the funds responsible for investing their money.

ShareAction, formerly FairPensions, has been around since 2005, when it emerged out of a campaign in the 1990s backed by academics and students to make investment strategy at the £34-billion ($51.5-billion) University Superannuation Scheme socially responsible and sustainable. Multiple events such as the explosion at BP’s Deepwater Horizon rig in 2010 – Gore jibed that shareholders would have avoided losses if “the metrics had been more sophisticated” – to a wave of authoritative studies on the damaging effects of short-term investment, the dire funding levels in many UK pension schemes and the harnessing powers of the internet have helped propel it’s message into the mainstream. It’s building a momentum that the organisation’s chief executive, Catherine Howarth, is determined not to miss.

Rank and change

When it comes to influencing schemes’ investment strategies, one of the most effective tools at the pressure group’s disposal is its ranking system. ShareAction grades the responsible investment performance of the 25 biggest UK funds. With a new ranking due later this year, it’s what Howarth calls a “nudging process” and a “catalyst for change”. “There is still a long way to go,” she explains, “but we’ve seen schemes really improve their responsible investment, transparency and award mandates according to ESG principles as a result of our rankings.” Pension funds are galvanised, particularly, she says, when scheme members push trustees on gaps in their responsible investment criteria highlighted by the rankings. It’s also a process that highlights what she calls a common disconnect between companies with front-office green credentials, but with employee pension schemes still “in the dark ages” when it comes to ESG.

The Co-op, which due to its strong ethical brand is one of the UK’s best-loved retail and financial services chains, was a case in point. One company in the group, Co-operative Asset Management, is even a leading light on responsible investment, truly embracing active ownership because it believes it is part and parcel of being a responsible owner. Yet the Co-op’s $9-billion pension scheme scored 35 per cent, coming fourteenth out of 30 in ShareAction’s 2009 survey. In response, the Co-op overhauled its strategy and beefed up ESG credentials scoring much higher in subsequent surveys. “The fund has gone a long way to implementing all of the recommendations we made,” says Howarth.

Membercentricity and mainstreaming ESG

She is also pushing the novel concept of pension funds shaping investment strategy around their members, putting savers’ values at the heart of fiduciary management. It sounds ambitious but she’s convinced it will happen, pointing out that with some funds, it already is. Research by the UK government’s National Employment Savings Trust, NEST, the new automatic-enrolment pension scheme for employers, found that its target membership is more worried about investment loss than particularly high returns. With this in mind, NEST set its growth target at consumer price index plus 3 per cent, compared to growth phases in other employers’ defined contribution schemes typically coming in around CPI plus 5 per cent. Regarding responsible investment, NEST found its target members highlighted concerns around labour rights and fair pay, wanting investment skewed to support these themes and greater stewarding on these issues of the underlying companies. “This kind of behavioural research is really innovative and others will follow; it’s a pioneering approach” says Howarth. Most importantly, she said, it’s a strategy designed to encourage people to keep saving and not opt out, crucial in NEST’s early years. Howarth contrasts the investment strategy in Australia, where the automatic-enrolment model doesn’t allow opting out and saving is compulsory. She says it has allowed providers there to adopt more bullish investment strategies altogether.

Tailored investment strategies designed for scheme members leads Howarth to her next point – “mainstreaming” the integration of ESG factors. She wants to open up the whole debate around fiduciary obligations altogether, pushing “a more enlightened view” in which trustees have “clear permission” to take long-term decisions rather than invest for short-term profit. Many trustees believe their fiduciary duty is only to maximise returns but this needs to change, with schemes investing for long-term value rather than short-term share prices, she argues. ESG is now applied to a broad range of asset classes and available to investors through a wide range of products, she insists.

Working from the inside

As well as cajoling pension funds to alter their strategies to invest responsibly, ShareAction wants schemes to become more active asset owners. The pressure group doesn’t advocate screening or excluding stocks. On one hand this model is outdated, focusing on so-called sin stocks such as tobacco and pornography rather than asking today’s questions around human rights and environmental issues. On the other, Howarth argues disinvestment, or not investing per se, makes wielding any kind of influence impossible. “We are not big disinvestment people. Once you disinvest, you lose the opportunity to influence. Disinvestment can and does have its uses, but if you sell your shares no one will notice,” she says. Having honed her ability to build tricky alliances between different interest groups and work the system from the inside after years working as a community organiser in London, Howarth’s campaign successes include demanding more transparency from Shell and BP regarding tar sands projects and, together with Oxfam, pushing institutional investors to pressure pharmaceutical group Novartis to ensure the continued availability of affordable generic medicines in India.

Passive investors are just as capable of having the conversation. Managers such as Legal and General Investment Management, one of the biggest passive managers in the UK, is a case in point. Howarth refers to the company’s “brilliant work” on responsible investment. “Trustees may struggle to sell companies because they are invested in a passive tracking fund, but they still have good access to governing boards and can have a powerful effect.”

Howarth is convinced the tide of change is now unstoppable. Lively investor activism in Australia, the US and Europe, is keeping pension providers in check with members’ interests and increasingly offering better value for money. Although Asian institutions continue to lag behind Western counterparts in ESG adoption, with schemes in Asia “less inclined” to alter investment strategies or challenge the companies they invest in, foreign investors in Asian corporates are taking up the mantle and encouraging debate. “It’s our money after all,” she says.