The trustees of public pension funds are entrusted with the life savings of millions. They must understand the most intricate details of finance, demography and technology. They are rarely noticed for doing their job well and publicly condemned if they do not. Being a trustee is already difficult. For a panoply of reasons, it will soon be even more challenging, especially in countries where laws and institutions are weak.
First, sociopolitical pressures will intensify. Governments have always seen PPFs as potential sources of development finance. Calls to use pension reserves to fund ‘job-creating industries’, ‘strategic enterprises’, ‘regional integration’ or ‘prescribed assets’ are common. But, as those reserves grow – they stand at about 25% of GDP in South Africa, for instance – the call on trustees to direct investments towards national development priorities grows as well. Whether those investments maximise the returns on the funds is not always clear.
Second, there is broad consensus that environmental, social, and governance risks must be considered when assigning strategic asset allocations. It would be irresponsible to invest in, for instance, coastal housing without studying climate change. But there is no consensus that PPFs should conduct ‘impact investing’. Legal frameworks and trustees’ mandates seldom, if ever, accommodate that. Yes, when return-maximisation and ESG goals coincide, the opportunity should be seized. But that kind of complementarity is rare. For asset managers, building an equity portfolio with companies that are ESG-compliant requires firm-level data that are not always available, comparable or verifiable. Even the data-reporting standards fluctuate. Institutions like the Sustainability Accounting Standards Board, Global Reporting Initiative and Task-Force on Climate Related Financial Disclosures are yet to harmonise their guidelines – which regulators may or may not then enforce.
Third, the state of the world economy is frustrating the governance of PPFs. Low, zero or negative interest rates reflect too much savings relative to investment projects. This means lower returns across asset classes, not just fixed income. To maintain portfolio performance, trustees are having to tolerate more risk – a politically difficult decision when people’s retirement is at stake – and to understand ever more sophisticated financial instruments.
Fourth, in emerging and developing markets, active and retired members of pension funds are seen as a small, privileged portion of the labour force. Numerically, they are. Informality in these economies has kept most workers outside social security. Countries are trying various models to foster coverage and inclusion – such as Chile’s ‘solidarity pillar’ and India’s ‘single-trust defined contribution’ – but this is a pending agenda in most places. It might also put more pressure on the governance of PPFs, which are sometimes asked to give retirement benefits to people who have not contributed.
Fifth, investing abroad is not seen favourably by the public, even though it makes sense for protecting the financial well-being of PPF members. Communicating the need to allocate national savings to foreign assets is not easy anywhere, but it is especially difficult in low-income countries.
The good news is that PPFs are reacting to all these pressures, albeit slowly. The selection of trustees is increasingly conducted more independently. New Zealand’s Superannuation Fund and its ‘double-arms-length’ model is the finest for this, but some developing countries like Uganda are catching up. Efforts at continuing education of trustees are helping them cope with the ever-more-sophisticated evolution of finance. In fact, law-makers are beginning to write into law requirements for ‘collective technical competence’, as Australia has done. Better systems to select, monitor, evaluate and discharge external asset managers are helping boards focus on profitability – reputable managers tend to resist politically-motivated investments. The World Bank has a capacity-building programme dedicated to this. And clearer legal and policy frameworks are being designed to guide investment decisions around ESG, and to fence off requests for funding outside the institutional mandate. Canada and Japan come to mind.
Of course, not all is progress. There are still many countries where PPFs are, by law or by practice, forced to finance governments – notably, through the purchase of treasury bills. In extreme cases, PPFs are instructed to fund state-owned or state-favoured enterprises. This can bankrupt them, turning payments to retirees into one more fiscal expenditure.
But, by and large, the tendency is towards more transparency. As information spreads and populations age, current and future retirees demand better performance. That cannot be achieved without better governance. While tricky to calculate, good governance has been estimated to raise the long-term rate of return on PPF assets by one to two percentage points per year – a significant difference, as anyone living on a pension will tell you.
Marcelo Giugale is the Director of Financial Advisory and Banking at the World Bank.