Garry Weaven makes the case that not enough has been done in pushing the boundaries on the conflict between maximising returns for members and acheiving a social good
If neo-classical economics in its purest version were to be taken seriously, there would be no need to debate the issue of whether socially motivated investment was permissible or desirable. Maximising investment returns would be synonymous with maximising social outcomes. In reality of course, markets do not deliver such an agreeable outcome. They do not, for example, guarantee a fair or even a sustainable distribution of work and income.
Nevertheless, it is fundamentally wrong to start with a presumption that seeking to enhance social outcomes through investment strategy must compromise the pursuit of maximising long term returns. It is also plain crazy to expect that individuals, who normally include moral and ethical considerations in the regulation of their daily life, should suddenly abandon such considerations when they take on the role of trustee.
What has come to be known as the industry fund movement, or the all-profits-to-members movement, was founded on a clear purpose of simultaneously serving the interests of society and of fund members. Its aims include facing up to an ageing demographic, maximizing the nation’s pool of savings and investment, maximizing workers’ retirement living standards and removing discrimination
Tensions between competing interests need to be confronted and at a high level, there are four areas of competing interest in our industry, as follows:
1. The interests of the members vs the interests of service providers.
The financial services sector globally stands out in its ability to extract an increasing amount of “rent” per dollar of investment. Even given the experience of the trans-Atlantic financial crisis, governments appear helpless in the face of
individual and corporate greed and excess. Little wonder that trustees struggle to make a meaningful difference. While superannuation fund governance does better than most other parts of the financial services industry, it is still heavily impacted by the practices of the industry. It cannot of itself , for example, solve problems of excessive short-termism, excessive intermediation or excessive reward structures.
The forthcoming Financial Services Inquiry presents an opportunity to “shine a great big spotlight” on these issues. On the other hand, the current Federal Government initiatives in the area of financial advice, which seek to weaken the “clients’ best interest” test and transparency around ongoing fees, are an excellent example of putting the business interests of service providers ahead of the interests of beneficiaries.
2. Individual interests vs the interests of the members as a whole.
Outright discrimination, for example against women and shorter term employees, was once the norm, but is now broadly illegal as is cross-subsidization of one group of members by another (although this is not rigidly enforced). However, the wider issue of individual interests has generally been addressed by trustees offering more choices and by government regulation mandating it.
This has sometimes worked out well, but more often badly for the individuals; for the system as a whole it has produced two significant negatives. It has been a major source of increasing administrative complexity and cost, massively increasing the cost of member communication and usually focusing that cost on a relatively narrow band of membership. It is unlikely that these costs have been recovered on a user pays basis. Secondly, over time, member choice offerings greatly increase the need for superannuation funds to hold liquid assets, both to cater for swings in net fund outflows and for member switching between investment options. This reduces the ability of trustees to opt for longer term, less liquid investments, such as unlisted infrastructure and property, and ultimately foregoes that source of investment premium, an outcome clearly not in the interests of the members as a whole, nor in the national interest. The direction of regulatory change however, for example through fund choice legislation and facilitation of “self-managed” super, has tended to exacerbate this problem.
3. Short term vs long term.
While a few people trade between superannuation offerings on a very short term basis and others change schemes frequently due to work requirements, most people have some or all of their superannuation with the same scheme for quite long periods, often for life or at least their working life.
This means that trustees must have regard to time when setting their investment objectives and while the long term is clearly the sum of lots of short terms, long term investing can require quite different considerations to simply trying to maximize every short term outcome.
I do not want to stretch this point too far because I am fully cognisant of the limitations on human powers to accurately forecast the future. It is sufficient to again point to the rational argument for capturing an illiquidity premium. Because the system generates the need for large flows of cash and short term funding, those that least need that cash can extract a premium for illiquid investing. Similarly, they can avoid the very high costs of constant trading. Indeed, this is one of the principal virtues of creating a system of collective investment vehicles like industry superannuation funds – it allows ordinary working people to save and invest as if they were the wealthiest people on earth.
Taking advantage of this opportunity, however, may still require trustees to have the courage, on behalf of their members, to face periods where their investment performance may fall below the top quartile or even the median funds.
4. Social interests vs maximising returns.
This is perhaps the most controversial area of tension for trustees, but I would argue it is also the most overrated controversy, because in practice acting in the social interest seldom involves a real need to consciously forego long term investment returns.
Nor do I believe that there is any part of the law that requires trustees or other fiduciaries to act immorally, unethically or anti-socially.
There are two main sources of legal governance of trustees relevant to this issue: the common law relating to the role of trustees; and the so-called “sole purpose” test in superannuation law.
Trustee law basically requires trustees to act in the best interests of the beneficiaries. It does not involve any narrow definition of best interest. Clearly trustees must follow the rules of their particular trust. I am not aware of any fiduciary being penalised where their actions exhibited bona fides in acting in the best interest of members.
The sole purpose test requires that superannuation funds operate only to provide retirement benefits for members. This has been broadly interpreted by APRA to include various insurance products, financial advice and all sorts of member choice investment products, as well as embracing non-preserved investments. The real purpose of the sole purpose test is to prevent superannuation funds from using their preferred tax status to compete with full tax-paying entities in the provision of goods and services.
In my view, nothing in the law prevents trustees from considering and giving weight to the social consequences of their investment decision-making. Indeed, at least in the case of large mass-member funds, the trustee law may well be considered as requiring trustees to give weight to social outcomes, as their membership is a significant chunk of the society. So, for example, the long term existence of decent productive jobs in the Australian economy might be considered a precondition for both the members’ best interests and the provision of retirement benefits and could therefore be not only a legitimate, but a necessary consideration in investment decision-making.
A particular concern of mine is to observe some trustees and advisors behaving as if innovation is in itself suspect in terms of fiduciary duty, simply because there is no reliable historical data on which to base a decision. No rule requires trustees to stick close to the herd in terms of investment performance. In fact, it can be argued that fund managers who are driven by their business risks to stay close to the pack and trustees that are not prepared to pioneer new asset classes and investment ideas, are in fact failing their fiduciary duty by not striving to add value on behalf of their members.
There are, I believe, a small number of investment rules to which trustee investors should always adhere. Beyond these rules I think trustees should always be striving to innovate and improve long term social, economic and environmental outcomes.
The rules are:
Use asset class diversification to achieve a volatility/return trade-off optimised to your fund’s objectives.
Recognise the limitations of professional analysis and judgement by ensuring that asset selection is sufficiently diverse.
Try to capture a premium through long term, illiquid (unlisted) investments.
Explore less-researched areas and be an early-adopter where possible.
Try to take advantage of the (infrequent) occurrences of extreme market irrationality.
Look for good people to help you and avoid paying too much.
Over the years I have been associated with or advocated a range of investment initiatives that have had either a social dimension in addition to their investment case or have represented an innovative departure from convention, or both. These include unlisted property, unlisted infrastructure and other private equity, alternative fixed interest/credit, clean energy, ESG analysis, global unlisted property, residential property-social/affordable/general, ME Bank and even a digital daily news service – thenewdaily.com.au
Some of these have been very successful for IFM Investors or others, some have not got off the ground yet; some have had limited success; some it’s too early to know; a couple not on the list have been buried. But all of them have been an attempt to do a bit better over the long term in the interests of the broad membership of industry funds and the wider social interest and I am happy to defend them in terms of both trustee law and the sole purpose test.
Indeed, if an idea is advanced partly on the grounds of its social desirability, I think the onus should be on its opponents to demonstrate that it would reduce long term returns. After all, the status quo is hardly an ideal paradigm.
Garry Weaven is chair of IFM Investors and of Pacific Hydro