Back in the mid 90’s, managing pension fund capital had to be a relatively peaceful job. They had billions of dollars under management but few customers or members seriously questioning how they did it and no true competitive market where customers walk if they don’t like the service. It isn’t as if a member of the Alabama State Pension Fund can join the British Telecom Pension Fund after all. The retirement savings industry has become the largest industry on Earth and yet thanks to its nature is the least accountable to its customers or members. But this isn’t the fault of the funds as much the customers, since despite pensions being the key to their future and often their second largest asset, they remain completely bored with the whole business.
But the easy days for pension fund staff and trustees are long gone in part thanks to prickly issues like climate change that has spawned the divestment movement, public ranking of funds (via AODP) and a host of high profile criticisms ranging from UNFCCC retiring head Christiana Figueres to ITUC Head Sharan Burrow who famously told an investor conference to “press the reset button on the entire industry”.
Main street has always known that money is influence and now people are learning that the most boring industry on Earth can actually be exciting if used to save the grandchildren from a fate not worse than death but not far off it. All of this new pressure has brought about stark change with many pension funds essentially become “active” in both an investment and engagement sense. In the past few years, leading pension funds have dumped coal, front-run investment in renewables (the AODP AAA rated funds are on average double the mean) and voted their proxies madly to establish a leadership pack (31 funds in the AODP Climate Index rate A and above).
But asset owner leaders can only do so much, and understand the inconvenient truth that the real powerbase in finance is still in the hands of the banks and fund managers: the bloated middle layer. Their clients, the pension funds, are highly fragmented with the largest funds outside Japan (a unique financial system) having less than half a trillion dollars. Indeed, with most markets tending in the long term to consolidation, Australia is the only country to see any meaningful merger activity amongst its retirement funds. Compare global pension funds to the fund management market where there are 30 funds with more than half a trillion dollars. Furthermore, the more direct contact between fund managers and the markets means the emphasis on trading rather than on long term investment and risk management is paramount. Just as critical to the management of climate risk are other agents such as asset consultants, ratings agencies, proxy advisers and accounting firms.
In April, AODP announced a programme to rate these agents so that the entire asset owner supply chain can be assessed in the context of climate change risk. All of the agents face challenges. The consultants and advisers largely cling to outdated strategic asset allocation models and methods of calculating risk like VaR that didn’t survive the sub-prime stress test but still dominates. The ratings agencies are starting to re-assess climate risk but know they have a long way to go and there are literally trillions of dollars of high carbon debt that rely on their judgement both at a corporate and sovereign level. It’s a brave person who bets their house that there aren’t any derivatives or weird OTC products that aren’t exposed to climate risk. Way behind both the consultants or ratings agencies are the proxy and engagement advisers. To be fair to them they don’t live in the world of incomprehensible complex portfolio models – these poor souls are in the middle of an increasingly vicious battle between NGO’s and active funds (mainly in the US) on the one hand and the climate exposed companies on the other with their savvy, high powered and well connected boards ready to use any means or tricks necessary to ensure their surviving profitability. Whilst we sympathise, they are going to have to change faster than anyone as they are finding themselves in increasingly thorny positions having to judge short term decisions versus long term risk. Increasingly investors and companies aren’t agreeing on the advice. The critical credibility test that the two largest firms, ISS and Glass Lewis, face over the forthcoming Exxon and Chevron AGMs will be talked about for many months.
We think leading asset owners will welcome the rating of their agents to help to bring them to account and pass on some of the pain they are feeling themselves. In a fast changing world, those agents that read the changing tide will find themselves with a competitive edge and like the leading asset owners themselves might find that the early mover advantage is one that the laggards might not find easy to catch up to. Only once we have a proper transparent view of all players in the market can the market really become effective. With around $10 trillion of investment needed to solve climate change, the battles within each agent industry will not only be fascinating but this time there will likely be big winners and losers.