William Eichler 02 November 2015

Where should councils invest their pension funds?

This year Suffolk County Council decided to stop investing its workers’ pension funds in tobacco stocks. And then it changed its mind. Councillors had reached their original decision based on ethical considerations; as politicians they felt morally obligated to disinvest from an industry that causes harm to their constituents.

The second decision was based on very different criteria. The council consulted a lawyer who advised it would be acting illegally were it to disinvest on moral, political or social grounds, rather than for sound investment reasons.

This was not an isolated case. Many councils are facing a similar dilemma. As public servants they have a moral duty to do right by the public, but as fund managers they have a legal (and, it should be said, moral) duty to ensure their often poorly paid workers get the best returns on their investments.

What considerations, then, should influence the exercise of investment decisions? Should ethical, political or social factors enter into the equation? Or should councils base their choices entirely on economic calculations? As our survey shows 67% of respondents said councils should not invest their pensions in areas that had a negative social or environmental impact. But, on the other hand, the same respondents also stressed that return on investment should be the key priority when making investment decisions.

Nigel Giffin QC, the lawyer who advised Suffolk County Council, also provided a legal opinion to the Local Government Association (LGA) concerning the duties local authorities have when it comes to the pension funds of those who work for them. The first part of his opinion states that local authorities have a fiduciary responsibility to those who pay into the pension fund. Put another way, they are legally bound to act solely in the interests of the workers who pay into the funds.

This much is uncontroversial. The second part of his opinion is where it gets more complicated. Here he focuses on what considerations may legitimately influence the exercise of investment decisions. Could a local authority invest pension fund monies in, say, social housing in order to improve the local area? Could it decide not to invest in the arms industry simply because it might feel such an investment is immoral?

Mr Giffin QC concludes that, legally speaking, councils must invest solely with financial considerations in mind. When faced with a choice between investment options, local authorities must always seek to maximise the returns for their workers.

‘The first point is that the power (in fact the duty) to invest fund monies…is a power of investment,’ he wrote. ‘Therefore it must be exercised, when it comes to the discretion to choose one investment rather than another, for investment purposes, and not for some other purpose.’

He does, however, add an important proviso. In cases where there is a ‘tie break’ between two possible investments, i.e. where they both promise to deliver comparable financial returns, it is legitimate to bring other considerations to bear on the decision.

‘It follows’ he writes, ‘that the administering authority can in principle have regard to wider considerations where that does not run the risk of material financial detriment to the fund.’ If a council is, for example, deciding between investing in tobacco stocks or cancer treatments, and they both promise to deliver the same financial returns, then it is acceptable for ethical, political or social considerations to enter into the mix.

A crucial point to take into consideration where this issue is concerned is time-scale. Mr Giffin QC’s legal opinion on this question arguably depends on a narrow definition of what constitutes a financially sound investment. What is profitable in the short- or medium-term might not be in the long-term.

An argument, therefore, could be made that local authorities should look beyond short-term financial gain and consider wider, longer-term trends when investing its pension funds. This could mean taking account of factors that do not, on the surface at least, relate to money, and investing in, or divesting from, industries based on the possible long-term economic impact of these ostensibly non-economic factors.

Cllr Sandy Martin, the leader of the Suffolk County Council Labour Group, makes this argument with regards to tobacco investments. ‘Even if,’ he says ‘[investment] decisions are based solely on the ultimate financial returns to the investment, it is not far-fetched to argue that the weight of medical and social opinion, the accelerating role of legislation in limiting the consumption of tobacco, and the probability of even steeper taxes all place a serious risk on the value of current tobacco stocks.’

The same could be said where investments in fossil fuels are concerned. Earlier this month local government workers lost £683m from their pension funds due to a fall in coal share prices. Given the consensus on the link between the burning of fossil fuels and global warming, environmental campaigners argue, disinvesting from fossil fuels makes sound financial sense in the long-term.

As divestment campaigner Danielle Paffard from 350.org puts it: ‘Increasingly fossil-free funds have been shown to out-perform their fossil-fuelled counterparts. For a savvy investor, the direction of travel away from fossil fuels should be clear.’

Taking the long-term perspective, and factoring apparently non-economic considerations into investment decisions, appears to be compatible with councils’ fiduciary responsibilities. In fact, as Ms Paffard points out, not doing this could leave local authorities in breach of their fiduciary duties.

‘With increasing financial warnings surrounding fossil fuel investments,’ she says, ‘failing to properly manage the risks associated with fossil fuel investments will find pension funds in breach of fiduciary responsibility.’

Some councils are already taking this long-term perspective. Dundee City Council, in its Statement of Investment Principles for the Tayside Pension Fund, highlights the importance of socially responsible investment and it incorporates issues that might not be considered economic in a narrow sense into its investment decisions. ‘The fund believes,’ the statement says, ‘that environmental, social and corporate governance (ESG) issues can affect the performance of investment portfolios through time,’ (my emphasis). One of its main investment principles is, in fact, to ‘incorporate ESG issues into investment analysis and decision-making processes’. This, it emphasises, is wholly compatible with its ‘over-riding fiduciary duties’.

Aside from the legal question, it seems quite clear that seemingly non-economic factors already enter into the decision making process of politicians when it comes to decisions about where to invest pension funds. Earlier this month George Osborne announced plans to combine 89 local authority pension funds into six new British Wealth Funds to help increase investment in major infrastructure projects.

This may well be a good idea for the long-term development of the UK economy, but it is not fulfilling the fiduciary duties as they are laid out in Nigel Giffin QC’s LGA legal opinion; a point alluded to by Brian Strutton, the national secretary of the trade union GMB, who accused the chancellor of treating council workers’ pension funds like ‘politicians’ playthings.’

This brings us back to Suffolk County Council’s decision not to disinvest its pension funds from tobacco stocks. The council’s u-turn was due to the above legal opinion that suggested that, according to the strictures of the law as it presently stands, short-term financial gain trumps moral (or any other) considerations. But in reality, it is possible to argue that just as with George Osborne’s British Wealth Funds plan, Suffolk CC’s investment choices are already shaped by non-economic factors.

As Suffolk cllr Sandy Martin puts it: ‘Spearmint Rhino is a very profitable operation I am led to believe, and doubtless there may be even more profitable operations based in e.g. Koh Samui, none of which Suffolk Pension Fund has had the imagination to invest in. I do not believe we should invest in sex or drugs, and I don't believe we should invest in tobacco, and I am at something of a loss to understand how a moral argument can be made in the first instance but then suddenly be ruled illegal in the second.’

These are financially tough times for councils, particularly for their workers, and the decision of where to invest pension funds is not an easy one. But a strong case can be made for councils to think beyond narrowly defined, short-term economic gains, and to consider moral, social and political factors when choosing where to invest pension monies, and still be fulfilling their fiduciary duties.

Indeed, as we have seen, they already do.

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