TH2010 chapter 4 NEW:Layout 1 - Engaged Investor chapter 4_NEW:Layout 1 11/17/09 3:58 PM Page 42 Chapter 4 Emerging markets T he term emerging market is associated with economies that

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TH2010 chapter 4_NEW:Layout 1 11/17/09 3:58 PM Page 37

Sub-committees

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The trustee board can delegate certainpowers to sub-committees. The mostcommon is the investment sub-committee, but others can cover

administration, defined contribution schemes,individual cases, and risk management.

THE INVESTMENT COMMITTEEThe investment committee is a sub-committeewithin your scheme that is responsible forsetting the scheme’s investment policy. Thisusually takes the form of makingrecommendations on investment policy to thetrustee board for approval.

An investment committee usually consists ofbetween three and eight people, depending onthe size and complexity of the scheme.Trustees on this committee will have thenecessary skills and experience to determineinvestment policies. The investment committeeworks closely with the investment adviser,actuary and fund managers. Not all schemesuse investment sub-committees.

Sub-committees that directly oversee areassuch as investment typically have ‘delegatedpowers’, which means that in certain areasthey have the power to make decisions withoutformal approval from the full trustee board.Normally the delegated powers do not extendto hiring (or firing) investment managers ormaking major changes to the strategy of thescheme. In the case of hiring investmentmanagers, the sub-committee would build ashortlist, interview the managers and decide

on a first choice before recommending a singlecandidate to full trustee board for approval.

Key responsibilitiesThe exact responsibilities of the investment sub-committee will be detailed in the scheme rules.But for most it will include: • Monitoring investments on a regular (at least

quarterly) basis, which includes meetinginvestment managers and reviewing theliterature they circulate

• Recommending new manager appointments• Making asset allocation decisions within the

guidelines of your Statement of InvestmentPrinciples

• Recommending changes to investment strategy• Investigating new approaches to investment

and new asset classes• Reviewing and appointing investment

advisers

Tips for investment sub-committeetrustees• Talk to your investment adviser about the

pros and cons of the investments you hold and the level of perceived risk in each case

• Ask them to evaluate the additional or reduced level of risk when recommending changes in your scheme’s investment strategy

• Ask them to explain any areas you do not fully understand

• Make sure that you have considered each of the relevant risks. ■

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Statement of Investment Principles

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The Statement of InvestmentPrinciples (SIP) documents thescheme’s investment strategy,providing the guidelines within which

your investment managers should work andoutlining the objectives of the trustees.

INVESTMENT OBJECTIVESThe investment objectives outline the scheme’soverall goals and its appetite towards risk.Many schemes will highlight two key objectives:1 To manage the scheme’s assets responsibly

and prudently to protect the scheme’s capital2 To maximise the investment return within

given risk parameters.It may also set a numerical objective eg togrow faster than the liabilities of the schemeby 2 per cent a year, and often sets out thebroad asset allocation of the scheme.

ASSET ALLOCATION STRATEGYAsset allocation refers to the distribution ofthe scheme’s money among the asset classes inwhich it will invest. Trustees must giveattention to the scheme’s asset allocation, tomaintain investment income and fordiversification.

The SIP will outline the asset allocationstrategy the trustees have agreed. It shouldalso contain:• How fund manager performance will be

measured• The reasons why a particular strategy has

been adopted

• Broad asset allocations within which thescheme is expected to operate.

The investment management industry oftenrefers to asset allocation strategies comprisedof ‘mandates’. So, a typical strategy couldinclude a UK equity mandate, a US equitymandate, a UK corporate bond mandate, andso on.

The SIP will also include information onthe scheme’s appetite for other activities in the financial markets such as: currencymanagement, use of derivatives, stock lending,corporate governance.

Like the trust deed and rules, the SIPoutlines the specific responsibilities of thetrustees. It also outlines the role of the fundmanagers and investment advisers, as well asthe target funding level for the scheme.

The SIP should also outline the contractualarrangements that have been set up with theinvestment advisers and fund managers andthe ‘responsible investment’ policy, where oneexists.

QUESTIONS YOU MAY WANT TODISCUSS INCLUDE:• Are there investments which would provide

better returns but without increasing thelevel of risk?

• Would a change in the internationalbalance of your investments be beneficial?

• Are there alternative investments, such ascommercial property, private equity or hedgefunds, that would benefit the scheme? ■


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Equities

Equities are also commonly describedas stocks and shares. The terms areinterchangeable: they mean owninga part of a company. The total

number of shares, or certificates ofownership, that are issued multiplied by theshare price gives the total value of thecompany. This is called the marketcapitalisation. When pension funds purchaseshares, they buy large numbers of them orbuy into funds that own large numbers ofthem.

INCOME FROM SHARESThere are two ways in which pension fundscan benefit from owning shares: when theshare price increases and the company paysdividends. Dividends are paid by thecompany to shareholders from its profits, atleast once a year. A company’s share pricerises when predictions for its future earningsimprove – either due to the company’s ownactions or due to an improving outlook forthe economy generally. The increase in valueis called a capital gain. Investors only realiseit, however, when they sell.

INVESTMENT FUNDSThe very largest pension schemes canappoint a broker to directly buy shares on itsbehalf, but this method requires an in-houseteam of experts and can be expensive.

Large schemes often set up ‘segregatedmandates’ instead. Here, an investment

manager is appointed to buy and sell shareson the scheme’s behalf.

The most common approach today,however, is to invest in pooled funds. Thesefunds combine the investment of severalinstitutions. Fund managers then invest in acertain mandated type of equities. Foractively managed funds, success will dependon the experience and expertise (minus fees)of the fund manager.

BULL OR BEAR?A bear market is when share prices fall for aperiod of months or even years, as we sawuntil March 2009. Conversely, a bull marketis when share prices are rising for anextended period of time. A bear market rallyis when prices rise strongly for a short periodof time when the generaltrajectory is downward.

Volatility – or rapidchanges in prices – isnormal in stockmarkets. Eachindividual shareprice can riseand fall,sometimes severaltimes each day letalone each week,month or year.Historically, theoverall trend isupwards. ■


Chapter 4

Emerging markets

The term emerging market isassociated with economies that arepoorer than the developed world ofthe US, EU and Japan. Emerging

economies are typically reliant on basicindustries and agriculture rather than servicesand technologies. However, to be trulyemerging a market needs to have anestablished and reasonably liquid stockexchange that is at least partially open toforeign investors, and a functional financial,legal and regulatory framework. If any ofthese characteristics are missing an economymay be considered only a “frontier” marketby index providers such as MSCI.

Emerging markets are characterised byrelatively rapid economic growth, growingurban populations and industrialisation. Theyare typically more volatile, have more capitalcontrols and have less liquid stock marketsthan developed countries. Emergingcountries contain 80 per cent of the world’spopulation and 10 per cent of the investableworld market, as measured by MSCI.

EMERGING MARKETS AND PENSIONFUNDSAdvocates of investing in emerging marketsexpect high rates of economic growth to filterthrough into earnings growth for the localcompanies and therefore stock market returns.Investing in emerging markets can also beused to diversify away risk, as they have a lowcorrelation with developed world markets.

The prospect of strong returns fromemerging markets requires a tolerance forequity risk, foreign currency risk and liquidityrisk. Emerging market equities are likely tounderperform bond returns in some periods –investment should always be made with a longtime horizon.

A defined contribution (DC) pensionscheme may offer an emerging market fund asone option for members. The long-termcharacteristics of the asset class are moresuitable for those far from retirement; the risksmust be clearly communicated to members.

GETTING INVOLVEDPension schemes can invest in emerging marketsthrough a global equities fund or a dedicatedfund. A dedicated fund could invest in allemerging markets or focus on a geographicalregion such as Latin America, or by othercriteria such as economic strength in a Brazil,Russia, India and China (BRIC) equities fund.

The advantage of a fund is that investingin the developing world can be complicated,with unfamiliar languages, currencies andlegal systems. Pooled funds are simpler andpractical for smaller funds. Segregatedaccounts offer greater flexibility and may becheaper for large funds. ■

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Good to know

◆ Advocates of investing in emerging marketsexpect high rates of economic growth


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Fixed income refers to a loan made to acompany or government with anagreement to pay it back after a setperiod of time with a set interest rate.

The term covers corporate bonds andgovernment bonds, known as gilts when issuedby the UK government. Highly rated bondsare one of the most dependable, low risk formsof investing.

The organisation to which you have lent themoney is called the ‘issuer’. Over the duration ofthe loan the issuer pays a fixed rate of interest.

There are two main ways in which thatinterest can be paid. A coupon bond makesregular interest payments and a discountbond pays all of the return at the expiry ofthe bond. Either way, the interest is the mainway in which you make a return, referred toas its yield. The biggest enemy of bonds isinflation: a promise to pay £1,000 in 2015when inflation is 10 per cent is worth only£590 in 2010.

A SAFE HAVEN? Gilts, and to a lesser extent bonds, havetraditionally been seen as a very safe form ofinvestment for pension schemes. Your originalinvestment is safe as long as the issuer of thebond does not go out of business during theduration of the loan. The danger is that theissuer does go bust. The degree of riskdepends on the health of issuer. The greaterthe risk, the higher the rate of interest theissuer needs to offer on its bond to attractlenders.

BOND RATINGSBonds are rated by agencies to help investorsdetermine how safe they are. Bond ratingswork downwards alphabetically from a triple-A, denoting the safest type of investment.Anything below a triple-B grade is consideredto be junk or non-investment grade, meaningthat there is a significant risk that you willlose your original loan.

The main ratings agencies are Standard &Poor’s, Moody’s and Fitch. Theseorganisations rate the amount of riskassociated with a bond, using two mainmeasures: • the probability that the organisation will

go bankrupt before the final bond paymentbecomes due

• the percentage of the value of the bondthat the holder will receive if the companygoes bankrupt. ■

Fixed income

Example

◆ You buy a 1-year, £1,000 bond withCompany X at an interest rate of 6 percent, you are loaning Company X £1,000for the course of a year. At the end of theyear, Company X will pay back the £1,000,and on top of that it will pay you 6 percent interest on the loan.£1000 loan + 6% interest = £1060 return


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Alternatives and diversification

Traditionally pension schemes tendedto invest only in equities and bonds.Equities were intended to enable thescheme to grow its assets, whereas

bonds would provide less growth, but wouldalso involve less risk. This theory works fineprovided that the stock market continues on anever-upward curve, which was certainly not thecase in 2008. For this reason alternatives toequities and bonds have become increasinglypopular.

PRINCIPLES OF ALTERNATIVEINVESTMENTSDiversification: By investing in differenttypes of assets, the dependency on producinggood returns from equities alone is reduced.

Correlation: asset classes that behavedifferently in a given set of economicconditions are described as being uncorrelated,or having low correlation, which is importantto balance out the effects of stock market dips.

Leverage: Leverage is the practice ofusing debt to finance investments. One ofthe outcomes from the recent crisis has beenthat because easy loans are not available,alternative investments are now lessleveraged, and therefore less risky, than theywere two or three years ago.

Liquidity: this refers to the ease withwhich you can withdraw your money from afund. Many alternative investments aretermed ‘illiquid’, meaning that it won’t be soeasy to simply take your money and run.

ALTERNATIVE INVESTMENT TYPESThere are many different types of investmentgrouped under the ‘alternatives’ umbrella.

Private equity: Private equity involvesinvesting in companies to benefit from theirgrowth. One can invest in complete start-ups,the riskiest end of the private equity spectrum,through to those that are well established andrequire capital for further expansion.

Hedge funds: As a general definition,hedge funds are an investment type (not anasset class) that uses a mix of financialtechniques to generate returns.

Fund of funds/fund of hedge funds:It’s more common for pension schemes toinvest through a fund of funds, or fund ofhedge funds. In this setup, a scheme’s hedgefund allocation will be invested across multipledifferent funds. This can be a lower-riskapproach to hedge fund investing.

Currency: Pairing foreign currencies ofagainst each other can be risky, but has benefits.

Real estate: ‘Real estate’ can encompassboth property investment and ‘infrastructure’projects such as hospitals, roads and bridges.

Commodities: Fancy investing in gold,oil or even oranges? Commodity investinginvolves trading in consumable goods.

MANAGING ALTERNATIVES Managing alternative investments is a verydifferent process from equities and bonds.Governance is a big consideration; one optionis fiduciary management. ■


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Private equity

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The easiest way of describing ‘private equity’, is investing incompanies which are not part of any stock market.

Most large and medium-sized companies atsome point in their life decide to issue shares ona stock market and become publicly-owned.Pension funds that want to invest in companiesin the UK and around the world do so bybuying up the shares they issue to the public.

Private equity investing is about companiesthat do not issues shares. Such companies areeither too young or too small, or simply want toremain privately-owned.

GETTING INVOLVEDThere are three ways to take part in thegrowth of a private company.

The first is to support a management buy-out (or MBO). This happens when a seniormanagement team buy their company, or thedivision they run, from the owners.

The second is when a large public companyputs up one of its divisions up for sale – mostlikely one that is quite different from its mainbusiness. Here investors can come in, buy upthe business and hire a team to run it.

The final one is ‘venture capital’ andinvolves investing in a small or start-upbusiness and making it grow. In all casesinvestors clump together to buy a stake in thebusiness and work closely with themanagement team to make sure the enterpriseis successful. A few years down the line the

hopefully successful business is sold to anothercompany or floated on the stock market.

WHO ARE THE INVESTORS?The actual investors are private equity funds.They agree to invest in the ventures outlinedabove, and work with the management teamsto make sure the project has a happy ending.But they get their money from pension fundsand other major institutions.

HOW IT WORKSA private equity fund raises money overmonths from investors. Then it spends the nextfew years investing the money in ventures andfive to 10 years nurturing its new enterprises.Because these are all young companies, orcompanies under new management, there is arisk that no matter what the private equityteam does, some of the projects will fail. So tooffset this risk, the fund will look to be involvedin around six to 10 enterprises at any one time.

Most pension funds consider that putting alltheir allocated money into one private equityfund is a high risk business. A better bet for apension fund is a private equity fund of funds.The manager of this fund will have the job oftaking your money and handing it over, in theright amounts, to various private equity funds.

The end result is that investors will have asmall stake in dozens of enterprises. Andbecause the enterprises that succeed tend to dophenomenally well, you can afford for abouthalf to go up in smoke! ■


Currency management

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It’s not just the shopping budgets ofholiday-makers which are at the whimof foreign exchange rates – so are youroverseas investments. Exchange rates for

foreign currency go up and down every day.Now think about what exchange rates can

do to your pension fund’s overseas investments.Say you buy $150 worth of shares in a

company called Team USA listed on the NewYork stock exchange. When you make thepurchase, it costs you £100 because theexchange rate is 1.50 (£1 buys $1.50).

Team USA performs well and one yearlater the shares are worth $180 – an increaseon your investment of 20 per cent.

However, over the same period of time, thevalue of the pound has strengthened andstands at 2 (£1 buys $2). On this exchangerate, your $180 of shares would be worth £90.

So while your investment increased in valuein dollar terms by 20 per cent, when convertedback to pounds, you actually made a loss in‘real terms’.

Because exchange rates go up and downmany trustees are put off from investingoverseas. Despite this, the vast majority ofpension funds still invest some portion of theirassets abroad – how do they deal with thewhims of foreign exchange?

CURRENCY MANAGEMENTThe solution is ‘currency management’. Acurrency manager is an investment expertwho oversees the currency risk that you

run by investing overseas.Trustees who invest overseas have three options:

1 do nothing2 passively ‘hedge’ or insure their portfolio 3 actively manage their currency.

Option 1 Means leaving your overseasinvestments to their long-term fate, believingthat over time the fluctuations even out. Butdoing nothing can be risky in the short term.

Option 2 If you hire a ‘passive currencymanager’ you are asking them to insure yourportfolio against exchange rates. Theyconstantly monitor your overseas investmentsand buy financial derivatives to balance out thecurrencies you own. This is often known as‘currency overlay’.

Option 3 This is a different asset class. Anactive currency manager buys and sell anycurrency in the world in the expectation ofmaking more money than they lose. It isentirely down to the skill of the individualsconcerned – there is no market or averagebenchmark you can track.

This makes it sound pretty risky: essentiallyit is a series of bets on currencies going up ordown in value.

But currency is unique in another way. 95%of the foreign exchange markets comprisesamateurs who don’t care whether they aremaking money. Who are these amateurs? It’syou: every time you go on holiday you lose orgain due to exchange rates. But a bad ratedoesn’t stop you buying foreign currency –you’re on holiday after all! ■


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Hedge funds

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Ahedge fund is an investment fund inwhich the managers can makemoney irrespective of whethermarket prices go up or down. This

means they can profit from the price of aninvestment falling. Conventional managers canonly hope the price of their investments rise.

Hedge funds adopt all sorts of strategiesand can invest in anything at all. But whatthey all have in common is that they arecurrently lightly regulated – which meansthey are free to invest as they wish. They canborrow money to amplify their returns andthey can bet on prices going down, as well asup known as ‘short selling’. However, thereare proposals in the pipeline that would seemore stringent standards in place.

Hedge funds do not compare themselves toequity or bond indexes – their target is‘absolute’ or a level above the returns youwould receive on cash; ie ‘cash plus 4%’, forinstance. Partly for this reason, the focus ofmany hedge funds is consistency of returnswhile preserving the original investmentrather than high returns.

THE STRATEGIESHedge funds adopt a number of strategies,focusing on different assets in different markets.Some of the investment strategies are:

Global macro: Instead of focusing onmovements in particular shares or bonds,global macro funds focus on worldwidetrends.

Market Neutral: These funds investsystematically so that the portfolio isunchanged if the whole market goes up ordown

Merger Arbitrage: Once an acquisitionhas been announced, the share price in thecompanies involved will fluctuate. Fundmanagers buy shares in the target companyand short sell the acquirer

Event Driven: Fund managers long andshort sell companies in financial distress orpending major deals

Fixed Income Arbitrage: Fundmanagers adopt the same strategy of buyinglong and selling short in bonds rather thanequities.

FUND OF HEDGE FUNDS In order to spread risk and to invest in arange of hedge funds adopting differentstrategies, pension funds can invest in ‘fundsof hedge funds’. These invest money acrossseveral different hedge funds, to spread therisk over several managers and strategies.This is a more expensive option, however, asmanagement fees are higher. In addition tomanagement fees, hedge fund managerstypically take a commission of 20 per cent ofnet profits. ■

Good to know

◆ Hedge funds can profit from the price ofan investment falling


Infrastructure

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An increasingly popular asset class forpension funds is infrastructure,although it still represents only acouple of per cent of most schemes’

assets. Infrastructure refers to projects such asbridges, toll roads, public amenity buildings(like army barracks) where a governmentalinstitution requires private investment. In theUK, Public-Private Partnerships (PPP) andPrivate Finance Initiatives (PFI) have enlistedprivate firms in a wide variety of governmentprojects from social housing and motorways.

There are two stages of an infrastructureproject. The primary stage involves the actualconstruction and the secondary stage involvesits ongoing management. For example, theprimary stage of a toll bridge project wouldinvolve funding and overseeing the buildingof the bridge. The secondary stage would beinvestors funding the upkeep of the bridgeand collecting tolls.

Investing at the primary stage is morelucrative but more risky, as the scale of theseprojects means that there is an acute risk of

delays and other problems.The secondary stage

involves less riskand provides a

steadyincome –which is

generally unrelated to other asset classes – butthe returns will not be astronomical.

Pension funds often opt to invest throughspecialist pooled funds. These raise moneyfrom multiple institutions and invest in a selectrange of projects, defined by geography orindustry. A fund could focus on either theprimary or secondary stage or a mixture ofthe two.

The primary stage is similar to investing inprivate equity: there is a risk that the projectwill not pay off but the potential returns canbe significant. The secondary stage it is moreakin to investing in commercial property, onlyincome streams are even more stable.

The rent on infrastructure is normally paidby the government (which is assumed to be themost reliable payer). Toll-based incomestreams such as those from roads depend onthe flow of traffic, which tends to be constantirrespective of economic conditions.

The key attraction of investing ininfrastructure is that it ‘diversifies’ yourinvestments. The returns from investments donot go up and down with the equity market soit can help schemes smooth out the ups anddowns of the investment cycle.

Infrastructure funds are sometimes onlyavailable to investors for a short period of timeuntil they have raised enough money to carryout their plans. Others are ongoing concerns:one infrastructure fund has stakes in a Belgiumairport, gas pipelines in England, wind farmsin France and a deep sea port in Poland. ■


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Commodities

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Commodities are basic rawmaterials and foodstuffs gold, tin,copper, petroleum, gas, sugar,coffee, orange juice, livestock and

cocoa have low correlation to traditionalasset classes like equities and so bringdiversification to a portfolio. They offer thepotential for huge returns very quickly andwith very little initial investment. But thereis also the risk of rapid price changes andunlimited losses.

HOW COMMODITIES ARE TRADEDAt a basic level, commodities can be soldimmediately on the ‘spot market’, wheretheir price is determined by currentconditions of supply and demand.

More usually they are sold on the ‘futuresmarket’ so that farmers, growers or minershave a means through which to manage their business. They sell their commodity onthe futures market at a fixed price. Thismeans the supplier is entering into a legalagreement to make a delivery of acommodity at a fixed date in the future, at aprice determined at the time of dealing.

These futures contracts on commoditiesare bought and sold among speculators every day.

COMMODITIES AND PENSIONSCHEMES Investing in commodities, whether directlyon the futures exchange or through pooled

funds, can give similar levels of returns toequities, with robust, long-term inflationhedging – risk management – qualities.

It does not, however, always guaranteegains – basic supply and demand factorscan affect commodity prices. Just look at theway that the price of oil has fluctuatedthroughout 2009.

HOW TO GET INVOLVEDMost pension funds gain exposure tocommodities through pooled funds. Thesetrack an index measuring the pricemovements of a wide range ofcommodities. Most schemes stick with themain providers and choose either theStandard & Poor’s GSCI (Goldman SachsCommodity Index) which devotes around70 per cent to energy, or the DJ-AIGCI(Dow Jones AIG Commodity Index) whichlimits any weighting to 33 per cent.

As well as tracker funds, there hasrecently been a move towards ‘enhanced’commodities products – in effect, activecommodities funds. Active strategies includethose that employ seasonal tactics,momentum based strategies (buycommodity futures that outperformed in therecent past and sell those that under-performed), and relative value strategies.

You should seek advice from consultantsand commodities experts to decide whichform of commodities investment is bestsuited to your pension scheme. ■


Real estate

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There are several different ways ofgetting involved in real estate – orcommercial property – depending onthe type and size of scheme you

have, and what you want to gain from theinvestment. Property for pension schemesrarely means buying residential houses andacting as landlord: offices, retail space andwarehouses are the most common investments.

Listed property funds In this type ofinvestment the properties are owned andmanaged by a manager and investorseffectively buy shares in a company. Althoughthis can be loosely grouped under the generalheading of property, listed property funds arealso viewed as equities. So, if your scheme isalready investing in equities it may mean thatthe investment is replicated elsewhere in itsportfolio.

Non-listed property funds This is afund that buys and manages property onbehalf of its investors. Investors put moneyinto the fund, generally for a specifiedminimum period of time (as it takes time tobuy and sell property). The fund managerthen uses that money to buy property.Investors see returns from the increased valueof the buildings and also, depending on thefund, money generated by clients paying rent.There can be considerable variety within thisheading in terms of the location and type ofbuildings.

Direct purchasing/management ofproperty Large pension schemes are able to

build their own portfolio of bricks andmortar and manage it themselves, but thispractice is increasingly unusual. Holdings aregenerally the result of historical purchases orbecause the scheme sponsor has given thepension scheme buildings in lieu ofcontributions. Owning whole buildingsconcentrates the risk in one asset.

Fund of property funds These offer astraightforward way for smaller schemes toachieve a diversified property portfolio with asmall investment.

TERM AND LOCATIONProperty investments are generally termed‘illiquid’ as investors are generally not allowedto take money out whenever they like. Mostreal estate should be considered as a long-terminvestment – typically from 10 to 15 years –with the possible exception of listed propertyfunds.

Property has a low correlation with thestock market i.e. prices move independently ofequities. If you are investing in property,through non-listed funds particularly, thequestion of where to buy is also significant.Many property funds invest overseas ratherthan in the UK. This can produce higherreturns, but managers’ awareness of localrules on taxation; relationships betweentenants and landlords; risks to the stability ofthe country where the property is located; andexchange rate movements are every bit asimportant as rising prices. ■


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Responsible investing

Responsible investment (RI)advocates suggest that long-termreturns are enhanced byconsidering environmental, social

and governance (ESG) criteria. They arguethat ESG factors affect the performance ofcompanies so it is rational to consider themalongside other business risks.

Defined benefit pension trustees have afiduciary duty to maximise their investmentreturns so they need a solid reason to rule outany given type of asset. RI limits the choiceof investible assets but, according toresponsible investors, the assets ruled out aremore likely to perform badly in the longterm.

Pension funds are long-term investors andESG issues are considered long-termproblems. The approach entails tracking risksor opportunities and understanding moreabout the companies in which you areinvesting. Formulating and implementing anew investment strategy takes time andmoney, so adopting a new policy needs to bejustified by higher returns.

RI should not be confused with ethicalinvesting. Responsible investors are acting outof self-interest – they are concerned thatESG problems will damage their investments.Ethical investing is about making ‘mission-based’ investments to improve the world, oravoid supporting companies not approved of.

The United Nations has formalised theconcept of RI through its Principles for

Responsible Investing (PRI). The sixcommitments provide a framework thataligns investment practice with social goalsthat can be universally applied by pensionschemes. A recent Fiduciary Responsibilityreport by the United Nations EnvironmentalProgram Financial Initiative even suggestedthat schemes could be negligent if they donot consider ESG issues.

IN PRACTICEResponsible investing criteria can becommunicated to fund managers and votingdirections can be written into a mandate. Itentails telling fund managers that the needsof the scheme extend beyond the short term.Consultants can advise on fund managers’ESG and active ownership practices.

Globally there are 560 signatories to theUNPRI including pension schemes(including 25 state and corporate ones in theUK) and fund managers that togetherrepresent US$18 trillion in assets, or roughly5 per cent of developed market equities.

Empirically determining the value of RI totrustees is difficult as there is variety amongpractitioners and constant evolution. There issome evidence to suggest that ESG factorsmake a difference to share prices but it isimpossible to say ESG funds will definitelyoutperform, as there are too many otherconsiderations. RI is still in its infancy butmay prove to be a valuable tool in trustees’armoury. ■


Documents

TH2010 chapter 4 NEW:Layout 1 - Engaged Investor chapter 4_NEW:Layout 1 11/17/09 3:58 PM Page 42 Chapter 4 Emerging markets T he term emerging market is associated with economies that