When duty calls

Christine Berry asks what a trustee’s fiduciary responsibility really entails

Pension fund trustees are acutely conscious of their fiduciary duty to act in members’ best interests. But what does that duty mean in practice in the increasingly complex world of modern pension saving? FairPensions’ new report, Protecting our Best Interests: Rediscovering Fiduciary Obligation, sets out to ask precisely this question.

In the centuries since fiduciary obligations were first developed, the world of investment has changed radically. First and perhaps most obvious, the fairly simple bilateral relationship between trustee and beneficiary has been replaced by a complex web of principle-agent relationships between trustees, asset managers, investment consultants, brokers, investment bankers and so on.
How can trustees deal with the challenges presented by this situation, which allows them to delegate power over decisionmaking, but not the fiduciary duties that go with it?

It’s no longer enough for trustees to be conscious of potential conflicts of interest affecting themselves or their board. They must also keep tabs on the way conflicts are managed by their agents. Whether it's an asset manager voting on matters which affect its parent company, or a consultant with an interest in recommending evermore complex investment approaches, these agents are far from immune from conflicts of interest which could harm beneficiaries.

It’s a massive undertaking, and many trustees who took part in our research process said they didn’t feel adequately supported to fulfil it. The solution to this may be two-fold. Firstly, The Pensions Regulator could ensure that adequate training is available to trustees on this critical matter.

Secondly, the legal definition of a fiduciary suggests that asset managers and consultants are fiduciaries in their own right, and so are themselves subject to the same stringent duties as trustees. Confirmation of these duties from the regulator would go some way towards protecting trustees and beneficiaries.
A second thing that has changed since the eighteenth-century world of private trusts is our understanding of the complex factors determining outcomes for beneficiaries. For instance, evidence suggests that the vast majority of variability in pension fund returns is down to asset allocation and the resulting beta exposure, rather than manager outperformance.

Even more fundamentally, the credit crunch was a wake-up call to the potentially disastrous effects of systemic risk: an individual fund can follow the most prudent investment policy in the world, but this will not mean it escapes the consequences of reckless behaviour by other market participants.

Our current understanding of fiduciary duty may not provide trustees with the tools they need to address these enormous issues. The idea of a ‘fiduciary duty to maximise returns’ does not help fiduciaries to think about the full range of risks to their beneficiaries’ capital. And the traditional levers trustees can pull – such as manager selection and asset allocation – do not protect against threats like climate change or systemic financial risk. There’s a need for the industry to think creatively about how these risks can be managed – for instance, by collaborative investor action through forums like the Principles for Responsible Investment, or by collective engagement with policymakers to ensure that risky practices are properly regulated.

There’s also a need to free trustees from the fear that any course of action which departs from the norm leaves them potentially exposed to liability for breach of fiduciary obligation. Legal advice that makes trustees feel compelled to follow the crowd may not produce the best outcomes for beneficiaries. Indeed,
if it exacerbates ‘herding’ in the markets, it may contribute to the build-up of exactly the kind of systemic financial risk we need desperately to avoid.

Fiduciary duty is traditionally all about the reasonable exercise of trustees’ own judgement, in good faith, of how to serve their beneficiaries’ interests – subject to the overriding duty of undivided loyalty. In an investment context, it seems to have moved a long way from these origins.

We need to reclaim the fundamental principles of fiduciary duty from a narrow interpretation that may have served the investment industry much better than it has trustees or their beneficiaries. That's why our report recommends the adoption of an ‘enlightened fiduciary’ standard, modelled on the legal duties of UK company directors – one that authorises trustees to take a rounded, long-term view of their beneficiaries’ interests, and act on it in the way they see fit.

Christine Berry is policy officer at FairPensions

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