Berry and Scanlan argue that beneficiaries should be consulted on the general policies of their pension fund, and that trustees should take their wishes into account when making investment decisions.
They discuss and refute some of the common objections to beneficiary consultation, drawing on examples from the UK pension fund landscape to illustrate why and how beneficiaries’ views should be heard across a full spectrum of issues: financial, “quality of life” and “ethical preferences”. The authors conclude that the legal framework in the UK supports a broader interpretation of fiduciary duty than is often claimed, both in terms of beneficiary involvement and consideration of all such issues, though clarification of the law would support greater engagement in the future.
The case for beneficiary engagement
Historically, beneficiaries of private family trusts have been passive in their relationship with fiduciaries. Pension scheme beneficiaries are, however, fundamentally different because they have paid for their benefits. In defined benefit schemes, where the employer bears the investment risk for guaranteeing future benefits, some residual paternalism may be at least understandable. Increasingly, however, pension schemes are defined contribution schemes where the beneficiaries shoulder all the risk, making such an attitude even less defensible.
Exploring legal and practical barriers
Some of the common objections to greater beneficiary involvement include confusion between the roles of trustee and beneficiary, and beneficiaries’ lack of qualifications to express a view on trustee decision-making. Greater beneficiary involvement has also been seen as a potential breach of the trustee’s duty of impartiality. Berry and Scanlan refute the first objection by citing examples where a degree of consultation is undertaken or mandated without negative consequences. For example, in the UK occupational and personal pension schemes are required to consult with employees on certain matters, and the recently established National Employment Savings Trust (NEST), a defined contribution scheme set up by the government targeted at low paid workers, undertook a consultation survey of its target demographic (future beneficiaries) for the specific purpose of informing its investment strategy. The second objection relating to beneficiaries dependence on trustees is true to an extent since most beneficiaries are not equipped with the technical skills to participate in decision making on asset allocation or complex investment products, but it is difficult to see why beneficiary views on issues such as risk tolerance, shareholder engagement and ethical questions would not be highly relevant.
The third objection, that fiduciaries risk breaching their duty of impartiality if they take into account any views of beneficiaries unless there is a complete consensus, poses a particular barrier to considering environmental, social and governance (ESG) issues and ethical questions. However, Berry and Scanlan point out that beneficiaries are more likely to differ in their awareness of the issues and in their order of priorities, rather than be in direct conflict with one another. In any case, balancing the varied interests of beneficiaries is already one of the tasks of fiduciaries since beneficiaries do not all have identical financial requirements. The alternative to finding a compromise would be to deny all beneficiaries any opportunity to voice their opinions. They argue disempowering everyone is surely a suboptimal outcome.
The need for transparency
The authors also discuss the need for greater transparency and accountability in the fiduciary relationship for beneficiary participation to be effective. Currently trustees are not legally required to disclose the reasons behind investment decisions to beneficiaries, and delegation to external asset managers appears to reduce transparency even further creating a “broken link in the chain of accountability”. Improved accountability would help to restore the trust in the financial system that has been eroded in recent years.
The authors’ review of legal precedents for incorporating ‘quality of life’ and ethical factors finds the predominant view of lawmakers to be that such factors can be considered provided that there is no likelihood of significant financial detriment. The authors argue that since the benefits of portfolio diversification have been shown to be greatly reduced above approximately thirty stocks, as long as there are no sweeping sector exclusions, there are sufficient investment opportunities for a responsible investment policy-driven portfolio to have the same expected return as one managed purely for return maximisation.
Considering the future direction of beneficiary engagement on issues beyond purely financial matters, Berry and Scanlan cite the example of Denmark, where pension plan member engagement is more widely accepted. In Denmark, fiduciaries are still legally obliged to seek the best possible return for beneficiaries, however they have developed responsible investment policies that reflect member views and do not compromise the funds’ ability to deliver returns. While developments such as the UK’s voluntary Stewardship Code are broadly supportive and continue to evolve, the authors conclude that further legislative reform is needed to encourage engagement with pension fund beneficiaries.
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RI Quarterly Vol. 2: Fiduciary duty
RI Quarterly Vol. 2: Fiduciary duty
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The voice of the beneficiary