Pension funds have been at the forefront of the responsible, sustainable, ESG and impact investment movement. These institutions, central to the establishment of the Principles for Responsible Investment (PRI), are also driving forces in investment industry initiatives such as the Net Zero Asset Owners Alliance, and many have now also incorporated the UN’s Sustainable Development Goals (SDGs) into their investment policies. As a result, many have made significant changes to the way they invest, such as:
- exclusions: divesting from companies, sometimes even entire industries, that they consider unethical or unsustainable.
- engagement: having dialogues with investee companies with a view to changing them and improving their ESG performance.
- ESG integration: basing investment decisions explicitly on ESG factors as informed by ESG data, for example carbon intensity of firms.
- impact investment: allocating capital to companies that support the SDGs in order to ‘make a better world’.
To support these ESG investing activities, many pension funds now employ dedicated staff and work with data providers and consultants, sometimes at significant expense.
But despite this mushrooming in ESG activity, many are forgetting to make one crucial investment: an investment in connecting with their members – who are after all the ultimate ‘owners’ of pension funds’ capital – and seeking to fully understand their ESG preferences.
Why is this important? Changing the world through investing appears to be an appealingly simple idea, but introduces some difficult decisions. In fact, there are countless different ways for a pension fund to demonstrate it is a “responsible” or “sustainable” investor; countless different norms, principles and guidelines a pension fund can decide to subscribe to (e.g. PRI, SDGs, Net Zero commitments), and countless different ways to reflect these commitments in investment portfolios (e.g. through exclusions, engagement etc.). And sometimes there’s clarity as to the likely financial or real-world outcomes of these actions. But just as often, it seems to us, there is not.
Clearly, the main purpose of a pension fund is to provide retirement income to its members and should therefore be seen first and foremost as a fiduciary to those members. And while of course those members have delegated management of the pension pot to a board, the board maintains a duty to keep the interests of members in mind in doing so and – where there may be doubt as to how members view certain key aspects of pension fund management – they should also engage with those members.
In other words: ESG investing is all about understanding and making trade-offs. We believe it is essential for pension funds to provide clarity on this to their members, and to seek to understand members’ views on these trade-offs, to inform the fund’s decision making.
Understanding pension fund member preferences – it’s not straightforward
However, understanding preferences is not simple and this is especially the case with ESG investing, where there are often questions about how to trade off financial returns, ethical values and real-world outcomes. In some cases members prefer to invest in line with their values, and their pension funds’ investment strategy aims to reflect this. For example, the health care pension fund in Netherlands states that it does not to invest in tobacco firms.
But when it comes to values-based investing, the question is not only which values are important, but also what the consequences are – if any – for the investment strategy, for wider society, or for the environment. Do members still stick with their preferences if it is probable that ESG actions would result in (much) lower financial returns? And what about the real-world impact? What are members’ views on the matter if they understand that divesting tobacco companies does not result in less smoking? Again, do they still maintain this preference if they understand their action is not part of the solutions needed to eradicate smoking?
To be sure, some pension funds have engaged with members on these questions; for example, by working with market research firms to undertake surveys and organizing focus groups. However, we would argue that these approaches have significant limitations.
First, often there are problems with the research methods employed: self-completion surveys suffer from low response rates and response bias, and ask respondents to answer questions based on their own individual preferences; as a result, results are often limited in their generalizability, and provide little insight into how the collective should balance concerns.
Second, most pension funds do not have the capacity or specialist knowledge to manage market research projects, while many market research consultants lack a specialist understanding of financial, investment and ESG issues.
Third, it is widely recognized that financial literacy levels are low and that pensions topics have limited appeal to the average consumer. At the same time, responding to questions about ESG investing requires a certain understanding of how financial markets and pension funds work and of how to address often complex systemic issues such as climate change or biodiversity loss.
Fourth, members are often not adequately informed about what ESG tools can and cannot achieve in terms of driving behavior change or addressing SDGs. This also has to do with how ESG investing initiatives and questions are usually – and perhaps unwittingly – framed: as trade-off-free, “win-win” solutions, that give members a “warm glow” from investing in line with their values, boost financial returns and therefore their retirement income, help manage investment risk and – as icing on the cake – contribute to a better world! When presented this way, what’s not to like?
Finally – but crucially – these forms of market research ask members to reply individually; respondents are usually not given the opportunity to engage in a deliberative way with other beneficiaries in a public forum, or to hear the views and recommendations of experts, before offering their views.
What’s a pension fund board to do?
We believe that beneficiaries need to have a better understanding of what ESG investing approaches can and cannot achieve, and pension funds should listen to their views. Engaging with members in a deliberative way – involving dialogue rather than asking members to respond to survey questions ‘from the top of their mind’ – can address issues such as lack of knowledge or understanding, and can attune members to collective rather than just individual preferences.
In other words, pension funds who want to design ESG investment policies that better reflect their members’ views and preferences should consider looking at the way in which deliberative democratic innovations – emerging from theories of deliberative democracy – have opened up dialogues with citizens and other stakeholders, and what they can learn from them.
What are citizens' assemblies?
Deliberative democratic innovations, such as citizens assemblies of randomly selected citizens, offer an alternative approach to engaging with public and understanding public preferences. While citizens assemblies are just one model, and part of a wider family of models known as ‘mini-publics’, they are characterised by:
- a deliberative engagement with a public;
- a focus on plural perspectives; and
- a focus on matters that are central to their lives as citizens.
These approaches inform citizens about complex policy issues, and through deliberation foster shared understandings and agreements that can feed into public policy decisions.
This approach differs markedly from classic market research surveys. Rather than producing a representative, statistically robust analysis, such approaches offer institutions with in-depth understanding of a representative, randomly selected, public’s views, and specific recommendations for action.
In other words, a defining feature of all deliberative democratic models is a focus on sustained, in-depth, engagement with a public. In many cases deliberations take place over two to five days, but in some cases, it can involve up to thirty days of deliberation.
This appreciation of the time required to develop good judgements and recommendations is a distinctive characteristic of these innovations, situating them halfway between quick market research and one-off consultation events on the one hand, and the long-term commitment required by an elected representative on a council or committee.
And, crucially, this time investment enables participants to become informed about a complex question; to learn about the issues, about the perspectives of others, and about factors which shape and constrain decision-making. It also offers participants the opportunity to fully express their own opinions and beliefs, including attention to the expression of ‘un-heard’ and minority views that are often unexpressed, unacknowledged, or misunderstood.
What are the benefits of deliberation?
We believe this focus on learning offers unique benefits and is ideally suited to engaging with pension fund members on the question of ESG investment. Not only do many members start with low levels of financial and pensions literacy, ESG and sustainability issues create complexity by layering ethical norms and societal issues on top of – already complex – financial considerations. And then there is the need for clarity on the expected real-world impacts of investing that are often hard to establish objectively or to attribute to individual investors.
In the face of these challenges, achieving greater understanding of these issues with pension beneficiaries is essential to ensuring ESG investment is governed effectively, and with transparency.
And by facilitating the expression of opinions, deliberative democratic innovations enable participants to consider not only their own individual position, but also the positions of others, as well as areas where they share common ground. Rather than focusing solely on eliciting individual preferences, these collective processes seek to achieve a degree of convergence – where diverse opinions and concerns can be brought together into areas of mutual agreement.
With good facilitation, eventually this leads to the formulation of collective recommendations. In contrast to classic market research, we believe these approaches are well suited to collective investment institutions where fiduciary duties require governance decision-making to be in the interests of the membership as a whole.
All well and good, but does it work in practice?
Deliberative experiments in public governance have flourished in recent years, providing insight on the potential for the institutionalisation of deliberative democratic ideals. Participedia offers plentiful examples of the breadth of models instigated across the globe, addressing a host of different, complex public policy questions.
On pensions issues, varied models – such as citizens' assemblies, along with participatory and representative models – have already been established to address wicked questions around state pension systems. The Arizona Citizens’ Initiative Review (CIR) on Pensions Reform, the National Deliberative Poll in Chile, and the Mini-Public on National Pensions Debate in the UK are just three examples.
Easy when you know how
While these deliberative forums offer a beguiling alternative to standard forms of market research and consultation, achieving its goals in practice is no simple matter. In practice, social and economic inequalities underscore asymmetries in power, which inevitably find their way into communications between individuals and among groups. Deliberative approaches can’t remove these, but practitioners can minimise their impact by designing recruitment procedures that ensure a representative group and not only the ‘usual suspects’ – citizens with the time, skills and capacity to be engaged in their community.
Another technique is utilising skilled facilitators to ensure the equal participation of every individual involved, contributing to the realisation of higher-quality deliberations. And at a broader level, ensuring the design, process and outputs and influence of these forums are publicly accessible enhances their accountability and legitimacy to the wider membership.
So what are the takeaways for pension funds?
The widespread use of models such as citizens' assemblies in the public sector has greatly improved our understanding of how these models can work in practice, and under what conditions they realise good outcomes. Pension funds can tap into these learnings to understand the value of these innovations, and their relevance for informing pension fund decision-making.
This approach to engaging with citizens also offers two easy takeaways for pension funds who wish to improve their governance of ESG investing.
1. Address knowledge gaps
First of all, models such as citizens' assemblies illustrate the value of addressing knowledge gaps in governance. Pension funds should consider how they are informing and engaging members on the question of ESG investing. If they are using surveys, are they considering what questions are reasonable to ask members in a ‘top of mind’, 10-minute survey? Pension funds should think carefully about how much, and what type, of information respondents need to effectively grapple with survey questions. They also should consider the thorny issue of bias: how is this risk taken seriously, and addressed? Does the survey address potential trade-offs directly or are they brushed under the “win-win” carpet? Finally, if members indicate they wish to know more, are they offered the opportunity to access further information about this issue?
2. Ensure representation and deliberation
Second, the learnings from citizen assemblies illustrate the added value of truly representative governance bodies – with not only socio-economic or demographic representation, but with representation of diverse viewpoints. In addition, they illustrate the added value that deliberating issues can have, where beneficiaries provide input to pension funds based on debate with other beneficiaries and informed by subject matter experts. Pension funds should seek to realize similar high-quality deliberations, drawing in diverse perspectives, to enhance decision-making on ESG investing.
In some countries, pension funds already have governance bodies that represent members, such as member councils. As an easy starting point, pension fund boards should assess how these governance bodies can be used more effectively, first, to inform members on ESG investing and thereby close potential knowledge gaps, and second, to gain their considered feedback.
Pension funds have been at the forefront of the shift to ESG investing in the last twenty years. However, we believe there hasn’t been enough effort to engage with their members on the complex issues this entails, including hard-to-pin-down preferences, ethical values, and potential trade-offs.
We argue that the pensions sector should be inspired by how deliberative democratic thinking has re-energised public governance – through pioneering models such as citizens' assemblies. These models, with their emphasis on the need for democratic representation, and the quality of deliberation, show how the governance of ESG investing can better reflect member preferences.
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