What if pension funds grabbed the reins?
Those factors create investment opportunities that are not available to many other types of investors. If a manager makes investments from the point of view of trying to help a private company maximize its own returns over a relatively short investment horizon, that manager can often miss investments that require either more initiative or a longer-term perspective, Lemoureaux said. “There are dozens of opportunities that we would have lost if we hadn’t had people with the expertise looking for them.” (See sidebar titled “Easy marks?”)
Beyond returns
Advocates of socially responsible investing, mission investing, and shareholder activism have taken notice of the Canadian model, as well. Though most of the Canadian funds have an “investment only” mandate that precludes them from considering any factors aside from risk and return, many see the more direct and active role being played by these funds as more conducive to investing with those other considerations in mind, which are often shunned by outside managers.
Easy marks?
Since the trustees of many American pension funds, especially public funds, do not have financial expertise, private companies are sometimes able to manipulate them into making investments that are actually against their interests, said Keith Ambachtsheer, the president of KPA Advisory Services, which consults for pension funds on management issues.
“There is a fundamental asymmetry of information in that relationship,” he said. “A lot of these experts have their own financial interests, and the people running the pension funds are not equipped to separate those interests from the goals of the fund.”
One private equity executive, who declined to be named, said that pension funds are essentially treated the same way as other investors, except that, in many cases, it is understood that they are less knowledgeable. “It’s kind of acknowledged that they are not going to be the smartest guys in the room,” he said.
David Wood, the director of the Initiative for Responsible Investment at Harvard University, said that because of the potential market power of pension funds, empowering them to become more active social investors could make a huge impact. “They should be able to powerfully dictate how they act in the market,” he said, “but that has not been the case so far.”
Wood said that the layer of mediation created by the reliance on outside managers, who sometimes have conflicting interests, means that pension funds effectively have less agency over their investments. “How can we help them be more like market makers and less like price takers?” he said. Simply eliminating that layer of mediation “is probably the easiest way.”
Keith Ambachtsheer, the president of KPA advisory services and a professor of finance at the University of Toronto, agreed. “Right now, the outside tells the inside what to do,” he said. “It’s only when you build the inside strong can you tell the outside what to do, and that’s always the best way to further your mission.”
Because of their size, Ambachtsheer said, if pension funds were to think more broadly about their mission and make investments geared to creating long-term value, it could lead to more stable and sustainable financial markets.
The short-term investment horizon of many private money managers increases the likelihood that they will favor complex financial products, or methods like “flash trading,” that do not add value to the economy over the long term — what Ambachtsheer, following John Maynard Keynes, called “beauty contest investing.”
Others said that having more control over their investments could allow pension funds to put their assets to more specific uses, such as providing capital for green energy, or focusing investment on economically depressed areas.
According to Edward Waitzer, a partner at the law firm Stikeman Elliot and an expert on pension fund governance, making large, direct investments in companies allows the funds to have more control of the companies and exert influence over their policies. “When you have internalized management, then once you decide to do something, you can do it faster and more effectively,” he said.
And though there are some legal limitations on what pension funds can do with their money, some have suggested that a type of investment known as “mission investing” — normally reserved for investors like philanthropists and foundations — would be appropriate for pension funds, as well.
For example, Sam Munger, the managing director of the Center for State Innovation, a think tank based in Wisconsin, said that, for union pension funds, reliance on external managers can make it more difficult to make labor-friendly investments, such as investing in businesses that hire only union workers.
Munger has also advocated for public pension funds to invest in ways that would provide benefits to the residents of their state. Some funds already apportion assets for in-state investments, but Munger urged trustees to think more broadly. “The people running the pension funds are not generally known as the most creative people,” he said.