What if pension funds grabbed the reins?

Munger suggested that pension fund assets could be used to capitalize a state-owned bank, along the model of the Bank of North Dakota. The same idea, he said, could be applied to union pension funds that wish to capitalize a union-owned bank or credit union.

“We’ve [traditionally] defined the mission of pension funds very narrowly, simply in terms of safeguarding the money for retirees and, hopefully, getting some kind of investment return to add to the fund” he said. “Those things are certainly important, but I think there’s a lot of room to consider more nuanced and multi-dimensional missions.”

What stands in the way?

A variety of cultural, legal and political obstacles would need to be overcome before large American pension funds could internalize more of their asset management and increase their direct investment, experts said.

John Conley is a law professor at the University of North Carolina. In 1992, he co-authored a book with William O’Barr, a professor of anthropology at Duke University, called Fortune and Folly: The Wealth and Power of Institutional Investing, an anthropological study of how and why public and private pension funds in the United States make investment decisions.

“The primary finding of the book was how un-financial the whole process was,” Conley said. “Decisions were not being made on the basis of any kind of rigorous quantitative criteria. They were being made on the basis of relationships with the money managers, who were just there to sell them stuff.”

The book resulted in calls for the sponsors of pension funds to appoint people to their boards with at least a modicum of investment experience, or to provide financial training to the current trustees. But Conley said that lack of investment expertise was only one reason that trustees preferred to rely on private money managers.

The other reason was that it allowed them to shield themselves from accountability for their investment decisions, he said. “A lot of the people on these boards are union representatives or political appointees, and if a deal goes south or the fund doesn’t do very well, they don’t want to be blamed for it. But if they hire people to do it for them, they can say, ‘Look, I hired these expensive and reputable managers that everyone else was hiring, so you can’t blame me.’”

Conley said that this culture results in a kind of “herd behavior,” in which pension funds are reluctant to do anything that they have not seen their peers doing first, but are quick to “jump on the bandwagon” when another fund changes their practices. “From what I have observed, it seem that is even more true today than it was when we wrote the book,” he said.

One reason that the Canadian funds have been able to adopt a different management structure is that their investment managers operate at a level that is more removed from their boards of trustees and government sponsors than American public funds, Lemoureaux said. “We were given a degree of freedom, but at the same time, we knew that if we did not perform well, we would be completely accountable for it,” he said. “If we made a few bad decisions in a row, we were going to be out of a job.”

The paradox of fiduciary duty

Pension fund trustees are bound by “fiduciary duty,” a legal relationship that binds them to act in the best interests of those whose money they are managing. For private pension plans in the United States, fiduciary duty is codified in the Employee Retirement Income Security Act (ERISA), while for public pension funds, each state has its own set of laws defining fiduciary duty.

According to David Wood of Harvard, fiduciary duty in the United States has generally been interpreted very narrowly. On both a formal and informal level, the exercise of fiduciary responsibility — “prudent investing” — is most frequently associated with a heavy emphasis on maximizing returns through conventional, short- and medium-term investments.

Ron Davis, an associate professor of law at the University of British Columbia and the author of Democratizing Pension Funds: Corporate Governance and Accountability, explained that a narrow interpretation of what can be considered “prudent” — in addition to political pressure on funds to maximize their investment returns — has limited the willingness of large funds in the United States to make longer-term investments that take many years to realize a gain, or may yield slightly lower returns, even if the investments were low-risk and could easily be characterized as prudent. Funds compare their returns with the returns of other funds in their peer group, which can make them less likely to initiate deals that would include even a small amount of long-term risk.

“If they don’t see the other funds doing it, then they are much less likely to consider those kinds of investments,” Davis said. “The safest position for a fiduciary is to put on a lamb’s coat and walk around bah-ing like all the other sheep.”

The hurdles posed by fiduciary duty are even larger when it comes to investment decisions that consider factors besides risk and maximizing return. Some pension funds have made modest efforts to engage in socially responsible investing, in-state investing, and shareholder activism, but they are constrained by the fear that the employees and pensioners covered by the fund might sue them for failing to produce the highest possible returns, Davis said.

“Anything that would be perceived as mission investing would be seen as a clear breach of fiduciary duty,” Davis said. “Fiduciary duty is critical because it has been interpreted as being extremely restrictive.”