What if pension funds grabbed the reins?

Additionally, public pension funds are also subject to state laws that can restrict their investment decisions further, and make it more difficult for them to hire skilled investment managers. In California, for example, a hiring freeze on public employees would apply to the pension funds, and state law mandates that a representative of the pension fund is not able to sit on the board of a company that the fund has invested in.

Finally, there are political obstacles. Joseph Dear, the Chief Investment Officer of the California Public Employees Retirement System, has said that he does not believe that voters would permit a public employee to make the kind of salary that it would require to attract and retain the quality of investment managers that would make developing an in-house team possible, even though public funds are likely paying more to outside managers, an arrangement Ambachtsheer characterized as “more than a little ironic.”

Not set in stone

Though the cultural, legal and political obstacles to releasing the power of pension funds are formidable, experts argued that none of them was inherently insurmountable.

“If the governance were changed” — to allow the funds more flexibility and independence — “and we changed our understanding of fiduciary duty,” Waitzer said, “these funds could become very formidable in several ways,” including flexing their muscle to initiate longer-term deals and to consider social responsibility and shareholder activism.

Waitzer said that the narrow interpretation of fiduciary duty was likely the most difficult obstacle to broadening the mission of pension funds, but even here, he said, there exist possibilities for change. The concept of fiduciary duty, he said, “is incredibly dynamic. Our understanding of what it means to be a fiduciary, what factors they can consider, has evolved significantly over the years. It is certainly not set in stone.”

Indeed, the labor departments of different presidential administrations have frequently issued “interpretive bulletins” that explain how the administration will be interpreting the fiduciary duty of the trustees of private pension funds. The Clinton Administration issued a bulletin that specifically allowed funds to engage in “economically targeted investment,” or investment that is still considered prudent but that is targeted to a particular end, such as community development. The latest interpretive bulletin, issued by the Bush Administration, is significantly more restrictive.

In regards to public pension funds, states have also adopted a variety of laws that dictate how the funds may and may not invest their assets. Most state laws simply clarify whether the fund is permitted to target investment within the state itself, but some go further. For example, laws in Wyoming and North Carolina allow the state pension funds to “consider benefits created by an investment in addition to investment return” so long as “the investment providing these collateral benefits would be prudent without the collateral benefits.”

If the interpretation of fiduciary duty were broadened on a larger scale, Davis said, it could lessen the propensity for herd behavior among funds, and increase the likelihood that states would be willing to the give the funds a greater degree of autonomy.

“The potential is there for pension funds to play a much larger role,” Davis said. “I think we have been blinded to the possibilities that they offer.”