I was giving evidence to the Scottish Parliament Local Government Committee this morning on the use of pension funds for infrastructure investment. The Scottish Local Government Pension Scheme has some £26bn to invest. Half of this is invested in overseas equities, investment that comes with significant and often hidden management costs that are poorly understood.
In 2013 I wrote a report With assistance from the SFHA on the use of pension funds to build houses and there has been some take up of the idea in Scotland and the rest of the UK. I argued today that the same principle could apply to other forms of infrastructure investment including transport and energy generation. The best investments are those that have a low risk revenue stream.
I was asked what are the barriers to greater infrastructure investment?
The first is a small 'c' conservatism in pension funds generally. Managers prefer to invest in what they understand and don't like change. This is closely linked to a lack of expertise. They understand equities and commercial property, they don't have much experience in housing or infrastructure generally. If there is a will, there is a simple solution - recruit the in-house expertise.
Another barrier is the claimed impact of fiduciary duty. Again there is a conservative interpretation of the legal position that is holding back infrastructure investment and results in pension funds investing in wholly inappropriate and unethical investments for a public body. Our funds invest in tobacco, arms and fossil fuel companies. The LGA recently commissioned counsel opinion on this issue and this quote sums up the position well:
"the precise choice of investment may be influenced by wider social, ethical or environmental considerations, so long as that does not risk material financial detriment to the fund."
It is perfectly possible to invest in infrastructure and ethical investment within this framework and pension funds across the UK are doing this better than many Scottish local government funds. The risks involved in some of these unethical investments are not sufficiently well understood. Funds are also weak on shareholder engagement and they could use that leverage to promote trade union, government and council policies more effectively.
Another barrier is the investment regulations. I argued today that they are over prescriptive, specifying limits to specific forms of investment. A better approach might be to have a broad duty and a code of practice.
That leaves how our funds are structured. We have eleven funds in Scotland and that leads to duplication of cost and little sharing of expertise. Bigger funds are generally more effective in securing better returns on investment and would enable funds to develop greater in-house expertise. It doesn't necessarily have to mean merger, but we can and should collaborate much more.
This month sees the start of new governance arrangements for the Scottish LGPS. The new Scheme Advisory Board meets for the first time tomorrow and these issues are in the draft work plan. We also have representatives appointed to the new Pension Boards in each of the eleven funds. It will take time, but this should lead to much greater transparency and challenge to vested interests.
Pension funds are a hugely important and under used resourced in Scotland. The new governance arrangements are an opportunity to move in a new direction. But we will need to work hard to break down entrenched positions. Today's parliamentary scrutiny is helpful in moving this along