Source: www.ft.com

By Donald MacDonald

The reported 20 per cent decline in the value of pension fund assets in OECD countries in the first 10 months of last year has meant the current round of pension fund valuations is unlikely to bring much cheer to pension beneficiaries or their sponsors.

Those numbers are a powerful reminder to all institutional investors that decisive action is needed to protect our investments over the long-term.

So perhaps this is an appropriate occasion to consider how this crisis might change investor behaviour in the months and years to come. Will the behaviour of pension funds (particularly larger ones) better match the fact that their long-term horizons for liabilities and investments and diversified portfolios give them a direct and genuine fiduciary interest in the long-term economic health and wellbeing of the world?

To rebuild trust and confidence within financial markets, investors need fundamental improvements in risk management and transparency. To help achieve those goals, some suggest a commitment to active ownership must surely be at the heart of any successful long-term response from institutional investors.

That is why the global asset owners who sit on the board of the UN-backed Principles for Responsible Investment (PRI) are issuing a statement today asking fellow institutional investors to acknowledge, as owners and clients of many of the institutions involved, some responsibility for the behaviours that led to the crisis and to work together to respond to it.

There are four priorities for action from institutional investors and our agents.

The first is to acknowledge how a flawed understanding of some complicated financial instruments put not only our immediate investments at risk, but also the wider global economy.

To remedy this, institutional investors need to exercise proper due diligence of the investment chain and enhance our capacity to research, understand and address the full range of risks and opportunities.

This range includes environmental, social and corporate governance (ESG) issues, which can be material to the interests of beneficiaries and clients, and a thorough assessment of counterparty risk.

The accumulation of toxic assets, and unsustainable risk-taking, lay at the epicentre of this financial earthquake and these are the sorts of issues a more holistic approach to investment research should detect.

We should also consider how to encourage the fund managers, asset consultants, brokers and research providers they work with to ensure those agencies can also address ESG issues.

The second priority for investors is to consistently monitor companies and ensure risks are managed properly.

Collectively, we need to put greater resources into shareholder engagements.

More active ownership enhances accountability and should reduce the need for one-size-fits-all regulatory responses. There is no doubt that properly managed regulation, both hard and soft, with proper oversight, will be an important part of building well-functioning markets. However, regulation alone is not enough. Investors must take it upon themselves to ensure assets are managed in the best interests of end beneficiaries and clients. Where investors are restricted from exercising such shareholder rights they should engage actively with governments and market authorities.

The third priority is to tackle the lack of transparency that was such a major contributor to the severity of the crisis. As active owners, investors should work with investee companies to ensure comprehensive and systematic disclosure of the information they need in order to make responsible investment decisions. Ensuring the disclosure of information on ESG and other issues will enhance investors’ understanding of their underlying investments and avoid a repeat of recent mistakes.

When it comes to transparency investors must also practice what they preach. We should publicly disclose the measures we are taking to respond to the crisis and our responsible investment activities in general.

Finally, if we are to address the problems facing the economy then investors must adopt a collaborative approach. Many of the problems, particularly around systemic issues, are too great for any investor to tackle on their own.

That is an ambitious agenda. However many institutional investors are already responding to the crisis using the Principles for Responsible Investment Initiative as a robust framework for action.

I invite all institutional investors to consider becoming signatories to the PRI and join a global network of peers working to address these priorities.

Donald MacDonald is chair of the UN-backed Principles for Responsible Investment Initiative. www.unpri.org