Rethinking fiduciary duty

Is it time to rethink our definition of fiduciary duty? Nobel Prize-winning economics professor Professor Oliver Hart recently called for pension managers to be freed from the ‘straitjacket’ of fiduciary duty in a comment piece for Pensions Expert.

It’s all too common to hear pension scheme fiduciaries lamenting their inability to incorporate broader ESG goals in their investment strategies because their purpose, as set out in the law, is to pursue the best possible investment returns, setting all else aside.

Does fiduciary duty already grant scheme decision-makers the discretion to consider wider factors? Or does the law need to change?

Julius Pursaill, investment adviser to master trust Cushon, believes that fiduciary duty is currently too narrowly interpreted – and our growing collective focus on climate change is creating inconsistencies.

Pursaill said: “Trustees are effectively forced to focus on financials - on optimising funds’ risk adjusted returns. But at the same time, TCFD imposes a non-financial, impact objective; portfolio decarbonisation is not the same thing as portfolio risk return optimization.”

He added: “Optimising member outcomes ought arguably to involve maximising the standard of living that members can secure with their retirement fund. It would be hugely helpful if trustees could take into account the state of the world into which their members will retire in their decision-making.” 

Pursaill questioned the logic of fiduciary duty as it stands, saying: “Currently trustees may feel fiduciary duty compels them to invest in particular way, that might perhaps deliver £1,000 a year in extra income, but which at the same time contributes to a world in which there is no effective social care, health care or access to green spaces.” 

Fiduciary duty 101

Before we consider whether fiduciary duty needs to change, let’s first remember the basics.

Fiduciary duty is made up of three limbs, said Stuart O’Brien, partner at law firm Sackers. “You’ve got to exercise the powers given to you as a trustee for the purpose for which they are intended. That’s called the proper purposes test.

“The second limb is when you are exercising those powers, you have discretion as to how they are exercised. In making a decision which is a discretionary decision, you have to take account of all factors that are relevant and put anything irrelevant aside.

“That means personal views of trustees have to be set aside, you have to look at what is a relevant factor in exercising your investment powers for the purpose of the trust, which is paying members’ pensions.

“The third limb is you have to act in accordance with a prudent person test. You can’t put it all on the fourth horse at Chepstow. You have to steward your assets as if you felt morally obliged to invest for your beneficiaries.”

Extending the duty

Nick Spencer, founder of Gordian Advice, points readers to the Institute and Faculty of Actuaries’ Emperor’s New Climate Scenarios report, which argues that the impact of climate change could be far more severe than current modelling indicates.

With that in mind, surely it would be prudent to factor climate change into investment strategies today.

Spencer said: “If you look at the context of the range of returns and set the context as you need to look at investor outcomes over the next 20-30 years, as a prudent person, at the very least, you would be looking to accelerate towards better outcomes and managing those risks.

O’Brien added: “If you ask most people, they’ll say, at the moment the law says that fiduciary duty is to maximise risk-adjusted returns. I am very strongly of the view that that is not the fiduciary duty and I think if you ask most pension lawyers who have looked at it in detail, they will say no, the duty is not to maximise risk-adjusted returns, that’s too simplistic.”

O’Brien added: “If it was that simple, you would struggle to do things like inflation-risk hedging because that might not give you a return at all. You might deplete your assets, but you’re doing it for a sensible objective, which is to hedge your interest and inflation rate risk.”

Clarification needed

The trouble is that not all trustees feel confident in considering climate change as a financial factor, experts agree. Nor do they feel comfortable taking a wider interpretation of fiduciary duty and considering how their scheme investments will benefit society.

With the government keen to bolster UK private equity with pension scheme money, PE hears that the government is looking at whether the law needs to change – or greater clarification be given to trustees.

Most experts are of the view that a written clarification, rather than a wholesale re-write, is needed, to reassure trustees. O’Brien said: “We don’t need to change the core dynamics. But perhaps we need to be more broad minded when we think about what we consider a relevant factor.”