In determining the investment policy of the fund, I considered whether the policy should be strictly commercial or whether it should be qualified by ethical, environmental and other public policy criteria. A major difficulty in deciding on an ethical investment policy is where to draw the line, given there will be different opinions and intense debate on what constitutes ethical and socially responsible investments. In short, there is unlikely to be broad consensus on any ethical investment policy.
Furthermore, the list of what might be considered as unacceptable investments is likely to continually change in light of developments in the political, social and scientific spheres. If one was to attempt to delineate appropriate investments for the fund there is a great danger of dragging the commission into a quagmire of public controversy and paralysing the fund's investment procedures.
Notwithstanding these considerations, I examined a number of approaches which might be taken to implement an ethical investment policy. One could copy the UK precedent whereby from July of this year the annual report of pension funds will have to contain a statement of the approach to ethical investments adopted by a fund. There will be no requirement on funds to invest in this manner but merely to state their policy.
A fund can use its voting rights to put pressure on companies to pursue ethical policies. It appears this approach can be accommodated within a commercial mandate, though its effectiveness is somewhat debatable, particularly as the shareholding in a fund of any one company will be relatively small. Some funds put aside a small portion of their assets into a separate fund which is invested according to ethical criteria. The drawback with this approach is that it is largely tokenism with the majority of the fund being invested in the normal manner.
Screening is an approach being used by some funds. This involves hiring analysts to examine all companies on an index. The analysts identify those companies with assets of the class to which the investor objects or, alternatively, companies adopting best practice. Having done so, the investment managers of the fund in question are given the target of beating the adjusted index, that is the index excluding the forbidden sectors or companies by a set percentage.
However, there are a number of drawbacks to this approach. For example, major costs are involved in hiring analysts and tracking the performance of the adjusted index. These costs would be multiplied for a large fund where a number of indices will be tracked. In addition, as the list of forbidden investments lengthens, there will be an increased risk of the portfolio becoming less diversified.
There would also be other operational difficulties. For example, with a customised portfolio it would not be possible to use equity futures to hedge against market exposure as such futures contracts are linked to broad market indices. In addition, there would be less opportunity to undertake crossing transactions whereby equities are traded directly with other funds, thereby cutting out brokers and reducing fees.
Clearly there would be significant difficulties in incorporating an ethical policy into the investment mandate, no matter what approach is taken in pursuing such a policy. Accordingly, the investment mandate included in the legislation is modelled on the standard commercial mandate for private pension funds, namely, maximise returns subject to prudent risk management. Indeed, any explicit reference to ethical investment would politicise the investment mandate and would give rise to significant difficulties both in its interpretation and in its implementation. I cannot, therefore, accept the amendment.