A lot of things have happened in the pensions world since I wrote Pension Revolution in 2007, some foreseen, some not. I decided last April that the time was right for an update that would thoroughly review and recalibrate the challenges facing the global pensions sector, viewed through the triple lenses of plan design, governance, and investing. And so the idea of The Future of Pension Management: Integrating Design, Governance, and Investing was born. As the subtitle indicates, the new book calls for action on three fronts.
On the pension design front, the traditional DB (defined benefit) and DC (defined contribution) formulas are converging into hybrids with names such a ‘Defined Ambition’ (DA) and ‘Target Benefit’ (TB). The Netherlands and Australia offer good examples. The former country is transforming its traditional DB plans into DA plans, while the latter is transforming its traditional DC plans into TB plans. At the same time, workplace pension coverage is expanding. The United Kingdom is leading the way with its National Employment Savings Trust (NEST) initiative, while the United States and Canada are now busy designing their own expansion initiatives.
On the pension governance front, the process of reconciling the opposable needs for boards of trustees to be both representative and strategic continues to slowly move in the right direction. There is a growing understanding that it is not a question of ‘either-or’, but of how to get both ingredients into board composition. Why both? Because pension boards need ‘legitimacy’ to be trusted, and at the same time, need to be strategic to produce ‘value for money’ outcomes for their stakeholders. This strategic mindset addresses tough issues such as organization design and culture, investment beliefs, incentives, and stakeholder communication and relations. Behind these governance imperatives lies the broader question of organizational autonomy. Unnecessary legal and regulatory constraints are increasingly seen as ‘value for money’ destroyers in pension organisations.
Pension investing has been changing for the better too, starting with serious re-examinations of investment beliefs. There is growing evidence the leadership of the global pensions sector is beginning to see their job as transforming retirement savings into wealth-producing capital. There are a number of factors at play here. One is the simple reality that good investment returns are increasingly difficult to come by. Another is a growing understanding of the zero-sum nature of short-horizon active management. Yet another is that both logic and empirical evidence support the idea that long-horizon active management should, and actually does, produce higher long-term returns than either short-horizon active, or passive management. However, saying is one thing, doing another. For many pension organizations, there is still a sizable aspiration and implementation gap to be closed.
Five ‘unreasonable’ men
Taken together, these developments add up to significant advances in the ‘pension revolution’ since 2007, and are worthy of being chronicled in a coherent, integrated manner. I took comfort in knowing that I would not be doing this alone. Much of the necessary insight and inspiration to write this book would come from five ‘unreasonable’ men as defined by the Anglo-Irish playwright George Bernard Shaw in his 1903 play Man and Superman:
“The reasonable man adapts himself to the world. The unreasonable one persists in trying to adapt the world to himself. Thus all progress depends on the unreasonable man …”
Jan Tinbergen established the principle that the number of economic policy goals has to be matched by an equal number of instruments designed to achieve them. In pensions, this offers a solution to the ‘affordability vs. safety’ dilemma in pension design. Achieving two goals requires two instruments: one that focuses on affordability through long-term return compounding, and another that focuses providing payment safety for life. Yet, ‘reasonable’ people persist in beating their heads against the wall trying to achieve these two goals with one instrument. Some ‘reasonable’ people say that the ‘right’ instrument is a DB plan; others say it is a DC plan. Both are equally wrong.
Peter Drucker asserted that pension organizations are not exempt from universal governance effectiveness dictates. Ineffective governance will produce poor outcomes for the pension organization’s stakeholders. Effective pension organizations have clear missions, inspired governance, and great execution capabilities.
John Maynard Keynes makes a clear distinction between the dysfunctional short-term ‘beauty contest’ investing practices of most institutional investors, and long-term investment processes that convert savings into wealth-producing capital. ‘Beauty contest’ investing is a zero-sum game played for the enjoyment of professional investors, funded by the fees paid by their clients. It has little to do with ‘real world’ wealth-creation.
George Akerlof’s ‘asymmetric information’ insight figures prominently in my thinking about the design of pensions systems and organizations. Fair pricing and efficient resource allocation require that all market participants have the same information when they buy or sell goods or services. This is not the case in the market for pension management services. As a result, unless steps are taken to level the informational playing field, buyers will pay too much for too little value.
Roger Martin’s work on integrative thinking and the creative resolution of opposable ideas also played an integral role in the structure and tone of the book. Logic tells us we lose a lot by being ‘silo’ rather than integrative thinkers. Connecting the dots between pension design, governance, and investing leads to more holistic thinking and more thoughtful solutions. On resolving apparently opposable ideas, three direct applications in the pensions space are: 1. The ‘DB vs. DC’ debate in pension design, 2. The ‘lay vs. expert’ debate in pension governance, and 3. The ‘active vs. passive’ debate in pension investing.
Launching in Australia
Many more people (and not just men!) have contributed to the book. Its first official launch just occurred at the University of Toronto, and launch action now moves on to Cambridge University, London, Amsterdam, Washington, Ottawa, Montreal, Boston, Hong Kong, Singapore, Sydney, and Gold Coast over the course of the rest of the year. For more about the about the book and the launch schedule, go to http://kpa-advisory.com/books/the-future-of-pension-management/
Keith Ambachtsheer is among the world’s leading pension authorities and was named as one of the ’10 Most Influential Academics in Institutional Investing’. He is Adjunct Professor and Founder at the International Centre for Pension Management based at the Rotman School of Management at the University of Toronto.