DCLG response to Law Commission paper on social investment

The DCLG slipped out an interim response to the Law Commission paper (274) on Pension Funds and Social Investment a couple of days before the Christmas break.  The recommendation is to accept the original paper’s recommendations to encourage pension schemes to place more emphasis on ESG considerations when investing, although DCLG will consult on some before enacting them.  While the LGPS is statutory rather than trust-based, legal opinion has previously made it clear that these changes will also apply to them. The most important new requirement is for pension schemes to ‘state their policies’ in relation to how they evaluate investment risks, including ESG considerations, in the long term (our italics).  While most funds will already be considering the financial risk to portfolios from climate change, there will now be a legal requirement to do so, or at least to state publicly if choosing not to.  The implications are wider than just climate change: it will become less easy for a company to pay its senior management disproportionately, for example. The second proposal is that pension schemes should say how they will consider and respond to members’ ethical or other concerns.  Again, a fund may choose to ignore them but will have to state publicly that it is doing so.  We expect most will find it easier to find a way to respond. If an administering authority wishes to make an investment or divest for ‘non-financial’ reasons, it will still have to pass the two tests set by the Law Commission: no significant financial detriment and that members share the concerns.  There is some interesting language on the latter point in the Law Commission paper:  if an authority does conduct some form of broader consultation - as opposed to, for example, simply asking the Local Pension Board - the bar to pass the test is not necessarily complete agreement. However, a court would consider a significant minority disagreeing sufficient to fail it. The administering authority would then have to make its investment decision on financial grounds only.  Apathy and lack of response need not be taken as disagreement. In practice, most LGPS funds seem to prefer engagement - through LAPFF or more directly - to divestment. However, at the margin, the legislation will perhaps make it clearer what is required in order to divest from, for example, fossil fuels and will make it harder for funds to ignore well-organised pressure groups.    ​

Upcoming events

Please find below a selection of upcoming events William will be attending:   6th February 2018 - HCIL Capital Markets Seminar - InfraRed Capital Partners, London 7th February 2018 - LAPF Strategic Investment Forum, London 1st March 2018 - 4th Global Independent Research Conference, London 13th March 2018 - Capital Group investment discussion dinner, London 15th March 2018 - SPS Local Authority Pension Fund Investment Issues, London  18th April 2018 - Janus Henderson 2018 Institutional Investor Conference, London       

Despite headlines about US bond yields, William Bourne, albeit reluctantly, is staying ‘risk on’​

Investors have begun 2018 much as 2017 ended – with a high appetite for risk (call that complacency if you will) and a willingness to ignore politics in the hunt for return of any kind.  Hence arises the conundrum we have regularly referred to – ie. that market volatility remains stubbornly low while political risk appears to be high.     Global liquidity at end December, as measured by our colleagues at CrossBorder, was 51 on a scale of 100.  This provides some justification since it is not at a level which predicts any kind of financial crisis.  However, when there is a consensus, one has to ask the question: what could possibly go wrong? Well, there are the obvious geo-political risks but they would have to be of a cataclysmic scale to burst investors’ complacency.  In the Linchpin view of the world, all market setbacks involve some form of financial crisis where one entity can’t pay its debts to another.  Think back to the UK in the 1970s, Latin America in the 1980s, Russia in 1998, Enron in 2002 or banks in 2008.  We can only see a few plausible candidates here, principally in the US and China. Today’s headlines feature a technical break of the US two year bond yield downward trendline, with comments that they are for, the first time in ten years, close to 2008 levels.  If this does signal an end of the bull market in bonds and a normalisation of the ‘price’ of money, that has the potential to impact investor complacency, simply because of the level of debt in the western economy.    Investors should also keep an eye on the US$ since cross-border flows out of the US are accelerating.  If currency weakness is gentle, investor confidence will probably be maintained; however a sudden lurch could be sufficient (as in 1987) to burst confidence, and lead to a further rise in bond yields and downward repricing of equities. China is another possible candidate, though the level of state control in the financial system means that any financial crisis would be the result of deliberate state intervention rather than market forces.  We are more optimistic about China than the consensus in the short term but are also aware that at some point the People’s Bank of China will need to turn off the monetary taps, as it did in 2015, to control excessive domestic credit growth.  This is not a 2018 story but if it is done in a clumsy way, so that there are major defaults, the domino effect may take over. All that said, despite the jitters in US bond markets, we are not predicting an imminent correction, simply because the gross level of cross-border flows remains healthy (currently 66 on a scale of 1 to 100) at the end of December.  It is when they turn sharply down that we should be afraid.  So we will be watching them closely in 2018 and until then will retain a reluctant ‘risk-on’ mindset. Information on how to purchase CrossBorder's research can be found here.​


At Linchpin we have for a number of years written an annual update on the long term outlook for inflation by monitoring shifts in a varied range of inflation indicators.  12 months ago, we suggested that after many years with deflation firmly in charge, the forces pulling each direction were roughly equal.  Today the consensus seems to have tipped towards inflation: we would agree that inflation is inevitably on the rise but argue that the global level will stay low for a few years yet.  Click here to read the full update.

William Bourne attends 22nd LAPF Annual Conference

On 6th to 8th December 2017, William attended the 22nd LAPF Annual Conference in Bournemouth.

Why the TOPIX index might finally make new highs after 25 years

Peter Tasker's article reflects on what is going right in Japan and why after 25 years the TOPIX index might finally break upwards through the 1800 barrier. At the very least, it should be food for thought for those who are still bearish on Japan's future.

Liquidity to ward off the bears in 2018?

The growling of bears seems to be growing louder, despite the fact that markets have so far been remarkably calm in the face of unsettling political news on a range of fronts.  I very much doubt we have seen the end of history, as Francis Fukuyama’s celebrated 1992 book postulated when liberal democracy seemed to win over all other political systems, but we have to ask why the bears have been wrong so far. The latest piece from our colleagues at CrossBorder starts off: ‘Does Global Liquidity Warn of a Bear Market in 2018?’  From a liquidity perspective, the answer is pretty clearly ‘no’.  At the end of November, global liquidity stood at 48, just below neutral.  They argue that the world is focusing too much on Developed Market central banks withdrawing liquidity and not sufficiently on what is going on in Emerging Markets, where liquidity is loose and the sums are - surprising though it may be - significantly larger.  The implication is that what’s going on in China, in particular, will be sufficient, at least for the time being, to stop the world catching a cold if America sneezes. In their experience, sharp and accelerating falls in cross border flows are also a valuable signpost to an impending market crisis.  The aggregate today stands at 58 (scale 0-100), compared to 88 six months ago but the trend is not speeding up, which should give investors some reassurance.   We see the US as late in its economic cycle, Europe as mid-cycle, and China and the Asian bloc as early cycle.  It can be seen most clearly in private sector liquidity flows, where Europe is strongest at 88 and the US weakest at 34.  This underpins our view that when economic trouble comes it is most likely to come out of the US.  But, unless history reasserts itself through a geo-political jolt, probably not in 2018.  We would advise investors to watch the upswing in China just as much as the downturn in the US. Information on how to purchase CrossBorder's research can be found here.​

Is divestment really the esg answer?

Responsible investing is taking up more and more of my time at the moment.  Don’t get me wrong:  long-term investing institutions wish, and should wish, to invest in sustainable businesses.  That makes it important to look at environmental, social and governance (“ESG”) considerations.    The difficult bit is what to do with companies which don’t tick all the boxes.  One option is simply to divest and exclude, which is what fossil fuel activists, as an example, promote.  (A small memo item here: the vast Norwegian sovereign wealth fund has chosen to divest from oil primarily for reasons of diversification, not for ESG reasons.)   Let us leave aside for the moment the important question of the fiduciary duty to act in the financial interest of the pension fund.  The problem with divestment is that i) any ability to influence the company’s behaviour is limited, ii) the company is owned by shareholders who may not care at all about sustainability  - look at Thames Water for an example.  Activists will respond by saying that leopards don’t change their spots and tobacco companies, for example, are never going to stop selling tobacco, so that doesn’t matter.  In my view, that is too harsh a view: even within ‘sin’ sectors, there is a huge variance in behaviours and companies change over time.  It is not sufficient to simply depict companies as good or bad. There is a growing number of ‘sustainable’ funds which exclude stocks which do not pass the relevant ESG criteria.  Their claim is they can deliver equivalent returns and I do not dispute that.  I prefer this approach to straight divestment, because it allows for companies to move back into the investment universe if they clean up their act.  However, this approach does not avert the problem that, without being a shareholder, engagement with the company can only be limited. The alternative approach focuses on engagement in some form.  There are pressure groups (for example LAPFF within the Local Government Pension Scheme) who are undoubtedly having some positive effects by targeting quoted companies.  The real challenge is to make the power of institutions’ passive holdings work when an institution cannot even threaten to sell its holdings.   Here the growth of ‘tilted’ passive strategies may help, because they send a signal to the target companies without necessarily divesting completely.  However, it should be noted that the cost of running a tilted strategy is several times higher than a traditional passive mandate.  It is not a cost-free strategy and nor will it keep the activists off an institution’s back. To learn more about Linchpin’s governance services please click here.