Can pension funds make the world a better place?

In November 2023, pension funds ABP, BpfBouw, and Bouwinvest announced a joint investment of €400 million in rental and care homes to address the housing shortage of the Netherlands. This serves as a good example of pension funds aiming to improve the world while achieving reasonable financial returns.

The trend of pension funds pursuing both financial and societal positive returns extends beyond the Netherlands. In countries like Sweden, Switzerland, and even the United States, I’ve encountered pension funds that seek to make a difference with their invested capital.

Why do pension funds want to make the world a better place? Is it a good idea, and what challenges do they face?

Why do pension funds want to make the world a better place? 

Societies face significant transition challenges, including climate change, declining biodiversity, and increasing inequality. These issues put livability at risk. Consequently, investments in solutions - products and processes that don’t harm the environment or society - are crucial. Ideally, we achieve a just transition to a society and economy within planetary boundaries.

For pension funds, this matters because a world that is unlivable won’t allow for a good retirement. Therefore, it makes sense to pursue not only financial goals but also long-term broad value, with financial value being just one component.

Objection 1: Isn’t this the government’s role? 

While broad value is a commendable goal, there are at least two objections. First, some argue that governments should solve the mentioned problems directly. They can limit harmful processes, shift taxes from labor to emissions, and encourage green investments. Private players then respond to these incentives.

According to this perspective, pension funds should focus solely on their core task. To paraphrase Milton Friedman, “the business of pensions is pensions.” However, this reasoning assumes that governments fully shoulder their responsibility and execute all the mentioned tasks effectively. Unfortunately, that’s not the case, and we shouldn’t expect it to change rapidly. We’re dealing with turbulent transition processes where various factors and actors lead to unpredictable outcomes. The responsibility extends far beyond the (imperfect) government.

Pension funds possess the capital, influence, and responsibility to play a role here. Yet, they haven’t fully realized their potential. While ESG (Environmental, Social, and Governance) processes are widespread, they primarily manage financial risks. Regarding societal outcomes, they don’t make a significant impact.

Objection 2: Be cautious about financial returns 

Another objection is that pension funds would jeopardize their financial obligations by focusing on broader value or other goals. However, the opposite is true. Purely financial steering is problematic because it leads to shortsightedness and neglects anything not immediately financially relevant. This undermines long-term financial success.

Organizations with a broad perspective on value outperform purely financially oriented ones. On average, they have longer lifespans, grow faster, and achieve higher profits. Companies with a negative societal impact also face financial risks that conventional models barely consider. A narrow financial focus is therefore imprudent.

Yet, we must take this objection seriously because investing remains a balancing act. First, societal goals can lead to portfolios with unintended and unnecessary risks. Second, there are forms of impact investing with unfavorable risk-return profiles. Institutional investors should engage in such investments only if 1) they are small and 2) strong societal returns accompany them. In summary, steering toward broad value is advisable, but vigilance is required, and practical challenges exist.

Challenges 

The main challenges lie in data and mental models. With the currently reported data, we cannot adequately measure environmental and (especially) social value. Knowing the results and being accountable requires addressing this data gap. However, the data problem is overstated: data quality continues to improve, and in the absence of data, estimates can take us far. Lack of data seems more like an excuse for inaction.

The greatest challenge isn’t data—it’s mental models. People are accustomed to certain ways of thinking and working that are hard to change. Yet, change is necessary because steering toward broad value demands a wider perspective:

• Considering both returns and risks.
• Not just financial aspects but also social and ecological dimensions.
• Understanding the interconnections between these forms of returns and risks.
• Looking forward, not just backward, to account for transitions.

Enormous opportunities 

Transitioning to value-based steering isn’t easy and takes time, but it’s achievable. Dutch pension funds, with their €1.5 trillion in assets, have enormous opportunities for capital allocation. While this capital ultimately belongs to participants, taking the allocative function seriously is crucial. The question isn’t whether we should invest with an eye on broad value but how. I’ll delve deeper into this topic in my upcoming blogs.

This blog is the first in a series on pension investments. You can also read Blog 2, Blog 3, and Blog 4.

My other series focuses on CFOs and value creation within enterprises. Feedback is welcome: w.schramade@nyenrode.nl.