Pension Funds and Fiduciary Duty
Whenever investors pool their resources together in order to create a fund that then invests in other assets, the concept of fiduciary duty comes into play. The average investor considers fiduciary duty to be a complex legal subject and hence tries to avoid delving into the details. However, the subject is not very complex. Also, fiduciary duties of pension funds are at the center of another debate. It is commonly believed that pension funds cannot direct large amounts of money towards socially responsible investments because their fiduciary duties restrict them from doing so.
In this article, we will understand the concept of fiduciary duty. We will also understand how it applies to pension funds and why some experts claim that it restricts the type of investments that a pension fund can possibly make.
Meaning of Fiduciary Duty?
The word fiduciary relates to the ethics which govern the actions of people who are in a relationship based on trust. The basic premise is that people spend their own money very carefully. However, when you put them in charge of someone elses money, they become extremely callous and imprudent. Therefore, the concept of fiduciary duty binds the pension fund to act in the best financial interests of its client. The pension fund is known as the fiduciary in such a relationship whereas the investors are known as the beneficiary.
What are Some Fiduciary Duties of Pension Funds?
Now, since we know the meaning of the word fiduciary, it is also important to understand the set of duties which are referred to as fiduciary duties. The list of duties can be quite long and can differ based on the situation as well as the type of investors. However, the guiding principles remain constant. The details of these guiding principles have been listed below:
How Does Fiduciary Duty Interfere with Pension Fund Investments?
For pension funds, fiduciary duty is defined as financial prudence. Hence, pension funds are not allowed to take non-financial factors into play while making investment decisions. For instance, if pension funds have to make an investment in either a weapons manufacturing company or a renewable power company, their decision has to be driven purely by financial considerations.
Pension funds do want to make socially responsible investments. However, till now, there is no wide consensus on what constitutes a socially responsible investment.
There are some crude mechanisms that the pension funds have devised in order to help them define what socially responsible investments are. The details of these methods have been mentioned below:
The entire fiduciary duty conundrum is based on a simple problem. The essence of the issue is that since we cannot clearly communicate to pension funds what socially responsible investments are, we should not be evaluating their performance on the same basis. Some method has to be created by which investors can periodically specify their preferences to the pension funds. Once pension funds have the required information, we can expect them to include the same in their decision-making.
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