Frank Jan de Graaf writes: Most leading economists - including Ben Bernanke, chairman of the US Central Bank - believe that money creation can solve budget deficits by increasing liquidity. I think this works only in the short term. In the long term, loss of solvency is the real risk because it can lead to loss of trust: investors are afraid they will not get their money back. This in turn increases the risk of stagnation, inflation, and ultimately, economic downturn. Money creation merely fuels debt addiction, adding to the risk of insolvency.
Pension funds and their beneficiaries are at risk from inflation as a result of printing money (even though I recognise that interest rates need not necessarily follow). They cannot afford to be passive market participants and must seek to influence the way markets operate.
Pension funds own the majority of assets under management. Given their market position and interest in the durable stability of financial markets, pension schemes are ill advised to follow mainstream economic reasoning. They should adopt pro-active investment strategies supporting long-term solvency.
I recommend two principles:
- 1: A shift away from short-term returns towards long-term economic relationships should be at the heart of pension fund investments. Turnover of most actively managed portfolios is less than a year. This can be costly, and prevents a long-term perspective. Longer holding periods and long-term relationships with companies could have many benefits, such as better governance and better risk management.
- 2: Pension funds should consider the interdependency between investors, governments, companies and, ultimately, the wider economy and society. This could mean investing in climate change mitigation and adaptation (e.g. via climate bonds) or in sovereign debt of the fund’s home country to help address budget deficits, which in turn is good for markets and market participants.
To achieve this, radical reform is required. Pension funds mostly delegate asset management to investment managers and banks. This leads to agency problems and inadequate alignment of interests. Taking decisions on policy and strategy in-house can remove this inefficiency.
In summary, those with direct fiduciary duty towards pension fund members should take active responsibility for the development of investment strategies in line with the two principles above. The first step is to agree that we should be doing this. The "how" will then follow naturally.
Dr. Frank Jan de Graaf is professor International Business at the Hanze University of Applied Sciences and lecturing in the executive education program of the Amsterdam Business School. His research focuses on governance issues in international business, with special interest in financial institutions and the relationship between CSR and internal control.
This article is part of our NSFM opinion series, in which participants propose specific steps towards real and sustainable market reform. Contributors write in a personal capacity. NSFM participants are invited to contribute to the series. Please contact Ebba Schmidt or Frank Jan de Graaf for further information.