PENSION FUND CAPITALISM
by Gordon Clark,
Oxford University Press
Published March 2000
Paperback ISBN 9240485 £17.99
Hardback ISBN 9240477 £40
The broad theme of this book, as its title suggests, is the dominance of pension funds in allocation of saving to capital investment, as well as provision of retirement income, in the Anglo-American countries. In this context, the particular focus is an exploration of the constraints on investment in urban infrastructure by pension funds, in a context where the state is tending to retreat from the provision of such public goods. In addressing this issue the author investigates broad aspects of pension fund activity and implications of the growth of institutional investors which are relevant to a much wider range of issues than the topic in hand.
The approach is both normative and positive. On the normative side, Professor Clark, an economic geographer, seeks to controvert the arguments of those who maintain that pension funds should have no role in community economic development and provision of ‘public goods’. On the positive side, he seeks to probe all relevant aspects of the pension industry – behaviour of trustees, investment management and regulation – to find the possible sources of bias against such alternative investments.
The book seeks first to assess what are the factors underlying the phenomenon of pension fund capitalism. While this is to some extent attributed to the impulse of privatisation that characterised the 1980s, its roots are shown to lie much further back, in the development of fiduciary institutions to care for the elderly in Victorian Britain. The book goes on to assess the structure and nature of competition in the investment management industry, the logic underlying pension fund trustees’ decision-making and possible institutional mechanisms to target pension fund investments on infrastructure. In each case, the author assesses the possible structural and institutional barriers to urban infrastructure investment by pension funds.
In the final section of the book, where he focuses most closely on the issue of urban investment, Professor Clark look at issues linked to the political economy of the regulation of pension fund investment. The discussion is focused in particular on the debate in the US Congress regarding the justification of Economically Targeted Investments (ETI) on the occasion when in 1995 the majority Republican House outlawed initiatives to encourage private pension funds to
undertake such investments.
Considerations proposed by the author on either side of the argument go deep into the nature of the individual and society in a capitalist polity, viewed through the optic of the issues of trustee responsibility and investment management outlined in the earlier sections. Not that urban infrastructure investment is seen as justified independent of its risk-return characteristics. An interesting chart does show returns on infrastructure such as power generation, bridges, pipelines and airports to be well ahead of (Australian) equities and bonds, and potentially a component of efficient portfolios.

The analytical approach of the book is broad. Professor Clark utilises tools of analysis not merely from economic geography, mainstream economics and finance, but also philosophy, behavioural psychology, law and political science. Underpinning the many insights is the familiarity of the author with all aspects of the process of pension fund investment, derived from interviews in many parts of the world with trustees, consultants, investment managers and regulators. The insights derived from these interviews shines through the analytical work and ensures its ongoing relevance to real world issues.
An important aspect of the approach of the book is the characterisations of economic, institutional geographical and historical developments, from such a multidisciplinary point of view. Only two of these can be covered in a brief review, so as to give a flavour of the narrative.
One is the explanation of the rise of pension fund capitalism. ‘Structural determinants’, besides the development of pension related institutions in the UK in the nineteenth century, are the establishment of long-term employment relations (in the interwar and post-war periods) and the political preference for market based solutions. ‘Second order aspects’ of the post-war situation – economic and demographic growth, state sector employment growth and anti-discrimination legislation such as ERISA amplified these structural aspects. Finally, growth of pension assets themselves can be linked to the system of incremental collection of contributions, minimum funding requirements and centralisation of assets in pension funds rather than sub contraction of investment to insurers. The lack of pension funds in continental Europe can be seen as linked to absence of the structural and third order determinants of Anglo-American pension fund capitalism.
A second is the analysis of the logic of trustee decision-making. Professor Clark argues that the situation of trustees is best seen in the context of three frames of reference in decision-making, based respectively on habits, rules and norms. These help the trustees – who are typically neither trained investment professionals nor among the key decision-makers in the sponsor – cope with the risk and uncertainty related to investment in financial markets, delegation of investment responsibilities and related principal-agent problems.
Habits of prudence are the immediate response to risk and uncertainty. They may lead trustees to adopt many of the ‘irrational’ biases predicted in the ‘behavioural finance’ literature, such as loss aversion (displeasure at losing money exceeding pleasure of winning the same amount); preference for certainty and preference for similarity (to other trustees); and regret for lost opportunities. Second, there are rules of proprietary conduct, regulating the process of collective decision making by trustees. These involve fiduciary duties, regard for beneficiary interests, impartiality and, increasingly, the requirement for diversification set out by modern portfolio theory. Rule-based decision-making is seen as a means of justifying past investment decisions but the rules are themselves often vague and inconclusive. Finally, there are norms of relationships that govern trustees’ interactions with others outside the fund, such as consultants and investment managers. A key norm is that of reliance, whereby trustees must rely on others to actually discharge their responsibilities – and use appropriate tests of commitment and sincerity. Then there is reciprocity, including an element of loyalty to the service provider. Underpinning these is mutual respect, that trustees have a major burden of responsibility and rely on expert advisers to discharge it. These norms underpin longer term relationships, overlapping the rules of proprietary conduct and prudential habits.
The point arrived at is that all of these habits, rules and norms in the context of risk and uncertainty can help sustain conventional decision- making – and thus decisions against holding alternative investments such as equity in urban infrastructure. Another difficulty of such investments is that all too easily, those undertaking them can be accused of corruption – a line of argument that justifies a separate chapter assessing this topic.

One of the rich aspects of the book is the exploration of Anglo-American law as a background for the role of pension fund trustees and their fiduciary responsibilities. This is an aspect that should be of particular interest to those in continental Europe seeking to set up pension funds from scratch. The book is also highly relevant to the UK government initiative to assess the modus operandi of institutional investment (the Myners Review), since many of the arguments deployed relating to urban infrastructure apply equally to other forms of alternative investment. This is notably the case for venture capital, an area where America tends to be ahead of Europe, and continental pension funds ahead of the UK.
A few cavils: the book is based largely on US experience, and hence relevant UK aspects such as the ‘Scargill judgement’ against union-directed pension fund investment are not developed in detail. Another possible area of interest would be to probe Swiss pension funds’ sizeable property investments. More data to back up the arguments would have been helpful, not least on the experience of US public pension funds with alternative investments of the type considered. Finally, the distinction between issues relating to debt versus equity financing could have been utilised to a greater degree.
These should not be seen as substantive criticisms of the book. Even those not interested directly in the topic of urban infrastructure investment – or for that matter taking an opposing line – will find the book rewarding, as a source of challenging, original thinking on fundamental issues linked to the investment of pension assets.
E Phillip Davis is senior international adviser at the Bank of England in
London

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