Local government pension schemes should resist political pressure

September 25, 2015 10:43 AM

There has been a certain amount of noise recently suggesting that Local Government Pension Schemes (LGPS) divest from (sell so they are no longer part of the fund’s portfolio) fossil fuel and other supposedly “sinful” stocks.

This Guardian article suggested that “millions of UK public sector pensions were ‘exposed to risky fossil fuel investments’”, and Sadiq Khan, the Labour candidate for the London Mayoralty has also called for LGPSs to divest from such stocks.

These probably well-meaning pronouncements are wrongheaded and costly to the taxpayer.

A report published yesterday by Europe Economics has found that the hypothetical investment performance of funds which had divested from fossil fuels in 2002 would have underperformed by around 0.7 percentage points annually. Or, in order to compensate for this the investor would have had to accept an additional 20 per cent additional risk in order to compensate for this.

So to suggest that holding fossil fuel stocks in a portfolio is inherently more risky is inaccurate and actually divestment would have required increased risk in the recent past in order to compensate from lost portfolio performance. As a side note, commentators who can decide which stocks will be particularly risky in the future should probably become fund managers; such clairvoyance would be extremely helpful.

There is a more important point to be made for the LGPSs and the taxpayer. LGPSs are defined benefit pension schemes that guarantee certain levels of pensions for former employees, so they have significant future obligations. If the LGPSs were to have divested from fossil fuels in 2002 they would have sacrificed a significant amount of portfolio growth which may impact their ability to honour these future obligations.

In all likelihood the taxpayer would be required to step in and cover any shortfall. Clearly this is not acceptable when the government continues to run up £70 billion deficits and the prospect of shrinking our£1.5 billion of national debt looks remote.

Lastly, for every sale there must be a willing buyer, and divesting of stocks just means that they pass into the hands of someone who you may consider less scrupulous, or if you want to “greenify” these companies you have to actually have a say for which ownership of stock is usually a precondition. Divestment is just hand-washing.

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