Earlier this week I published the first part of a post on pension reform by Jim Osborne. This is the follow-up, and concluding, second part:
In Part one of this guest post I explained my ideas for a National Pension & Investment Fund (NPIF) the main objectives behind the proposals and how it could be created.
In this second post I will set out how I think a NPIF would invest its capital, what its investment portfolios would look like and what principles of investment it should adopt.
The primary purpose of the NPIF is to invest to support the development of a productive economy for Scotland, and avoid as much as possible investments in the trading of securities. It is inevitable, however, that holding a portfolio of financial assets will still be required because opportunities for investments in production are unlikely to call upon all the capital in the fund, at least over the short-medium term. In this case the assets being held should be selected according to strict criteria and held for the long term unless conditions change which create a breach of the criteria.
This approach to investments will produce two distinctive portfolios – one dedicated to active investment in productive enterprises, the other holding a range of financial assets such as government bonds, corporate bonds and shares. Further consideration needs to be given as to whether the NPIF should also hold other assets such as currency, commodities and land.
The active investment portfolio will feature a diversity of investments. The diversity will be across a number of dimensions – enterprise size, type (joint stock companies, partnerships, co-operatives, social enterprises etc), industrial sector, and risk profile. This latter diversity factor means investments across the risk spectrum from venture capital type of investments in new innovations to low risk, stable revenue generating businesses and infrastructure, such as energy, social housing and public transport.
The mode of investing is based on equity direct partnerships (EDPs) in which the NPIF provides capital as an active partner in return for agreed sharing of profits (operating surpluses). The terms of the EDP are agreed in advance, including how the surpluses are to be shared between the enterprise and the NPIF, and social and environmental conditions to be met (such as employment standards, rates of pay, environmental standards etc). It is proposed that these are aligned with the requirements set out in a Corporate Code/Company Law, which are also the basis of listing rules for a Stock Exchange.
Note. This model of investing is not a Jim Osborne invention. It is a concept developed by the Capital Institute in the USA and by Tim MacDonald, a US investment professional who I met in 2013. The original concept was called “Evergreen Direct Investment (EDI)”. It was aimed at large pension fund investors and remained a rentier form of pension fund investment in that its main focus was on cash rich, stable companies and revenue rich infrastructure. My adaptation of this concept is designed for a large sovereign wealth fund, accountable to the public, which invests across the whole of the risk spectrum so that it provides a source of national capital to support innovation, new technology and new industrial sectors. The risky nature of venture capital is balanced with revenue rich infrastructure such as housing and renewable energy but in the NPIF model it is no longer a rentier but a mutual network as all citizens are both ultimate investors and ultimate beneficiaries, not just a fortunate few members of a private pension scheme.
The fact that EDPs are based on contractually agreed partnerships, which cannot be terminate other than by express mutual agreement, means that they are impervious to hostile takeover – the NPIF as a partner holds a veto over any possible sale of the partnership’s assets. It is a form of mutual.
The portfolio of financial assets will have to be restructured so that assets being held at the time of formation of the NPIF, which do not meet the new selection criteria, will have to be disposed of in a phased manner and replaced with assets which meet the selection criteria.
The selection criteria will be aligned with the social values of the public as a whole as set down through Parliament and the democratic process. Values expressed in the Constitution of the state will frame the broad principles. For example a constitutional right to housing will inform selection of financial assets which support the housing and construction sector. Standards of corporate governance, accounting and disclosure will also comprise an important element in the framing of selection criteria.
In summary, the NPIF will be created to support productive activity which meets the needs of all citizens and which connects the purpose of money and NPIF capital to the social values of the people as a whole. Its conception is founded on the principle of a proper popular democracy.