Behavioural economics could help trustees avoid making mistakes that could ultimately put members at risk. Michael Klimes investigates
- Research shows DB trustees are not challenging consultants' advice
- Behavioural economics can improve self-awareness and self-discipline
- Members could exercise pressure on trustees by asking questions
As fiduciaries looking after savers' pensions, it is absolutely crucial for trustees to be able to question any advice they receive.
Yet research has found that despite the amount of power trustees have, they lack confidence to challenge advice from investment consultants.
SEI Institutional Group's study published in January revealed many trustees of defined benefit (DB) schemes are failing to challenge their investment consultants. The survey of 100 DB trustees revealed just one trustee always reached "their own conclusions" and 59% did not frequently consider alternatives to their consultants' recommendations. The report puts these worrying figures down to the prevalence of group think, which is where a desire for harmony or conformity in a group can result in irrational decisions.
In a PP Pensions Buzz survey, when respondents were asked how trustee boards can best avoid group think, almost half said a combination of techniques.
These included: have someone roleplay as devil's advocate, have decisions reviewed by an independent sub-committee, appoint a fiduciary manager, and listen to consultants. Beyond the numbers, the main theme which emerged from comments was that trustees should be sceptical and ask hard-hitting questions.
Unfortunately, the SEI research did not show that trustees are asking hard hitting questions. The firm's institutional group managing director Patrick Disney said: "The investment consultant is metaphorically put up on a platform where his or her advice is handed down. This is the sort of relationship which does not make for a lot of collaboration. There is a heavy reliance where the key inputs/advice is not directly aligned with the final outcome of the fund."
Clearly group think can be a big problem but what can trustees do to avoid it? Behavioural economist Paul Craven who has been working with City Noble to promote behavioural finance believes psychology can offer trustees ways to challenge biased thinking. "Behavioural science offers the chance to understand how we can become more self-aware through psychological insight and self-discipline," he says. "I think we can all benefit from awareness and self-discipline in any job and profession. We can recognise the fact that human beings have biases and they have heuristics which is essentially mental short cuts."
These mental short cuts developed for sound evolutionary reasons and were useful in the pre-modern world. One example of bias which helped people when they lived in caves was conformity. It made sense to not be different from other people in the tribe when its survival was at stake. However, in the context of twentieth first century financial markets they can cause problems as people are prone to make snap decisions.
While trustees are not in a life and death situation, they are still exposed to stressful situations where their decision will impact many people. This can be compounded by decision-making structures within firms.
Behavioural economics in bitesize
Behavioural economics has established itself as a prominent branch of the social sciences.
Two of the main disciplines it fuses are psychology and economics. It has gained popularity in the wake of the 2008 financial crisis where standard economic models failed to predict the crisis or explain what happened.
The "rational expectations" economic school was criticised for failing to spot the build-up of massive asset bubbles, highly indebted banks, countries and consumers.
Humans are no strangers to hubris, which can plague the corporate world. This emerges in three ways. "You have this illusion of invulnerability," Craven continues. "People can join a group and one can see how they conform together. Any corporate body overestimates its abilities and there is close mindedness and pressure for uniformity."
To combat overestimation, trustees should admit if they do not know everything, be honest about their track record, examine their previous decisions and ask whether they meet their goals for the scheme.
To deal with closemindedness, it is important to discuss anything which could help a pensioner and stop the board falling into conformity bias. Craven believes the devil's advocate role pointed out in PP's Pensions Buzz survey could make a critical difference here. "The devil's advocate is absolutely crucial and I always ask people, ‘Do you have a devil's advocate inside your head and if so do you ever challenge it?' "I am not necessarily saying the devil's advocate is right or wrong but it is just there to explore ideas. It can potentially even bring out better ideas. We don't do it enough in our own heads and therefore we probably do not do it enough in groups when discussing major decisions."
When it comes to breaking uniformity, the role of the chairperson is fundamental as they set the tone of how a board of trustees is run. "If you [as a chair] want a good debate at a meeting it is probably good that other people do not know your views as you will influence them," Craven continues. "It might also be good to ask the shy people to speak first as they might have a view which is valuable but they are shy about sharing it."
The most interesting meetings that Craven has sat in are where people have taken a slightly different position to the consensus and generated a discussion. Even if the consensus did not change the ultimate decision, it was useful to have, he says.
The end point is to achieve better outcomes for members. Craven adds: "None of this is rocket science. It won't teach you to be a brilliant investor but it enables you to avoid silly mistakes. We slip into human biases [but] the end user is the pensioner. Having information going down and up the chain is equally important."
Like Minds communication consultant Trevor Rutter is convinced that pressure from members could make trustees raise their game. Overcoming the apathy of members is difficult however. He says: "From a member's point of view the initial reaction is, 'Why should I care? I have a pension promise which is a sixtieth of my final salary. Why should I care about where my money is being invested by the trustees and if they are blindly following the advice from their advisers'?"
To inspire more curiosity among members and encourage them to ask questions, trustees need to capture their interest. Rutter says: "There is no point in talking about equities. You cannot communicate this in isolation but it can be done in a context which allows people to take an interest and challenge the trustees. But it is difficult for trustees to communicate this and it is a struggle at first as people switch off."
The priority is to get away from technicalities and talk about how important a trustee's decision on investments is to a member's standard of living in retirement. "They need to understand this is what they can live on and how it could fund their lifestyle for decades. Whatever your hobbies or plans are, this is going to make it happen," says Rutter.
"You are not talking about tax relief, you are talking about what you want to achieve in life. Even if retirement is a long way off, this can help. Look at the way the advertising industry sells cars: they talk about freedom. It is the uses you put it to rather than the technicalities. Whatever age you are, you can relate to that."
But ultimately the lead must come from trustees. "It is not enough to be doing the right thing; you have to make sure people are aware of it and that you communicate it," he continues.
Arc Pensions Law senior partner Anna Rogers agrees up to a point but warns trustees should not go from group think to needless conflict. "There is normally a lot of conflict of interests around the table and vested interests where people want things to stay as they are and one really wants to rock the boat," she says. "In some ways there are probably very good benefits of that. If people go around rocking the boat all the time in order to generate disputes then that is not good either. I think we can beef up on trustee governance not by having tick boxes but asking: 'are we running things the best we can and could we be more proactive'?"
It seems the only answer to group think is eternal vigilance practised by those trustees on boards. A little behavioural economics could certainly help.
Three influential books on behavioural economics
Thinking, Fast and Slow is a book by Daniel Kahneman published in 2011 which became a bestseller. Kahneman won the Nobel Memorial Prize in Economic Sciences in 2002. His work challenges the assumption that humans are rational economic decision-makers.
Nudge: Improving Decisions about Health, Wealth, and Happiness is written by Richard Thaler and Cass Sunstein. It was published in 2008. Thaler has also scrutinised the concept that people are rational when it comes to making their own decisions.
Inside the Nudge Unit: How small changes can make a big difference by David Halpern published in 2015. This work looks at how behavioural economics was practically applied in David Cameron's government. Halpern is the chief executive of the Behavioural Insights Team in the British government.
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