Could my pension save the planet?

ESG web header
By Stephanie Hawthorne, award-winning financial journalist

26 June 2018

Millions of pieces of plastic polluting the ocean, flagged up so poignantly in the Blue Planet series have focused the public’s attention on green issues.

Many people are no longer content to leave it to investment managers just to make money. A clear majority of the public wants their money to do good – only 39% of UK investors are only concerned about whether their investments make money, 47% want to both make money and make a positive difference to the world according to a YouGov poll last October.

Savers feel disempowered by the industry – 76% of the British public doesn’t know how much of their pension is invested ethically and 30% believe they have “no say” in how their assets are invested.

Since the creation of the earliest ethical fund, the Pax fund, launched in the USA in 1971 by two Methodists who did not want to financially support the Vietnam War, the fund management sector has expanded to incorporate environment, social and governance (ESG) issues.

ESG explained

The umbrella term ESG means different things to different people, but one thing is certain – it is gaining momentum on the pension investment agenda with implications for pension savers, asset managers and pension scheme fiduciaries.

But confusion reigns. Cindy Rose, head of ESG investing, at Aberdeen Standard Investments, says: “The market should have a common ESG definition. We do need a common, global language so that everyone understands what everyone else is talking about”.

It is clearly a hot topic as Ian Pittaway, partner of law firm, Sackers, emphasises: “At one Annual Members’ Meeting held by a large pension scheme I attended recently, nearly all of the questions from members concerned this topic.

“Trustees of occupational schemes are actively reviewing their policies in this area – partly driven by regulatory or legislative intervention and partly by member interest.”

Industry skepticism

Institutions have some way to go before they catch up with the public’s enthusiasm.

Rachel Haworth, senior policy officer at ShareAction, says:

“The Environmental Audit Committee (EAC) recently surveyed 25 UK pension funds (with combined assets under management worth £555bn) and found that only 14 had considered climate risks at board level, with three funds being unable to identify one climate action they had taken and a 2018 survey by Hermes Investment Management of 104 leading institutional investors indicated that fewer than half (48%) believe companies that focus on ESG issues produce better long-term returns.”

It is legitimate to take ESG into account when determining an investment strategy provided it is driven by cogent investment reasons.
- Ian Pittaway

In the past, trustees were concerned over how much of an ESG stance they could take but Pittaway says:

“The legal position is much clearer now thanks to the excellent work of the Law Commission. It is legitimate to take ESG into account when determining an investment strategy provided it is driven by cogent investment reasons. Clearly non-ESG investments may carry more risk – and understanding and mitigating that risk is both legitimate – and highly desirable in terms of formulating and monitoring an investment strategy which will deliver successfully for the pension scheme, whether DB or DC.”

Trust-based DC schemes now have to disclose through their statement of investment principles whether ESG has been considered and from April 2019 trustees of DC pension schemes will have to provide disclosure on costs and where the money is invested.

Government support

Parliament has begun to take an interest in ESG too.

The second report from the UK Government’s cross-party Environmental Audit Committee (EAC) following a Green Finance Inquiry concluded that the Government, regulatory bodies and some pension funds have failed to take sufficient action to protect pensions from climate change risk.

Professor Carol Adams CA of Durham University and a member of the ICAS Sustainability Panel highlights: “‘misunderstandings’ of the meaning of fiduciary duty; poor governance with respect to the application of fiduciary duty; and, lack of reporting (or plans to report) on climate-related financial disclosures.”

The EAC recommends mandatory reporting by asset owners of the recommendations of the Task force on Climate-related Financial Disclosures by 2022.

Regulatory inconsistencies

Complexities abound. The EAC points to differing regulatory regimes for ESG.

The Pensions Regulator (TPR) updated its guidance in July 2016 on investment by defined contribution (DC) schemes and in March 2017 on defined benefit (DB) schemes. The guidance clarified that trustees are required to take into account factors that are financially material to investment performance, including environmental, social and governance factors.

However, the FCA did not publish similar guidance for personal pension providers governing the contract-based pension schemes, which it regulates.

Over the longer term they will benefit, as intuitively ESG investments are likely to do better than other investments.
- Andy Scott

The DWP is also currently consulting on the legal duties of trustees of occupational pension schemes to take account of ESG risks, among other risks.

Impact of ESG on performance

One of the key concerns of pension trustees who adopt an ESG approach is that of its impact on investment performance as this approach can limit choice and boost research costs.

Andy Scott of pension trustees Capital Cranfield and a member of the ICAS Pensions Panel, says that trustees “may lose some return over the short to medium term. However, it is likely that over the longer term they will benefit (and pension schemes invest largely for the longer term), as intuitively ESG investments are likely to do better than other investments which will become less popular and where social, legal and financial barriers will start having an effect on the profits they can generate.”

He points out: “One consequence of the increasing focus on ESG is that indices are starting to be used which consist solely of ESG investments. That will help remove any distortion from non-ESG investments and will enable trustees to see if their ESG managers are doing as well as others.”

Another problem with ESG is that the definition varies between investors, e.g. a Dutch insurer will have a different view to a UK pension scheme.

Scott says: “Investment managers will therefore have to focus on which of the environmental, social and governance sides they wish to concentrate on and this could lead to distortions between the index and the pension scheme’s investment preferences. It might also limit the number of ESG funds that a small to medium pension scheme can invest in.”

It’s clear that many institutional investors still view ESG as a tick-box exercise to keep risk managers happy rather than part and parcel of building a better future for retirees.
- Saker Nusseibeh

There is also danger that ESG could become too complex and this may put trustees off from developing an ESG portfolio. Scott points to a number of distinct ESG strategies that can be followed, such as:

  • ESG integration,
  • Active ownership
  • Exclusionary Screening
  • Positive Screening
  • Impact investing

He says: “Any or all of these may require fairly involved training and buy-in from the Trustees.”

Not just a box-ticking exercise

Many investors cling to a persistent myth that to meet ESG criteria something must be sacrificed but this need not be the case as Saker Nusseibeh, chief executive of Hermes Investment Management says:

“It’s clear from this year’s Responsible Capitalism survey many institutional investors still view ESG as a tick-box exercise to keep risk managers happy rather than part and parcel of building a better future for retirees. The link between ESG considerations and financial value creation needs to be more clearly recognised."

Clearly, profit and green credentials can go hand in hand.


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