Auto-enrolment has certainly been successful in boosting contribution levels. Opt-out rates remain low, despite stepped contribution increases, and there are now more than 10m people enrolled in workplace pensions, many of whom are in master trusts. But a system that relies on inertia is not ideally primed to boost levels of engagement among members.
Delegates at a round table – ESG in Auto-enrolment: Entering the Mainstream – hosted by Corporate Adviser last month argued that the pensions industry has a fresh opportunity to reach out to savers by constructing narratives around the positive impacts of environmental, social and governance (ESG) investing.
Nest head of responsible investment Diandra Soobiah said talking to scheme members about ESG factors can be an effective way to turn around the low levels of engagement with pensions.
She said: “Nest has 7m members, and all our research indicates that there is a great deal of interest in a whole range of ESG issues, from climate change to how companies pay their workforce, and manage supply chains.
“By implementing a clear ESG strategy that reflects these concerns we can hopefully get them more engaged and interested in pension savings.”
Soobiah said that while Nest looks at a whole range of ESG factors, it has a thematic focus on both environmental and social issues. Nest has chosen to prioritise factors that matter financially to its members, she said.
These environmental and social factors include climate change, human capital in the workplace – such as companies’ fair pay and living wage policies – and banking culture and conduct. Fair pay is a particularly relevant issue for Nest, she said, because many of its members are low earners, some of whom will themselves be earning less than the living wage.
Soobiah referred to research among Nest members that found almost half of those surveyed, from a pool of 3,000 respondents, said they wanted their workplace pension to adopt an ESG-led approach, even if this meant slightly lower returns. She pointed to research that showed the reverse is more often true of performance, and an ESG-led strategy can boost long-term risk adjusted returns, rather than comprise them.
But not all of the panelists at the round table discussion on the role of ESG strategies in DC pension provision were convinced that the majority of pension savers were willing to put principles before profits.
Lorica consulting and wellbeing partner James Biggs said: “My sense is certainly that millennials, and the younger ‘generation Z’ have a keen interest in this environmental and social justice issues.”
But he said a recent straw poll that he had conducted with younger people, which he accepted was statistically not significant, found that there while there was an interest in ESG, none wanted to adopt this approach if it meant lower returns on their pension or investments.
He pointed out that when there is an option to select an ethical fund, as part of the wider fund selection in a workplace pension proposition, take up is typically low.
Aon head of DC investment James Monk said that the conversation shouldn’t focus on any presumed trade-off between ESG investing and returns.
He said an ESG-strategy should be primarily about longer-term risk management of assets. For this reason he said it should be fully integrated within the default fund. But he added that an ESG-led strategy also offers an opportunity to boost engagement levels among members. “This is a good way to start a conversation, about how pensions are being used to transition to a low carbon economy, for example.
“People can see the potential risks to their savings by having too much invested in assets which are over-reliant on fossil fuel production, for example.
“It is a good story to tell, with tangible examples. If an ESG strategy is done well, and communicated properly, it could also help rebuild trust in the pensions industry.”
But these issues highlight some of the more complex issues surrounding an ESG-led strategy for a default workplace pension scheme.
While the panel agreed there was evidence to suggest that companies that adhere to ESG-principles tend to perform better over the longer term, there can often be significantly different views from professional research companies as to what an individual company’s ESG credentials actually are.
Lane, Clark & Peacock senior consultant Nigel Dunn said: “You would think it should be clear which are the ‘good’ companies, and which are the ‘bad’ ones, in terms of ESG criteria. But this isn’t always the case.”
He points out that third party rating agencies that compile ESG data for the asset management and pensions industry each have very different methodologies. The way they ‘rate’ individual companies varies, often significantly. A prime example is Tesla which scores very differently with each of the three major ESG rating agencies. Asian investment bank CLSA said that as at 17.9.18, FTSE ranked Tesla last for global auto ESG, while MSCI rated it best and Sustainalytics ranked it in the middle of its range.
Soobiah said that often these agencies are looking at one specific dataset – one might be more focused on governance issues, another on a company’s environmental policy and track record. This can account for such discrepancies.
Companies – like Tesla – may look attractive in one sense, for example developing electric cars that have the potential to significantly reduce pollution on the road. On the other hand Soobiah pointed out there are currently a lot of environmental issues around the mining of components needed for batteries for cars, as well as other additional governance questions to address.
Similarly, individual pension providers and their asset managers may look at a different range of factors when conducting their ESG assessment. Some may look at far more factors than others, which can lead to very different portfolio constructions.
Delegates at the roundtable agreed that this was a major challenge for them going forward, as there was clearly a need for them to get “under the bonnet” and fully understand what sits behind the various ESG-led strategies in the DC workplace sector.
Dunn said: “It is going to take time for consultants to understand what the best methods and approach actually are.”
Over the next few years, as master trusts become more dominant, ESG may become an important differentiator when it comes to selecting a workplace pensions proposition.
Willis Towers Watson consultant Mark French said it is not a differentiating factor at present, but he expects this to change. He pointed out that there are likely to be reputational issues for corporates – as well as master trust providers – if they don’t have clearly defined ESG strategies.
Pressure groups such as ShareAction already highlight companies which fail to adhere to some ESG standards. There could be issues for corporates who have exposure to companies with extremely poor records on issues such as fair pay or pollution through their pension fund.
French added: “As master trusts become more dominant it is clear that there will be a lot of competition around the pricing of default funds. But adding a well-defined ESG strategy can also provide a competitive edge.”
Monk said: “It is a question of when this becomes a key differentiator and part of the providers’ proposition, not if.”
For the larger master trusts – which are predicted to have some £300bn of assets under management by 2026 – one key differentiator could be their use of big data, to help shape a relevant ESG strategy and further boost engagement levels.
Those attending the roundtable thought such developments are likely from providers who also offer a range of banking or insurance products. This offers the opportunity to devise more tailored marketing campaigns, particularly focusing on ESG strategies. For example if someone makes a regular donation to the World Wide Fund for Nature they may be more receptive to information about the pension funds’ environmental policies.
Nest senior business development manager Stephen Argent said: “We already see this data being used to drive engagement and deliver more tailored services in supermarket, via their loyalty schemes.
“At the moment the pensions industry has been slower to adopt this, partly because there has been less of a financial incentive to do so.
“Knowing more about how you pension fund invests its money, and what its ESG policies are is undoubtedly a good thing but will this necessarily translate into higher contribution levels?”
However, French pointed out that the drive to increase engagement, particularly by using new technology and mobile apps, could stimulate change in the sector. If members are able to see a number of their saving and investment holdings through one platform, this could certainly help drive transfers within the workplace pensions market, potentially concentrating more assets with the master trust providers.
Monk said: “This is something that the regulator certainly has its eye on. While it is not against consolidation, it wants to ensure that it is not simply a case of people rolling assets over without shopping around effectively.
“Regulators are alive to the risk of convenience over value and will want to ensure the two are appropriately balanced.”
A copy of this Nest ESG supplement is available to download here.