People say they want ethical, SRI and ESG pensions yet they rarely put their money where their mouth is. But is that, asks Michelle McGagh, because the industry is not putting these products at the front of the shop?
Ethical investment may finally be having its moment as socially conscious millennials call for a new type of pension.
Global research by BNY Mellon has found that millennials – those born between 1980 and 2000 – would allocate 42 per cent of their pension portfolio to ethical, impact and social finance, with UK investors interested in financing crime prevention and homelessness initiatives.
But they do not feel that insurers and pension funds are providing ethical options, with 95 per cent of millennials saying they were offered only poor and limited options or no options at all.
SRI, ESG, ethical and the latest colour of investing for good – social finance – have all talked a good story when it comes to engagement but so far it seems pension savers have been slow to match their words with deeds.
Newton Investment Management head of responsible investment Sandra Carlisle says generations X and Y are accused of being “disengaged” but their investment priorities prove otherwise.
“They care about the planet they live on, they care about people; they are global citizens,” she says. “They care much less about profit because they have less money to spend.”
Carlisle says there is a “mismatch” between “boring and inflexible” pensions and the way millennials see the world. She argues for pension funds to better articulate how their investments make a positive impact.
“We are not very good at explaining what we do,” she says.
“What we’re really talking about when we talk of social investing is something positive. We are saying ‘Every company you invest in is creating an impact; it can be for the greater good or it can cause damage.’
“We need to reframe the conversation around ‘Why would you not use your money to influence the world around you… and in a longer-term sense to deliver profit to you?’”
Poor communication of the ethical options may be a reason why take-up is so tiny – just 1 to 2 per cent of pension funds is invested in SRIs. But it could also be a case of people failing to put their money where their mouth is. Nest director of investment, development and delivery Paul Todd says the take-up of ethical funds in his organisation’s auto-enrolment scheme is “less than 1 per cent” and he blames a lack of understanding of pensions generally.
“I’m not surprised that people aren’t flocking to ethical funds, because a lot of them do not understand how pensions work,” he says.
“People are surprised that they are even invested and a lot of times they see pensions more as a building society or savings account. It is quite a journey for them to get to the point of talking about long-term growth.
“People realise they are in a pension scheme but they have not got their head around what they have to do. We suspect that take-up figure will change when the pot size gets more meaningful and they get more engaged.”
With millennials making up an increasingly large proportion of the workforce – they are expected to comprise three-quarters of workers by 2025 – the call for more ethical pensions will only grow.
AllianceBernstein managing director of sales and client relations Tim Banks says his firm already runs a series of ethical pension portfolios worth £100m for a company in the voluntary and charity sector.
“The company puts a lot of effort in to make sure the ethical beliefs of the pension members are referenced,” he says. “Members can choose a ‘normal’ default fund or an ethical default and a lot choose the ethical default.
“We are seeing increased interest in this area. Although we do not see a huge demand from individuals, if we give the choice to employers a significant number of them would be happy to embed an ethical default strategy into their pension scheme.”
Banks believes the appetite for ethical pensions is increasing and, “in terms of young people, ethical investing is built in to their DNA. We are certainly reviewing and building options to reflect that.”
While both employees and employers are showing interest in this area, Barnett Waddingham pension consultant Malcolm McLean says convincing trustees of the merits of ethical investing remains a hurdle.
Concern about returns
McLean says the issue of whether to offer more ethical funds to pension investors is “long-standing” and the reason has always been the same.
“People would like ideally to invest in ethical funds but the worry is they won’t get the best returns,” he says. “For trustees, they hold the responsibility when picking funds to act in the best interests of members and get the best possible returns.
“There is a place in the market for ethical pensions. The people who want to invest in ethical funds should be allowed to but they may not always get the best returns. There are companies that are keen to go down this route.”
McLean believes that promoting ethical funds and offering more social finance solutions could encourage young people to engage in pensions. But he warns they should be made aware of the potential for lower returns so that they do not become disenfranchised with pensions.
Carlisle disagrees that ethical funds cannot produce decent returns, particularly in pensions, which have a longer time horizon.
“You are investing in a way that does not harm returns,” she says. “Over the long term, 40 years-plus, it will generate a decent return.”
Ethical investment no longer means screening out stocks but “investing and looking for a positive impact”, she adds.
“This may be protecting the environment or not harming the environment but it is a different sort of dialogue from just screening out companies.”
But Carlisle acknowledges that investors in ethical funds must accept that analysis of companies’ ethics costs both time and money.
“Millennials want to get to grips with investment but they also want to do something good, and feel good and see that good is being done in a way that makes sense to them,” she says.
“You can do it in a passive equities solution that is cheap or in an active equities solution that is more expensive. Or you can use micro-finance in Africa, which is going to be more expensive again and your money will be locked in.”
While ethical pension funds may seem short on the ground to millennials, and companies’ interest in ethical funds for workers is in its infancy, Todd argues that inv-estors are not losing out because default funds are becoming more ethically focused.
He says the default Nest fund, in which 99 per cent of pension savings is invested, is “not unethical” simply because it is not a specifically ethical fund.
“We spend a lot of time and effort in being responsible and a lot of time thinking about how we vote in the companies of shares we hold and how to engage those companies. Take banks: we are talking to them about their culture and ethics,” he says.
Nest also spent a lot of time researching clients’ investment preferences and found that ethical had moved from traditional anti-tobacco stocks funds into something more modern.
“A lot of ethical funds have come from legacy positions such as Quaker backgrounds, where they screen out things like tobacco and pornography,” says Todd.
“When we talked to a sample of clients, those more traditional screens were less relevant. For younger savers there is more of a focus on human rights and child labour and the environment.”
Todd believes a focus on the environment is not just an ethical fund issue but one that affects all investments.
“We want to understand the risks of not investing ethically, not just traditional risks of liquidity and inflation,” he says.
“These investments have a timeline of 60 or 70 years and that is a long time. We cannot think only about what will happen in the next two years.
“Climate change is a classic example: if international standards are agreed on carbon reduction next year, that will have a direct impact on companies around the globe. How are we positioned for that?
“Thinking about that is not ethical – it is just sensible, long-term investing.”
How have socially responsible investments fared?
According to environmental, social and governance research company EIRIS, the amount of UK money invested in ethical funds has more than doubled in the past decade.
In 2005 there was £6bn invested in ethical retail funds; this has grown to £15bn.
The top-performing ethical fund, according to FE Trustnet, is the 7IM Sustainable Balance fund, which has returned 4.3 per cent over one year, 26.5 per cent over three years and 33.6 per cent over five years.
The performance outstrips that of the Aberdeen Ethical World Equity fund, which is in second place with returns of -9.8 per cent, 10.3 per cent and 11.2 per cent over one, three and five years respectively.
This is against cumulative performance of the UK All Companies returns of 5.13 per cent over one year, 39.91 per cent over three years and 50.81 per cent over five years.