Should default funds consider ESG factors or is offering a broad range of self-select funds sufficient?
Many ESG factors are relevant to the financial performance of the fund so it should be the default fund manager’s job to take these into account. We shouldn’t have to ask members whether to take these factors into account – this should be done as a matter of routine.
When it comes to non-financially relevant factors, which can reflect members’ ethical and moral beliefs, a scheme can address these by offering a range of self-select funds that are tailored to reflect these beliefs.
How important to members is ESG integration into defaults?
Awareness of responsible investment issues amongst members is growing, but we are coming from a low starting point. Many people do not even know they are invested in the stock market, let alone have a view on how their investments are managed. But as people learn more they will want to know what schemes are doing with their money, which is why we not only need to embrace ESG considerations within the default but also offer people alternative options that match their beliefs.
Will members be prepared to sacrifice returns to incorporate ESG factors into their pension investments?
Some will, some won’t. There is definitely a trend, particularly amongst young people, towards investing for good, and we are seeing increasing take-up of social impact investment.
But the fiduciary’s job is to ensure there is enough money in the pot when people come to retire. That means taking into account financially relevant ESG factors, which should boost rather than diminish returns.
Non financially relevant factors can only be taken into account in the default where a two-step test has been satisfied. Firstly the fiduciary needs to be confident that a sufficient proportion of the membership support the factor being taken into account. And secondly, that taking this factor into account will not cause material detriment to the default’s performance.
Stewardship is arguably the most visible element of ESG in terms of media coverage. Is strong stewardship the main ESG priority for default funds?
There are four key tools in the ESG toolbox – stewardship, investment tilts, screening and exclusions and the integration of ESG into the stock selection process.
Stewardship can bring about real change. Last year we were the second biggest shareholder behind a motion calling on BP to commit to disclosing how its spending plans, emissions policies and business strategy aligned with the Paris climate agreement. We also backed a motion requiring Royal Dutch Shell’s executive pay to be linked to their performance on transitioning the company to a low carbon future.
But if default funds want to get the full benefits of an ESG approach they will need to use the other tools, to the extent that the default’s charging structure allows it.
ESG integration is typically associated with active management. How can ESG be delivered within default funds operating within the charge cap?
Integrating ESG into an active management approach comes at a high active management fee, which is against a general fee reduction trend in DC.
But tilts, screens and exclusions are more readily accessible. We have seen the launch of lots of new indices that incorporate tilts, for example reducing oil and gas exposure.
How far should the industry take belief- based investment options? Do we need a vegan fund, for example?
The idea of offering members the option to invest their pension in a vegan fund may sound farfetched, but who knows what investors will demand in the future? When it comes to engaging members with their DC pots we are at the start of a long journey. Giving people options that speak to their core beliefs has to be a good way to achieve higher levels of engagement.
Is climate change the most urgent ESG consideration?
Climate change is certainly the biggest systematic risk to the global economy. And it is the one ESG factor that schemes must expressly set out their approach to in their Statement of Investment Principles.
As the world strives to rebalance to a lower carbon future there will be serious implications for the valuations of companies that do not successfully adapt to that change, which could become stranded assets. We can already see oil and gas being one of the worst performing sectors over the last ten years. So schemes need to analyse how climate change will affect the value of their investments.
But climate change also brings big investment opportunities as economies restructure – an ESG approach can help capitalise on this.