ESG investments and your workplace pension default fund

What’s inside your pension investment strategy? How to ensure it meets your organisation’s environmental, social and governance criteria.

The focus on our collective need to try and have a positive impact – both on our community and environment – and find more sustainable ways of living, has been growing for some time now. But 2019 was the year that public awareness really exploded – particularly in relation to climate change. Alongside the broader Extinction Rebellion movement, Greta Thunberg, a then 16-year-old schoolgirl and climate change activist from Sweden, captured the interest of millions across the globe. Her passion, determination and commitment to ‘leading by example’ not only made her a household name, but also led to her being named Time magazine’s person of the year – much to the dismay of a certain President.

Recent research from online pension provider, PensionBee, showed that 81% of consumers want transparency about which companies, and the type of business activities, their pensions are invested in. When drilling down into specifics, examples included:

  • 61% would like to see an active screening approach to tobacco companies – and 35% favoured outright removal
  • 63% advocate an ‘engage with consequences’ approach to oil companies, with 15% favouring outright removal and 21% opting for a ‘do nothing’ approach
  • 61% want pension investment managers to avoid companies involved with banned weapons

When it comes to investment management, this focus on trying to do good in the world typically comes under the banner of ‘ESG’: environmental, social and corporate governance factors. 

What is ESG?

First, a quick recap on exactly what we mean by ESG:

Environmental factors include the contribution a company or government makes to sustainability – such as tackling greenhouse gas emissions, or prioritising effective waste management and energy efficiency.

Social elements include human rights, labour standards, and more routine issues such as adherence to workplace health and safety, as well as broader factors such as the organisations’ impact on its local communities.

Governance refers to a set of rules or principles defining the rights, responsibilities and expectations of different stakeholders running an organisation. A well-defined corporate governance system can be used to balance or align interests between stakeholders and be used as a means of supporting a organisation’s long-term strategy.

Good intentions – but beware ‘greenwashing’

In its broadest sense, ESG means a focus on encouraging good practices. However, this very broad definition can make it tricky when trying to assess exactly how ethical, sustainable or ‘green’ your investments actually are.

As with many things in life, not all ESG funds are created equal. This was highlighted in the press last year, with a number of funds and managers accused of ‘greenwashing’ – inflating, rather than actually improving, their ESG credentials. That said, there is a huge (and growing) range of good quality ESG options available today – employers and trustees might just need to dig a little deeper in order to ensure your investments meet your criteria and objectives.

This is probably a good time to also clarity that I’m focusing on ESG for defined contribution (DC) schemes in this article, although many of the points would apply equally to employers and trustees running defined benefit (DB) arrangements. The main difference there, of course, is that the trustees shoulder all of the decision making, not to mention risk and responsibility, in relation to investment choices.

The legal requirements

Considering ESG factors is no longer simply ‘best practice’ for pension schemes – it is now a legal requirement. This doesn’t mean employers need to panic if it is not something you have looked at for your scheme yet. The main legal duty sits with the scheme trustees or provider. But workplace pension governance committees should ensure this is included as part of the key factors they review and monitor in each governance cycle.

Since October 2019, trustees of both DB and DC plans with more than 100 members have to state how they address financially material considerations, including ESG factors such as climate change. Crucially, trust-based schemes also have to set out how they take account of ESG factors in their default strategy.

As usual in the world of pensions; where trust-based schemes lead, contract-based schemes follow. In April 2019, the Financial Conduct Authority (FCA) ran a consultation on extending the remit of independent governance committees (IGCs) to include a new duty to report on ESG, consumer concerns and stewardship for the schemes they oversee.

What’s important to you and your workforce?

As you would expect, the first step in aligning the ESG criteria of your scheme with your organisation is to define what is important to you. Larger organisations are likely to have formal corporate responsibility strategies or policies in place already. Smaller businesses may not have. Where you don’t have a formal policy, consider your priorities – what are your organisation’s core beliefs and values? You can then document this as part of your governance committee’s terms of reference. Then ensure the ESG criteria of your default fund, and/or your scheme’s wider investment options, is a key point on the agenda at each governance meeting.

Ask your employees what is important to them. And remember, ESG is not just about climate change – it covers a myriad of issues including taxation, worker’s rights and labour treatment, equality and diversity, community impact and so on.

You can also use your governance procedures and scheme management information (MI) to assess current member behaviour. How many members are currently choosing to invest outside of your scheme’s default? Of those, how many are choosing ethical/sustainable/ESG options?

What are your options in the current market?

As you would expect, the ESG criteria of workplace pension scheme default funds is now firmly under the spotlight – with provider offerings currently varying dramatically in this respect. Employers running master trust arrangements can refer to research from sustainable investment advocacy group, ShareAction, to check the ESG credentials of their provider’s offering: https://shareaction.org/wp-content/uploads/2019/12/Master-Trusts-Review.pdf. (See below for more on contract-based default options.)

Outside of the default fund, many schemes will also offer specific ethical or environmental funds. Master-trust-only providers typically only offer a very limited fund range – but ESG options are often still available. For example, although they only offer five and eight ‘self-select’ fund options respectively, both NEST and The People’s Pension include an ethical fund and a Sharia fund.                 

On the other hand, most modern contract-based schemes, such as group personal pensions (GPPs), include a very wide fund range, with numerous ethical, environmental and/or sustainable options for members to choose from. Just make sure they know about them.

Promote your sustainable/ethical options to your members

If sustainable and ethical factors are important to your workforce, run a communications campaign to make sure they know the relevant investment options available to them through your scheme. Care is needed, of course, to ensure you don’t appear to be recommending specific funds – if you have concerns in this regard, then ask your advisers to help you.

Moving to a sustainable default

Recently, the increased focus on responsible investing has led some of the major providers to develop an ESG or sustainable default option. In 2018, Legal & General launched their ‘Future World Multi-Asset Fund’ for exactly that purpose. Aviva followed last year with their ‘Stewardship Lifestyle Strategy’. The AEGON Workplace ARC platform does not currently have an ESG/sustainable default option, but this is reported to be in development. Given the significant rise in ESG investing across the asset management industry as a whole, I would wager others will soon follow suit.

However, that doesn’t necessarily mean that you should be rushing to move to a ‘true’ ESG fund as your default option. ESG is just one of the many criteria that need to be considered when selecting an appropriate default. The importance of different criteria will vary greatly from employer to employer, and member to member. Perhaps you operate in a sector that was highlighted above in the PensionBee research – oil, mining, defence, tobacco etc. In those cases, avoiding funds that invest in your own sector is unlikely to be a priority. But ESG, what it means specifically to your organisation and how that is reflected in your workplace pension scheme offering, needs to be firmly on your radar – and agenda – regardless.

This article was first published with REBA on 18 February 2020.

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