In this blog, Laura Myers considers how defined contribution (DC) pension schemes are tackling responsible investment and environmental, social and governance (ESG) issues.
Last month saw both the release of the Pension and Lifetimes Savings Associations’ discussion paper on ‘ESG risk in default funds’ which states that DC members in the UK are significantly exposed to a variety of ESG risks, and the announcement by National Employment Savings Trust (NEST) that it will be looking to reduce the climate change risk in its default. This news comes on the back of The Pensions Regulator (TPR) introducing guidance on considering ESG factors when making investment decisions in its revised Code of Practice 13 for trustees of DC schemes.
So with this backdrop of increasing guidance, and the PLSA’s paper stating ‘We no longer understand ESG as a niche product designed to enshroud investors in a warm glow of righteousness, but as a critical component of the wisest investment strategies’, have things actually started to change in DC schemes?
Since TPR launched the revised Code we’ve seen an increase in DC trustee bodies who are considering responsible investment and ESG issues. We’ve also seen a shift towards considering how to protect members’ investments from sustainability risks such as climate change, particularly in the default option. However at the moment this is being driven by the largest UK DC schemes and has yet to become mainstream. Positively, the PLSA says it now wants to help its members fully integrate ESG into their investment strategy, so we may see more action taken by DC schemes in this area going forwards.
We think responsible investing makes a lot of sense for DC scheme members, and for those who run them. DC investment strategies are designed to be long term, and there’s building evidence that companies that are well-run and have strong environmental, social and governance practices have a better chance of sustaining long-term success and profitability.
So what can DC trustees do to start to incorporate responsible investment into their DC investment strategies? A good starting point would be to include ESG credentials in their manager selection process and ask managers to report regularly on how they are tackling sustainability risks. Trustees should also make sure they select managers with strong stewardship practices – such as voting at AGMs, engaging with investee companies and engaging with public policy issues – and then continue to engage with managers on this key issue.
On the investment manager side much is being done to improve the way ESG issues are taken into account, both in mainstream funds and in new funds with a specific ESG focus.
One of the newest responsible investment funds we’ve seen is a passively managed fund that uses factor based investing, with an additional low carbon tilt to reduce the exposure to climate risks. What makes this fund quite unique is that it also has a strong policy on engaging with investee companies about climate change. It has the ability to disinvest from a 'pivotal' company it feels is not making sufficient changes to adapt to global climate policy (pivotal being large companies in carbon intensive sectors). If this happens I expect that the news of the disinvestment will hit the headlines, and hopefully result in change.
This new passively managed fund, and others which track low carbon or ESG indices, are a great start in making responsible investment accessible for all, and we are hoping to see continued innovation – and take up by DC Trustees - in this space.