In the last few months, I have completed three projects on Responsible Investment (also known as Environmental, Social and Governance (ESG)) in the pensions sector. One a broad policy paper and two projects reviewing the Responsible Investment policies of pension funds. In this blog post, I cover some of the issues I encountered.
All pension funds should understand that we must keep global warming to less than 1.5oC (compared to pre-industrial levels), in line with the 2015 Paris Agreement on climate change. UK and Scottish legislation set ambitious targets and measures to help achieve this. Most funds also understand that the ethical policies of the firms they invest in can also impact on investment performance. A study undertaken by Morgan Stanley shows that sustainable funds provide both financial performance and lowered risk, as well as ways to invest responsibly.
The mechanism pension funds use to consider ethical investment is usually through their Environmental, Social and Governance (ESG) policies. Many have signed up to the UN Principles for Responsible Investment, which has more than 2,000 institutions with over US$82 trillion of assets as signatories. At the heart of the Principles and other frameworks is the commitment to integrate ESG factors into decision-making at all levels.
Many pension funds use a systemic approach such as the investment statement on the Just Transition, Climate WGBI and certification schemes. More than 20 UK-based institutions with nearly US$2 trillion in assets have signed the international investor statement on the Just Transition. The problem with these schemes is they are primarily about sharing best practice. There is little in the way of targets or other accountability measures.
One of the funds I have been working with had signed up to one of the certification schemes that companies can join. There is a legitimate criticism that some of these schemes are simply cash generators and require minimal hard action from the companies concerned - a nice plaque on the wall. I am also pretty sceptical about the growth in ‘Ethical’ funds, as only a tiny number of these funds screen out fossil fuel companies.
Pension fund trustees are reluctant to join divestment campaigns, sometimes because they are frightened off by advice (usually wrong) that this would be a breach of fiduciary duty. They are therefore more likely to want to focus on shareholder engagement.
Only the largest funds have the capacity to do this effectively themselves and rely heavily on agencies or their external investment managers. The quality of these varies considerably, with most adopting very conservative strategies, which are unlikely to be very effective. Most of the funds I have worked with believe their engagement strategies have been effective, but in practice, they struggle to support that belief with any meaningful data.
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| Share Action is one of the better agencies |
If pension funds are serious about responsible investment, they need something more than a glossy document and some fine statements of principle. Here is my outline seven-point plan:
1. The statement of investment principles needs to explicitly set out the pension fund position on key ESG issues including climate change, workforce issues and tax avoidance. Vague assurances that these issues will be considered is not enough.
2. Systemically assess the risks associated with their investments concerning ESG policies. This must include pooled investments.
3. Risk assessments should be published regularly along with regular communications to scheme members.
4. The annual report should include progress made by the fund in reaching their ESG objectives.
5. Publish an engagement policy which includes how voting of shares is handled, together with an annual assessment of how they have advanced the fund’s ESG principles.
6. Identify categories of investment that represent a significant long-term risk to the funds and consider the case for divestment in a way that ensures no damage to the fund and members pensions.
7. Set targets for positive, responsible investment in specific sectors, including low-carbon infrastructure, housing, and low emission transport.
Pension funds exist to provide pensions for members. However, surveys show that members want to see their pensions invested responsibly, especially when this can be done without damaging the fund. To achieve this, pension funds need to move from fine words towards effective systems for delivering responsible investment.