Smaller pension schemes lack the governance, investment choice and concrete understanding required to properly engage with environmental, social and governance factors, according to the Pensions Policy Institute.
The findings come as a survey by RBC Global Asset Management found fewer than half of UK institutional investors regard the integration of ESG into investment strategies as part of their fiduciary duty, despite regulations coming into force in October next year requiring trustees to address all financially material risks in their statements of investment principles.
If the larger schemes encourage the market to adjust, the smaller schemes can then access it in a lower cost way without huge regulatory burden
Naomi L'Estrange, 2020 Trustees
The PPI’s ‘Past, Present and Future’ paper identifies confusion among trustees when it comes to ESG investment.
While there remains widespread support for ESG, the paper quotes the views of some trustees who regard it as “a distraction from the goal of delivering long-term returns” and “a wishy-washy, altruistic approach”.
Smaller schemes hamstrung on ESG
Where smaller schemes do want to consider the risks posed by factors such as climate change, poor governance or a negative social impact, the PPI found that they are less able to do so than larger peers.
Bigger schemes often have access to an internal investment manager, research and ESG ratings, which inform investment decisions, the paper observed.
Smaller schemes, on the other hand, are often forced into pooled funds, where it can be more difficult to assess the ESG qualities of their investments.
Chris Curry, director of the PPI, recognised the ESG difficulties faced by trustees of smaller schemes.
“It can be quite time-consuming and quite expensive for trustees to do it on their own behalf,” he said, observing that many smaller schemes “don’t have access to some of the larger services which are available to larger investors”.
“A lot of it is that people just don’t understand what ESG is, which probably isn’t helped by us referring to it as ESG,” he added.
Better data will justify ESG strategies
Nonetheless, evidence is mounting that members expect trustees to consider issues like climate change. The PPI cited Department for Work and Pensions figures identifying that 82 per cent of members ‘strongly agree’ their contributions should be responsibly invested.
Meanwhile, 74 per cent ‘strongly agree’ that schemes should engage with companies they invest in.
While members can approach issues from an ethical standpoint, regulation maintains that performance must guide trustees when making investment decisions. The DWP dropped a controversial proposal to consider members’ views in the final version of next year’s SIP requirements.
But to keep this focus on risk and return, trustees may need access to better data. According to Honor Fell, vice-president at consultancy Redington, schemes need data that will help them to quantify ESG-related performance, adding that it can be hard to identify where ESG has improved returns, except on a case-by-case basis.
“The evidence at a longer-term and a higher level is that you can take it into account and it won’t damage returns, but the evidence that it is additive to returns is... more mixed,” she said.
These mixed results have fuelled scepticism of ESG in some quarters, she added.
Regulation must lead the way
For Naomi L’Estrange, director at professional trustee company 2020 Trustees, “the law on taking these factors into account has been quite restrictive”, and “regulation is the only way” to promote the importance of ESG.
When member engagement should take a knee
From the blog: Pension schemes are under increasing pressure to invest responsibly. Alex Janiaud takes a look at a case where engagement may have gone too far.
“You have to be careful about the content of that regulation, that it isn’t too constraining, because the biggest impact will be made if the market adjusts,” she said.
“If the larger schemes encourage the market to adjust, the smaller schemes can then access it in a lower cost way without huge regulatory burden,” she argued, adding that “it just doesn’t make sense from any perspective to have the smaller schemes forced to incur cost in relation to this”.
