Trustees still conflicted between fiduciary duties and ESG goals

A recent Twitter poll conducted by Pensions Expert reveals that pension funds’ growing green investment agendas are perceived, by some, as conflicting with the fiduciary responsibility to deliver returns to investors.

The poll found that 60 per cent of respondents had witnessed opposition to sustainability in trustee meetings. 

Talking about sustainability as an end in itself would rightly get short shrift

Paul Lee, Redington

Push back to be expected

It is inevitable there will be some opposition to sustainable investments because of the inherent conflict between two competing strands — the compatibility of ESG-friendly investments with trustees’ fiduciary responsibilities to deliver investment performance. 

XPS found one in 10 trustees oppose addressing climate change risk in their scheme’s investment strategy.

There can also be opposing views on dealing with legacy investments in pension funds. “Members might call for a ban on fossil fuel investments, while advisers might engage with fossil fuel companies to encourage them to transform their business,” says Tegs Harding, director at Independent Trustee Services. 

But in Harding’s experience, the biggest barrier is “not putting it on the agenda in the first place”. 

“It is not surprising that 60 per cent of respondents said they had seen some opposition to sustainability in trustee meetings,” Harding continues. Trustees must consider investment decisions against the backdrop of climate risks that “by definition have not yet emerged”.

This means there is not a consistent and reliable data set on which to base decisions and governance procedures. “Given these demands, we can expect some push back,” Harding adds.

Opposition can come from consultants’ efforts to explain the issues and solutions, and how these can be implemented effectively; for instance, whether green gilts really are green and whether they are worth the asking price.

“Some trustees still think sustainability is for environmental campaigners, at the expense of investment performance,” says Wayne Phelan, chief executive of Punter Southall Governance Services. 

But this view is waning as arguments for unsustainable underperformance gain more prominence. Greenwashing practices still exist and breed scepticism.

Infrastructure investments into renewable energy are most commonly illiquid, meaning that assets are tied up for five years or more. Defined contribution schemes need to provide daily liquidity for pension obligations, yet many green investments invest in illiquid funds. 

This illiquidity can be in direct conflict with scheme end dates when investments need to have performed well enough to meet pension payouts. This is perhaps the biggest cause of opposition, Phelan suggests.

“It is strange to think that as defined benefit pension schemes become mature and better funded, trustees don’t want to tie up assets into illiquid investments. This is increasingly a discussion point for trustees,” he says.

Consultants also recognise the challenges fiduciaries face. “They are charged with looking after money for others,” comments Paul Lee, head of stewardship and sustainable investment strategy at Redington. 

He believes consultants must frame sustainability within the context of broader investment strategies and the ability to deliver positive, risk-adjusted investment returns. 

“Talking about sustainability as an end in itself would rightly get short shrift,” he adds.

Sustainable investments vs fiduciary responsibility

Trustees must prioritise member outcomes, which means evaluating their investments’ risk and reward merits. 

“The majority now conclude climate risks pose a material financial risk to parts of their portfolio,” says Harding. But even for trustees that have set specific sustainability objectives, it can be complicated.

Investors have been willing to pay a premium for green bonds if the issuer claims proceeds will be spent on green projects. 

A trustee may want to invest to meet sustainability objectives, but it might not be justifiable if returns are unattractive. In practice, this can result in a compromise, with mandates only investing in green bonds when there is value in doing so.

“There are long-term risk factors that affect investments over the time horizons required for pension investments,” says Lee. The reason ESG issues and green investments have been ignored by investors is that fund managers have a shorter-term time horizon than their clients. 

“The scale of the financial impact can be unknowable — for instance, major oil leaks or flooding events — meaning these issues are very difficult to build into traditional investment models.”

Resolving concerns  

To resolve the conflict between incorporating green investments into pension funds and safeguarding returns is a challenge and can come down to a choice between responsible investing and ensuring optimal returns.

“ESG investments aren’t compatible with short-term objectives to secure members benefits with an insurer due to their illiquid nature,” notes Phelan.  

“Until trustees can be 100 per cent confident that an insurer will take an illiquid asset at full value for an insurance buyout transaction, I’m not sure this tension can be resolved.”

There are practical barriers to switching investments and governance can be a barrier. Creating an investment policy is complex and involves setting targets, prioritising actions and agreeing and implementing a business plan.

 “The only way these concerns can be resolved is by taking the time to properly understand the issues and their potential solutions, asset class by asset class,” adds Harding.