Scarcely a week passes without an announcement of a new environmental, social and governance-oriented venture. But experts warn more needs to be done if onlookers are to be confident that words have meaning.
During December, Pensions Expert reported on Phoenix Group launching a new default solution, a bid by Legal & General to halve its carbon emissions by 2030, the founding of the Net Zero Asset Managers Initiative, and a new ESG-focused emerging markets-tilting strategy unveiled by Nest.
In November, the Defined Contribution Investment Forum launched a new report, which showed that 17 of the 18 master trusts surveyed had some level of ESG integration in their default funds. However, the precise form of this integration ranged from simple ESG tilts in the growth phase of equity allocation and allocations to “green” fixed income, to more complex-sounding strategies.
One of the key barriers to doing this well and avoiding greenwashing is the lack of standards. We need a global standard for applying ESG
Tony Burdon, Make My Money Matter
Amanda Latham, policy and strategy lead at Barnett Waddingham and chair of the Investment Consultants Sustainability Working Group, told Pensions Expert that this was encouraging, but in future master trusts would have to do more than have a percentage of their default funds allocated to ESG.
“Trustees of master trusts will need to understand and assess how their scheme is contributing to climate change, how exposed it is to climate risks, and make decisions based on these considerations. They will need to calculate the ‘carbon footprint’ of their pension scheme,” she said.
“Achieving net-zero by 2050 is already law in the UK, so now is an opportunity for those running master trusts to get a head start managing the risks stemming from climate change, as well as taking advantage of the opportunities coming from the transition to a low-carbon economy.”
Fears of ‘greenwashing’ assuaged?
XPS Pensions’ National Pension Trust was the only master trust listed in the DCIF report that did not integrate ESG into its default fund, though the report noted that such integration was under consideration.
Paul Armitage, head of the scheme, told Pensions Expert that these considerations had been under way for some time.
“At the previous review of the investment design, we took a conscious decision to incorporate a strong stewardship approach to ESG. This approach reflected our concerns about potential ‘greenwashing’ in the investment industry and recognised the challenges and cost barriers to providing improved member outcomes at an acceptable price, which is our primary fiduciary responsibility,” he explained.
Since then, member awareness of and appetite for ESG, most especially measures to combat climate change, has dramatically increased, Mr Armitage continued.
“We are now confident that solutions are available and can be accessed at an acceptable price. We therefore intend to strengthen our focus on ESG in our current review of default fund design beyond strong stewardship. The changes to the NPT strategy are expected to be launched for members in the second quarter of 2021.”
Concerns remain
However, issues arising from the lack of standardised ESG measurements and ratings are still present. This is especially true in passive approaches, like those adopted by default funds and the types of data they tend to use.
“At present, there is a fragmented and highly varied approach to measuring ESG,” said Neil Brown, chief risk officer of Earth Capital.
“There is only around 60 per cent correlation between the range of ratings approaches that are widely used, compared with 99 per cent for different credit ratings providers.”
The problem is acute in passive products, which “tend to rely heavily on limited and incomplete approaches that focus on carbon footprints, rather than a wider and more meaningful understanding of ESG”, he said.
Pensions Expert has reported previously on a study by Research Affiliates, which showed that Wells Fargo had been ranked in the top quartile by one ESG ratings provider, and in the bottom 5 per cent by a second provider.
Mr Brown noted that there needs to be a more “holistic understanding” of ESG criteria that considers “the full supply chain and genuinely incorporates all three aspects of ESG”.
It is something with which Tony Burdon, chief executive of the campaign group Make My Money Matter, agrees.
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Arguing that the future should be one in which the entirety of a pension portfolio is invested in ESG by default, Mr Burdon said: “One of the key barriers to doing this well and avoiding greenwashing is the lack of standards. We need a global standard for applying ESG — [at present] it is variably applied to different standards and thus hard to compare funds.”
He added that, given ESG is still “nascent” in the DC space, and due to the low fees and profit margins attainable, it is likely that better ESG solutions will “evolve elsewhere and migrate into the DC arena over time”.
Tim Orton, managing director of investment solutions at Aegon, acknowledged that the lack of standardisation poses a challenge to the industry. He argued that it cannot be resolved by individual providers but instead requires “a concerted effort by regulators, fund managers and providers driven by consumer demand”.
