The pandemic has turned the attention of many, including pension funds, to social factors, but there are more challenging issues for trustees to address, writes Lauren Wilkinson, senior policy researcher at the Pensions Policy Institute.
Public attitudes on social issues are shifting and becoming increasingly important, as awareness and concern about inequality and injustice grows.
As schemes seek to better protect members against ESG risks, decision-makers will need to ensure they have sufficient understanding and flexibility to meet challenges in the rapidly evolving area of social risks
However, pension schemes are not necessarily monitoring public movements and shifts in opinion that may affect the financial positions of companies in which they are invested.
Sixty-one per cent of schemes in the Pensions Policy Institute’s ‘Engaging with environmental, social and governance survey’ said that social or environmental movements had not affected their investment strategy.
But nearly two-thirds (64 per cent) of Principles for Responsible Investment signatories surveyed in 2020 said that Covid-19 had highlighted new social issues.
Pandemic turns attention to social factors
The events of the past year appear to have begun a shift to greater consideration of social factors, albeit one that will require much development before it achieves the same levels of integration as climate change, which has been in heavy focus for some time.
Developments last year and in the early months of 2021 have emphasised how rapidly focus on social issues can evolve and come to the fore, underscoring the importance of schemes being both proactive and flexible in their approach to considering the financial implications of social issues, and ESG more broadly, in their investment strategies.
Social risk factors can have a substantial impact on the sustainability of supply chains and the value of shares held by investors, presenting a material financial risk to schemes that do not appropriately take account of these risks.
However, the broader range of issues that fall under the social area of ESG considerations, along with the qualitative nature of social metrics and lower levels of familiarity among scheme decision-makers, can make it complex to integrate social risks into investment strategies.
More than a quarter (28 per cent) of respondents to the PPI’s survey said that too much information had been a challenge when designing their ESG approach, while 22 per cent said that conflicting information had also been a challenge.
Difficulties associated with evaluating social risks and opportunities mean that developing an understanding of data around social factors, and how this relates to scheme investment decisions, is more challenging than for environmental and governance factors.
The challenge posed by social factors
While financial risk must be the main focus of pension schemes when integrating ESG factors into their investment strategies, the social investment sphere generally focuses not just on limiting potential damage but also creating social benefit.
This means that social factors can be more challenging to assess than environmental factors, which tend to focus on reducing harm, or governance, which tends to operate within existing legal or stewardship frameworks.
Considering historical confusion about the extent to which ESG factors are financially material and a perceived conflation between ESG and ethics, the nature of social factors might make some investment decision-makers more hesitant to engage where the financial materiality is less obvious than for environmental or governance factors.
These are challenges that schemes and those investing on their behalf will need to get to grips with if they are to protect members appropriately against the full range of ESG risks, including social factors.
Alongside external events and societal shifts, the government is working to broaden the ESG focus beyond climate change and exploring ways in which schemes can better integrate social risks into their investment strategies.
In March, the Department for Work and Pensions announced a consultation on ‘Consideration of social risks and opportunities by occupational pension schemes’, which highlights the need for the ESG investment landscape to expand from a specific focus on climate change to a broader approach.
As schemes seek to better protect members against ESG risks, decision-makers will need to ensure they have sufficient understanding and flexibility to meet challenges in the rapidly evolving area of social risks.
Lauren Wilkinson is a senior policy researcher at the Pensions Policy Institute
