Disinvesting on ESG grounds ‘often’ discussed at trustee meetings

Earlier in March, Pensions Expert conducted a Twitter poll surveying how often trustees discuss divesting from investments on ESG grounds at meetings. 

The majority (80 per cent) of respondents said that they did so frequently, while 26.7 per cent said they talked about it every meeting.

Just over half (53.3 per cent) said they discussed disinvesting from investments on ESG grounds “often”. 

Trustee boards typically don’t operate an explicit standalone divestment or exclusion policy, and there are many good reasons for that

Lorant Porkolab, Law Debenture

A small minority (6.7 per cent) said they have never had such a conversation, while just more than one in 10 (13.3 per cent) said they “sometimes” talk divesting during trustee meetings. 

The fact divestment is being discussed more frequently should come as no surprise, as pension schemes are under pressure to increasingly consider ESG factors as part of investment decisions.

Discussing divestment, however, does not necessarily lead to action. 

In Wayne Phelan’s experience as chief executive of Punter Southall Governance Services, most trustee boards now consider ESG at each meeting, but “it is rare for pension scheme investments to manifestly fail on all three elements of ESG to warrant immediate disposal”. 

There are exceptions. A sudden geopolitical shift, like the invasion of Ukraine, can cause swift action from trustees and asset managers to change a fund’s portfolio. 

Some of the UK’s most prominent pension schemes, including Nest, the Church of England Pension Fund, the Universities Superannuation Scheme and Local Government Pension Scheme funds,have been freezing or seeking to cut their investments in Russia since troops set foot in Ukraine in February.

The pragmatics of divestment

There is also a practical barrier scheme trustees interested in divestment could run into, Phelan says. 

Only segregated mandates grant trustees autonomy to decide on exclusions and divestments, and these are often the preserve of the largest schemes and fund management providers. Most trustees are therefore only able to select funds based on exclusions. 

Law Debenture director Lorant Porkolab says discussions on divestment tend to form part of wider debates about ESG factors at trustee meetings. 

“Trustee boards typically don’t operate an explicit standalone divestment or exclusion policy, and there are many good reasons for that,” he says, adding that divesting purely on ESG grounds in isolation may result in suboptimal outcomes. 

“It requires a careful approach if it is part of the trustees’ wider consideration at all. These decisions should be fully consistent with the trustees’ overriding investment objectives and fiduciary obligations to members,” he notes. 

According to Porkolab, trustees must also engage with their investment advisers and relevant asset managers and consider the existing market conditions, valuation of the underlying assets, cost and timing of the transactions, cash flow implications and reinvestment options. 

To proceed with divestment, all of these have to be considered alongside other investment and cash flow activities of the scheme.

“If there are several divestments and the overall allocation to the underlying assets is material, the trustees also need to consider if their portfolio requires an appropriate rebalancing,” Porkolab adds. 

To divest or not to divest

Divesting is only one option open to schemes and managers hoping to make their portfolio more ESG friendly. This means it is often not seen as the most favourable choice.

Pension schemes can instead choose to actively engage with companies to influence them to become more sustainable, socially conscious, and so on. 

“Engaging, voting — where you hold those rights — and influencing are much more effective tools than divesting. Divesting should be pursued only once engagement has failed,” Phelan says.

Maria Nazarova-Doyle, head of pension investment and responsible investment at Scottish Widows, agrees. She notes: “Staying invested and using shareholder rights to promote positive change is a very strong tool to protect and enhance value for our customers. We always prefer engagement to divestment.” 

However, there are exceptions to that rule. “There are types of business or industries where opportunities for successful engagement are very limited or non-existent, such as controversial weapons, so that’s where exclusions can play a role,” she explains.

Exclusions powerful when combined with engagement

For some, divestment can be most effective when part of a wider strategy and this does not mean choosing between exclusion and engagement. 

Veronica Humble, head of DC investment solutions at Legal & General Investment Management, says exclusions can be a powerful tool when combined with engagement and voting. 

“Under LGIM’s climate impact pledge, we apply voting and investment sanctions for companies that do not meet our minimum standards. At the 2021 annual meeting season, through voting we sanctioned 130 companies that fell short of our minimum standards,” she says. 

The stringency of LGIM’s standards and sanctions increase over time, with the possibility of divestment for persistent offenders. 

“If companies do not meet the minimum standards we have set out, engagement may translate into firm-wide voting sanctions and exclusions,” Humble continues, adding that in 2021 the company kept nine firms on its sanction list from previous years, while adding four more.