The HSBC Bank UK Pension Scheme has selected a multi-factor fund with a tilt towards low-carbon businesses as the equity component of its default offering, a switch that will see £1.85bn of defined contribution savers' money invested in line with green principles.
Environmental, social and governance factors have moved up the trustee agenda recently. The UN’s Paris Agreement came into force last week, and the Pensions Regulator’s DC guides now demand consideration of the risks relating to ESG practices.
But default funds that include ESG as a factor – such as the scheme's Future World Fund, built in collaboration with HSBC by Legal & General Investment Management – are more seldom seen. Chancellor Philip Hammond called the product “groundbreaking”.
Consideration of a wide range of ESG issues in an investment process will help to mitigate risk and enhance potential return
Fergus Moffatt, UKSIF
Despite its commitment to reducing the carbon footprint of its investments, HSBC said better risk-adjusted returns were still the overarching consideration when selecting its default fund.
The £2.59bn pension fund’s default option provides for 90 per cent of its members and about 70 per cent of its value. It holds 100 per cent of members’ assets in passive global equities until 20 years from retirement.
Returns still key
An LGIM survey of savers found that while most expressed a desire to support responsible companies through their investments, 33 per cent of respondents were not even prepared to sacrifice 1 per cent of annual returns.
As such the Future World Fund is based on a multi-factor smart beta strategy, weighted towards value, low volatility, quality and low size.
“The key is to get this into a mainstream fund,” said Mark Thompson, chief investment officer at the HSBC scheme. “If this was an out and out green fund, [assets under management] would be down in the 14 millions.”
The fund will dramatically reduce its exposure to energy companies involved in coal mining, with less severe weight reductions for oil and gas.
Weighting will be further tilted towards companies with low emissions compared with their sector, and those who can demonstrate revenues that are related to environmentally friendly practices.
The strategy also includes a tracking area budget of 30 basis points for divestment from companies that consistently disappoint on ESG issues, while manager LGIM has pledged to use its shareholder vote to enhance corporate responsibility across its funds.
Hugh Nolan, independent trustee at Dalriada Trustees and president of the Society of Pension Professionals, said the risk of unethical companies suffering severe penalties justified this.
"Whenever people get caught up with not having done the right thing at the right time, you're judged by the standards of the future," he said.
He said ethical funds are unlikely to perform worse than other offerings, and might well deliver an upside surprise.
However, he tempered his praise of the new fund, adding that the transaction costs associated with switching the default, which are ultimately paid by members, might see other trustee boards become hesitant to follow suit unless they can be certain of enhanced performance.
Selecting sustainable managers
Asset manager engagement with ESG factors appears to be on the increase. On Monday, Natixis Asset Management and 17 other institutional investors demanded an unlimited moratorium on oil and gas activity in the Arctic high seas, citing the threat posed to the environment.
As a result, the industry has seen a growing number of sustainable products, which can vary in quality, according to Honor Fell, manager research associate at consultancy Redington.
“We’ve got to sit here as a manager research team and work out who’s just jumped on the bandwagon and done a quick job,” she said.
Fell, who advised the HSBC trustees on their investment, praised LGIM’s combination of several responsible measures with a smart beta framework, and warned schemes to avoid basic products. “Just blunt downweighting of high carbon is a little bit simplistic,” she said.
How can you see through 'greenwashing'?
Socially responsible investment has grown in popularity in recent years, filling up column inches in the industry press and sections of annual reports, where schemes and asset managers outline their philosophies and approaches.
If schemes are to navigate the widening array of products available, they will have to ensure they gain insight into their managers’ decision-making processes, according to Fergus Moffatt, programme director and head of public policy at the UK Sustainable Investment and Finance Association.
“Ask the manager what they consider to be financially material issues and how they will identify new issues and changes. Looking at the answers to these questions will give an indication of where the fund manager is on these issues and how well resourced,” he said.
He echoed Nolan’s assertion that responsible investing can be financially material to schemes. “Consideration of a wide range of ESG issues in an investment process will help to mitigate risk and enhance potential return.”
