Pension trustees walk something of a tightrope these days, having to balance maximum short-term returns with being mindful of long-term factors that might affect future performance.
Because of this pressure to perform today, environmental, social and corporate governance considerations are often overlooked.
That is why it is important that the Department for Work and Pensions is looking to expand the scope of the statement of investment principles.
Trustees are often confused about what ESG actually means, while others believe it is a distraction
The proposals aim to make it clear that ESG risks are among the financial risks trustees should take into account when making investment decisions, something that does not always happen.
Trustees still confused on ESG
As far back as 2012, the Kay Review of UK equity markets and long-term decision-making flagged concerns that trustees were focused on maximising short-term returns, while overlooking long-term factors that may affect performance. These include ESG issues, such as climate change.
Even now, ESG issues take a back seat when it comes to investment decisions. In its consultation the DWP flagged evidence that trustees wrongly think ESG are ‘irrelevant, or run counter to, financially material concerns’.
Trustees are often confused about what ESG actually means, while others believe it is a distraction or even potentially detrimental to returns.
As part of its consultation, the DWP has proposed new rules to ensure trustees set out in a statement of investment principles to what extent they will take members’ concerns into account regarding ESG and the scheme’s investment approach more generally.
Broadly speaking, we agree with the proposals, although there are some things we would like to see clarified and expanded upon.
Key questions need answering
For the policy intent to be achieved, we feel there needs to be clear guidance on how trustees are expected to fulfil the need to take into account members’ concerns. For example, what does appropriate engagement with members look like? And under what circumstances should this be reflected in the investment strategy?
We also think a distinction could be made between defined benefit and defined contribution schemes. In DC schemes, for example, there is typically more perceived individual ownership over pension assets and potentially higher levels of member engagement. In addition, there are lower proportions of deferred members and pensioners.
Crucially, it is also not possible within a DB fund for a member to make an individual investment choice in order to take account of non-financial matters that they may consider important.
The distinction between DB and DC, we feel, is an important one to make. Within DC, the rules also need to differentiate between default strategy and self-select options.
Separate stewardship
The DWP also proposed that trustees should include their policy in relation to the stewardship of investments – including monitoring, engagement and voting – in their statement of investment principles.
We think it is a good idea to split out these three activities. This makes it clear that stewardship is an important element of responsible investment and that it extends beyond equity and into asset classes such as fixed income, which do not confer voting rights but still need to be monitored carefully.
Overall, we believe the proposals, should they become rules, will place ESG at the heart of the investment process, which is to be welcomed.
Lydia Fearn is head of DC and financial wellbeing at investment consultancy Redington
