New collective defined contribution schemes are perfectly placed to embrace the long-term opportunities offered by ESG strategies, experts say.
With the rules now laid out and the first scheme — Royal Mail — expected to be launched imminently, attention is turning to scheme design, and in particular investment portfolios.
With environmental, social and governance factors now firmly at the centre of pension fund investment, many proponents of CDC believe that it is perfectly positioned to progress the responsible and sustainable investment cause to the benefit of members.
CDC has the ability to seek greater investment returns through investing in different types of assets and doing so over a significantly longer time horizon
Chintan Gandhi, Aon
The Pensions Regulator expects any CDC scheme to have documentation detailing the trustees’ policy on ESG risks and investments, as well as a specific policy on climate change, in line with rules for defined benefit and traditional defined contribution schemes.
‘A pivotal role’
Beyond the minimum regulatory requirements, however, CDC schemes could have “a pivotal role to play” in furthering ESG causes, according to WTW senior director Edd Collins.
CDC has “a big part to play in the productive finance conversation”, Collins says, such as mobilising investment into tangible assets like renewable energy generation.
“Pension schemes have historically had a big role to play in private sector investment. There’s potentially a concern with DB and DC schemes as they are today that this may not continue into the long term. CDC provides a big opportunity for that private sector investment to continue,” he adds.
These are early days for CDC, however.
The new scheme model is starting from scratch and has a multi-decade time horizon over which to invest, and so CDC arrangements “are going to be able to elicit change over the next several decades”, says Aon's head of CDC Chintan Gandhi.
Gandhi points out that the pooled risk qualities of CDC arrangements — combining investment and longevity risk of a large group of members — means schemes will be able to remain invested in growth-seeking assets such as public and private equities for longer, without a sudden need to divest to generate cash for retirement income.
“CDC has the ability to seek greater investment returns through investing in different types of assets and doing so over a significantly longer time horizon,” he explains, meaning the structure “aligns really naturally with investing in a sustainable, responsible and ESG-friendly way”.
Looking to the long term
The Pensions Policy Institute surveyed DB and DC schemes on ESG themes last year and found that DC schemes were often more advanced and engaged with sustainability issues.
As PPI senior policy researcher Lauren Wilkinson explains, many DB trustee boards “just didn’t think it was relevant for them” given their maturity profiles and income needs.
“For CDC schemes, because they have very long investment horizons but are coming at it from quite a fresh perspective, they could take the steps that DB schemes perhaps have been a little bit apprehensive to take because of the potential impact on the sponsoring employer if those investments don’t deliver,” Wilkinson says.
“The timeframe and the ability to pool risk means that investing in a sustainable way is incredibly relevant for CDC schemes,” says Aon senior investment consultant Joshua Tipper. Long-term risks such as climate change are an important consideration for trustee boards when establishing their approaches, he adds.
“Managing these risks and looking at the opportunities that the transition to a low-carbon economy creates is going to be, in our view, a key part of how you invest for CDC,” Tipper says.
“We expect a lot of CDC schemes will have targets of some kind, whether it’s net zero emissions, Paris Agreement alignment, or more broadly the UN Sustainable Development Goals.”
Membership priorities
Several surveys of millennial and Generation Z investors conducted across the UK, Europe and the US have shown these age groups to be significantly interested in ESG issues such as climate change and diversity and inclusion.
Membership demographics could play a significant role in how CDC schemes adopt ESG strategies. A younger scheme membership could “potentially be more engaged on these issues”, Wilkinson suggests.
“It’s a hard one to quantify at the moment because younger savers just aren’t engaged with pensions at all, but generally they are more interested in things like climate change and social issues,” she says.
“As we see them ageing up through the pensions system, we might see their views being taken more into account and having more power to influence investment strategies.”
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Crucial to this, however, is communication. Unlike CDC arrangements in other countries, the UK’s model gives members the option to opt out — meaning schemes must clearly communicate their benefits. This includes their ESG credentials, Wilkinson says.
“There is a massive communication challenge. If benefits have to be cut or indexation is reduced, the scheme will need to explain why it is invested in the way it has,” she explains.
“If it has backed some radical ESG projects, for example, it will need to be able to explain why it had a strong belief that those would deliver the returns expected.”
