Schemes to pay more attention to social factors in ESG strategies

Until recently, however, the social factors in ESG considerations have received less attention when compared with concerns around environmental and governance issues.

This is partly down to the issue of measurement. While you can, for instance, measure a company’s carbon emissions for the ‘E’, or their corporate governance codes for the ‘G’, the ‘S’ element of ESG has historically been more complex to track beyond some narrow points around a living wage and compliance.

It does seem, however, that this issue is being addressed. For instance, the government now appears to be taking a leading role in driving greater consensus about what constitutes social factors, and how risks and opportunities associated with them can be managed.

There is wider recognition of the positive role social impact investing can play for investors to achieve both a financial and social impact return, and it is likely to play an increasingly important role in helping communities with the post-Covid recovery

In March, the Department for Work and Pensions issued a call for evidence on pension schemes’ approaches to social factors.

This exercise could result in policy changes that will affect how pension trustees meet their legal obligations. 

Incorporating social factors can drive up returns

There are a variety of ways that pension trustees can consider social factors in their investment approaches.

One obvious method is screening, whereby investors simply exclude particular companies or investment in particular areas that are considered to have a poor track record on social issues — for example, companies that have poor policies around the treatment of workers in their supply chains.

Other pension schemes and fund managers will have the desire to take the positive social impact their capital — the ‘S’ — one step further.

This is where social impact investing comes in. Rather than avoiding doing harm by screening out companies that have a negative impact on society, social impact investing works by targeting and supporting organisations that are dedicated to delivering a measured, deep and lasting positive social impact, while providing financial returns.

By engaging in this approach, it demonstrates that a pension scheme has a willingness to consider really tough and entrenched social issues, and back organisations that have a long-term commitment to social impact at their heart.

There are some pension trustees who may have reservations as to whether social impact investing is compatible with their fiduciary duty to act in the best financial interests of their scheme members.

On this, however, we are seeing increasing alignment between the two objectives.

While delivering returns to pension scheme beneficiaries should naturally remain the priority for trustees, there is increasing evidence to suggest that incorporating social factors in their investments delivers better returns in the long term.

Moreover, social impact investment can make up an important part of a portfolio by providing diversification from many mainstream investments, since they typically rely on different sources of value and will not always move in line with other investment markets.

Many social impact investments have inflation-proof income streams, such as social housing funds that rely on local housing allowance from local government. What is more, demand for these types of services is only set to increase in the wake of Covid-19.

Social impact investment increases sixfold

We are already seeing evidence of pension funds recognising the benefits of social impact investment.

For example, Local Government Pension Schemes including Merseyside Pension Fund and the Greater Manchester Pension Fund have invested in Bridges Fund Management’s Social Outcomes Funds, which support government-commissioned outcomes contracts in providing services to help those in need.

These services include family therapy to children on the edge of care, helping people to manage long-term health conditions via social prescribing and supporting young people at risk of homelessness.

To date, these funds have helped more than 25,000 beneficiaries around the UK, while also delivering a return to its investors.

The social impact investment market is now significant and growing fast, with social impact investing in the UK increasing sixfold over the past eight years.

It covers a wide range of asset classes, including social housing funds, venture and equity investing, charity bonds and social outcomes contracts.

As we have seen how considerations over societal impact have gradually become part of mainstream finance, we are seeing more institutional investors, including pension schemes, become interested in social impact investing.

There is now a wider recognition of the positive role it can play for investors to achieve both a financial and social impact return, and it is likely to play an increasingly important role in helping communities with the post-Covid recovery and the ‘build back better’ agenda.

Stephen Muers is interim chief executive at Big Society Capital