What role does ESG play in default fund design?

Paul Todd

We incorporate ESG into our default strategy because it is good investment practice. There is a load of data about how companies or different asset classes will perform that is provided by ESG data providers.

As a trustee, why would you ignore data that give you more information about likely risk and return?

Therefore, with our approach to ESG the only reason why we are ever considering these factors is that in lots of asset classes, in certain times in certain places, it improves risk-adjusted return. There is no member consideration.

Lydia Fearn

There was a scheme that did a research piece and asked their members whether, if they created an ESG lifestyle or strategy, they would invest in it. Over half said yes. They then created it and actually no one went in it.

We talk about inertia, but I talk a lot about barriers to making change for a member. It is actually quite hard for members to make a different investment choice, or even feel confident to, so the default really is where we need to think about how ESG works.

We incorporate ESG into our default strategy because it is good investment practice

Paul Todd, Nest

Keith Stephenson

That survey points to the default funds needing to move in the ESG line to be in line with investor choice.

I fully support the logical investment arguments that a company that does not pay its staff well, pays its executives too much, does not split its chief executive and chairman and makes products that deliberately kill people – in the case of tobacco – are not good investments in the long run.

Todd

We did a statistical analysis of ESG, and it does lower volatility. Not all ESG factors do, but there are definitely certain things that have a real impact on risk. It is things like how companies manage their environmental impact – very specific things about environmental audits and how well the organisation is set up to manage externalities.

Corporate governance was incredibly important. A lot of it is pretty obvious; it is well put-together companies that have a strategic outlook and look to the long term that, on the whole, seem to perform better on most metrics.

Stephenson

From the employer’s point of view and from my colleagues’ point of view, as members of the scheme, all of what you just touched upon are rather esoteric arguments, or debates, that we are just not ready to grapple with yet. But the danger is, if we do not, we will suddenly discover that the pension scheme was invested in something that we would really rather not.

Fearn

We are trying to talk more about ESG. This is about defined benefit and defined contribution. DC feels a bit easier to talk about than DB. Unfortunately, the data just are not there at the moment. You can talk about corporate governance, and I completely agree that then should help to create a better, sustainable, future company, but the data are just not quite there.

Therefore, in terms of getting an ESG score for a company, it has to be a qualitative view, and unfortunately that then brings up fees.

Pensions Expert

What are the main challenges facing default fund providers?

Fearn

A challenge is getting more of the DB-type asset classes into DC in order to improve the diversification and really get ready for this potential volatility that we might hit next year. We all kind of feel that it is coming. Everyone keeps saying we cannot carry on the way we are. It is a low interest rate environment; it will change and next year will be quite a tricky time for the UK.

It will be interesting to see how the default strategies out there stack up against it. We have seen defaults being put against the performance perspective; that is quite a simplistic way to look at it.

It is not just about the performance, it is about the experience over different market cycles and over a short time frame that is not very helpful, and which direction we see that moving in.

A challenge is getting more of the DB-type asset classes into DC

Lydia Fearn, Redington

Stephenson

We should make people aware that the past five or 10 years of this bull market of gently rising values may not go on forever, and if it does not then do not panic. We need to make people aware so that if it does happen and the volatility hits, then it is manageable.

Todd

I think market conditions over the next few years are going to be quite challenging.

The asset management industry is thinking a lot harder about how to develop products that meet the specific needs of DC schemes. As that is going to be the growth area there needs to be a lot more focus on how you access illiquids.

There needs to be a big focus on being able to diversify away from more traditional asset classes but being able to access that at the right price, within the operational differences between DC and DB.