Granted, in the past few years, support for ESG has begun to wane among some investors, particularly since Donald Trump’s re-election as US president late last year. In the first quarter of this year, Europeans became net sellers of ESG funds for the first time since 2018. However, that was after successive years of massive inflows.
Meanwhile, the world’s biggest pension fund, Japan’s $1.8 trillion Government Pension Investment Fund (GPIF), is considering a shift to impact investing, reports Bloomberg. Other large Japanese pension funds are expected to follow suit.
UK-based pension funds are also strongly committed to ESG. More than four-fifths (84 per cent) of pension professionals have expressed strong support for incorporating ESG factors into scheme investments, despite concerns about the availability of credible data, according to a recent poll by the Society of Pension Professionals (SPP).
This has important implications for trustees of all pension funds. The decisions we make in the ESG space are increasingly consequential. If you are the trustee of a small or medium-sized pension scheme, there are, we believe, three key considerations to take on board to navigate the risk-benefit balance of ESG investing.
1. Choose Managers Who Specialise in Your Kind of Scheme
When it comes to ESG, doing something very bespoke can often end up costing far more than the actual benefits it brings. But that doesn’t mean that we can ignore or sideline these issues. Even if you are not that interested in ESG per se, you still need to make sure you’re meeting all the regulatory requirements.
Ultimately, all trustees are exposed to some degree of regulatory risks in this area. They include (in no particular order):
- Non-compliance.
- Sponsors and members being dissatisfied with what you are doing.
- Making investments that expose the scheme to political downsides and other ESG risks.
- Counter risks – that is, you don’t know exactly what you are doing and as a result make poor ESG investment decisions.
If, on the other hand, you are really enthusiastic about ESG issues, you need to be wary of over-expending time, effort and money on them. This is ultimately about scaling your commitments appropriately to the size of your scheme, and the particular risks and opportunities relevant to it. If you’re dedicating, say, £20,000 of annual resource to ESG issues for a portfolio with total funds of £1 million, that’s the equivalent of 20 bps. For all but those highest exposed to ESG risks and that would be too much.
One of the best ways of navigating the balance between costs, risks and benefits is to ensure that you are working with advisors and managers who specialise in schemes of your size and particular situation. When choosing which approach to adopt, be clear about what you want to achieve, and make sure your manager is on board with it.
2. Do Not Underestimate the Potential Repercussions of Your ESG Choices
There are many possible approaches to ESG investing, all of which carry their fair share of risks and benefits. They include:
- Excluding companies with high exposure to ESG risks.
- Buying stocks from companies that are more resilient to ESG risks, such as those that have lower exposure to risks and/or are good at managing those risks.
- Investing in companies linked to a sustainability theme, for example clean water or energy transition.
Alternatively, investors who wish to take a less active approach could instead turn to funds with credible ESG approaches that align with their priorities.
Whatever choices you end up making will involve costs. In some cases, those costs can be onerous. Trustees who are particularly motivated by environmental issues may, for instance, be tempted to remove all of their fund’s exposure to fossil fuels. However well intentioned, the financial impact of such a move could be significant since it would mean cutting off their pension scheme from a large part of the economy – even to some companies who may lead the market in renewables too.
3. Think Carefully About What You Should (And Shouldn’t) Be Doing
It’s important for trustees to realise that we don’t have an infinitely fine scalpel with which to set ESG policy. Ultimately, you have to select the investment products that best align with your particular strategy and goals.
Here are eight questions you may want to ask yourselves to help form a clearer idea of what you want to achieve and the various risks and benefits that may entail:
- What do I ultimately want to achieve with my ESG policy? Is it minimum compliance, maximum impact, or somewhere in between?
- How much value can I add through my ESG policy?
- What additional costs can I expect to bear?
- What are the biggest risks I might face?
- What is the financial value of those risks?
- What is the non-financial value of those risks?
- Which measures can I take to mitigate those risks and lever potential upsides?
As we noted in a previous post, investors need to give serious consideration to what their main priorities are before making their ESG investment decisions. That need not entail going through the particulars of each company with a fine-tooth comb, but rather being able to provide clear pointers to those managing the investments. This is why it is key to hire an adviser who is experienced in dealing with clients that have a similar profile to yours.
Yona Chesner, Head of Investment – Cartwright
