ESG and stewardship factors are at the forefront of investors’ minds, with new regulation requiring additional disclosure on the trustees’ policy on a number of areas, including ESG and stewardship. Greater awareness of these factors is being raised more widely, particularly issues around climate change, where globally governmental policy is trying to manage this threat more strongly than it has in the past.

Historically, investment managers’ approach to ESG has been heavily focussed on risk management (protection of value) rather than impact investing (changing the future). Whilst the latter should, theoretically, enhance value over the longer term, due to these strategies being introduced fairly recently, data supporting it is limited. This creates a dilemma for trustees, who are trying to dually manage asset growth for members whilst supporting better ESG integration and are struggling to make a stark switch to impact funds when there is insufficient data to prove it has worked in practice. This is particularly difficult when investment managers already have a degree of ESG management built into their strategy, even if this is for risk mitigation purposes.

With pension schemes being a large asset owner globally, they have the ability to drive significant change, although we are yet to see a meaningful shift into “impact” targeting strategies. This could be because the market more generally and the availability of pooled solutions to facilitate this, especially in asset classes outside of equities. The asset management industry is recognising the need for products that specifically address these factors and therefore 2020 should hopefully see wider choice for trustees.

As awareness of ESG rises even further, the topic is likely to resonate more strongly with members of DC schemes, that have perhaps been less engaged with their investments in the past. This may lead to more demand from members for investments that align more closely with a “sustainable world” and trustees should be thinking about how they can reflect these within their pension scheme’s investment strategy. Trustees should also be mindful that whilst it is essential that members have the assets to support their retirement needs, the environment in which they retire is also of great importance.

The Department of Work and Pensions’ (DWP) consultation in 2018 on the use of illiquid assets within Occupational DC schemes intended to raise awareness of the opportunities that these assets offer and the possibility that DC pension schemes could benefit from them, given their long-term investment horizons.

However, the majority of trustees of DC schemes have not incorporated such assets into their investment strategies. With some of the challenges faced previously (such as complexity) being addressed, the inclusion of such investments should be given greater consideration, as investors continue to seek portfolio diversifiers. The use of such assets still has some difficulties, the largest perhaps being ensuring members are engaged and understand the nature (and potential illiquidity) of such investments. Nevertheless, these can be overcome. In 2020 we may find more trustees consider illiquid assets and their place within investment strategies.

Since the pension freedoms were introduced in 2015, there has been a marked switch from the purchase of annuities at retirement, which have become increasingly expensive, towards Uncrystallised Funds Pension Lump Sums and income drawdown. However, many pension schemes are yet to review the target retirement option of their default arrangement, and whether this is aligned with what members do/will do. Perhaps because they were unsure what the preferred retirement option would be in light of the pension freedoms.

After four years of retirement experience, since the flexibilities were introduced, trustees should have a better idea of the preferred option for the members of their pension scheme. This should enable them to design default strategies that are more consistent with the expected preferred retirement option for their scheme, where this has not been factored in already. Clearly, one size does not fit all, and so it will be key for trustees to determine their membership needs and preferences and ensure their strategy reflects this.

Member engagement is key when managing a DC scheme, enabling trustees to understand their membership and its beliefs better. Whilst this may be the driver of changes within investment strategy, trustees should also be considering change as part of their fiduciary duty to act in the best interest of members, which includes, but is not limited to, the areas discussed in this article. It will be interesting to see what changes 2020 will bring.

Jayna Bhullar, Investment Consultant, Quantum Advisory