Investing to improve the world we live in

Laura Stewart-Smith explains how providers and pension schemes can keep members aware and engaged with ESG investing.

Investing responsibly, and the need for investors to consider how a company behaves in environmental and societal terms, has been propelled into the limelight in recent years. The Covid-19 crisis will not be a reason for investors to pull back from this area.

On the contrary, we believe strongly that if anything, the pandemic will place an even bigger emphasis on how companies behave, and the firms that people’s retirement savings are invested in. Since the outbreak of the pandemic in 2020, greater attention has been paid to how companies treat their staff and their customers, and the reputational risk that this can bring. Covid-19 has also raised serious questions about firms’ supply chains, their approach to diversity, and their policy on sustainability in general.

Continuing to rebuild the economy and people’s livelihoods is going to require us all to pull together and help one another. The pensions industry can play a crucial role here given its objective to help people achieve financial ‘peace of mind’ in retirement.

This is supported by regulation introduced in 2019 that requires occupational pension schemes to have a Stewardship policy and to show their voting record. In our opinion, pension providers should grasp this opportunity to demonstrate to customers that they really do care about the world that future generations will inherit.

Auto enrolment – millions of people in UK are shareholders in businesses around the world

Workplace pensions have the potential to be real drivers of positive change in the environmental, social and governance (ESG) space for several reasons. The most obvious is auto enrolment and the fact that millions of people in the UK of working age became shareholders – almost overnight - in the businesses held in their employer’s pension scheme.

The second reason is the length of time people pay into their pensions – up to 30 or 40 years in some cases, or four decades, and so time for positive change to take place, not only at a company level, but more importantly at an industry level, such as the transition to a carbon-free world.

Responsible investment in default funds and self-select funds

The fact that default investment solutions tend to be well-diversified, and all-encompassing, in terms of the assets they use to grow people’s pension savings and then to preserve capital in the years leading up to retirement, is another important point.

Default funds invest in traditional asset classes, UK and international equities and bonds, as well as alternative asset classes, such as real estate and commodities, to provide customers with the benefits of diversification and to manage risk throughout the retirement journey.

ESG investing is not just the domain of equity investors. Many asset managers are realising that the expertise and the relationships built up by equity analyst teams can be leveraged by fixed income and real asset investment teams, which also have the ability to support long-term change and opportunities to shape the future of our world.

Default investment solutions are often made up of passive investment funds, and again we do not believe that this should be an obstacle to the integration of a responsible investment approach.

The investment manager of a passive or index fund is still a shareholder in the businesses held in the portfolio, providing an opportunity for the pension scheme to have a structured engagement policy and to vote on company resolutions. Index funds can also exclude companies and sectors based on their overall ESG characteristics or 'tilt' the funds away from poor ESG performers or some specific sectors such as coal.

Or pension providers could go one step further and offer a dedicated Ethical and ESG default solution which invest in actively managed funds, to to align their investments with their beliefs at each step of their retirement journey.

Self-select funds to integrate responsible investment

As well as the default solution, advisers and trustees are paying greater attention to self-select funds and how well they integrate ESG factors into their investment process. This puts the onus on pension providers and trustees to include responsible investment as one of their selection and governance criteria and then as part of their regular governance.

Regulator and pension scheme members force greater spotlight on ESG investing

The regulator and members themselves are on the other side of this dynamic, acting as a powerful pull for pension schemes to pay greater attention to the companies and sectors in which they invest. 

With the introduction of TCFD reporting for defined contribution occupational pension schemes where they are required to disclose how exposed they are to climate change and set out a strategy for how they will manage their exposure to this theme and its risks. 

This is the latest in a series of measures over the past couple of years by the DWP to improve pension trustees’ duties on environmental, social and governance (ESG) issues. Regulations for schemes to publish their Statement of Investment Principles (SIPs) on a public website by October 2020 were put to parliament in June last year. 

Trustees are now required to annually produce an Implementation Statement that provides evidence that they continue to follow and act on the principles outlined in their Statement of Investment Principles (SIP), which will most likely include how they take into account and manage financially material risks, including ESG factors, within their investment strategy. As part of this they can request from their fund managers evidence and examples of the voting and engagement activity undertaken by the fund manager on their behalf and which will be across the E, S and G.

As mentioned earlier, schemes are now required to contain a statement on their Stewardship policy and voting behaviour. Speaking about this move in June 2019, pensions minister Guy Opperman said [1]Footnote 1: ‘People are talking about ESG – the response to the initial consultation and engagement has been transformational.’

A survey [2]Footnote 2 by the Defined Contribution Investment Forum supports the point that more people are asking questions about the world they live in and want to help bring about change. It found that 66% of respondents were more worried about the state of the world and felt personally responsible for making a difference, compared to 59% only two years ago. 

Aviva has set an ambition to be net zero by 2040, 10 years ahead of the Paris agreement target - this ambition includes the investments under control, such as its defaults. As part of that it plans to invest £5 billion into low carbon equities and climate transition strategies across its default funds over the next 18 months and will look to increase this level of investment after that.

Aviva has also called on the Government to pass a law requiring auto-enrolment default pension funds to achieve net-zero carbon emissions status by 2050 to help to address the challenge of climate change. 

Strength in numbers

The real challenge for schemes is to reach out to their members and to turn complicated investment speak into clear and enjoyable communications about what investing responsibly means, and why as a company they are passionate about reducing the risks posed to the environment or to society. 

Specific engagement examples could be included to illustrate this, such as how discussions with a company’s management team have led to a business ending its financing of coal-fired plants, how increased investment is making a difference to a firm’s ability to make vaccines and treatments more accessible to people around the world, or how engagement has resulted in increased female representation on a firm’s board, and how this will benefit the business. 

If such communications are done in a lively and informative way, in which members feel engaged, investing responsibly could trigger greater interest from scheme members in timely ESG themes. 

The adage ‘strength in numbers’ applies here; ultimately insightful communications could result in greater numbers of people taking an active interest in what is happening in the world around them, and demand change themselves as a result. Pension providers, asset managers and the corporate sector in general stand to benefit from the powerful domino effect that this could create. 

Schemes and providers could also use this as an opportunity to engage in a more relatable way about pensions and investing in general, something which the industry has struggled with. This, is in turn, could lead to increased contribution rates from members wanting to use their savings to help create the type of world they want to retire into.

Helping each other overcome challenges we now face due to Covid-19

After all, members at the start of their retirement journey might be wondering why they should have a pension at all, following the volatility in financial markets at the height of the outbreak in Covid-19 in March. 

We cannot rule out further swings in asset prices over the next few years as economies go through a period of recovery. 

Providing members with a pension through which they can benefit not only from long-term capital growth, but also from having regular updates on how their savings are being used to help bring about much-needed change, such as the move to renewable energy, could even be a major step in helping members to understand the importance of investing and preventing them from opting-out. 

The challenges we have all faced so far in 2020 - from businesses, pension providers and pension scheme members to asset managers - are quite exceptional. 

But in the same way that businesses, industries, economies and policymakers can use the crisis to improve their approach to addressing ESG as they try to get through this unprecedented period and look to the future, it can also be used by the pensions industry to show pension scheme members that their contributions are being used as a force for good. 

Laura Stewart-Smith, Head of Workplace Savings and Retirement at Aviva, is diploma qualified in financial planning and has spent the last 15 years working in workplace benefits. She is an Aviva spokesperson specialising in employee engagement and financial education and is regularly featured in the media

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