Now that all pension providers are legally required to consider environmental, social and governance (ESG) factors in their default fund investment processes will we see less scheme members opting for ethical or responsible investment (RI) options?
Far from it. The legal ESG obligations on schemes are not very stringent. They are required to consider environmental, social and governance factors along with other materially relevant financial factors when setting their investment strategy. But they can ignore ESG altogether if they want to. All the research shows that a very high proportion of millennials are interested in investing responsibly. The problem facing them is twofold – there is a lack of clarity about whether and how schemes actually implement responsible investment factors in their portfolios, and, particularly for those in workplace schemes, there has not been an easy way to access alternatives, without losing the crucial employer contribution.
These days people expect choice, but when it comes to investing in a workplace pension, which will often be either the biggest or second biggest investment of their life, there is very little real choice.
Do DC pension providers’ claims about their funds’ ESG credentials stack up?
Some do, but by no means all. Too many providers are adopting the typical financial services industry approach of taking an existing product and rebadging it as meeting the needs of whatever the market is demanding at the time. This is happening with ESG right now.
We have seen some providers pushing the ‘G’ of ESG, be it their voting rights activity or the governance that comes with active management due diligence. While in technical terms they can correctly argue these existing defaults have some ESG traits, they can be a million miles from what an employee might expect from an ESG fund. For many employees, particularly millennials, their focus is more likely to be on the ‘E’ and the ‘S’ of ESG – environmental and social factors.
So are today’s default fund investors not getting the investment strategy they want?
Very possibly. But at the moment scheme members don’t know this because they don’t know what they are invested in. This perpetuates a lack of engagement, at a time when responsible investment factors could be a real opportunity for engagement with pension savers.
Many of today’s millennials, and older investors, have very strong beliefs that they hold to be part of their identity. Climate change is probably the most obvious example.
An example of how today’s defaults can fall short is the fact that even if certain oil companies achieve a really high ESG score because they are making huge efforts to transition to a low-carbon future, there are still going to be scheme members who don’t want any of their pension investments to be in oil at all. But at the moment it is hard for members in this situation to do anything about it.
How could the user journey be adapted to make it easier for these savers to get to the types of products they want to invest in?
If the existing workplace pension provider already offers ethical or RI alternatives that are easy to access, then that journey can be relatively straightforward, although the industry still needs to do more to put these options front of house.
If the scheme member opting out of the default is swamped by a range of hundreds of fund options, then they can end up disengaging and doing nothing.
If there is no suitable alternative available through the existing workplace pension provider then the employee should be able to choose an alternative, and crucially still get their employer contribution paid into that alternative. Technology, which is notably scarce in the workplace adviser space, is the only way to make this happen.
How can offering choice improve financial wellbeing?
Offering access to more suitable RI funds will help overcome the mismatch between individuals’ expectations and the reality of the default funds they currently invest in. Performance can be a strong engagement factor too.
Using smart technology to nudge individuals to the pension investments they want will create more engaged investors that save more and feel more connected to their finances. These more confident investors should have bigger funds and become more likely to want to engage with financial advisers, leading to improved financial resilience.