How do you embrace the wide range of ethical views held by customers when implementing ESG into DC schemes?
The challenge is twofold – meeting the needs of those with specific, strongly-held views and reflecting the views of the broader scheme membership through the default fund.
For those with strong views it is important to ensure appropriate investment options are available, where possible. Options include impact investments, social bond funds, ethical and Sharia funds.
Reflecting the values of the majority of savers within the default fund is more complex. We have been taking ESG into account within our active portfolios for some time as our managers integrate ESG factors into their investment process. We’re also planning to introduce a passive ESG default option which will screen out certain asset types. Our approach will be to balance internationally recognised voluntary initiatives such as the UN Global Compact and our own customer insights.
The last few years have seen a tangible shift in DC scheme member behaviour from the majority focusing on returns to a greater proportion wanting to know their investments are doing good, and it is important to reflect this.
What are the biggest barriers to implementing ESG in DC?
Cost is a key challenge. Tracking an ESG index, for example, is more expensive than tracking a vanilla one, and in the cost-sensitive world of workplace pensions there perhaps needs to be an understanding across the sector that to do ESG well may cost slightly more in some areas.
Managing expectations of performance will also be a challenge. There will be inevitable comparisons between ESG and non-ESG options, and while the evidence is ESG funds outperform over the longer term, there will be periods when they underperform and stakeholders will need to manage this eventuality. Implementing ESG in legacy schemes may be complex and costly, but if we want to stand up for our beliefs then it’s the right thing to do.
What is the biggest opportunity from ESG?
While it presents a big challenge for providers, implementing ESG across default funds is also an opportunity to influence the world our children will grow up in. One provider changing its default ESG strategy, for both legacy and new business, can influence tens of billions of pounds of investments in one go.
This in turn presents an opportunity to communicate with scheme members about subjects they feel passionate about and potentially engage a population that may not previously have engaged with pensions, helping to nudge behaviours that achieve better outcomes.
What role should policymakers have in determining schemes’ approach to ESG?
Policymakers and regulators can be a real force for positive change, creating rules that reflect the nuances of the system they’re regulating. With ESG having so many touch points, too broad-brush approach may lead to duplication of functions, creating unnecessary costs which ultimately end up being paid by the customer. For example, an asset manager performing the ESG stewardship role of voting at shareholder meetings, it would then not be very efficient if the provider, trustee and employer’s adviser all have to do similar due diligence on the ESG credentials of that asset manager.
We will be undertaking research with the Pensions Policy Institute in the months ahead to look specifically at the issue of how schemes take account of climate change and the related role of policymakers.
How big is the risk that the pensions industry pays only lip service to implementing ESG?
This is a really important issue for the industry. Trust is crucial to the pensions sector and we need to do all we can to protect it. ESG is a complex thing to implement, but if we say we are doing it, we need to do it properly and to continue to evolve as thinking progresses. We can’t stand still.
We need to find innovative ways to make ESG real for pension investors so they know what is being done on their behalf and why. If we overpromise and underdeliver, or leave out sectors such as legacy books of business, we run a real risk of undermining all the good work that is starting to be done on ESG.
What are you doing to integrate ESG into your DC investment options?
ESG has been taken into account within our active portfolios for DC investments for many years. Our active managers, Aberdeen Standard Investments, factor ESG into their investment process from the bottom up and are recognised among the fund managers at the forefront of ESG thinking. In addition, we’re planning to introduce a new passive ESG workplace default later in 2020. We’re also broadening our range of responsible investing fund options, and looking at our legacy defaults to consider how we further incorporate ESG factors.