As the popularity of environmental, social and governance (ESG) investing has grown, so have its various subsets.
Impact investing – a strategy targeting a real-world effect as well as a financial return – has attracted significant attention. The Global Impact Investing Network (GIIN) estimates the size of the market to be $717bn (£538bn).
So far, the leading asset owner supporters of this approach have been large foundations and charitable organisations. According to the GIIN, just 5 per cent of the 294 investors in its 2020 impact investing survey were pension funds.
However, it is becoming increasingly important for defined contribution (DC) funds to take the impacts of investment strategies
into account. For example, the Pensions Bill currently making its way through parliament will raise the bar significantly for pension funds to report the climate change impact of their investment portfolios.
Redington head of DC Jon Parker says: “There is a growing appetite among DC pension schemes to consider moving towards this type of approach to investing, and indeed regulations are likely to require governance bodies to disclose the wider impact of their investment decisions on areas such as climate change.”
For many DC funds, ESG and responsible investment policies focus on the reduction of specific risks – chiefly exposure to carbon emissions.
Diandra Soobiah, head of responsible investment at Nest, the UK’s biggest master trust by membership, says its focus is on achieving “the right risk-adjusted eturns for our members”.
“Our responsible investment approach helps us achieve this and naturally leads in many cases to positive outcomes for society and the planet too,” she says. “For example, encouraging good corporate practice such as fair pay and better working conditions via our stewardship activities and investing in renewable energy infrastructure.
“These offer attractive investment opportunities and should provide a reliable stream of revenue for members, while aiding the transition to the ow-carbon economy. With our commitment to be net-zero by 2050 or sooner, we’ll only increase our investment in similar projects.”
Earlier this year, Nest shifted its developed market equity allocation – representing 45 per cent of its £10bn in assets – into “climate-aware” strategies. Soobiah says this had the effect of reducing the pension fund’s carbon footprint “by the equivalent of taking 200,000 cars off the road”.
Nest’s next focus is on measuring and tracking carbon emission reductions across the portfolio to monitor its progress towards the net-zero target.
The People’s Pension, another leading UK master trust, has cut its exposure to fossil fuel reserves by 50 per cent through its multi- factor approach.
Nico Aspinall, the £8.4bn scheme’s chief investment officer, explains: “We’re currently looking at broader measures of impact in terms of climate change and ESG scores, which will enable us to tilt towards companies with a more positive role in addressing climate change.”
This will be done through increasing allocations towards companies that are shown to be adapting to the low carbon economy or producing products and services that allow the world to adapt to or help redress the impacts of climate change, says Aspinall.
However, impact investing goes far beyond carbon footprint reduction. Nest’s Soobiah explains that the master trust’s investment team is working with its private markets fund managers to develop reporting metrics to help improve its understanding of the impacts that certain projects and assets have.
Connecting with members
As pension funds strive to improve engagement with members, effectively communicating the positive real-world impacts of savings can be a key tool.
“We also know that many members want to know about the impact of their investments on society and the planet,” Soobiah says. “It makes their pension feel more real. Where we get it, we try to share this information with members in bite-sized chunks to help them understand more about where their money goes and what impact it’s having while it grows.”
River and Mercantile Solutions director Jit Parekh says that while it is too early to assess the long- term effects of impact investing, schemes can still quantify immediate and tangible results.
“For example, as part of the members’ annual benefit st at e me nt s, i t cou ld be communicated that the impact of their investments over the year were determined to be equivalent to, for example, planting trees covering an area equal to five football stadiums, or providing 50 Olympic sized swimming pools of fresh water to poverty-stricken countries,” he explains.
If this is shown to boost engagement, Parekh adds, it could result in impact investing becoming a “baseline requirement” for larger DC schemes and master trusts.
Shifting to an impact strategy is not simple, however. There are many competing standards for measuring and reporting impact. The Taskforce for Climate-related Financial Disclosures (TCFD) is gaining traction with many investors and will form the core of new UK climate change reporting rules for pension funds. The Investment Impact Framework, developed by Cambridge University’s Institute for Sustainability Leadership, s built on the UN’s Sustainable Development Goals (SDGs). These are 17 global targets for social and environmental improvements that the UN aims to achieve by 2030.
An increasing number of asset managers are incorporating the SDGs into their investment strategies, including Federated Hermes, Baillie Gifford, American Century Investments, Robeco and BMO Global Asset Management. This allows portfolio managers to demonstrate how their selections positively impact wider society.
Parker adds that “schemes can also use their stewardship and e ng ag e me n t p oli c ie s t o demonstrate the impact they have had on company management”.
While the size of the impact investing market has grown significantly in recent years, it forms only a small fraction of the wider ESG universe. However, as DC funds grow through auto- enrolment in the years ahead, Parker believes they will become a leading force in the impact investing universe.
Parekh adds: “With the majority of active pension savers in the UK today saving into a DC pension vehicle, the DC market has a large, expanding asset base that is well placed to drive these strategies.”
However, the financial return of any investment will remain paramount, Parekh emphasises. “Ultimately, DC schemes exist to provide an income for members in retirement and returning slightly above an impact-focused benchmark that has fallen significantly is not in members’ interests,” he says. “The risk is that we see investment strategies that ‘tell a good story’ without appropriate risk and return considerations or targeting of member outcomes in retirement.” One potential hurdle for DC schemes seeking to access impact strategies is the cost. Impact investment funds are typically concentrated, actively managed portfolios that require more resources than regular active products.
Parker calls for “an open conversation” involving pension industry stakeholders and DC savers to better understand the appetite for an approach that “may be slightly more expensive” but incorporates real-world impacts with long-term financial returns.
Impact investing is not a straightforward strategy to pursue, but as the regulations around pension funds and climate change develop, it will become an important element of responsible investment strategies.
“There is more and more widespread recognition that these ‘off balance sheet’ items are going to have a material impact on future valuations and the risk/ return of an investment opportunity,” Parker says.
“It feels like within a few years, taking into account impact factors is going to become the norm rather than the exception.”