ESG factors could improve pots

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The times, they are a changin’

ESG factors could improve pots

A question often asked by individuals new to sustainable and responsible investing is: "My priority is a secure pension pot for retirement, so why should I care about sustainability and climate change?"

And while the answer is nuanced, fundamentally it is: because you will have a bigger retirement pot by doing so. 

Mounting evidence shows this to be the case and it is a key reason why the Department for Work and Pensions recently laid new regulations that will require pension schemes to publish their approach to sustainability. 

Specifically, the DWP’s proposals, outlined in its consultation on Clarifying and Strengthening Trustees’ Investment Duties, make clear that pension scheme trustees are to consider all financially material factors – including environmental, social and governance concerns – and clarifies that even non-financial or ethical factors may be considered in certain circumstances.

ESG can create opportunities

ESG factors are often overlooked as being purely ethical, conflicting with our duty to maximise returns. However, investors that properly understand ESG issues and the impact they have on value can, and very often do, find their investments outperform.

Will Oulton, global head of responsible investment at First State Investments, says: “Across all our asset classes globally, 83 per cent of our funds on an asset weighted basis have outperformed their respective benchmarks over the past five years. We believe ESG issues are sources of risk and return and therefore contribute to such compelling performance.”

Key Points

  • The DWP recently issued new rules requiring pension schemes to publish their approach to sustainability
  • The government has been taken to court over its failure to act on air pollution
  • The new regulations offer an opportunity to innovate

Our approach to investment includes increasing our understanding of how emerging risks and opportunities can stem from ESG issues. Pension scheme trustees should already be considering such factors when they are material to their investments, and we welcome the government’s announcement that it will clarify this in law.  

Some individuals often labour under the related misconception that considering ESG means trustees will be forced to invest in line with members’ ethical views.

However, the government’s new rules are helpful in clarifying that financially material factors should always be considered while non-financial factors only need be considered in limited circumstances.

Caroline Escott, the policy lead for investment and defined benefit at trade body the Pensions and Lifetime Savings Association says that: “Pension funds increasingly recognise that they need to take account of ESG risk factors in their investment approach.

“Indeed, the PLSA’s steward-ship survey found three-quarters of pension fund respondents agreed ESG factors, such as climate change and human capital, can be material to investment performance.

“However, there is still some confusion around how and when schemes should take ESG risks into account in their investments. The government’s work to clarify investment duties should help tackle this issue and ensure trustees are clear on the distinction between when an ESG issue is a financial consideration or an ethical one.

“This should remove a key obstacle for trustees when considering ESG factors in their investment plans.”

The confusion about what factors can, should or must be considered has been a major obstacle for trustees in meeting their fiduciary duty to date.