ESG and pension schemes – the “new normal”

There has been much discussion about the “new normal” that we must become accustomed to in the wake of Covid-19 – from social distancing measures at shops and in our schools, to mandatory working from home, to the distant memory of a pint at the local pub, this global pandemic has drastically changed how we all go about our daily lives.

In addition to this, the virus has thrown an even brighter spotlight onto ESG investing. 

ESG investing has been a hot topic in recent years, not least for pension schemes, and its increase in prominence has further been accelerated by the current crisis. 

The Economics

It is not news that ESG investing has been steadily growing for some years now. The global market for sustainable investing assets (valued at $30.7tn in 2018, up from $22.8tn in 2016, by the Global Sustainable Investment Alliance) is increasing year on year. Pre-crisis, ESG investments were often outperforming the market and showed themselves to have a lower level of volatility in the long term. Further, ESG investing is proving to be attractive to, and a key priority for, millennials, when considering investment opportunities. The concern, however, is whether ESG investing is “a luxury that could only be afforded in a bull market”.

The current crisis seems to suggest that this concern is not one that will materialise. Research from Bloomberg has shown that the average ESG fund fell in value by just half the decrease registered of other funds in the S&P 500 index over the same period during the Covid-19 crisis. And BlackRock analysis indicates that funds tracking the performance of companies with stronger ESG credentials lost less money than those including worse performers in 94% of cases during the pandemic.

Interestingly, despite the disproportionate focus on the “E” in ESG given the current and ongoing climate emergency, the Covid-19 pandemic has magnified interest in the “S” - the social credentials of companies seeking investment. Research indicates that through this crisis, it has been companies with better customer relations, workforce management and effective, independent boards who have performed better. Outperformance of non-ESG investments does not appear to be linked only to environmental sustainability.

The Schemes

Pension schemes and the industry as a whole are responding to the growing prominence of ESG investing.

Earlier this month, the Universities Superannuation Scheme, the UK’s largest pension scheme, announced that over the next two years it will be divesting from companies involved in tobacco manufacturing, coal mining and weapons manufacturers, where this makes up more than 25% of their revenues. This amounts to a reported £1.6bn in assets and is perhaps the largest recent example of the changing approach to sustainable investing in pensions.

This changing approach is being supported by a number of industry groups, such as the Pensions Climate Risk Industry Group, which was established last summer and has recently produced draft, non-statutory guidance on assessing, managing and reporting climate-related risks in line with the Taskforce on Climate-Related Financial Disclosures.

The Government

Against the backdrop of an increasing market for sustainable investing and promising returns on those investments, ESG looks set to continue its transition to being the new normal in investing organically.  But when it comes to ESG and pension schemes, the government has opted to expedite the change in mindset through regulations and legislation.

Recent regulations have required schemes to update their statement of investment principles (SIP) to take account of financially material considerations, stewardship and any policy on non-financial matters.  DC schemes were also required to publish their SIP for the first time. 
By October this year, the SIP will need to be updated again to include policies on arrangements with asset managers and in relation to capital structure, conflicts of interest and other stakeholders.  DB schemes will need to publish their SIP for the first time and, from October, a new “implementation statement” must be produced.

Looking ahead, the latest draft of the Pension Schemes Bill has been amended to include a power to make regulations that could require schemes to report on their exposure to climate change risk. This demonstrates the government’s intention to further regulate trustees’ actions in this area, though it stops short of directing how trustees should invest.

The new normal

The economic argument appears to hold up, it’s supported by an increasing percentage of members, and the government is taking steps to push schemes towards it. ESG investing is here to stay. 

The key message for schemes at the moment is to ensure compliance with the new regulations already in force, to prepare for those in the pipeline and perhaps even to consider going further than the regulations require. The new measures have outgrown box-ticking exercises, and what underlies them now appears to be a desire to encourage a shift in mindset towards a new normal for investment, one based on stewardship and sustainability.