Few people are aware of what their workplace pension invests in, let alone how their pension provider incorporates environmental, social and governance (ESG) matters into the process. But there is good news for those wanting a greener pension: a raft of legislation is now driving a greater focus on sustainability. It should also become easier over time to check whether your pension is invested in line with your ideals, and to take action if not – something that may be necessary given the risk of fund managers 'greenwashing' portfolios.
The market value of UK pension funds reached £2.2 trillion at the end of 2019, according to the Office for National Statistics, making it integral to the national push for lower carbon emissions. The UK has an ambitious target of being net carbon neutral by 2050, and a combination of share voting and investor engagement has a large part to play in helping companies meet this target.
The first stage in the ‘greening’ of pensions took place last year with a requirement for schemes to address ESG and climate change issues specifically in their statements of investment principles. They will have to report on progress against these by the end of October this year.
Meanwhile, an amendment to the Pension Schemes Bill is currently going through parliament, which will force pension schemes to disclose how they will align their investment strategies with the Paris Agreement, which seeks to limit the increase in global average temperatures to 1.5°C above pre-industrial levels.
On top of this, the Department for Work and Pensions issued a consultation in late August proposing that large workplace pension schemes adopt the recommendations of the international industry-led Task Force on Climate-related Financial Disclosures (TCFD) by 2021. TCFD provides a standard for climate-related financial risk disclosures, which should help scheme members better understand the environmental impact of their pension.
The consultation also proposes that pension providers model the implications of a range of climate temperature changes for the scheme’s assets to prompt thinking about climate risks and opportunities. Mark Carney, now the United Nations Special Envoy for Climate Action and Finance, said these rules will affect the occupational pensions of more than 24m UK citizens, representing more than £1.3 trillion.
While some pension schemes are in the early stages of forming a climate change policy, others, such as Nest – one of the UK’s largest workplace schemes – are more advanced. Nest recently announced an aim to fully decarbonise its portfolio, which invests the retirement savings of 9m workers, by 2050. The scheme announced in July that it would immediately move £5.5bn in shares, or around 45 per cent of its portfolio, to so-called ‘climate aware’ strategies, containing companies likely to prove winners in the energy transition.
Scottish Widows, a subsidiary of Lloyds Banking group and large provider of workplace pensions, is also making changes to make its pensions more climate friendly. This year it collaborated with BlackRock to create the Climate Transition World Equity fund, a portfolio dedicated to helping the transition to a low-carbon economy. This fund will be included in the company’s flagship default fund, which holds £35bn of pension money. Maria Nazarova-Doyle, head of pension investments at Scottish Widows, says the Climate Transition World Equity Fund will initially make up 10 per cent of the scheme’s equity allocation.
Lorna Blyth, head of investment solutions at Royal London Intermediary, says: “There is no doubt that climate risk is an investment risk and going forward those responsible for investment solutions will be expected to have explicit policies on climate risk to explain how they are addressing it and building a roadmap to move to net zero.”
How to detect greenwashing
‘ESG’ has undoubtedly become a useful marketing tool for the investment industry as society has become more focused on the need for us all to be more sustainable. As ESG funds have attracted the greatest volumes of client money in recent years, there has also been a proliferation of asset managers who talk a big game on ESG without making any changes to their investment process – so-called 'greenwashing'.
Luba Nikulina, global head of manager research at Willis Towers Watson, says investors should consider the whole chain of the investment process when looking for signs of greenwashing. This includes the company you work for, the pension provider, the trustees and consultants appointing the pension provider, and the asset managers from which the pension provider selects funds. But she notes that greenwashing is most abundant among asset managers themselves as pension providers tend to be very careful about exclusions.
The absence of standard definitions and lack of consistency in ESG reporting makes it difficult to detect the authenticity of an asset manager’s ESG approach, but this should improve as requirements for standardisation, such as TCFD reporting, are introduced. The EU is working on a labelling system for sustainable products, which should make funds easier to compare, while UK fund manager trade body the Investment Association has been looking to encourage standard definitions for the likes of ESG funds.
If you want to check that you are happy with your pension's ESG profile, you will have to do more than simply read your pension provider's annual report detailing their approach to sustainable investing. You need to look at what is owned in the funds you invest in to get a better picture. If scheme literature simply refers to a general desire to invest in ethical and sustainable investments but does not give any detailed examples of how a given investment meets that criteria this can often be a sign of paying lip service to ESG investing and could be a red flag.
Eimear Toomey, head of responsible investment at Quilter, says most managers publish responsible investment and engagement reports, which include details of their voting track record. You can look at these, see how they voted, and check it is in line with their policy and your preferences.
Making your own decisions
Unless you indicate otherwise, your workplace pension contributions will be paid into the provider’s default fund. But you can switch out of this and choose from a wider range.
Scottish Widows, for example, has a selection of funds that members can switch into if they have specific investment preferences. Its environmental fund avoids investing in companies that demonstrate a pattern of non-compliance with local environmental regulations or that significantly contribute to environmental problems. The provider’s ethical fund excludes any company whose business centres on seven criteria, including alcoholic beverages, animal testing, gambling, tobacco and weapons. Scheme members are able to opt into one of these funds on request.
Kay Ingram, director of public policy at financial advice firm LEBC, says that if ESG principles are important to you, you should ask your employer for a copy of your pension scheme's Independent Governance Committee report and its statement on ESG. She says providers who do not focus on ESG principles often cite a lack of demand from members as a reason. Those members who care about their savings doing good need to make their voices heard by asking for information on this.
If you are not happy with any of the options that your pension provider provides, you can move your pension into a self-invested personal pension (Sipp) and select where you would like to invest your pension money via platforms that give you access to thousands of funds and stocks listed on a range of exchanges. But it is advisable to pay into a workplace pension if you have one because otherwise you will miss out on valuable employer contributions. The maximum amount you can pay into a pension per year is £40,000, so if you have maxed out your employer contributions and still want to pay in more up to the limit, you could do this within a Sipp.
If you are choosing your own sustainable investment fund, Rowena Griffiths, chartered financial planner at Female Financial Management, suggests Liontrust Sustainable Future Managed (GB00B8FDBQ23), a multi-asset fund with a very strong performance record. The fund has 39 per cent of assets in the US and 31 per cent in the UK at the end of July and has had a top quartile performance ranking in the Investment Association Mixed Investment 40-85% Shares sector for the past four years.
Will an ESG focus damage your pension performance?
Many investment approaches can fit under the term ‘ESG’. In its broadest sense, companies integrating these non-financial factors as part of their analysis should be in a better position to identify material risks and growth opportunities. Ms Nazarova-Doyle says Scottish Widows does not have an exclusionary ESG policy on its default pension fund, but instead uses the principles to identify the best investment opportunities.
In 2018, Royal London commissioned research analysing the impact of ESG credentials on financial performance, in the equity, fixed income and property space. Ms Blyth says the research found “sufficient evidence” to conclude that strong ESG performance led to better stock returns, with governance being the most important factor of the three.
Some pension schemes do have an exclusionary policy, which could in theory damage your investment returns as the opportunity set of what you can invest in shrinks. But it could also steer your pot into assets that have better long-term growth opportunities. Over the 12 months to end of June, iShares MSCI World ESG Screened UCITS ETF (SAWD), which excludes companies in sectors such as oil production, thermal coal, weapons and tobacco, rose by 4.22 per cent. This was significantly better than the broader MSCI Word index, which was up 2.84 per cent.
Ms Nikulina says she is seeing an increase in the desire among pension scheme members to avoid companies producing fossil fuels. But she also cautions that active engagement by asset managers to force companies to improve their environmental policies can have more of an impact than not investing in them at all.
