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Why pensions have an ESG problem

Don’t get me wrong, I believe that the private sector has a hugely significant role to play in the fight against climate change and social inequality and the companies that take up the charge are well placed to excel in the coming years. I also think good governance is a key criteria for any investment: bad decisions are made in poorly run companies which can stifle returns. Indeed, it is not the principle of ESG which makes me extremely sceptical of its role in workplace pensions, it is its execution. 

Advocates argue that there is not much point in saving for a retirement if the world has burned in an oil-fuelled inferno (financed by your continued investment in petroleum producers) by the time you get there. They also have a growing body of evidence to confirm that caring about the planet does not mean you have to sacrifice returns: last year Morningstar found that 60 per cent of sustainable funds had outperformed their unfeeling counterparts in the last decade. 

But these two arguments can be swept aside by the cold hand of anti-ESG with one simple statement: sustainable pension funds are not as sustainable as their managers would have you believe. 

For example, Scottish Widows recently added BlackRock’s new ASC Climate Transition World Equity Fund to its default workplace pension scheme. This fund – which aims to “maximise the opportunities and minimise the potential risks associated with a transition to a low carbon economy” – has seven of the same top 10 holdings as the fund manager’s Aquila World Ex UK Equity Fund, which makes up the bulk of the Scottish Widows product. 

And BlackRock is not alone in greenwashing its standard funds to make them seem more appealing: during the final three months of 2020 at least 219 funds rebranded by adding terms like ‘sustainable, ‘ESG’ or ‘green’ to their names, according to Morningstar. Even funds that have attempted to realign to better reflect a sustainable future have fallen short, as most rely on companies to self-report on ESG criteria – which they do very inaccurately. And that is without even acknowledging the scientific shortfall in our understanding of ‘bad for the planet’ – is natural gas production really worse than hydrogen fuel cells?

For now, this behaviour is relatively harmless to pension performance – as long as funds don’t ramp up their prices when they falsely advertise their green expertise. But what happens when the bubble that has propped up the valuation of any company claiming ESG credentials (think, Tesla), bursts? And should savers who have been made to believe that their pension is doing good for the planet settle for a portfolio that is dominated by the big tech companies, just like most other pension funds? 

Environmentally and morally sustainable investment can be used to make the planet and its inhabitants healthier and wealthier, but that can not be achieved with the broad brush of ESG. Pension scheme managers have a duty to make this corner of the investment industry work better. And pension scheme members who care about the value created by their investments (both financially and environmentally) have a duty to engage – governance meetings are surprisingly enjoyable.