Value or values?
27 Mar 2019 - Estimated reading time: 3 minutes
I’m sure many of us will remember the catastrophic oil spill at Deepwater Horizon in 2010.
Images flashed across our news screens of the ecological disaster that had been caused by one of the world’s oil giants – BP. Whilst the impact on the environment was devastating, the effects on BP itself were huge; direct costs to date have been around $60bn, reputational damage has perhaps been greater and BP has significantly underperformed the UK stock market since then.
BP is one of the most commonly cited examples of Environmental, Social and Governance (ESG) issues creating loss for investors. Others such as the VW emissions scandal (which also significantly increased borrowing costs for VW), Facebook and Equifax’s data breaches, Tesla’s treatment of factory staff and health and safety issues all had a detrimental impact for investors. These examples simply highlight the importance of understanding ESG issues as potential sources of investment risk.
It’s against this background that trustees of DB and DC schemes will by October 2019 be required to provide details of the ESG policies in their Statement of Investment Principles. However, it is clear this topic still creates a barrier in the minds of many.
My recent discussions with trustees have explored the difference between Ethical investment – a “values” approach to investing that typically uses negative screening or exclusionary approach – and Responsible Investment – a “value” approach to improving long term, risk adjusted returns. Proper training is vital for trustees to both understand the topic sufficiently and then develop a set of investment beliefs and policies that the full Board can buy into.
Many trustees are worried that investing in a “responsible” way will negatively impact returns for members.
However, studies have shown that investing in companies with positive ESG credentials delivers improvements in risk adjusted returns. Studies also show that positive engagement with companies on ESG matters can lead to significantly improved outcomes – with this doing nothing to detract from returns.
DC trustees particularly face the decision on how, if at all, they will reflect ESG issues in the funds offered to members, including default arrangements. Many start from the position of “we already offer an Ethical fund and hardly anyone invests in it”. But should we really expect members to be taking active decisions on their investment strategy? In the vast majority of cases, I would say no.
It was really insightful for me to speak recently to Janette Weir of Ignition House who carried out the ESG research on behalf of the Defined Contribution Investment Forum1. She admitted that the most concerning output from the research was that most people surveyed already believed their pension was invested in a responsible way. Those surveyed were genuinely horrified to find out that their pension was invested in companies which make landmines and armaments.
For me, the positive coming from the research was that 57% of DC members said that investing in a responsible way would make them want to engage more with their pension and find out more about it.
Critically, in terms of member outcomes, 40% said it would make them want to pay more in to their pension. We all know how hard it is to engage members with pensions, so anything that can help us in that task is to be welcomed.
But in a world where the majority of DC assets are invested passively (largely due to cost constraints), what can trustees actually do to reflect their views on ESG issues? Investment managers – and particularly passive managers – are bringing to market strategies which track factor based rather than market cap weighted indices. Importantly, many of these strategies also incorporate forms of ESG tilting which offer trustees the ability to integrate ESG issues into default strategies, if they wish to do so. We expect this market will continue to see product innovation over coming months and years.
All DC SIPs will be published online when this year’s Chairs’ Statements are issued. Trustees have little time to delay; carrying out work now to determine out investment beliefs and agreeing how these should be reflected in the policy and strategy of DC schemes should be a key priority for many over coming months.