With regulations aplenty, taking ESG (that’s Environmental, Social and Governance) factors into consideration has become a common theme for almost all pension schemes – not just the tree-hugging ones as was the case when we first ventured into this area many years ago. For schemes that have worked hard to develop a strategy and move to a position of BAU, the thought of having to revisit their strategy so that it aligns with their newly established ESG beliefs can be daunting, but fear not, since we have some quick win solutions available that will require little governance budget to implement.
How are ESG regulations changing?
Going forwards, we expect the regulations surrounding ESG to require far more engagement from the Trustee and, although we don’t expect TCFD disclosures to become a requirement for pension schemes until c.2022, several of our clients have already started reporting in line with the these recommendations to better-position themselves when the regulations are enforced.
What do these regulations mean for the trustee?
The role of the trustee when it comes to ESG is becoming less of a tick-box exercise, whereby you add some fluffy sentence to your SIP stating that you are aware ESG as a concept exists, and more of a tangible exercise; whereby you’re required to formally agree a set of ESG beliefs, integrate those beliefs within your investment strategy and annually report on your alignment with those beliefs.
Clearly, the level of ESG integration within your investment strategy is highly dependent upon your beliefs, the nature of your investments and your governance budget. Schemes ahead of the curve in this space will be allocating significant governance resource to ensure that, where possible, all assets are wholly aligned with their ESG beliefs, whether this be investing in renewable infrastructure or refining a segregated credit IMA to limit carbon intensive issuers for example.
Conversely, for schemes with limited governance budgets or those just venturing into this space, completing an entire portfolio overhaul to ensure their investments are aligned with their ESG beliefs will not be feasible. But this doesn’t mean that there aren’t any quick wins available.
What quick wins are available?
Whilst it may seem that integrating ESG considerations within your portfolio requires a fundamental shift in your strategy, this isn’t necessarily the case. When devising our high-conviction preferred lists, we assess managers on 10 factors, one of which is their level of ‘ESG Advantage’. This factor assesses whether an investment team takes account of ESG risk factors, acts on these when financially material and has sufficient buy-in at the business level. By including an ESG factor within our research process, we are able to offer several practically implementable ESG-friendly solutions across almost every asset class we research (from merger arbitrage to credit).
Another quick win of including ESG considerations as part of our research process is that we are armed with the necessary information to assist our clients with formulating their annual implementation statement when this comes into force later in the year, which will help our clients align with the upcoming ESG regulations.
The level of ESG integration varies considerably across both asset classes and funds, depending upon where they sit along the responsible investment spectrum (i.e. whether they’re looking to minimise the negative risks associated with ESG factors or to target the positive impact associated with them).
As well as assessing all managers on their level of ESG integration as part of our standard asset class preferred lists, we also have a range of dedicated ‘ESG-friendly’ preferred lists, such as sustainable equity. Unlike our traditional preferred lists, these focus on funds whereby ESG is a core tenet of their philosophy and process.
To use an analogy, imagine you’re trying to lose some weight; you could achieve this by switching the escalator for stairs everyday (i.e. invest in funds from our standard preferred lists which possess an ESG advantage), this won’t cost you anything, but it will take you a while to reach your goal. Alternatively, you could invest in a personal trainer (i.e. invest in funds from our ESG-friendly preferred lists), this will be more expensive but you can expect to achieve your goal a lot quicker (the risk-adjusted returns of the second option are expected to be greater).
How can I enhance my ESG profile through equities?
Equities is by far one of the easiest means of accessing ESG within your portfolio since this can be achieved through a variety of ways: quantitative/qualitative analysis; over/underweighting the portfolio; and voting on the underlying securities to name a few.
What’s interesting about sustainable equity is the wide range of options available; wherever your scheme sits along the responsible investment spectrum. Whether you’re looking to reduce the carbon intensity of your portfolio or you’d like to invest in securities that generate positive societal and environmental impacts (i.e. education or renewable energy), there will be a suitable sustainable equity strategy available (see a summary of our sustainable equity preferred list here).
Deeply integrating responsible investment considerations isn’t going to happen overnight; it requires continuous improvement from both asset managers and investors. And, whilst pension schemes are not expected to perform a complete portfolio overhaul to address their newly articulated ESG beliefs; the trustee will need to make some strategic adjustments to demonstrate that they are taking steps to align with them and where better to start than the ‘quick win’ options I’ve mentioned above.