The impact of climate change on the planet is increasingly evident − the glaciers in Iceland have retreated at a rapid rate. It is currently believed that in 100 years they will no longer exist. The emergence of Extinction Rebellion shows an increasing minority of the population is frustrated by the lack of progress to address this issue. While consumer ire is often focused on governments, owners of assets will be expected to play their part in addressing the issues causing the planet to overheat.
The pressure on asset managers and pension schemes to act as responsible investors is mounting and attitudes are gradually changing among trustees. There is a growing recognition that a commitment to responsible investing is as important as their fiduciary role. Regulators are responding to consumer demands by pushing schemes to pay greater attention to environmental, social and governance (ESG) characteristics.
“We can change our behaviour … we can ensure that investment reflects the risks inherent in destroying natural capital as well as climate change and we can ensure that the infrastructure, on which some $90 trillion is to be spent in the next twenty years, is zero carbon and enhances the lives of those who depend upon it.” HRH The Prince of Wales, April 2019*
In October, the Department for Work and Pensions will introduce new rules for pension plans to report on their ESG policies. The Institutions for Occupational Retirement Provision Directive, by which the EU sets down standards for pension schemes, also requires schemes to spell out these policies, as do rules governing local government pension scheme (LGPS).
The challenge for both asset managers and pension schemes is to determine their definition of responsible investing. There are many different aspects to be considered including:
- From an investment perspective, tilting portfolios towards those companies with high ESG scores allows them to avoid risk from climate change and bad governance. It could also improve returns.
- For some schemes, a tilt towards a high ESG score may also require excluding certain stocks, such as arms manufacturers.
- Once an asset owner has shaped their portfolios according to investment criteria, they can turn their attention to being effective stewards of their assets. That requires a detailed knowledge of each company’s ESG profile in order to influence management to improve these characteristics and ensure good governance through effective engagement.
For large schemes using active managers, all of these requirements can be embedded in a request-for-pitch and then integrated into a bespoke mandate. Smaller schemes, which use pooled passive equity and fixed income strategies, face more of a challenge of how to incorporate such an approach.
Index providers have responded to this demand by providing benchmarks with tilts towards those companies with high ESG scores. Some also exclude “sin stocks”. There is huge variety of different funds offering a wide range of choice to investors.
But the greater challenge is for providers of passive funds to be active stewards. This is, on the face of it, a contradiction. Investors have typically chosen a passive fund because they want to track a particular index and/or reduce costs. There is an implicit lack of interest in how those stocks are governed.
Some of the large providers of passive funds are addressing these concerns by building large teams which can monitor companies and hold management boards to account. But, as many tracker fund providers are racing to catch up with this trend, it will take time before they can act as effective stewards. It takes time to build up specialist teams of people to engage with, and vote on, companies. Sourcing consistent data to make those decisions is also still challenging.
However, my belief is that responsible investing will become mandatory. This month, the CFA has launched the first formal qualification of its kind; the Certificate in ESG investing. Those who select passive funds will find it increasingly easy to implement this strategy but improvements still need to be made to match their requirements.
Photo credit: Aaron Overy