ESG is a hot topic among investors, but it appears that trustees are yet to catch on. Mark Dunne takes a look at the findings of a new report.
These are revolutionary times for pension scheme trustees. Attitudes towards climate change and human rights that were once limited to the longhaired lentil-eating brigade are now mainstream, and a growing number of savers want these views to be reflected in the investments that are made on their behalf.
They have the government on their side. In September, the Department for Work & Pensions (DWP) announced that from next year on trustees will have to tell their members how they are considering risks such as climate change in their investment decisions.
The witnesses to the growing popularity of environmental, social and governance (ESG)-led strategies are usually asset managers and consultants.
They regularly state that conversations with asset owners rarely pass by without discussing how to make the investment portfolio more sustainable.
Is this because trustees and scheme managers believe ESG can help generate the longer-term returns needed to pay members’ benefits? Is it a topic that the adviser or manager raises in meetings? Or is it a conversation that trustees and scheme managers feel pressured by their members to have?
To discover what trustees, scheme investment managers and consultants – essentially all those involved in the decisionmaking process in pension schemes – think about ESG, financial services data provider Research in Finance (RiF) has published The UK Institutional Market Study 2018.
In researching the study, RiF spoke to more than 200 people working for and with a range of schemes, from those with less than £50m of assets under management to those worth more than £10bn.
Julian Lyne, chief commercial officer at Newton Investment Management, describes this research as “timely” in that “interest in this area is ratcheting up, year-on-year”.
The UK Institutional Market Study attempts to predict changes in attitudes towards ESG-led investment strategies in the next one to two years and what that will mean for asset allocations.
Of the consultants, scheme managers and trustees questioned on how significant ESG factors will likely play in pension fund investments over this period, 11% said that they will be ‘very significant’, which was almost twice the 6% that said they would have ‘no part at all’.
Yet a look behind the headline results shows that opinion is split here. Those believing it ‘will not make an impact’ on decision-making stand at 35% of the sample, while those thinking it will be ‘quite significant’ are at 37%.
Another point for discussion is that consultants appear to be more pro ESG than trustees are. Of the consultants questioned, 13% think ESG factors will be ‘very significant’ in investment decisions over the period, while 46% believe they will be ‘quite significant’, with a lowly 3% stating that they will play ‘no role at all’.
This compares to 6% of trustees who stated that ESG will play a ‘very significant role’ in their investment decisions in the next one to two years while 28% believe it will play a ‘significant role’.
Scheme managers are more cynical. A tenth said it will play ‘no role at all’, while the same percentage said it will be ‘quite insignificant’ to asset allocations.
Lyne says that consultants being more pro ESG than trustees is an information issue, as consultants tend to have more knowledge, resources and expertise.
He adds that demand is high for Newton to speak to pension schemes and consultants about what ESG means. “What people are looking for is proof,” he says. “People want proof statements. How does it work? How do you measure it?”
Newton tries to put this information into its reporting to ensure that people can see that compliance with ESG criteria and is not just a theoretical discussion point. This is where Lyne is seeing traction picking up.
“Sustainability provides great opportunities,” he says. “We have a case study where we talk through electric vehicles and how that is driving returns. That is where we are trying to make the connection between ESG and genuine returns. It is an open and interesting area of discussion at the moment.”
There is one area, according to the research, where ESG factors appear to be more important for trustees and scheme managers. Almost a third (30%) of people in those roles use it as criterion in selecting managers, up from 21% in the 2017 report.
The smaller the scheme the more important this topic is. In schemes with more than £500m of assets, 32% said they expect an investment manager to have a clear ESG policy, but this rises to 61% for smaller schemes.
So does this point to trustees and scheme managers passing the ESG policy and implementation over to their external managers?
David Czupryna, senior SRI client portfolio manager at Candriam Investors, says ESG’s influence over the selection of asset managers is interesting. “Before it was more tick the box without having an impact on selection, now we see a growing impact. It is not just telling me to do something,” he adds. “It is part of the investment process, part of the requirement to get a chance to be selected.”
So how do those appointing managers decide if they are just talking the talk when it comes to their ESG credentials?
“One of the big challenges that we have here is making sure that trustees and consultants understand the difference between managers that have genuine ESG integration and those that are just jumping on the greenwash bandwagon,” Lyne says.
To bring clarity here, Newton has a set of questions for trustees to ask fund managers. “If you do this well, it can have a meaningful impact on portfolios and returns in the longer term,” Lyne adds.
Trustees at larger schemes also have a greater interest in a manager’s voting record at company meetings, 45% of respondents from larger schemes say they are considering it, compared to 39% of trustees of schemes less than £500m in size.
“Voting for UK schemes is something that is important,” Czupryna says. “They want see a policy in place.”
Robeco is one such asset manager to have secured a voting and engagement mandate recently. It now votes on its behalf of Border to Coast and works with the local government pool’s direct holdings.
Peter Walsh, Robeco’s UK head, says that other pools are looking to follow Border to Coast’s lead and get their voting and engagement services sorted early. “Most of them are moving down that path because it is something you want to have in-place upfront,” he adds. “You need some guidance for your broader manager selection as you go down the track.”
Larger schemes are more likely to hire external expertise to support their company engagement work, but just one of the schemes under £500m said they would make such a move. This is likely to be because of a lack of resources and concerns about costs.
“You would be surprised how many times we are asked by investors to help them draft an ESG charter or policy,” Czupryna says. “They want our help, as experts. They know that they want to do something.”
Of those questioned, 8% of larger schemes are planning to appoint a manager for a dedicated-ESG mandate, while no scheme below £500m has such a move planned on their agenda.
In 2015, Robeco published an ESG study where asset owners said that consultants and asset managers should take a more active role in driving the sustainability agenda. “Since that report, we have seen a step up in the focus of consultants on what they are doing around sustainability and the services that they are providing,” Walsh says.
“It is getting independent advice, as you would do with anything you are looking to do for the first time,” he adds.
From the clients and even non-clients that Robeco is speaking with, Walsh and his colleagues are sensing a desire, without necessarily a firm commitment at this point, to do more around sustainability and integration. Walsh says that people are asking his team: “We know that we want to something in this area, can you help us decide what we want to do.”
Fawzy Salarbux, Candriam Investors’ global head of consultant relations, says that in the average pension scheme an ESG policy is put in place when they choose a manager, but there is a long road ahead to get them to implement it from the start.
He adds that at consulting conferences there is a lot of chat around ESG. “You then have to put that into the context of how many schemes by their own volition are trying to do ESG. There is a big disconnect there. What this translates into is when pension schemes have agreed on their asset allocation strategy and are ready to implement it, that is when they look for a fund manager that does ESG.
“It probably is part of a long journey that the UK market still has to go,” Salarbux adds. “The challenges that are they are still there in terms of the average trustee is struggling to reconcile the fiduciary duties with investing in ESG.
“Until we hit a period where ESG strategies perform better, people are going to find it a little difficult to be convinced about the alpha generation of it,” he adds.
“The value of it is that you start having the ESG conversation earlier in the process rather than at the end. The UK needs to bridge the gap by bringing the ESG conversation in at the strategy level rather than at the manager selection level. It is still a long road.”
The preferred approach to incorporate ESG factors in pension schemes is to integrate it into all investment decisions, a route chosen by 60% of all respondents.
“In the main, most peoples’ starting point is that ESG should be integrated into all investment decisions,” says Lyne.
Divestment and negative screening are not popular. Only 11% of trustees, scheme managers and consultants prefer fund managers to avoid companies that do not meet their ESG criteria. The level rises to 19% when trustees’ responses are looked at in isolation, compared to 11% of consultants and 6% of scheme managers.
This is good news, of course, because ESG is not about divestment, unless an asset owner feels that a company’s management team are not listening to them when it comes to changing a business.
Since Robeco’s 2015 survey on UK asset owners’ thoughts on sustainability, Walsh has noticed an increase in appetite for ESG integration. “Three years later, we can see a difference in peoples’ appetite and interest,” says Walsh. “It is a hot topic that is on everyones lips.”
This growth could be down to pooling, which has given the local government institutional market more scale. With that bigger bucket to manage comes a greater level of scrutiny in terms of the resources you can allocate and in terms of the public interest. “If you have a £1bn pool that is interesting, but if you have a £30bn pool everyone wants to know what you are doing,” Walsh says.
He points out that the pools’ interest in building sustainable portfolios is clear. “If you look at the tenders that they are running: sustainability, stewardship, PRI, transparency codes, all of these things are front and centre and non-negotiable.
“That wasn’t the case three years ago,” Walsh adds. “That has caused a broader discussion in the market. Because of that consolidation these bigger pools are creating more interest, more appetite, more conversation and therefore the broader market is looking at this as well. It has become the topic that everyone is talking about.”
Lyne adds that the findings of this research are consistent with what he is seeing, which is that people are interested in ESG but the importance they attach to it varies depending on their role and experience. This also depends on the definition used, be it ESG, responsible investment, SRI or impact investing. People can sometimes get distracted by talk of exclusions, for example.
“It shines a light on a challenge that we have seen in the US and the UK where people need to speak with consistent definitions,” Lyne says.
THINGS TO COME
The UK Institutional Market Study 2018 was published before the government issued guidelines for pension scheme trustees to inform members of how they consider ESG factors in their investment decisions.
So could trustees’ attitudes towards ESG improve when next year’s study is published?
The DWP’s guidance is positive in terms of encouraging trustees to ask the question about whether they see ESG as important, Lyne says. “What needs to go alongside that is the idea of working with providers and consultants, getting the education part out, sharing some of the academic research and linking it into reporting and measurement.”
He adds that an academic once told him that asset managers create products left, right and centre. There are too many products. “Where she is confused is that the end users do not have a single view on how to take advantage of ESG,” Lyne says. “There are those that want to take advantage of social impact funds and there are those that want a thematic fund, such as water or healthcare.
“It is one of those subjects where you are never going to get a client demand for a single approach,” he adds.
“It is about making sure that people understand the difference between the various capabilities that are out there, and, more importantly, how they want to take advantage of it.”