Pension funds need to perform a complex balancing act, providing today’s retirees with an income while working to ensure investments for future generations have a positive impact, writes Romil Patel.
Investors recognise that managing assets to maximise returns today, while sending the bill to the next generation – often with huge environmental and social costs – is not acceptable and that the long-term interests of the global market and community require a sustainable approach. Governments too have woken up to the fact that the electorate – including those who own pensions and financial products – care about everyday issues, from the gender pay gap and executive remuneration to tax transparency and climate change.
With the shift towards defined contributions (DC), people are realising that their money is invested in sectors and companies that may come as a surprise to them. As the conversation around environmental and social governance (ESG) investing broadens into the public sphere, pension schemes not only need to deliver sustainable financial returns and impact over the long term, they also need to address how they are doing this.
The right questions
The scale of institutional investors is vast. For example, the Local Government Pension Scheme (LGPS) in England and Wales is one of the largest defined benefit (DB) schemes in the world, with more than 14,000 employers, 5.6 million members and assets of £263 billion (€295 billion).
The Brunel Pension Partnership is one of eight national LGPS pools and manages the funds of ten local government pension schemes, totalling roughly £30 billion. For them, the starting point for combining financial returns with sustainable outcomes is asking the right questions.
“What are those ESG risks that look like they are fundamentally going to have an impact across countries, sectors and a number of our different portfolios?” says Faith Ward, chief responsible investment officer at Brunel.
Covering every responsible investment (RI) and ESG issue evenly is practically impossible and Brunel looks at those that are going to apply to the vast majority of its stocks.
But what are the themes that are important to this multibillion-pound pension pool and, by extension, its members?
Capitalising on allocations
The first aim of pension schemes is to generate competitive financial returns over the long term. This is enshrined in Brunel’s investment policy, which requires managers “to vote their shares in line with good governance principles, but not to be activist investors”.
Delivering healthy returns starts with good corporate governance and having a well-balanced board. The US rules-based approach to corporate governance is considered through a legalistic lens and differs vastly from the Anglo-European collective model of trying to work out what is the right thing to do.
The other key theme that cuts across every ESG issue is about transparency. “On that governance backdrop, we look for companies that are transparent about how they are managing the various risks.
“The quality of their disclosures and engagement with shareholders and stakeholders will enable us to distinguish that they are clearly managing these actions effectively, and reward that through higher capital allocations,” says Ward.
Other important issues include climate change, how whistleblowing and sexual harassment are sat within an organisation and how effectively they are managed, tax transparency, supply chain management and diversity and human capital.
Given their size and weight, pension schemes are powerful conduits for change and they are increasingly looking at issues arising from the UN Sustainable Development Goals (SDGs) to play into and be a part of.
The SDGs are a set of 17 global goals, targets and indicators that focus on development in key areas and were set by the United Nations in 2015.
To achieve these, investors require robust information to make informed decisions, but the current standard of reporting is “poor, not fit for purpose and inadequate to equip us to make the types of decisions that we are expected to”, says Ward.
So, what type of reporting distinguishes the laggards from the leaders in the eyes of an institutional investor?
Stay on course
“I am not looking for standardisation in that formulaic sense. What I am looking for is the right sort of reporting on the right issues from the right companies,” says Ward.
“What I want see reported is that the board has analysed a broad set of risks, including those that arise from the SDGs. One of the things we are seeking is for the SDGs to be a point of reference for company board directors in reviewing their business risk.
“So it is about how they impact on the SDGs – negatively and positively – and how those goals might impact business models if we see those as a proxy for regulatory and financial change in the waves of megatrends that are happening.
“The SDGs are a good framework for thinking about that.”
Businesses need to show a thorough analysis of a raft of risks, identify those most pertinent to its business model, explain how they are being managed and set out the targets that they are seeking to achieve. They must then report on those annually to show progress.
“Our ambition is to see more businesses use integrated reporting as their goal so they really are giving a complete holistic picture of their operations and the impact they are having,” says Ward.
For Brunel and other pension funds, articulation of the thought process and thoughtfulness about real-world issues, rather than being prescriptive about standardisation, is highly valued. This explains why for the pool, responsible investment is integrated across everything it does.
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