Pension schemes are huge, and hugely influential, beasts. Scheme membership has widened massively over recent years as a result of auto-enrolment, with almost eight in 10 UK employees now enrolled in a workplace pension.
Clearly, then, they play a critical role in the country’s investment landscape. According to the latest government data, private sector pension funds had a market value of £2.2 trillion; in comparison, the latest market value of Isas stood at more than £600 billion. For most people, pensions (alongside their homes) are the biggest investments they ever make.
So the potential for pension investment to influence corporate behaviour for the better, and in particular to help fight climate change, is enormous, particularly as investor engagement has boomed over the past two or three years.
However, as new research from the Make My Money Matter campaign highlights, progress has been very mixed. Although £800 billion of UK pension money is now invested in line with the government’s net zero commitments, more than 70 of 100 major businesses’ defined benefit (DB) pension schemes, holding almost £2 trillion of pension investors’ money, have so far not signed up to a net zero pathway.
Among the culprits are the DB pension schemes of British Airways, Boots, GSK, the Bank of England, ITV, John Lewis Partnership, Sainsburys and numerous county councils.
MMMM is pressing for the Government to ramp up pressure. “Our report shows that voluntary action alone is not enough and that’s why we want the UK Government to make net zero mandatory for all [pension] schemes at COP26,” says founder Richard Curtis.
Smaller Schemes Lagging
What of the defined contribution (DC) pension funds, which now house the pensions of over 24 million people in the UK? Against those failures to take meaningful action by most DB schemes, almost all of the 15 main DC schemes run by insurers or dedicated providers have made credible emissions reduction pledges. However, less progress has been made within the long tail of smaller schemes, according to The Pensions Regulator.
As Nigel Dunn, a partner in the DC consulting practice at LCP, explains, ESG considerations have shot up the agendas of DC pension providers over the last few years.
Dunn points to “a combination of investor concerns, rising press coverage and increasing legislation – not to mention increased understanding of the impact that ESG factors can have on funds’ financial performance.”
Climate change in particular has been a focal issue for managers, he adds. Indeed, the Department for Work and Pensions has estimated that 85% of DC members are now in schemes with net zero targets.
The most common way pension fund managers have addressed ESG factors is by incorporating them into their stewardship and investment processes. “Trustees and providers are actively engaging with their investment managers to ensure they are incorporating ESG considerations when voting on shares or meeting with company execs,” says Dunn.
One key consideration revolves around the “greening” of default fund options, which house the pensions of around 90% of DC pension holders. As Jon Greer, head of retirement policy at Quilter, observes: “Pensions suffer from inertia, and often scheme members stay in the default fund after they have been automatically enrolled into a pension. This may not necessarily be a bad thing if the default fund is aligned with the UK’s climate goals under the Paris Agreement.”
He points out that the Work and Pensions Committee recently recommended the government should consult on the idea of aligning all default funds with the UK’s climate goals, “and it certainly seems we are heading that way”.
In fact, says Dunn, the past year has seen pension fund providers racing to incorporate ESG factors into their default strategies and funds to keep up with the market and remain competitive.
“This has been especially important in a market where many legacy DC schemes are closing and moving members to a master trust [with net zero targets already embedded in the default strategy] because ESG concerns are high up the agenda for the decision-makers,” he adds.
For instance at Fidelity International (which runs around 500 DC schemes in the UK), Daniel Smith, head of UK workplace investing, comments: “It’s imperative that the industry provides solutions to allow plan sponsors, trustees and members to make a positive impact with retirement savings. Almost two-thirds (61%) of our members believe workplace pension schemes should automatically incorporate sustainability within their default investment strategy.”
But Greer emphasises that “greening” a large fund is not necessarily a straightforward process and there remain challenges to resolve: “What assets exactly should be considered ‘green’ enough to be included in the default fund, and who will make those decisions?”
Disclosure is Key
For individual investors who want to know more about how their money is being managed, the picture is mixed. Pension funds are reliant on the ESG disclosure of the companies they invest in to report meaningfully. “The availability of this information globally remains an issue for everyone, not just pension funds,” says Dunn. As a consequence, disclosure varies from fund to fund. “Some specialist funds provide ESG information on factsheets, but most others are not providing this information yet,” he adds.
However, he believes that disclosure on climate change metrics is generally better than on other ESG factors, and it’s likely to improve further as master trusts and schemes over £5 billion in assets start having to report annually in line with TCFD [Task Force on Climate-Related Financial Disclosures] requirements this autumn.
Bear in mind, however, that ESG metrics only paint a partial picture of a fund’s sustainability credentials. There are numerous independent ratings providers including Morningstar, Sustainalytics and ISS that can help investors get an better idea of sustainability – but they all work differently, so if you make use of one, do make sure you understand what data is being measured and what the ratings represent.
