Our thinking Quick reads ESG factors gaining ground in pension fund investing
ESG and sustainability
September 2020
6 min read

ESG factors gaining ground in pension fund investing

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If the COVID-19 pandemic has shown us anything, it is the importance of the community in which we live and work. We see this importance upheld through organic ESG improvements. There have been many uplifting stories in social media about acts of goodwill, not just by individuals, but by companies who have responded to the crisis in a positive way. For example, manufacturers who switched to producing ventilators at short notice, hotel chains that agreed to house the homeless, supermarkets who prioritised delivery slots for the vulnerable and elderly to name but a few. Not only that, but employees have been sharing positive stories about the way their companies have looked after their financial and emotional wellbeing. Many firms have offered social events via Zoom for their staff, or have topped up salaries for those on furlough, or offered mental health counselling. More recently, companies have had to give careful consideration to the wellbeing of their employees as businesses start to re-open.

What are the implications for a pension fund investor of such activities, whether they are either good or bad? Should a pension fund worry about the social behaviour of the companies in which they invest? Can social behaviour ultimately impact the value of a company’s share price?

On top of this, it is not just social issues that have come to light during the pandemic. The impact of the lockdown restrictions on air quality have been eye-opening. Air pollution levels in London dropped by 35% during lockdown. In China, scientists saw a 25% drop in air pollution in cities. Commercial flights have also dropped significantly – in the last week of March, there were 63% fewer flights worldwide, than the same period a year ago, giving us an insight into how the world might look in a net zero scenario. However, what remains to be seen is how companies will respond to this dramatic environmental improvement as lockdowns ease and businesses begin to return to normal. Will they continue to send staff members on frequent flights for meetings or conferences? Will they slip back into old habits with ease, or will they use this as an opportunity for more permanent positive change?

In a recent article, “A Sustainability Framework: Societal Shifts as Investment Risk”, Lazard put forward the concept of a firm’s societal licence. They argue that relationship risks such as consumer values and environmental issues can influence the risk of an investment. Whereas traditional risk analysis focused on the relationship between a company and its industry, Lazard now argue that there is a third dimension, and societal influences need to be brought into any risk assessment. They suggest that “Every company and industry operates under a societal licence that, if damaged or revoked, can ultimately impact the bottom line.”

Where does this leave a pension fund committee, in terms of taking such factors into account in their pension fund? As an investment advisory firm, from time to time, MJ Hudson is asked to help funds with this. On a related note, recently in the UK, investment advisory firms have formed a working group on sustainability with the aim of seeking to improve sustainable investment practices across the investment industry.

The ESG & sustainability team at MJ Hudson has seen no let-up in focus on impact and socially responsible investing from asset managers and investors alike. It is encouraging that, whilst there have been tactical headwinds, for the most part investors have remained strategically steadfast to the objectives of a sound ESG policy and a focus on implementing it.

What we have seen, is that the pension funds that we advise are all on an ESG journey, and different funds are at different stages of that journey.

For some, this means they are looking to increase their understanding of how their investment managers assess the environmental, social and governance risks that could potentially damage shareholder value. They are seeking to increase their effectiveness as responsible shareholders, to vote in a considered way, to engage with the management of companies in which they invest, in order to drive positive change so as to maximise the return on their portfolio.

Some pension funds are now looking to become more purposeful in their investment strategy, and are trying to introduce a sustainable theme, such as low carbon, into their portfolios. This usually follows on from a discussion about their investment beliefs on environmental, social and governance factors. It results in a portfolio being tilted towards companies that are more aligned with their beliefs, and away from businesses that are negatively influencing these.

Pension funds who have been on their ESG journey for some time, are now looking to become even more intentional in their investments, by allocating to so-called impact investments. These are investments that have a dual goal: to deliver a financial return and, additionally, to deliver a positive impact on society or the environment.

The current crises, both the environmental one, which has been a gradual and progressive global crisis developing over decades, and the global pandemic, with its rapid and severe consequences have, brought the topics of ESG and Impact into sharp focus.

What is important, is that trustees take time to reflect and discuss their views with each other, in order to agree how they wish to take account of environmental and social factors in pension fund investing. This will allow ESG risks and opportunities to be reflected in the investment portfolio via a well-thought through strategy, rather than a haphazard response to individual concerns raised. Agreeing the right ESG strategy is best dealt with by a discussion at a separate trustee meeting, rather than tagging onto a regular committee agenda. This is something that MJ Hudson could organise and facilitate for you. From our fifteen-year experience, the ESG journey for pension funds requires a clear vison, a sound strategy and thoughtful implementation. Please do get in touch if you wish to find out more, or visit the webpages for our Investment consulting, pension trustees & advisory or ESG & sustainability services.

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