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The recent consultation, Pension trustees: clarifying and strengthening investment duties, is enormously well intentioned, being driven by the undeniable fact investing a substantial proportion of UK pension assets for the good of our society and wellbeing of our planet could bring about better corporate behaviours and drive positive change.
Pension trustees know they are long term investors on behalf of their members, many of whom (especially with defined contribution (DC)) will want a better world for themselves in 50 years and in 100 years for their children.
The problem arises in how to bring this about. Legislating to force pension schemes to invest in a certain way contradicts trust law. Trying to get around this fact (as this proposal does), is like asking the Queen to direct the government over Brexit. Yes, she might do a good job but it’s not something she’s allowed to do.
The government appears to have decided pension trustees aren’t taking ESG and climate change or the views of members sufficiently into account in investment decisions. They’ve proposed additions to a pension scheme’s statement of investment principles (SIP) to force trustees to consider these factors to a greater degree and report on the actions taken. Whilst it is important pension trustees consider these alongside all the other investment risks (and failure to do so represents an oversight), it feels a political agenda is at work here.
These risks are of an extremely indeterminate nature when it comes to the actual decisions the average pension fund has to make. The danger is, notwithstanding assurances that it remains the trustee decision where to invest, the exhaustive explanations about how pension trustees must consider ESG/climate issues will encourage them to tick this box even if this is in real danger of eroding returns required to fully fund the scheme or create unbalanced portfolios.
I am particularly concerned at the suggestion trustees “begin or increase the allocation of capital to investment opportunities such as unlisted firms, green finance and social impact investment”. These investments have generally had a poor track record, are often illiquid and might do real damage to recovery plans. Trustees should not be influenced by the political and personal agenda of others.
Taking member views into account is fraught with difficulty, and only relevant in practical terms with DC schemes. In a perfect world, DC members would be highly engaged and an easy consensus would emerge with one or two themes that could be easily converted into an investment approach providing long term value for members. We all know that won’t happen in reality.
Catering for divergent views with a multitude of fund options is expensive to run and risks confusing members, 90% of whom are generally not investment savvy. Trustees may also feel directed to make poor investment decisions because they have a regulatory duty to incorporate perceived member views. The more rules made, the more investment decision-making will be about box ticking – especially if a fine is the result of failing to tick that box.
A better way forward
In 2014, a Law Commission report concluded trustees should take into account financial materially factors, whatever their source, and that it was reasonable to take account of members’ views in making investment decisions provided they follow the ‘two-step test’ that:
1. Trustees have good reason to think members should hold a particular view.
2. The decision should not be expected to lead to significant financial detriment to members.
With this in mind, this whole topic would be better addressed by the Pensions Regulator (tPR) issuing guidance that reminds trustees to take ESG sufficiently into account in long term risk evaluation and expects it to be included in a balanced consideration of an investment strategy that is in the best interest of members. This would feed through to investment consultants who can drive asset manager behaviour.
A key concern is the added cost from advisory fees the proposed legislation could lead to. Larger schemes have the budget and ability to consider ESG requirements in detail. They can increasingly direct segregated mandates or direct investments to take ESG into account.
For smaller schemes, funding and diversification risks far outweigh ESG risks and this is where they should focus their limited budget. This often leads to allocations to pooled passive equity funds, which diversify the equity risk but offer pension trustees no ability to shape ESG and climate change requirements. Meaningful change will take place when asset managers know investment consultants won’t put their pooled funds on a buy list unless they can show they are addressing these topics proactively.
What trustees can do is select investment managers based on their adherence to strong ethical standards in their asset selection and their active engagement to bring about positive change in the companies where they already invest (or might invest if corporate behaviours improve to prescribed levels).
This consultation was clearly driven by the current fashion for ESG and climate change. They are very important issues - as are many others - but the industry is already plagued by directives driven by fashion. Trust trustees to be responsible. If they are, they will be addressing these topics. If not, they’re not doing their job.