Considering Environmental Social & Governance (ESG) investment issues

Pension Funds are key stakeholders in the life of a society. The long term capital they hold means they also act as stewards, taking care of assets which members will depend on, to pay them an income and provide security in retirement. As long term holders of investment capital, trustees have a duty to act in the best interests of the pension funds which they supervise.

Trustees of pension funds have a responsibility to make investment decisions that deliver sufficient returns and ensure schemes are run in the interests of members.

Pension scheme members may, if asked, probably support their pension fund assets being invested in a manner that reflects the world they wish to live in. This is increasingly demonstrated in people making choices about what they buy, and where they buy it. The growth of fair trade products is an example of this.

It may therefore only be a matter of time before they start asking questions about how and where their pension assets are invested in much more detail.

The DWP paper “Consultation on clarifying and strengthening trustees’ investment duties“, and the “Pension Funds and social investment: the Government’s final response”, are welcome additions to the debate. The consultation reminds us that Environmental Social & Governance (ESG) issues include climate change, pollution, deforestation, child labour, health & safety, communities, executive pay, bribery, income inequality etc. Also, that the long term impact of ESG issues on the profitability and sustainability of companies’ profits must be considered.

Trustees of pension funds are familiar with considering financial material considerations, examples of which are liquidity, counterparty, inflation, exchange rate, interest rate risks. It is time to recognise longer term risks such as slavery, air quality, water stress etc.

From this long and yet not complete list there’s much for trustees to consider with reference to risks and opportunities and how these might affect returns in the companies in which they’re invested. For instance, if investing in a mining company, do the Trustees ask their managers what the Company’s position is on restoring the environment to the state it was in before their operations? And if such a question is asked, how that would this affect their stock market price.

Trustees can choose to take this as an opportunity to engage with wider stakeholders and members. It can be used as an avenue to demonstrate that Institutional investors are interested in the long term sustainability of companies. It can be used to consider in greater depth, the governance structure of companies, not forgetting they (company or trustee?) must be aware of the risks.

It seems that it is time to have a mechanism to consider these wider questions, and a Statement of Investment Principles (SIP) could be used to achieve it. The challenge is to create a SIP that accurately reflects the Trustees position on ESG with which they are comfortable. To be fully comfortable, this means that they must reflect the diverse and potentially opposing views of members and try to quantify the long term impact of ESG investment.

As long term enterprises it is surprising that it has taken so long to ask the trustees to consider ESG issues. But, given the complexity involved and the fact that the adviser community is really just starting to wake up to the issues involved, this may be the reason why.

The future is a world where trustees will look at the SIP as part of demonstrating how they have considered ESG issues, which matters they have asked questions on, how delivery takes place and the investment decisions they have made, with such principles in mind. In this world, Trustees’ compliance and monitoring would be there for all to see.