The importance of good governance has been understood and assessed for many years, with investors paying close attention to the composition, behaviour, and running of corporate boards. Similarly, the full reality of climate change has become mainstream news, with the COP26 summit in Glasgow last year putting pressure on governments and investors around the world to limit the damaging effects of global warning.
New regulations for pension schemes also shone a spotlight on climate-related investment, with trustees now required to report on risks in line with the Taskforce on Climate-Related Financial Disclosures (TCFD) framework.
With such high-profile attention on the environmental ‘E’ of ESG, it can be easy for the other elements, especially the social ‘S’, to slip down schemes’ investment priorities. Trustees, consultants, and fund managers sometimes struggle with a definition of ‘S’ in particular and as a result it often doesn’t receive the focus it deserves. However, as with ‘E’, social factors offer both risks and opportunities for pensions investment, so it’s important that every scheme is aware of its importance within their portfolio.
1. Build your own beliefs - The Pensions Regulator now expects all schemes to report on how they are addressing ESG factors. But there is still plenty of scope for trustees to establish their own investment beliefs and determine the balance between E, S and G priorities in their portfolio. Putting more emphasis on ‘S’ could help schemes where the sponsor is disengaged with environmental factors, for example.
Trustees can combine best practice ideas and their beliefs to create their own scheme’s definition of ‘S’. For example, your criteria could include infrastructure and social housing, assessing the way in which companies treat their workers, how businesses interact with the wider communities in which they operate, and how their production methods affect wider society. For global companies, it could also include factors such as the human rights records of regions where a business operates, as well as exploring their supply chains.
2. Apply them to your own strategy - As with any other form of investment decision-making, ‘S’-related assets need to support your scheme’s overarching objectives. For example, value for members will be an important criterion for defined contribution schemes’ default funds, but schemes planning to buyout in the short term might want to avoid illiquid investments such as social housing.
Whatever your scheme’s objectives and timelines, there is no reason to overlook social factors – even if you are targeting buyout. Insurers are focused on the ESG credentials of their investment portfolios and may favour matching assets that mirror their own investment beliefs.
3. Challenge investment consultants and fund managers - Climate-change investment might be grabbing all the headlines, but that doesn’t mean fund managers are ignoring social factors. Some have addressed issues such as fair pay and worker welfare for many years and continue to put pressure on the businesses they invest in to improve standards. However, this hasn’t always been visible to trustees, and there are no consistent methodologies for reporting social factors, or comparing like-with-like. Investment consultants – and fund managers if you have direct access to them – should be able to explain how social factors are being addressed in their strategy and how these relate to your beliefs.
We’ll explore this in more detail in a later blog – watch this space.