There can’t be too many people across the pension’s landscape in Ireland who haven’t heard of the concept of ‘Responsible Investing’ or the acronym ‘ESG’ in relation to investments.
At Zurich, we see responsible investing, or the acronym ESG as an overarching set of principles, with ESG being a subset of the same idea. Environmental, Social and Governance (ESG) investing captures the zeitgeist of modern investing, and a perfect storm has emerged in terms of its growing popularity. Legislative, climate, and millennial trends are all combining to make ESG investing one of the most topical discussion points in the DC pensions market.
At Zurich, we believe that employers, trustees and advisors can use the concept in a number of ways to engage, connect and appeal to a younger workforce – essential if we are to combat the pension’s gap that exists in the DC world.
What are the considerations that go into ESG?
- Climate Change
- Human Rights
- Stakeholder Relations
- Supply Chain
- Director relationships
- Inadequate governance and compliance
- Shareholder dilution
In general ESG considerations can be another valuable input into stock selection and can represent an economic approach (depending on the price). ESG investing is not the investment panacea and the jury is still out on whether it is the route to enhanced investment performance. ESG investing increasingly does not represent an exclusionary approach for low ESG rated companies.
What is ESG investing?
But when you first hear about ESG or sustainable investing, what comes to mind? Millennials and their social conscience? Wealthy people who can afford some philanthropy? Or just a new angle for fund managers to promote funds on the back of It appears that ESG investing is here to stay and is more than just a passing trend. However, it can be hard to identify exactly what it means and how investment managers can incorporate a process into not only specific existing funds, but also into their overarching house philosophy and style of investing. For example, most active managers will rightly argue that taking into account social and governance factors is just part of being a prudent investment manager, but may have concerns about the economic impact of excluding or minimising exposure to certain sectors of the market, which may still be profitable and therefore ‘good’ investments.
At the other end of the scale are index tracking funds; whilst they can have an ESG strategy, they are somewhat compelled to buy the stocks that are part of their benchmark/index – excluding metrics other than market capitalisation, or company size.
The regulatory viewpoint
Responsible investing, continues to draw interest across the world from a regulatory perspective. With greater transparency to the underlying investments of a fund or holdings of a firm, many are urging rules that would require companies to disclose comparable, decision-useful ESG information. Regulators are now tasked with determining what a standardised reporting framework would look like.
The pressure is coming from a number of areas:
- IORPs II legislation will enshrine requirements on trustees of pension schemes across Europe to include ESG considerations in their decision making across multiple areas.
- In Nordic countries, where it has been prevalent for a number of years, investing without ESG considerations is uncommon
- PEPP, which stands for Pan-European Personal Pension, will contribute to the EU sustainability agenda in the financial sector in multiple ways. Most notably by name checking the Paris Agreement, UN Sustainable Development Goals and the EU Commission directives into account when considering an investment.
There are a number of ways in which insurance and fund management companies can incorporate a Responsible Investing perspective into their business operations. The companies they invest in via their equity investments are the most obvious, but equally effective measures would include carbon neutral workplaces (clean energy), green impact investing, and selectively excluding fossil fuel related companies from group underwriting and investing activities, and to extend fossil fuel exclusions to policyholder funds. A number of firms also support the Paris Accord on combatting global warming.
Challenges to investing
Despite significant appetite for Responsible Investing, there are daunting barriers to greater adoption. One is the lack of standardisation in measuring the ‘impact’ of investments. The Financial Times reports that investors are struggling to quantify the environmental impact of their investments. Both advisors (34%) and investors (61%) agree that it’s difficult to measure. The CFA institute has also recently reported that there is no standard framework to measure a carbon footprint, and this is a common theme throughout the area of Responsible Investing. The concept is also more prevalent in equities – but do investors want a 100% equity portfolio? This is not the right risk level for the majority of investors, but from a Responsible Investing perspective it is certainly the most advanced asset class. Fixed Income is catching up and in the corporate bond market a lot of the metrics applicable to equities are also relevant. The sovereign bond market is less advanced, but Responsible Investing multi-asset funds are beginning to emerge.
Whilst the conversation and interest in the area is growing – the fund flows haven’t quite caught hold just yet. For example, a recent BNP Paribas survey cites that 80% of investors in Italy have a ‘willingness to invest’ in a ‘socially responsible investment’ yet only 7% actually do currently. The lack of information is an obstacle to more widespread investment, but that is changing and fund managers and product providers are clamouring to portray their expertise in this area. Interestingly, the BNP survey also points to a connection between interest in Responsible Investing and events such as the UN Climate Change Conference on the ‘Climate Change‘ protests held across the world. In essence, if interest continues to grow in the mainstream media this will seep into people’s investment mind-set. However everywhere it holds true that the gap between a fundamental interest in the area and actual investment offers huge potential. Fund flows are small now, but will grow.
The fundamentals of investing
The fundamental goal of investing really hasn’t changed. We invest capital today, in the hope/expectation for a better, or wealthier future. However, what constitutes ‘better’ or ‘wealthier’ may well be changing. This cannot be ignored.
The growing prevalence of investing with a responsible framework is likely to grow further and you have a great opportunity to strengthen your DC strategy by using them. The benefits of offering these solutions are likely to far outweigh the drawbacks, but there will be challenges. The concepts within this area continue to mean different things to different people. While the investment industry continues to grapple with the best way to incorporate Responsible Investing preferences into previously standardised practices, initial research into the area could put your DC scheme in a great position - ultimately enhancing your proposition and providing value to both current and prospective scheme members.