No one really wants to think their pension fund is invested in the global arms industry or in companies notorious from profiting from child labour or other exploitative practices. But there was little most people could do about this until the fairly recent past.
The problem was not just the complex nature of global funds investment and how it can be difficult to figure out just where the money is going. It also comes down to the duty of care which pension fund trustees must exercise on behalf of members. Broadly speaking, their job is to seek out the best returns while not incurring excessive risk – not to guard the planet or become peace campaigners.
But that is changing. For example, the latest EU Institutions for Occupational Retirement Provision (IORP II) regulation requires trustees to consider environmental, social and governance (ESG) in investment strategy. At the same time, the UN has issued its Principles for Responsible Investment, which it defines as “is an approach to investing that aims to incorporate environmental, social and governance factors into investment decisions, to better manage risk and generate sustainable, long-term returns.”
ESG investing can involve a positive or negative selection process. Both integrate environmental, social and governance criteria into fundamental investment analysis. This can mean shorting or not investing in a company with governance issues such as bribery or tax evasion, or investing in companies with good ESG fundamentals to reduce risk or enhance returns.
Investors can also select for impact. This includes investments such as alternative energy and micro-funding that have a positive investment return as well as desired social, economic or environmental outcome.
Mission-related investing selects companies or funds that align with the investor’s mission. These can be involved in healthcare, education or other social issues.
The UN reference to sustainable, long-term returns is key. "ESG investment is a big thing for Mercer globally," says Rob Meaney, head of responsible investments with Mercer Ireland. "It is about taking a sustainable investment approach. But what is sustainable in the long term? ESG brings it into the investment process. It's not about ripping up what you've been doing up until now. It's about enhancing what you are doing and doing things better. It's also about thinking of other ways of doing things – that can only help."
ESG is an offshoot of socially responsible investment, he explains. “If you step back and have a look at things, it’s about things like looking at supply chains and workplaces and how well companies are governed. Taking those aspects into account makes a lot of sense from an investor’s perspective.”
The virtuous option can also be more profitable, Meaney adds. “We did a study on climate change and investment portfolios. The research showed if we tilted portfolios away from less environmentally friendly stocks the investments still did quite well. You’re not going to put everything on red, of course. We found that if you shift portfolios in that way, they should outperform from a forward-looking perspective. It can be the best thing to do for investors.”
The emphasis is very much on the long term, however. “Investors can sometimes get caught up in the quarter-on-quarter numbers,” he says. “Pensions are long-term investments and ESG investing fits in with that timeframe.”
AIB head of retirement planning Tony Doyle agrees that ESG investing can deliver superior returns. "We have been around this course before with socially responsible investment but there was an acceptance of weaker returns with that," he says. "That is not the case with ESG. The way the funds are looking at it is to deliver sustainable, long-term dividends."
Different approach
He is referring to the very different approach being taken by fund managers today. "In the past, they had a screening-out process on an ethical basis," explains Bank of Ireland head of pensions and investments Bernard Walsh. "They took out tobacco companies, arms firms and so on. It's quite different today and it's an issue that's coming up more and more at trustee and customer meetings. They want to see that there is a policy in place."
He gives an example of the way today’s approach works. An oil company with a long track record of environmental breaches and fines would eventually be screened out on both environmental and governance grounds. “That would protect investors by screening out the investment before a major disaster affecting the share price could take place,” he adds. “It has been said that companies with more diverse boards take their responsibilities more seriously and are less likely to suffer a major disaster. Those are the companies you are actively looking to screen them in. ESG creates a virtuous circle if you screen in the exemplars.”
It’s not as simple as screening out an investment totally, of course. It can also be a case of reducing exposure to companies with poor ESG scores and increasing those on the higher end of the virtue spectrum.
There is another advantage to this approach. “If you look at what’s happening in society generally, young people are very much engaged in these issues and having an ESG component to a fund can be a better way to get young people interested in retirement savings,” says Tony Doyle. “There is anecdotal evidence that young people put more into ESG investment. ESG investing could also be a way of putting pension funds to use for the betterment of the country. You’re going to be in a pension fund for 30,40 or 50 years and you have to do something with the money. If it can tie to investments that are to the advantage of the nation, so much the better.”
Rob Meaney agrees. “ESG can be used as a tool for member engagement. One of the things we are trying to do is engage people. Look at what’s happening with Greta Thunberg and climate change. A lot of people who are not engaged with investments are engaged with climate change and are more likely to put money into a fund that is aligned with that.”