Pension scheme investments: Low-carbon strategy or low-fat latte?

The Pension Regulator has warned pension fund trustees not to be complacent about environmental, social and governance (ESG) issues when looking at their long term investment strategy. ESG refers to the three central features in measuring sustainability and ethical impact of investment in a company.  It covers a range of topics and climate change is but one of the environmental issues.

I fully accept the body of evidence on climate change is compelling. I also accept it’s a human-created phenomenon and as time progresses governments are going to have to take greater action in this area than at present.  I am not yet clear on how that will affect pension scheme investments in the long term. Thus, although trustee boards are expected to take account of risks affecting the long term financial stability of investments, until the climate change risk is better quantified,  and perhaps a little closer to the risk happening, the tail is not about to wag the dog anytime soon.

David Piltz
“Only if trustees can adopt ESG-friendly investments in the short or medium term without damaging returns or increasing risk will members want them to invest in windmills.” David Piltz, EMEA Consulting and Market Leader

I was not surprised that professional pensions research revealed 53% of the pensions industry does not believe climate change is a financially material risk to portfolios.  That may well change over time.  There are however events going on round the world which trustees may see as having far more likely impact on pension scheme investments in the short term – such as Brexit. Climate change and indeed ethical, social and governance (ESG) factors generally are not being ignored; they are just some way down the queue in respect of immediate importance for pension scheme trustees.

The Pensions Regulator correctly keeps reminding trustees of the importance of  good outcomes for members, but that does not necessarily square with all ESG issues and particularly climate change.  In defined contribution pension schemes it’s fine to have an option for members allowing them to adopt ESG-friendly investments by choice, but the majority of the members are more concerned with the size of their pension pot than climate change or any other of the ESG issues.

If, for example, oil company shares are currently expected to do well, and adopting ESG-friendly investments in the short or medium term potentially reduces the size of their ultimate pension pot, members would not be amused with trustees who explained, well, the bad news is you’ll be poorer in retirement, but the good news is that at least you have the satisfaction of knowing you were trying to save the planet. Only if trustees can adopt ESG-friendly investments in the short or medium term  without damaging returns or increasing risk will members want them to invest in windmills rather than more traditional investments such as companies committed to fossil fuel exploration.

I am concerned anyway that in 10 to 15 years’ time there is going to be a scandal when those without any defined benefit pension  get to retirement and realise just how little they have got in their defined contribution pension arrangements, without trustees possibly making it worse by over-reacting on certain ESG considerations such as climate change today.

Moreover, in your average defined benefit scheme, which now has a substantial deficit, most employers would surely question the sense in trustees today potentially lowering the expected returns of their return-seeking assets on the basis that it was better to get a lower return now because of the longer-term risk of pension scheme investments being affected by climate change.

The Pension Regulator’s Andrew Warwick-Thompson suggest trustees wake up and smell the coffee.  For pension scheme trustees, future climate change in particular is more of a latte than a double espresso!

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