For Britain’s £2trn pension fund industry, it is undeniable that ESG risks have become a vital component to consider. Pensions minister, Guy Opperman succinctly illustrated this when he stated in July last year climate change is a ‘major systemic financial risk and threat to the long-term sustainability of UK private pensions’.
Larger pension funds already take climate risk into account, and the demand for ‘green’ investing in the coming year will only increase as reporting requirements strengthen for funds worth over £1bn.
Going ‘green’ with pension funds is very much on investors’ radars, but finding the right approach is rarely as easy as it looks on the surface. Everyone wants their investments to help in the transition to net zero, but there’s still a real debate around how best to make a difference and whether taking ESG into account will affect financial performance.
Understanding ESG investing
Many people think that the only way to make a difference from an ESG perspective is to shift pension allocations to so-called ‘green’ investments, or those that already derive most of their revenue from sustainable activities.
However, there is much more to this process than meets the eye. Simply shifting investments from fossil fuel businesses to solar farms won’t be enough to make a difference for the planet.
There is a knowledge gap we need to bridge when it comes to effective ESG investing. By understanding which actions are taken by all companies, not those that are green already, only then can we understand what can truly make a difference from a sustainability and profitability standpoint.
It is imperative that we do not ignore companies that need support to transition to a net zero economy – and which have credible plans to do so – even if they are not there yet. This is where the biggest wins in reducing emissions could come from.
These companies must be engaged with. Research shows that this engagement adds value, as well as being a truly sustainable approach. It is important to make sure we do more of this, and to encourage others to do the same rather than side-lining these companies completely.
Transition to net zero
It’s not an easy task to find out which companies are in the process of effecting a credible transition to net zero. To do this we need managers who engage, question and are willing to challenge the practices that companies are engaged in, so that they can manage the risks to pension funds, as well as make an impact on the planet.
It’s through engaging with these company processes, rather than simply divesting, that managers can build value and improve outcomes.
The importance of good governance
How a company reacts to its investors, as well as how it integrates its ESG goals, can be financially material. All these aspects contribute to good governance, management and an understanding of risk.
Additionally, we also know that positive financial outcomes can occur when investors engage with investee companies over their low ESG ratings. For example, a 2021 study found that engagement with companies with low ESG ratings could be correlated with financial outperformance compared to their peer group.
That’s why when choosing where to invest, it is important focus on stewardship, through both voting and engagement, as well as ESG integration.
As the transition to net zero continues, all of us will have a responsibility to engage with the businesses we invest in on their investment approaches, risk to the climate and how they plan to reduce that risk.
Government announcements and regulation about reporting on climate change are important but can only do so much. It is up to us, as investors, to engage with the companies we own, to make the biggest difference possible and mitigate the climate-related risks for our members.
Everyone would like sustainable investing to be simple. However, like so many other things to do with our finances, it very rarely is. By keeping up a rigorous approach and continuing to challenge companies on their path to net zero, investors can take a truly sustainable investment approach. An approach which is the best for clients, and for the planet.