Portfolio Design

The role of ESG in UK pension schemes

Sarju Mehta |10-Jul-2019

Whatever investors’ views on the subject, ESG is increasingly on the agenda – especially for UK Trustees who, from October, will be required to show more formally how they have taken ESG into consideration.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

What this means for UK Schemes

The Department for Work and Pensions’ statement of investment principles requires clear indications on how ESG and Investment Stewardship considerations are taken into account within investment arrangements. These are:

Department for Work and Pensions investment principles.

Time horizon

For a board that expects to complete an insurance buy-out within three years but believes carbon assets may still be on the balance sheet of an equity holding, this is a financially material belief as it could result in a fall of the stock price.

While many firms have made proclamations about reducing carbon, tangible progress has been harder to quantify. For a scheme, this makes it difficult to evaluate whether carbon or ESG concerns are material within the time frame they’re looking at. In the three-year scenario above, it’s difficult to know if the carbon theme might cause a stock price or market correction before they get to buy-out.

Scheme assets

There is usually a size threshold for how schemes can invest – pooled funds vs. bespoke funds or even segregated accounts. If going segregated, the scheme legally owns the underlying securities – the choice on whether to own certain stock and any associated engagement/voting. The scheme therefore has the ability to implement beliefs and to be active in influencing company management (particularly if a large holder).

For smaller schemes where individual investments are through pooled arrangements, the manager of the pooled assets will decide the ESG and corporate stewardship approach.  Going through pooled funds does not absolve schemes from having a view, but this would need to be expressed by finding a pooled manager which best reflects these investment principles.

Our observations 

Our observation is unsurprising: This new requirement has varying levels of engagement from different schemes. This may be partly due to differing circumstances, as referenced above, but also by the varying beliefs of what can be a marmite subject.

One point worth stressing, however, is that there’s an increasing ability to take more informed views on this area, and this focus will steadily increase as more reliable data becomes accessible to investors. Good quality information on prospective investments at worst does not change your investment thesis and, at best, it transforms an investor’s view – it’s key to ensure your pension scheme arrangements take this into account as part of the process.

Sarju Mehta
Head of EMEA Pensions team, Client Portfolio Solutions
Sarju Mehta, Managing Director, is the Head of the EMEA Pensions team in Client Portfolio Solutions.
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