Innovations and Pensions in a Post-Covid World

Panel:

Armit Bhambra – Head of UK Corporate Pensions, Mark Thompson – Executive Chair of the Investment Committee of the UBS (UK) Pension & Life Assurance Scheme

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Change has come to the pension industry. Mark Thompson, who has helped shape UK pension schemes for more than 35 years, talks us through the three big topics on the minds of trustees everywhere – ESG integration, the growth in private market investment and increasing consolidation.

ESG Integration

Mark has spent years promoting ESG in the pensions space, but it remains an uphill struggle – many trustees are put off by the terminology, perceived complexity and lingering fear that investing responsibly costs returns.

For Mark, it’s best to focus on what ESG means to pension funds – it’s about integrating another layer of risk management and investing in new opportunities. Integrating ESG is not about investing ethically. And it’s not necessarily about making an impact. Sustainable investing is about investing better.

Ultimately, trustees are the fiduciaries of their members’ pensions – ESG investing is not contrary to that. Impact investing, for example, can both do good and provide superior results. Why? Because issues like climate risk are investment risks. First there’s transitional risk – companies that do not update their operations to help meet climate goals will be penalised by governments, regulators and consumers. And, second, there’s physical climate risks, which could put facilities and staff at risk around the world.

But what can pension trustees do to make sure their investments are well-positioned for the future, both from a risk and return perspective? For Mark, it’s about talking to the people who talk to issuers – the asset managers. The recent Stewardship Code, which is designed to promote responsible investment to create long-term benefits for clients and society, has made it easier to hold asset managers to account when it comes to such issues. But Mark worries that, for some, putting in place regulatory hoops to jump through will turn ESG investing into another box-ticking compliance exercise. Setting up an ESG working group to tackle any issues that arise in underlying managers can ensure that ESG risks and opportunities are truly being addressed.

ESG risk: The environmental, social and governance (‘ESG’) considerations discussed herein may affect an investment team’s decision to invest in certain investment opportunities from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

Private Markets

Globally, this is the fastest growing area of investment for pension schemes. Investment in alternative asset classes has gone from 7% to over 20% in the past 20 years. In Europe, we believe the figure is lower than that and believe there is scope for further growth in the years ahead, both globally and in Europe.1 And private investments such as inflation-linked cash flows could have a real impact in today’s market environment.

When we talk about private markets, however, we are talking about a very broad church: from illiquid investments in start-up companies to secure infrastructure projects with 25 years of cash flow. Mark thinks trustees need to decide what private investments will be used for within their schemes’ portfolios. Is this a steady source of income or a bet on a high return? And the type of scheme may make a difference – a defined contribution scheme has more barriers to investment than a defined benefit scheme.

There are opportunities here, but there are also potential pitfalls that need to be considered.

Consolidation

Consolidation has spread. From the Netherlands, which now has around pension schemes, to Switzerland, where 200 schemes closed their doors in 2017–18, the number of pension schemes across Europe is getting smaller. In the UK, we are also seeing more and more outsourcing to asset managers and consultancies.2

Mark believes this will continue for some time – regulators and governments want pension schemes to increase scale. Scale should lead to a better deal for members in the long term as consolidation fuels better pension management and opens the door to more investment opportunities.

Consolidation and outsourcing in the pension industry will fuel – bringing us full circle – further growth in sustainable and private market investments. Smaller schemes simply don’t have the resource to fully benefit from these asset classes. Could a scheme with £10 million in assets set up an effective ESG working group? Probably not. Those with more resources can also act quicker to take advantage of market movements – you can’t do this at a quarterly trustee meeting.

Schemes holding back from the tide of consolidation need to ask themselves, what opportunities are we missing out on?

1 Source: Thinking Ahead Institute, Global Pension Asset Study, 2021
2 Source: Europe Pensions, November 2020