Published by Paul Maguire on
Estimated reading time: 4 minutes
Socially Responsible Investing (SRI):
SRI is big business – a 2016 survey by the US Forum for Sustainable & Responsible Investment estimated that it accounted for over 20% of assets under management in the US, or more than US$ 8 trillion, an increase of one third from just two years earlier.
By contrast, Environmental, Social and Governance (ESG) factors:
These issues are relevant to trustees of charities and pension schemes alike, and therefore of particular interest to trustees of charities with defined benefit pension schemes.
A fundamental question for trustees is whether these approaches to investment need imply a sacrifice in financial return (some, of course, might see that as a risk worth taking). There is some evidence that strong ESG scores are reflected in companies recording stronger financial performance and beating their benchmarks.
As yet, though, there is little or no long-term data available on the extent to which an ESG tilt can improve portfolio returns. Intuitively, one might expect companies with better ESG credentials to outperform lower-ranked competitors, based on the tenet that issues such as bad governance or environmental problems damage corporate profitability.
A Boston Consulting Group report in 2017 on over 300 of the world’s biggest pharmaceutical, consumer goods, oil and gas, banking and technology companies also suggested that those with more “ethical” operations are more profitable. There remains though a concern among large investors in particular that too great an emphasis on responsible investment can limit returns, for example by restricting investment in profitable sectors such as oil, which have traditionally paid out large dividends.
In June this year, the Department for Work & Pensions (DWP) caused a stir when it released a consultation paper on changes to the investment regulations for occupational pension schemes. We covered this event in an earlier briefing note; ESG in focus. The final paper, published in September, states that it remains government policy not to direct the investment decisions or strategies of trustees of pension schemes and includes what the government referred to as an “optional policy” on non-financial factors – these include members’ ethical concerns and their views on social and environmental impact matters and quality of life considerations. Trustees will be required to outline their policy on the extent - “if at all” – to which they take such matters into account.
“Perhaps more noteworthy for many trustees, the regulatory changes on the back of the consultation will put more pressure on trustees to have given proper consideration to the extent to which ESG factors are financially material.”
In particular, trustees will need to have updated their statement of investment principles (SIP) by October 2019 with a policy on how they take account of financially material considerations “over the appropriate time horizon of the investments”. Crucially, “financially material considerations” will include ESG considerations (specifically including climate change), which the trustees consider financially material.
Note that, where concerns are not financially material (e.g. concerns which are primarily ethical), trustees may only take the concerns into account where there is broad consensus. Where there are differing views on an investment issue, such as in relation to fossil fuels, trustees should focus exclusively on financially material risks and opportunities.
Whilst the regulations described above are of primary concern to occupational pension scheme trustees, charity trustees will wish to be aware of them, given the increasing importance of ESG topics in the charity sector. This is a complex and developing area, which can easily tie up trustees in lengthy and time consuming debate. We would of course be delighted to assist charities which are facing such a challenge.
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