Employer Solutions Insights: Retiring for Good – ESG and Pension Plans

The term “Triple Bottom Line” was developed to measure a business’ commitment to people, profit and the planet.

Recent research [1] forecasts that environmental, social and governance (ESG) assets are set to exceed US$100 trillion by 2028 and, today, in the US alone, one third of US dollars currently invested takes account of ESG factors[2].

Ensuring an international retirement plan’s approved fund range incorporates ESG factors is increasingly important for plan sponsors and members and, consequently, those managing the plans must build such considerations into their investment ethos and approach.

With this in mind, Anton Seatter takes a look at some of the questions advisors should be addressing when it comes to retirement planning, as we move into a more socially and environmentally conscious age…

What are the benefits to advisors of including ESG investments in a retirement plan?

Environmentally focused investing has never received more attention, particularly as there are a wide range of societal benefits to investing into funds with strong ESG integration.

Those choosing the investment options need to be mindful of returns, but thankfully, ESG strategies and strong returns are not mutually exclusive. Sustainable equity funds and sustainable taxable bond funds outperformed their non-ESG peer equivalents by a median total return of 4.3% and 0.9% respectively in 20203[].

In addition, ESG investment strategies tend to have a longer-term time horizon, which aligns them well with pension investment, as member contributions can remain invested for decades.

What are the key challenges advisors face in doing so?

The level of ESG integration into underlying investments can be nuanced. The most obvious type of ESG investments include environmental strategies, such as funds which invest into renewable energies. However, ESG investments can also include managers whose investment philosophy places high importance on corporate governance, firm culture and ability to engage with company management.

When selecting investments for an approved fund range, an ESG manager must go through the same prudent, thorough, and well-documented selection processes that are used to consider any other manager. However, the trustee also needs to consider the rationale (with supporting evidence) as to why the investment meets its ESG criteria and is therefore appropriate.

To demonstrate their commitment to ESG, an increasing number of managers are seeking signatory status to the United Nations Principles for Responsible Investment (PRI). Not only does this help to create a level playing field, making it easier for trustees to select ESG managers, but it also ensures managers understand the investment implications of ESG factors.

Similarly, companies are also looking to obtain external accreditation, such as B Corp, to help potential investors understand their approach to ESG. Again, this is useful from an investment perspective and provides greater clarity through the entire investment structure.

Trustees should however be wary of solely focusing on self-titled ESG investments and instead look to strategies where ESG is embedded in the investment process, with a clear approach and audit trails that support the substance of the strategy.

Given the speed at which the sector is evolving, the compliance and regulatory environment surrounding ESG investments is not yet fully developed. That said, various regulators around the world have introduced new reporting and disclosure obligations in an attempt to reduce greenwashing, and any fund identifying itself as an ESG Fund will need to be able to robustly demonstrate that it is just that. This is helpful for trustees and, ultimately, members as they can take additional comfort in the quality of a manager’s ESG credentials.

How can companies get started in integrating ESG into their retirement plans?

ESG is an increasingly embedded factor in international pensions. It is a journey for many companies and trustees as it requires significant upfront and ongoing commitment.

Measuring ESG integration across an entire investment range, rather than a select few investments, will help deliver a more positive ESG outcome, especially if default investment options score highly from an ESG standpoint.

One of the responsibilities for companies and trustees is to help members understand the role they can play. Engagement levels amongst younger members in their pensions is traditionally poor, mostly because retirement seems so far away. Giving these members financial education and helping them understand the impact they can have through their pensions aid our transition to a more sustainable future, while additionally increasing engagement levels in pensions generally.

1 Deutsche Bank and GSIA
2 Forum for Sustainable and Responsible Investment, 2020
3 Sustainable Funds Outperform Peers during 2020 Coronavirus, Morgan Stanley Institute for Sustainable Investing, 2021