There is a sea-change taking place when it comes to the value that investors and shareholders place on what a company does. I should add, a sea-change when it comes to investment decisions, not in a climate change detrimental sense.
In many instances, it’s no longer enough to just look at the financials – the profits, dividends and returns on investment. Instead, people are increasingly considering how these returns have been earned.
Here at the Government Actuary’s Department (GAD), my team deals with investment and risk issues by looking at all kinds of factors in determining the best investment approach. We analyse and spot patterns in data, and responsible investments are right up there as a growing field.
Proponents of responsible investing say that considering environmental, social and governance (ESG) issues can enhance returns over the long run and reduce exposure to risks. Climate change is one such example of these types of risks which can have material adverse financial and social impacts.
The thinking behind ESG means investing in companies that are looking at, for example, green energy production and driverless cars. Proponents also say that these types of firms are likely to have better long-term financial performance and social impacts than companies that are producing energy or cars that run on fossil fuels.
Things to consider when investing responsibly
The ESG criteria set out the range of factors that need to be considered when investing responsibly, such as:
- environmental criteria, which consist of looking at a company’s performance as a steward of nature, the environmental risks they face and how these are managed
- social criteria, which are used to examine how a company manages relationships with, and its impact on, communities
- governance factors, which look at issues such as executive pay, audits and shareholders’ rights
Increasingly, investors believe that ESG factors are increasingly important considerations for them as they are likely to be strongly linked to a company’s overall success or failure. Hence, investors are looking at these criteria when they evaluate investment opportunities and seek to influence corporate decisions as shareholders.
The impact on pension schemes
It’s no surprise that this change in emphasis also applies to pension scheme investments, which – across the many schemes – are one of the biggest players in the investment market. From October this year, the Department for Work and Pensions (DWP) has mandated that trust-based pension schemes need to say how they account for financially material ESG considerations, including climate change, in their investment approach.
The DWP added that the trust-based schemes will have to outline their policy on engaging with companies in which they have invested.
Pension schemes will also need to acknowledge and consider their members’ views on ESG risks and they will also be allowed to account for non-financially material ESG considerations where there is general member agreement. Previously, schemes have only been advised to consider these, so the increased requirement to consider ESG factors may require further consideration and oversight for pension schemes.
Better investment returns?
As the UK is a world leader in ESG fund management, our pension schemes already benefit from a wide range of approaches and investment opportunities. Further, many argue that allowing for ESG factors in a pension scheme’s strategy should not reduce investment performance and may even result in better performance.
So, the argument goes, more sustainable companies are likely to be more robust when it comes to tackling climate change issues in the future. This resilience will increase their profits and returns over the long run. Furthermore, companies with improved governance are more likely to be better at identifying, managing and mitigating financial risks relating to such factors.
All things being equal, it’s beneficial to consider ESG factors as part of the usual investment process. Undertaking this analysis now should pay off in the long run, as schemes should see greater and more stable returns for more sustainable companies.
It’s all food for thought, and in the meantime, here in GAD we continue with actuarial analysis for government and public sector clients. We provide advice on the investment aspects of pensions schemes close to government who are thinking about the investment risks that they are exposed to and how best to invest to meet their objectives.
If you’d like to know more about the risks, and the growing importance of ESG leave a comment here or have a chat with us in GAD!