Assets held by UK defined contribution (DC) pension schemes are expected to increase substantially over the next decade. That vast sum of money will support the retirements of millions of UK employees over the next 30 years and beyond.
Over the last few months, stock markets around the world have suffered unprecedented fluctuations as a result of the Coronavirus pandemic. It is still too early to determine how long it will take for stability to return to markets, or what normal will look like in the short to medium term from an investment perspective.
As long-term investors, pension schemes must continue to look beyond the current turbulence. They must seek to understand the ways in which the economy will rehabilitate itself after the current crisis, how organisations will run their businesses in the future, and how they will take account of enduring trends such as climate risk.
Even before the pandemic, the importance of environmental, social and governance (ESG) factors in pension scheme investment was gaining ground. Trustees and scheme managers want to know how the businesses in which they invest are responding to environmental threats, how they treat their workers and the wider community, and the quality of their corporate governance. These factors affect how well businesses perform over time, and, therefore, the returns they can generate for scheme members.
Aon’s Global perspectives on responsible investment 2019 research, published in October 2019, found that 87% of UK institutional investors believe responsible investment is somewhat, or more, important, reflecting this trend.
In contrast, our Defined contribution survey 2020, published in February 2020, found that just 8% of UK DC default funds currently invest in ESG funds. The same survey found that two in five schemes offer self-select ESG investment options to members, but do not focus on these factors in the default fund. This matters, because we know most members invest in the default strategy, rather than choosing their own investments.
To create real impact and genuinely improve member engagement with ESG factors, as well as the impact that businesses have on the world around them, these need to be embedded in the everyday processes and philosophy of the default strategy. This is about more than simply excluding ‘sin stocks’, such as armaments, from the default fund. It is about investing in well-run companies that provide products and services which have a positive impact on the world around us.
That could mean, for example, investing in the development of environmentally-friendly technology for distance learning, finding ways of reducing the impact of single-use plastics or research into new drugs and vaccines. These are examples of investments that can make a real difference to our world and help members to be proud of what their savings are achieving, driving good news stories to share with the membership.
Being able to quantify the positive effect of the default fund’s investment strategy provides a powerful engagement opportunity. Showing members how much single-use plastic has been eliminated through their investment in new technology, or the impact on developing communities of new approaches to education, for example, can be much more inspiring than dry figures about quarterly fund performance. And, the more that members feel their savings are having an effect on the world around them, the more likely they are to take an active interest in their savings and even increase contributions.
Research from the Defined Contribution Investment Forum in 2018, Navigating ESG, published in April 2018, found that 60% of all members are interested in responsible investment of their DC savings. A virtual investment experiment in October 2019 carried out by the Cambridge Institute of Sustainability Leadership (CISL) Investment Leaders Group, of which Aon is a member, found that members might be prepared to give up between 2% and 3% per annum in returns to ensure that their money is invested responsibly.
The long-term perspective of pension schemes means they must invest in companies that are well governed, behave responsibly towards workers and the society around them, and respect the environment, in order to deliver the returns members need to achieve their retirement goals. Companies that not only fulfil those criteria but also create goods or services which have a positive impact on society deliver the combination of strong returns and powerful stories that members can really engage with.
Joanna Sharples is a partner at Aon
