Environmental, social and governance (‘ESG’) investment can be quite a divisive topic in the Trustee world. There are those that view ESG as nothing more than a fad that will, like most fads, just disappear; if we can keep our heads down and tick all the right boxes for long enough, another checklist will pop up to take its place on the meeting agenda in no time.

My 20-20 Trustee colleagues and I take an entirely different approach. We believe that ESG should be a key part of any investment decisions and note how those companies with ethical practices, sustainable plans and overall higher standards of Corporate Social Responsibility (CSR) generally produce higher returns for their investors. We also consider our role in wider society very seriously; whilst we must, of course, always ensure our members’ needs are at the heart of the decisions we make, we also believe that pension scheme Trustees have a responsibility to ensure we’re using our financial muscle – as gatekeepers of significant sums of money – to influence and drive the right behaviours in the companies in which we invest.

But there are, of course, some key questions for those trustees of defined contribution (DC) schemes, where member choice is far greater and arguably more impactful than in a defined benefit (DB) arrangement. First, what do we – or more importantly, our members, mean by ESG and can we use it as an engagement tool? And secondly, must ESG come at the cost of investment returns?

Defining ESG

Are human rights more important than executive remuneration concerns? Does diversity in the workplace trump environmental worries? Defining what ESG means and which letter of the acronym takes precedent or whether all three should be equally balanced, is an obvious starting point for Trustees accepting this new way of doing business. In the DC world, where members have greater choice around investment, we may have to dig deep to discover what they care about and what might appeal to them when deciding where to invest their benefits.

I was very interested to read a report co-authored by Investment Management firm Franklin Templeton and Human Experience pioneers, Adoreboard, entitled The Power of Emotions: ‘Responsible Investment as a Motivator for Generation DC’. It focuses on the first cohort of UK people that will rely predominantly on their DC pension savings in their retirement and instead of simply looking at statistics, uncovered the emotional motivators that inform their decisions.

The results are thought-provoking for those trustees embracing ESG:

*78 percent of Generation DC survey respondents indicate that their current pension provision either doesn’t align with their values or they don’t know if it does.

*41% of their respondents said they would be willing to make additional contributions if responsible investing was incorporated into their pension. They translate that to around an increase of some £1.2bn in employee contributions which would go a long way to fixing retirement inadequacies.

*Over 50% said they think responsible investment should be incorporated into the default investment strategy. So does this mean that as Trustees ESG and responsible investment could be used as a tool to motivate people to save more? Could linking investment decisions to what is important to our members be a really effective engagement tool? Certainly, this research would suggest that we could be collectively missing a trick if we ignore the wider potential of responsible investment, outside of ‘box-ticking’.

Does ESG mean sacrificing investment returns?

However compelling the research, we still have to balance the potential increase in engagement, and it is only potential. Plenty would point to an array of ‘ethical’ options already available for self-selection in many schemes that are widely ignored and under utilised by members against the need to ensure strong investment returns. This is especially important amongst a population for whom DC benefits are likely to be their only retirement income, who may have been automatically enrolled without ever having made a decision relating to their funds and so who will look to the scheme’s Trustees to make sensible investment decisions on their behalf.  Yes, there is evidence to suggest that a company who is sustainable, operates strong levels of governance and high degrees of social responsibility is likely to produce higher investment returns, but let’s just roll forward a few years and imagine they don’t; where does that leave us as Trustees?

Case law (Cowan v Scargill 1984) makes it very clear that “the best interests of beneficiaries are normally their best financial interests”, in other words, Trustees should prioritise investment returns above all else.

Although this case is over 35 years old and doesn’t reflect how our world and regulation has changed in that time, it has drawn something of an unhelpful line in the sand. Nobody is going to challenge the decision to prioritise ESG principles over investment return if the returns are all brilliant. So how do we get a new precedent that gives us the green (pardon the pun!) light to look at things differently, and reflect the changing tide towards responsible investment? It may take some bravery from Trustees – especially around default designs – and some different ways of thinking before we start to see a genuine change, as opposed to box-ticking.

In the meantime, Trustees can and should be developing ways to demonstrate that pension funds can do good in the world for everyone’s benefit.