Pension funds placing more focus on ESG and climate risks

17 September 2020 5 min. read
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The proportion of pension schemes which consider climate change risk is rising rapidly, according to a new study. Funds perceiving climate change risks to their investments have increased from 14% to 54% in the last year, while the vast majority of schemes now report awareness of risks related to their broader environmental, social and governance practices.

Over the last decade, environmental, social and governance (ESG) risks have swiftly risen to the top of the investment community’s agenda. This is especially for large pension pots, sovereign wealth funds and ultra-high net worth individuals, all of whom have a great deal to lose from investments in ventures which may fall victim to the rapidly changing environment. Illustrating this for example, one survey from EY previously found that 92% of investors agree that over the long-term, ESG issues such as climate change and executive diversity have quantifiable impacts on businesses.

Focusing on the pensions sector in particular, a new study from actuarial consulting giant Mercer has found that the overwhelming majority of schemes now consider wider ESG risks as part of their investment decisions. According to the study, 89% of funds said this was case – a drastic rise from 55% in 2019. This is not just a matter of caution on the side of investors wary of regulatory change in response to the potentially disastrous warming of the planet, either.Does the plan consider ESG risksWhile 85% of respondents told Mercer that regulation continues to drive their concerns regarding ESG risk, a growing portion of 51% also said they were driven by the potential impact on investment returns. This stood at just 29% in 2019, suggesting they were finally beginning to recognise the drastic impacts a planet permanently bathed in fire is likely to have on their potential to accrue capital. With particular regard to climate change, 54% of schemes said they had considered if an investment faced climate change related risks, a dramatic rise from 14% in 2019.

At present, of the 46% who had not considered climate change risks relating to investments, only 7% say that is likely to change in the next 12 months – however, with wildfires currently engulfing the West Coast of the US, and disastrous bushfires likely to become a regular occurrence in Australia, this is almost certain to be an underestimation of the situation. On top of this, investors also seem increasingly aware that the material consequences of their investments will have lasting reputational damage that will make it increasingly difficult to maximise their returns in the future.

In 2019, for example, the world's 5th largest pension fund, Dutch scheme ABP, drew criticism for its continuing investment in companies on a collision course with the Paris climate goals, such as coal and oil companies. Analysis by four environmental NGOs – Both ENDS, Fossielvrij NL, Greenpeace Netherlands and urgewald – revealed that ABP's fossil fuel investments went up from €14 billion in 2015 to €16.5 billion at the end of 2018. This in stark contrast to other European investors, and perhaps this is why Mercer’s study found 40% of schemes cited the desire to mitigate potential reputational damage as a reason to consider ESG risks.

Governance, beliefs and policy

Jo Holden, European Director of Strategic research at Mercer, said, “It is encouraging to see such a strong increase in ESG risk awareness, including the potential impact of climate change, on the part of institutional investors. It has long been our view that these factors should not be afterthoughts, but rather actively considered in all investment strategy decisions. To enable long-term mind-set changes however, investors must realise the value for themselves. We can see this awareness emerging as more schemes witness how ESG risks in their portfolios may impact returns and how the company and scheme is perceived by the public.”

With that being said, many investors remain trapped in the nascent stages of their ESG journey. While 88% said their pension plan’s investment policy makes reference to ESG issues, fewer than one-in-ten had developed a dedicated resource focused on responsible investment. Even fewer meanwhile had installed a responsible investment committee, something which may be inhibiting how pensions funds demonstrate their ESG efforts to the public – even as they come under great scrutiny to disclose their voting and engagement on sustainability. Only 27% said they had a public statement outlining its ESG approach, for example.

While it is hard to find an executive or investor who would be unwilling to pay lip-service to these factors, real change on the matter of ESG remains slow then, meaning a large number of firms are failing to benefit from improved performance linked to ESG changes.

As a result, a recent report from Alvarez & Marsal the European market for activist investors is booming, as they target companies with poor ESG metrics driven by the idea that improving ESG at these firms can produce a rapid return on investment. To avoid becoming ‘at risk’ in this way, investors will need to up their ESG game quicker than they are currently mustering.