This is part two of an article that was published in the July/August 2024 print edition of HR magazine. Click here to read part one.
Is there a performance trade-off with ESG investment?
Achieving decent returns and realising ESG goals are not necessarily mutually exclusive. The decades ahead could involve significant opportunities.
Pension fund trustees should not put ESG considerations above their members’ financial interests but, as pensions are long-term products, they may have an impact on the assets they are investing in. Brian Henderson, Mercer’s head of sustainable investment, UK and Europe, explains: “Some areas of ESG present good opportunities over a 30-to-40-year pension time horizon.
“For example, something like a billion dollars a day was being invested worldwide in solar panels last year. There is money to be made if you are smart enough to get tied up with companies that are going to solve some of the big climate worries.”
Nevertheless, there are also obvious risks to not having exposure to strongly performing unethical stocks. It’s impossible to say whether employees who opt for funds with serious ESG commitments are likely to end up better or worse off than those who don’t.
Read more: State pension age must increase to 71 by 2050, researchers say
The My Pension Expert team doesn’t see ESG investment as a particular hindrance to performance. Representatives of PensionBee feel that its impact on performance is largely neutral over the long term.
When making comparisons, much depends on the time period and type of ESG fund selected. And there are also non-ESG factors at play. For example, UK ESG funds tend to screen out bigger UK companies rather than small ones, and so can underperform when small and mid-sized caps are faring badly.
If oil, gas and armaments are doing well, as has been broadly the case since the outbreak of the Ukraine war, ESG funds that avoid these could underperform. Similarly, on a global basis, ESG funds tend to do well when technology stocks are performing well.
“Globally, ESG funds tend to have a tech bias, partly because big tech companies often have positive ESG scores,” explains Laith Khalaf, head of investment analysis at the investment tech firm AJ Bell. “We don’t know whether ESG funds generally will perform better or worse than the market as a whole in the long term. But we do know they will perform differently. The question for employees is whether they want to invest for ethical considerations or for performance.”
The lack of any concrete performance messages and the fact that pension investment is so heavily dominated by default funds even sees Guy Ellis, HR consultant and executive coach at Courageous Workplaces, dismiss the challenge of aligning pensions with ESG goals as “something of a red herring”. He says: “Employers talk about it a lot as they are intent on coming across as environmentally and socially friendly.
“ESG is big for comms and PR but is outside the remit of most HR. In public, HR people will support it as they don’t want to rock the boat. But most senior people I’ve worked with understand that it’s simply one of those things you have to be on board with, and is largely a PR exercise.”
Other – perhaps less cynical – commentators, while acknowledging that ESG and pensions is not currently a big HR issue, feel that it could become so in the future and that credit should be given to organisations positioning themselves to take advantage.
Jay Williamson, partner at HR consultancy Netiro People, says: “I don’t think this is a box that employers currently have to tick but I think they are being quite smart and saying that if this is coming then they’re going to be ahead of the game. It’s a great attraction message for employees, especially Gen Z.”
Wider issues and trends
In the here and now, most agree that there are more pressing pensions issues, such as the need to educate employees. My Pension Expert research dated February 2024 shows that 59% of UK adults in full-time employment feel that their employer should help them better understand and engage with their workplace pensions.
Read more: Financial education is now a necessity
Elizabeth Cowper, founder and CEO of HR consultancy Ludo, says: “I think HR needs to focus more on educating and communicating about pensions generally, as in my experience they do little more than provide details of the pension provider. HR can’t give advice but they could perhaps go back to basics, particularly for younger members, and explain that pension funds are actually invested, and what a default fund is.”
Some experts highlight that employees are especially interested in working out what they are likely to get from DC schemes when they retire, and that HR can point them in the direction of relevant tools offered by their pension providers. Others stress that focusing on how much employees are contributing should be a higher priority than worrying too much about what they are invested in.
Watts-Lay is in that latter camp. He says: “Most commentators would say that employer and employee contributions combined should be 12% to 15%. We’ve done research showing that someone in their 20s saving an extra 1% a year, with their employer matching this, may be able to increase their pension pot in retirement by 25%.”
Perhaps the most important starting point is to consider the actual type of pension scheme required. On this, the CIPD’s Charles Cotton says: “Some organisations, particularly SMEs, will see pensions as a cost of doing business, and something they want to minimise, so a GPP or master trust may be most suitable. Others may want to go above the minimum to better attract and retain staff, and may want a standalone occupational scheme.”
Tips for aligning pensions with ESG goals
The key message for HR departments seeking to align pensions with ESG goals is that, as with ESG strategies generally, there is only so much they can do. As consultant Guy Ellis explains: “Five to 10 years ago, companies like Google and Meta tried to paint themselves as ethically sound, but ethics is a very personal thing and they realised it was impossible to succeed. So, no organisation any longer claims to be perfect in this respect.”
A company’s goals and investments can never marry perfectly because the task involves trying to align one business with thousands of others. But companies can at least share the same ambitions.
With this in mind, experts stress that the starting point is for an organisation to be really clear about what its ESG goals are. Does it, for example, have a largely exclusion-based strategy, or is it highly focused on the community?
Employers should then select a pension provider as closely aligned with these goals as possible. Employee benefit consultants are well placed to help here.
Suitable specialist ESG funds should be able to reflect the needs of employees with the strongest ethical stances. But particular attention should be paid to the default fund.
Default funds are likely to detail a commitment to net zero but HR shouldn’t be afraid to ask potential providers more specific questions about the provider’s approach to matters like impact on society, labour rights and poor historic corporate practices. They should also consider the level of investment risk involved.
“If ESG underperforms for a number of years then you might get questions,” says Khalaf. “HR needs to bear this in mind when discussing the default fund with company management or trustees. But if an employee is self-selecting a specialist ESG fund then it’s not really an issue for the HR department.”
Finally, once a suitable pension scheme has seen set up, it’s crucial to communicate its benefits effectively to the workforce. Having an admirable ESG stance will have limited benefits unless employees actually know about it.
Case study: Why Pipedrive chooses sustainable pensions
The software firm Pipedrive has an ethos to help small businesses grow. Due to this, its leaders were determined to select a pension provider with ESG credentials that reflected the importance of community.
All of the 40 UK staff are in a sustainable growth default fund with the Smart Pension master trust. In addition to investing to reduce carbon emissions and improve biodiversity, the fund focuses on impact, investing into projects or businesses that benefit local communities through education, clinical research and renewable energy.
Tanya Channing, Pipedrive’s chief people and culture officer, says: “We are not doing this as a box-ticking exercise, and we were determined not to have a greenwashing-type fund, as we are so focused on community and sustainability.
“There is no evidence to suggest that this approach involves any sacrifice in performance, so we don’t regard this as an issue. I never query whether I might get better returns elsewhere. I’m sure my pension investments will work hard for me.”
This is part two of an article that was published in the July/August 2024 edition of HR magazine. Part one is available here.
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