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Five ESG transition tips for pension trustees

By Carolyn Eagle, senior product manager, sustainable investment

As ESG integration into investment has grown and evolved, so too have the considerations for pension trustees. Many asset owners are under increased scrutiny by plan members who want to see ESG options and want managers to incorporate ESG risks and opportunities in their pension investments.

Pension trustees are no longer asking, “why implement,” but rather, “how do I implement?” When implementing ESG strategies, there are several key considerations for pension trustees.

1. Codify your beliefs

There are multiple approaches to integrating ESG into investments across active and passive strategies and asset classes—the themes covered by ESG are broad, there are different ways to implement, and there's much to consider. Benchmark providers can deliver a wide range of indexes to follow, and investment consultants can advise on implementation strategies, but the asset owner must first be clear on their associated investment beliefs including what themes and approaches are appropriate to support their investment needs.

This may involve codifying their approach by making any necessary amendments to the plans’ investment policy statement. This helps align ESG integration into investments with broader policy around engagement, advocacy and proxy voting. 

Many approaches include considering how investment managers integrate ESG into their investment processes as part of their selection and on-going monitoring. While these funds may not be explicitly marketed as “ESG,” “SRI” or “sustainable,” the underlying process should now reflect the investment and established ESG priorities of the asset owner. Alternatively, an asset owner with stronger conviction may choose to look for more explicitly ESG-focused funds.

There may also be a focus on specific themes within ESG, such as in climate change, which the trustees may believe have the greatest implications for future investment returns. Or it may involve establishing investment beliefs related to parts of the economy, or types of companies they wish to explicitly exclude from their portfolios, such as tobacco. If this is determined by ethical preferences, rather than reflecting beliefs about improving investment outcomes, this process should capture the preferences of scheme members. At a minimum, trustees should consider the relevance and materiality of the issues identified and prioritized.

Codifying these investment beliefs and investment preferences, to agree on a consensus position, can be a useful first step.

2. Recognize some asset classes are easier to address than others

When looking to apply ESG considerations across a multi-asset pension portfolio, trustees should be aware that this could be simpler in some asset classes than others. For example, incorporating ESG considerations has long been a trend in equity investing. It is slowly becoming more common also for fixed income portfolios. However, other assets such as real estate or private equity are newer areas of focus, although new tools and innovative practices are emerging.

3. Understand that benchmark selection matters

It’s vital for pension trustees to recognize that there are numerous approaches to incorporating ESG considerations, and that methodologies matter. This is especially relevant when selecting an ESG benchmark or choosing an index for the basis of an ESG passive portfolio.

We have developed a broad selection of ESG indexes that give pension trustees options to express their investment beliefs; for example, for pension trustees looking to address climate change risk in their plans, there is a spectrum of approaches. This ranges from applying climate risk parameters to vary security weights, through to full divestment from fossil fuels. The FTSE Global Climate Index Series integrates the risks associated with climate change (fossil fuel reserves and carbon emissions) by adjusting constituent weights using "tilts" while also considering the opportunities arising from the transition to a green economy. In this example, exposure to these factors can be dialed up and down, allowing pension trustees to address climate objectives while also maintaining broad market exposure and a low tracking error against their benchmark index.

4. Establish ESG metrics

Once ESG strategies are implemented, establishing comprehensive and consistent success metrics can be helpful. This allows pension trustees to properly measure the effectiveness of their ESG strategy alongside investment objectives. For example, establishing performance, risk and impact metrics for the FTSE Global Climate Series allows pension trustees to track progress towards meeting climate goals, with metrics such as emission reduction and reserve reduction, while also understanding the potential impact on the risk budget, using metrics such as tracking error.  

5. Remember it’s a process, not an event

Growing numbers of pension trustee boards are looking to integrate ESG into their investment strategies in response to rising demand from plan members and growing awareness of the investment relevance to long-term returns.

The process can seem daunting, due to the range of implementation options and nuances in definitions and approaches. However, with a few clear steps— such as those set out above—trustees can define a clearer approach to sustainable investment and begin their journey. It is important to start with beliefs and objectives as this sets the tone and direction. A staged implementation across asset classes helps to create a structured, and more manageable process. Access to ESG data and benchmark tools supports implementation and provides a means of measuring outcomes and progress.

Learning from other schemes and asset owners that are further progressed can be helpful here, too—a range of collaborative initiatives exist to support this (e.g. the PRI, IIGCC, TPI). There is no single approach to integrating ESG considerations, but it is important to make a start and then review and adjust as necessary along the way as knowledge and experience grows, beacuse this process is a journey, not a destination.


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