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How green are your pension funds?

Author: ICAEW Insights

Published: 14 Jun 2023

For all businesses aiming to strengthen their sustainability credentials to make a serious impact on climate change, pensions are the new frontier.

With fears growing exponentially over the impact of climate change on our daily lives, more and more people are looking at how to reduce their carbon footprint. But never mind going vegan, cutting plastic consumption and ditching the car – perhaps one of the most effective ways to help cut carbon emissions is by reviewing the investments of your pension provider.

The UK pensions industry is worth £3trn, with £20bn invested each year into pensions by UK businesses and their employees, according to Make My Money Matter (MMMM), a campaigning organisation set up in 2015 that works to transform the financial system by putting people and planet on a par with profit.

Make My Money Matter is campaigning to highlight the links between corporate pensions and climate change, and works to ensure all companies take urgent steps to ‘green’ their schemes. A report published in September by MMMM, FTSE100 Pensions Emissions, warns that businesses grappling with the challenge of reducing their carbon emissions are missing a poorly understood yet extremely potent climate action.

In a foreword to the report, MMMM’s Co-Founder, film director Richard Curtis, said: “This report leaves us in no doubt – pensions are one of the most powerful tools UK businesses have to tackle the climate emergency. 

“Company pensions now finance a staggering seven times more carbon than the emissions produced by those same businesses. For organisations to be acting credibly and decisively on climate, green pensions must be a crucial part of their plans.” 

The total carbon emissions financed by FTSE100 company pensions is estimated to be 131 million tonnes, equivalent to roughly one third of the UK’s annual carbon emissions, according to the report published in collaboration with Scottish Widows and Route2, which works to quantify companies’ impact on people and societies. 

Equally worrying, the research found that fewer than 10% of FTSE100 companies have included pensions in their publicly available sustainability plans, while only 45% of UK CEOs and managing directors make any connection between their company pensions and climate change.

MMMM is calling on all FTSE 100 companies to ‘green’ their pensions now and is calling on them to sign up to the Green Pensions Charter to ensure the £3trn in UK pensions builds a better world. Signatories already include Tesco, Riverford, Travis Perkins, EY and IKEA.

Hugo Kimber, CEO of carbon advisory firm Carbon Responsible, says the past five years has seen a rush for investment managers to make sustainability a focus and create environmental, social and governance (ESG)-driven investment products. “By 2025, ESG-labelled assets will represent around a third of all assets under management, with this trend largely led by institutional investors, and particularly pension funds.”

Awareness of the connection between pension funds and the ESG agenda is growing, but certainly more could be done and action may rely as much on individuals as company CEOs.

Pete Hykin, CEO and Co-Founder at workplace pension provider Penfold, says the pace of fund transition varies: “While some pension funds have shown significant commitment and urgency in incorporating sustainable investment practices, others may still be in the early stages of implementing such strategies. 

“Given the urgency of addressing environmental challenges, it is crucial for pension funds to expedite their efforts and proactively align their investment portfolios with sustainable principles. Continued engagement, awareness and regulatory encouragement are necessary to ensure pension funds adapt swiftly enough to the green agenda,” he adds.

The trend for ESG-led investment portfolios has experienced substantial growth in recent years. But because pensions are so complex, it’s difficult to pin down an exact number for the amount of sustainable and responsible funds available to retail investors in the UK. 

“Around 300 wouldn’t be a bad guess,” says David Macdonald, Founder of ethical financial advisers Path Financial. “I’d make the distinction between funds that exclude things that are deemed to be negative, such as oil, gas and tobacco, and funds that are positively aligned to solutions for people and planet, which I call ‘positive impact’, as opposed to just avoiding the things that negatively impact people and planet.” 

Greenwashing curbed

However, the rise in ESG investments has also led to a rise in ‘greenwashing’, when a product claims to be more sustainable than it actually is. In a bid to clamp down on the practice, the Financial Conduct Authority (FCA) is due to publish new rules on labelling to restrict how terms such as ‘ESG’, ‘green’ or ‘sustainable’ can be used.

The new FCA rules will include requirements for more detailed disclosures, suitable for institutional investors or retail investors that want to know more, as well as restrictions on how certain sustainability-related terms can be used in product names or marketing.

UK advertising watchdog the Advertising Standards Authority also recently banned advertisements from big oil and gas companies Shell, Repsol and Petronas for “misleadingly omitting material information” as part of an ongoing crackdown on greenwashing.

Kimber says consumer demand for green pensions has incentivised investment managers to label products as sustainable for marketing benefit, without the right supporting evidence. “With both investors and consumers being misled as a result of vague sustainability claims and unrealistic net-zero targets, greenwashing has become a significant concern for financial regulators,” he says. 

“But there’s still an open question as to whether this anti-greenwashing regulation will address opaque ESG credentials of pension funds. Due to the structure and investment strategies of pension funds – which are typically multi-asset, including bonds alongside equities, and diversify over time – most will not qualify for a sustainability label,” Kimber adds.

Authentic choices

Amid the maelstrom of options for long-term investments and popularity of ESG, how can the average individual be assured that they are making an ethical choice? The short answer is: with difficulty. 

“It’s very difficult for the consumer to make any kind of judgement. If you make a market complex enough, you create the need for an intermediary. It’s a shame that it’s that way in this space, but for the moment somebody needs to be taking the fight to the market and maybe we will get a more authentic marketplace in due course,” Macdonald says.

Even if a pension fund claims to be an ESG fund, it is still difficult to fully understand. “Does it say ESG on the tin or not? It’s giving you a clue that it might be one to investigate more fully. But is that a guarantee of authenticity? Absolutely not,” Macdonald says. 

So where do we go from there? Typically, funds will publish a fact sheet listing its top 10 holdings – many of which may be labelled as ESG – but it will still require further research to fully understand a fund’s composition. 

“Most funds badged ESG these days are quite careful not to have Shell and BP in the top 10, so not on the fact fund-sheet. But that’s not to say they’re not in 11th and 12th position,” Macdonald says.

Ethical funds outperform traditional ones

Sluggish transformation in the pension funds sector is partly due to some resistance to change, but also to influential lobby groups. The majority of people, especially younger generations, want to know that their pension fund – their long-term investments – are improving the world we live in, and yet change is slow to filter down.

There is also a presumption that there is a price to pay for ethical investments through lower returns, despite a growing body of research suggesting that long-term, ethical investments outperform traditional ones. 

In 2020, Morningstar examined more than 700 sustainable funds and compared them against 4,150 traditional ones. It showed that they either matched or outperformed returns in all categories in the UK or abroad. Similarly, research by Moneyfacts found that ethical funds were resilient during the pandemic. 

But Moneyfacts also found recently that ethical funds performed worse than non-ethical funds over the past year during a notable period of stock market volatility. It explains: “Despite more subdued returns, ethical funds have outpaced non-ethical funds in previous years and, during 2021, investors were keen to place their cash in responsible investment funds amid global attention for investing greener.” Ethical funds overall returned 3.97% over the past year, versus 6.06% for non-ethical funds, but overall ethical funds have outperformed non-ethical over longer investment periods.

It is perhaps ironic that our pension funds – our long term investments for our future and those of our children – are predominantly invested in companies that are actively damaging people and planet, rather than companies that are protecting our natural capital.

 “It might sound fluffy, but the biggest short-term gain is one of personal existential, philosophical comfort that you've made a conscious decision to stop doing something harmful and align your money in a more positive way,” Macdonald says.

If, as a society, we genuinely want to have a positive impact on the world, ensuring that the £20bn invested annually into UK pensions goes into ethical funds is a good place to focus.

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