During the early weeks of national lockdown, while other people were baking sourdough bread, writing Zoom quizzes, and making the most of their streaming subscriptions, I too found two new hobbies: listening to podcasts and buying clothes online. However, the former soon quashed the latter. As I listened to exposures of the terrible conditions of workers in factories and warehouses across the globe, and discovered the disastrous impact of fast fashion on the environment, I decided that my weekly deliveries of home-working attire (read: leisurewear) had to stop. Months, and many online articles later, I’m a proud convert to beeswax paper and reusable straws.

I’m not alone – more and more consumers are becoming aware of how their choices impact the world around them. What is often derided as “cancel culture” may hold just as much power in the markets as it does on social media - according to a recent study, 57% of UK consumers would boycott a brand because of its position on a social or political issue¹. A recent poll for Nest, the UK’s largest Master Trust, found that 65% of pension savers believed that their pension should be invested in a way that reduces the impact on the environment².

When we talk about environmental, social, and governance (ESG), we are talking about managing our impact on the climate, developing greater diversity, inclusion and wealth-sharing in organisations, operating for a greater purpose in society, and focusing on how organisations should be controlled and managed in a responsible manner. Although focusing on this is important for regulatory and ethical reasons, it can also aid in providing positive outcomes for members.

In a recent government consultation on member outcomes, three main factors were highlighted for comparing value for money: costs and charges, net investment returns, and administration and governance³. These are also important factors for Trustees of defined benefit schemes to consider in regards to responsible stewardship of the scheme.

When it comes to charges, it may be more prudent for Trustees to use ESG funds. A study by a global financial services firm found that, on average, the fees levied for ESG funds were lower than those for non-ESG funds as a whole. However, when active and passive funds were viewed separately, the costs for passive ESG funds were higher⁴. But given the increased competition between fund managers around fees, termed by some as the “fee war” – which has led to some passive fund charges dropping by about 35%⁵ – and the relative novelty of ESG funds, this may level out in the future.

ESG goals are often seen as ‘non-financial’ considerations, but this can be misleading in terms of the performance of those investments. For example, last year, European ESG equity funds increased by 1.1%, while non-ESG funds fell by 1.8%⁶. This has shifted significantly in 2021 – only 26.58% of ESG funds outperformed non-ESG funds in the first part of the year⁷. However, this may be linked to increases in certain sectors as we come out of the Covid-19 pandemic that are not likely to be represented in non-ESG funds, such as oil companies and airlines – over the long-term, this may have less of an effect⁸.

ESG funds also have a distinct advantage over non-ESG funds in that their returns are less likely to be affected by public-relations controversies over damaging practices. After an online retailer was concluded to have “weak corporate governance” following an investigation into it not complying with UK Health and Safety and minimum wage standards⁹, its share price was still less than it was before the scandal, a year after¹⁰. After the Deepwater Horizon oil spill on 22 April 2010, BP’s stock price plummeted and has never regained its performance before the disaster. Part of this was related to its inability to operate in its full capacity, but even after that was restored, the impact was still felt¹¹. Reputational damage because of irresponsible ESG practices as a company can have lasting effects on company reputation, and therefore investments in those kinds of organisations.

A further way that focusing on ESG goals can have a positive impact on member outcomes is on member engagement. As members become more interested in ethical considerations around what products they buy as consumers, this is bound to follow on to how their benefits are invested or their pensions funded. A Department for International Development study in 2019 showed that 71% of millennials (usually defined as people born between 1981 and 1997) are interested in investing sustainably¹². New organisations like ‘Make My Money Matter’ help members achieve their own ESG goals – part of their recent 21X Challenge claims that you can “Cut your carbon 21x more than going veggie, giving up flying and switching energy provider simply by making your pension green”¹³, and they work with “net-zero heroes”¹⁴, who are pension providers committed to more sustainable investments. For a comfortable retirement, it is usually estimated that from the age of around 30, members will need to save around 12 – 17% of their salary ever year. However, with the introduction of automatic enrolment, there is the danger that members will become disengaged, as there is an assumption that everything is in hand. Member engagement is inextricably linked to member outcomes, and the earlier that someone starts thinking about their retirement the better the outcome they’re likely to see.

Of course, the primary duty of Trustees to ensure that member’s financial interests are protected first can cause concerns around the impact of focusing on ESG. In the US, in October 2020, the Department for Labor severely limited ESG funding for retirement plans, stating “Plan fiduciaries should never sacrifice participants’ interests in their benefits to promote other non-financial goals”¹⁵. A recent survey suggested that half of scheme representatives believe “current fiduciary duty of trustees restricts their ability to make decisions in the best interests of their membership around climate change” – but that 94% believed that “returns can have a positive effect on society without necessarily detracting from financial returns”¹⁶. As previously described, ESG-focused investments are not necessarily less successful than their non-ESG counterparts, so presenting fiduciary duty and ESG regulatory obligations as two opposing responsibilities is inaccurate and such a position may hinder, rather than help, member outcomes.

Additionally, in terms of governance, the government have highlighted the importance of “long term financial sustainability of investments”. As ESG funds can be more sustainable, financially – 77% of ESG funds that were available 10 years ago still exist, compared with 46% of non-ESG funds¹⁷ – they can help Trustees to fulfil their obligations to pension schemes and their members.

Understandably, caution should still be exercised, as it is difficult to analyse ESG funds due to their categorisation. For example, a company could pay a minimum wage that is much higher than the national average, but still emit large amounts of carbon dioxide as part of its operations – a fund based on this company may be categorised as some as an ESG fund, and others as not.

There is also the problem of diversification. By limiting an investment portfolio, concentration risk becomes more of a danger, which may be seen by many members and Trustees as too high for their retirement savings¹⁸. However, there are methods to reduce this risk – a small core group of objectionable funds can be excluded, and all other funds given weight according to different ESG aspects. This weighting could also account for how well companies may have improved over the last 12 months in terms of ESG, which has the added advantage of providing incentives for companies to engage with ESG concerns¹⁹. This weighting method would also help with the problem of classification highlighted earlier, as different weightings would be added according to how well a company satisfies each part of ESG.

Although it may not seem like it should be a concern in terms of pensions, perhaps the main positive outcome of focusing on ESG relates to the world in which members inhabit. This is not alarmism - the planet we inhabit is being rapidly affected by human activity. Last year was the hottest year on record²⁰, but it is not just heat that is the problem – devastating floods are affecting communities in coastal regions, caused by factors such as unsustainable development, and melting ice caps²¹. It is not just the environment itself raising problems for human health and mortality, either. Inequality has led to a chasm between the richest and poorest in society – combined, the world’s richest 1% of people have more wealth than 90% of the global population²². Some estimates suggest that, without drastic change in our behaviour, human civilization as we know it will not survive by 2050²³. By focusing on ESG principles, we can help to encourage companies to also focus on social and environmental issues, and to have the proper structure to oversee changes that positively impact them. To quote Make My Money Matter, “What’s the point in saving for retirement in a world on fire?”.