The Pensions and Lifetime Savings Association (PLSA) has released its newly commissioned study into the environmental, social and governance (ESG) risks facing members of default funds offered by defined contribution (DC) pension schemes in the UK.
The number of savers enrolled in DC workplace schemes in the UK is expected to rise to 17 million (up from 11 million today) with an expected aggregate pension pot of GBP554 billion (potentially as high as GBP914 billion) by 2030; and currently 90 per cent of DC savers are in their scheme’s default fund.
At the same time, ESG investing has gained significant momentum in the UK, with GBP1.4 trillion in assets under management in the wider investment community in 2015 versus GBP500 billion in 2013. The combination of these two factors underscores the importance of managing ESG risk in default fund arrangements.
The research by Sustainalytics, a provider of ESG and corporate governance research and ratings, assessed the equities allocation for a typical DC default fund, and mapped this against the most prominent ESG risks and found that ‘human capital’ is the single biggest source of ESG risk at the companies in which DC default funds invest, accounting for 11 per cent of the ESG risk to which default funds are exposed.
Climate change risks from energy use and greenhouse gas emissions are also substantial, affecting 22 industries found in a typical DC default fund’s portfolio, more than any other ESG issue.
Luke Hildyard (pictured), policy lead: stewardship and corporate governance, Pensions and Lifetime Savings Association, says: “Pension funds are moving beyond the debate about whether or not the environmental and social impact of their investments matters to long-term returns and on to what they should do to manage it.
“The PLSA commissioned this research to better understand the scale and type of risk facing DC pension savers. The findings demonstrate the importance of stewardship activities around issues including human capital, business ethics, data security and climate change. Over the coming year we will be developing further resources to help our members engage with asset managers and investee companies around these issues.”
Report author Doug Morrow, associate director, thematic research, Sustainalytics, says: “Given the convergence of UK market trends, understanding and managing ESG risks in DC default funds is becoming increasingly important. Our research findings reveal pension schemes can potentially mitigate these risks by embedding ESG investment products in default fund allocations and engaging on ESG issues with external managers and investee companies. We applaud the PLSA for raising awareness of this critical topic and believe these findings will help to advance the dialogue around ESG issues and default funds.”