Environmental, Social & Governance (ESG) investing is often described as having your cake and eating it. ESG strategies, so we are told, promote the greater good and provide superior long-term financial performance. However, most of us realise that this win-win argument is not certain. Only time will tell which ESG strategies have outperformed. There remains a significant amount of uncertainty over how quickly global policy makers will take strong action on the environment and the potential this would have on the financial performance of different industries. In this blog, I will discuss one key point for defined benefit pension scheme trustees to consider before deciding whether or not to invest in an ESG constrained strategy.
Align ‘Value’ with ‘Values’
The primary objective for defined benefit pension fund trustees is to maximise the chances of benefits being paid. Before investing in an ESG constrained strategy trustees should ensure their investment beliefs correspond to any tilts and biases the strategy would introduce.
ESG constrained strategies will present a certain set of investment attributes similar to factor considerations in equity investing such as company size, stock momentum, or profit growth. For example, strategies that focus on climate change often underweight the energy sector and overweight the financial sector versus a broad market index. How these sectors perform on a relative basis will depend in part on future de-carbonisation initiatives and subsidies paid to renewable energy companies just to name a few considerations.
Trustees should consider these sector and other factor differences to ensure their views on ‘financial value’ are aligned with moral and ethical ‘values’. They are responsible for ensuring any tilts or biases introduced by an ESG labelled strategy correspond to their own investment beliefs; which may not be the same as those of the investment manager who designed and manages the ESG constrained strategy.
As an independent advisor, Broadstone helps trustees develop investment beliefs, policies and processes around ESG investing. We believe investors who integrate ESG factors into their asset allocation can improve portfolio performance and resilience by identifying sustainability-related risks and opportunities.