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July 26, 2022

Putting the ‘social’ into pension investing

Compared to environmental considerations, social factors have often been underrepresented in pension funds’ investment decisions. There are signs this is beginning to change.

Earlier this month, UK pensions minister Guy Opperman announced the launch of a new task force to help pension schemes address the risks, and seize the opportunities, of the social element in environmental, social and governance investing.

Social issues cover a wide range of themes including workforce conditions, fairness of pay, community engagement, consumer protection, diversity of work places and modern day slavery.

The new minister-led task force will help identify reliable data sources and useful resources for pension schemes to assess and manage financially material social risks and opportunities. The work will contribute towards the development of wider principles, standards and metrics.

Opperman says that although he is proud of the progress the industry has made in pushing environmental and climate issues up the pensions agenda, they should not be pension funds’ sole consideration with regards to sustainability. “Financially material social factors also pose risks and provide opportunities to schemes’ investments, and our taskforce will help ensure that focus on social factors continues to grow among pension schemes and throughout the investment chain,” he says.

Reaction to taskforce

Adam Matthews, chief responsible investment officer at the Church of England Pensions Board, welcomes the decision to set up the task force and says accounting for social factors is integral to being a responsible investor.

There are opportunities for the task force “to do some good grounded work and practically look at what are the gaps pension funds have in preventing them from interacting with these issues”, says Matthews. For example, what are the information sources that pension schemes need, and where can good practice be established?

He says pension funds need to engage with social issues because they have a material impact. “If you are a long-term institutional investor, these issues will directly affect the companies you are invested in and sectors you are invested in. Unless you have a good grip on them, you will be impacted.”

Not only does he want to avoid creating a negative impact in wider society, but he is also aware that pension funds must manage the financial realities of social risks over the long term.

Philip Pearson, head of LGPS (Local Government Pension Scheme) investment at consulting firm Hymans Robertson, says: “We are aware that social factors can have a material impact on investment outcomes for occupational pension schemes and other long-term investors. We recommend pension schemes take action to mitigate the associated risks and capture investment opportunities that arise through their investment and engagement processes.”

The firm supports the proposed task force, on the understanding that it aims to help pension schemes to address this issue, rather than layering additional requirements onto decision-making processes that are already highly complex. Pearson says areas where support would be welcome include impact metrics and data; the dissemination of investment best practice; the creation of networks to facilitate the origination of new investment opportunities; and the removal of regulatory obstacles to suitable investments.

Making change

A key stated aim of the task force is to identify reliable data sources for pension schemes to manage social risks. Matthews says schemes can already start making headway with this challenge.

“You might not have the data but you can work to develop that,” he says. “Often people think a lack of data means that you can’t do anything until you have a complete picture. I don’t think that’s the case at all.” Pension schemes should be encouraged to start working with peers in the industry and with companies to develop an understanding of an issue and then develop the data and disclosure around that, he says.

The Church of England Pensions Board has been working on improving social issues in the mining sector. For instance, looking at the Brumadinho dam disaster, which caused 270 deaths and severe environmental damage (pictured above), Matthews says that was related to the way the industry was managing its waste. He says investors should recognise that as a risk and establish which companies have tailings dams (a method of storing mining by-products, which can be dangerous).

The pension fund has compiled data on tailings dams, an issue that the industry had been treating as an externality. “We have built up that database and made it public to the investment industry and on the back of that, established an international global standard together with the United Nations,” Matthews says.

Working with the UN and the Swedish National AP Funds, the church fund has also created an independent institution that will monitor the implementation of this global standard for every mine site that has a dam across the world. “We have demonstrated that it is possible to drive change on social issues in the mining sector but it takes time. It’s having the confidence that you can address these issues and change them,” Matthews adds.

Integrating social risks in investment decisions

Managing social risks in investment portfolios is another challenge. Carina Silberg, head of governance and sustainability at Swedish pension fund Alecta, says the ‘E’ and ‘G’ parts in ESG have dominated over the ‘S’ when it comes to addressing indicators in a more systematic way. However, in the past three to four years, the scheme has been working with social aspects more thematically, both in ESG research and in engagement.

The scheme’s investment strategy is based on an active approach where it carefully selects each holding and invests with a long-term horizon, which has resulted in a relatively concentrated investment portfolio. Silberg says this allows it to look beyond rankings or scores, to instead take an overall ESG perspective on the business model, identifying material risks relevant to the sector and the company. This entails a more qualitative approach in the analysis.

“We have been engaging thematically on research and engagement on issues such as labour conditions in the supply chain, including child labour and living wages, and on health and safety. The purpose has been both to educate ourselves on best practices within companies and certain sectors, but also to better understand how investors can monitor social indicators in a meaningful way,” she says.

Silberg adds that environmental data and indicators have a longer record and have been more consistently measured over time compared to social indicators, which has been a challenge for the inclusion of social indicators on an aggregated portfolio level.

Different standards

Hanna Kaskela, director of responsible investment and sustainability at Finnish pension insurer Varma, says the company expects its investment managers to comply with international norms and standards, including the principles of the UN Global Compact initiative on sustainability and social responsibility. The principles of the Global Compact initiative cover the UN Declaration of Human Rights and Convention against Corruption, International Labour Organization conventions and the Rio Declaration on Environment and Development.

With the support of an external service provider that has a database of companies and their confirmed and suspected violations, the pension insurer observes compliance with the standards. The service provider engages in discussions with the companies that are suspected of violating, or have been found to have violated, standards and updates the database accordingly. In this way, the portfolio managers always have access to up-to-date company data.

Kaskela says the insurer is also aware that governments’ human rights violations may be significant, and since 2018, the scheme has used the UN’s SDG index to monitor them. In the SDG index, the realisation of human rights at the national level, for example, is assessed using sustainable development goals related to the UN’s Universal Declaration of Human Rights that governments have set for themselves.

In 2021, Varma improved the means for assessing governments’ sustainability. This included improving the monitoring of the realisation of sustainable development goals, and of corruption and political stability.

On the development of the EU social taxonomy, Alecta’s Silberg says it is important that disclosure of any ESG indicator is developed in a standardised way, becoming broadly accepted in the sector and allowing for meaningful comparison and monitoring of performance within an asset class.

“We believe that the EU regulations, including the Taxonomy, and other initiatives to standardise ESG disclosure over time, will contribute to the development, and for us and other international investors it is important that disclosure standards – in particular for a set of core ESG indicators – become global rather than regional,” she says.

A service from the Financial Times