Taking pensions to the next level with ESG investments

In spite of growing economic challenges all over the world, responsible investments hit the $3 trillion mark last year in Canada for the third year in a row. The numbers are even higher globally – and growing. And although these environmental, social and governance (ESG) investments are not new, they are now viable investment options in retirement plans.

While plan sponsors may not be thinking about ESG options, plan participants certainly are. Roughly three-quarters of Canadians say organizations have a responsibility to act sustainably and mitigate environmental impacts – but only one quarter of the same group knows how to find the relevant information on specific organizations.

Investments with a Purpose

Although the acronym is everywhere, not everyone understands what ESG investments are. On the simplest level, they are investments like any other. But those who are looking for ESG investments tend to be people who are concerned about the company’s business practices.

Specifically, ESG refers to three aspects of business practice:

Environment: climate change, greenhouse gas emissions, deforestation

Social: working conditions, local communities, employee relations

Governance: executive pay, corruption, board diversity

Managers may incorporate these criteria into their decision making on investments. The idea is that companies that focus on these issues tend to be stronger, more sustainable companies – and therefore better investments.

5 Tips for Introducing ESG into Your Retirement Plan

As with any other new type of investment, ESG funds may come with risk. Many have asked whether these funds actually underperform the market. Or perhaps these funds may be politically driven or fail to meet ESG standards.  Proponents of incorporating ESG considerations argue that it will lead to a better understanding of financial and non-financial risks which may lead to better investment returns. Others argue both investors and companies have a responsibility, irrespective of financial considerations, to improve environmental, social, and governance circumstances. This second line of argument is of relevance to investors who want to be faithful to their concerns as they invest. By engaging investment managers in this dialogue, investors can influence their approach to investing.

The good news is that plan sponsors and their advisors can mitigate this risk through thoughtful, data-driven decision making. When introducing an ESG investment option in your retirement plan, keep these five tips in mind:

1. It’s an imperfect world. Many people are drawn to ESG investments because they care deeply about climate change or diversity. Some organizations are more successful in some areas than others, though, so it may be challenging to identify a single fund that meets everyone’s needs. Consider funds that hit as many of the high points as possible. It is important to spend time to articulate your ESG investment beliefs.
2. Do your homework. Marketing may be misleading. Many funds advertise themselves as ESG driven, but the fund may not address the same concerns. Plan sponsors need to do their due diligence and independently confirm the selection as they do with other investments.  Review the suitability of managers and their ability to integrate your ESG needs and have existing managers articulate how they employ ESG relevant criteria into their investment process and decisions.
3. Gather your data. Before selecting specific investments, find out what your plan members care about. For DC and Group RSP plans, for example, create a survey to gather the data and then use that information to drive fund selection. Quantitative data can also provide an industry comparison and detailed ESG measure of underlying investment holdings for each manager and alongside other material information to help with investment decision-making. Establish appropriate standards for integrating ESG into investing decisions to ensure continuous alignment with ESG policies and regulatory requirements for disclosure.
4. Educate plan participants. Just like plan sponsors, plan members need to be educated on ESG investing - what it is, the reasons it might make sense for individual investors and the effect on participants’ portfolios. Show how investment managers will be selected with consideration given to their beliefs relating to ESG issues, their track-record of incorporating ESG factors into the investment management process, with particular emphasis on ESG; their practices and policies regarding voting using best practice fiduciary standards and guidelines, and dialogue/engagement on ESG-related issues.
5. Consider investment potential. It’s tempting for plan sponsors to adopt an ESG fund to meet plan members expectations but be sure these funds have a solid economic rationale before inclusion. This means the companies must not only be “virtuous,” but they also must perform well. In the end, an investment needs to earn the return required by the plan to meets its obligations.

Joe Connolly is Senior Vice President in the investment consulting group of global insurance brokerage Hub International. He has over 25 years in the investment industry and specializes in pension and investment consulting