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dcif.co.uk

Navigating ESGA Practical Guide

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Produced for the DCIFWords: Gill Wadsworth, Janette Weir, Nico Aspinall, Rhys Williams and Simon GroverDesign: Judy Skidmore© DCIF 2018Citation: Navigating ESG: A Practical Guide, (DCIF 2018)

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About Us 3

The Chair’s Foreword 5

Executive Summary 7

Chapter one An introduction to responsible investment 9

Chapter two Responsible investment: the member perspective 13

Chapter three Law and regulation on ESG for DC pension schemes 27

Chapter four Responsible investment in practice 35

Chapter five How to talk about responsible investment 39

Chapter six: How investment managers approach ESG 44

Contents

The DC Investment Forum would like to thank everyone who contributed chapters to this report: Nico Aspinall, Rhys Williams, Simon Grover, Janette Weir, Ed Ripley and Gill Wadsworth.

The report’s steering group gave a great deal of time and invaluable feedback, for which we are very grateful: Rosie Rankin, Hilary Inglis, Annabel Tonry, Elaine Alston, Lucy Johnstone, Rob Barrett and Elena Zhmurova.

Thank you also to the responsible investment teams at the DC Investment Forum’s membership companies, many of whom commented on various drafts of this report and met with its writers.

We would also like to thank the many people who kindly agreed to be interviewed for this report, from Ignition House’s interviewees to the industry experts who spoke to Gill Wadsworth, Rhys Williams and Simon Grover.

Acknowledgements

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Dedicated to promoting investment excellence

dcif.co.uk

The Defined Contribution Investment Forum (DCIF) aims to exchange ideas and develop initiatives to promote investment excellence in Defined Contribution (DC) pensions in the UK. The DCIF consists of investment firms and selected other industry participants who believe that members in DC pension schemes deserve the best possible investment services to help them meet their retirement objectives.

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About us

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There are significant practical and philosophical questions associated with becoming responsible investors

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The Chair’s Foreword

Annabel Tonry, Chair, DC Investment Forum

Responsible investment, ESG, impact investing… the terms are endless, the research infinite and the surrounding regulatory and academic field huge. Understandably, some pension funds have struggled to get to grips with how to distil responsible investment

and adopt its principles on savers’ behalves. We hope this research paper will help demystify

this subject and give trustees some practical steps towards incorporating responsible investment.

There are some significant practical and philosophical questions associated with becoming responsible investors, which we seek to answer. Are trustees obliged to prioritise investment returns above all else? Do savers really care how their pensions are invested? How do you even define “responsible investment”, anyway?

Taking these issues in turn: there isn’t any regulatory requirement specifically to incorporate responsible investment, but nor is there a barrier. However, risk management is an essential part of a successful investment approach, which is part of why investment managers believe it is so important. If pension funds fail to consider such issues, they could be in dereliction of their fiduciary duty. Read more about what the law says in chapter three.

We commissioned Ignition House to find out the answer to the second question; they do so in chapter two. While many savers are deeply concerned about the environment, businesses’ social responsibilities and the state of the world, most do not make the connection between it and their pension money. When this was explained to them in one to one interviews, they were more than a little surprised to hear that schemes were not necessarily taking account of responsible investment on their behalves.

Defining responsible investment is challenging, as it can mean different things to different people. This makes explaining it to members a particular challenge. The expert communicators at Quietroom take up the challenge in chapter five.

We hope that this report arms pension schemes with a clear rationale for responsible investment, however, complexities remain. With so many pressing issues taking up pension scheme decision-makers’ time, responsible investment issues can end up relegated to the bottom of the

agenda. Perhaps a more unequivocal message from regulators that considering responsible investment issues is an important part of a trustee’s duties would help.

A key related challenge is agency. Pension scheme trustees have a fiduciary duty to act in savers’ best interests. Yet with so many factors involved in the responsible investment chain, from the chief executives running companies, to the investment managers asking questions at Annual General Meetings, to the consultants advising pension funds, it can be unclear where accountability lies for ensuring investments are made responsibly. Making a change requires passion and commitment from all actors in the chain.

Another issue is that despite our efforts to clarify the language used in this area, debates about semantics distract from the central issues at stake. This points to a wider issue: responsible investment is such a broad area that it can be difficult to pinpoint exactly what we mean when we discuss it. We hope this report is a useful contribution to that debate.

What’s clear is that these problems will have to be overcome. With a flood of new DC savers saving for pensions for the first time and from Ignition House’s findings, it is clear that they care about where their money is invested and it’s time we started reflecting that.

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To get members engaged, it’s important to make the issues clear, vivid and real

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Executive summary

An introduction to responsible investmentUK pension schemes approach responsible investment with varying degrees of knowledge and enthusiasm, from the evangelical to the dispassionate. Wherever they stand, it’s clear that responsible investment is gathering momentum.

The Department for Work and Pensions is consulting on whether trustees should be required to state their investment policies on ESG. The public also cares about these issues, particularly once they understand that their pension savings are invested and that those investments can make a difference to the state of the world.

Yet confusion abounds about what responsible investment means, let alone how to explain it to savers.

Responsible investment: the member perspectiveResearch consultancy Ignition House surveyed 1,000 DC members to explore their awareness of and attitudes towards responsible investment. Despite most having low levels of knowledge and understanding of pensions, many felt strongly about responsible investment issues. The youngest age groups are the most likely to have strong feelings about environmental issues, and to feel personally responsible for the state of the world.

Some sentiments were universal. For example, the vast majority (81%) believe businesses have a wider social responsibility than simply making a profit, 74% want to protect society’s vulnerable people, and 73% felt strongly about the environment. Yet many had never connected these issues to where their pension savings are invested.

This gap was clear from face-to-face interviews with DC scheme members. They were very surprised to find out that, unless they had specified otherwise, their pension money could well be being invested in companies and sectors that they oppose.

As members’ awareness increases, we can expect momentum to build quickly. Real life examples are a great way to get their attention. It could also be worth considering a Fairtrade-style kitemark to help members to identify whether their money is being invested using these principles.

ESG law and regulation for DC pension schemesAt present, the law largely gives pension schemes the discretion to make their own decisions around whether to incorporate responsible investment. Trust-based schemes should disclose whether they have considered ESG, while contract-based schemes are not required to make any statements on the subject. Indeed, in general, responsibilities vary for trust and contract-based schemes, which we explore in this chapter. The law could change in future and compel pension schemes to address ESG more explicitly in their reporting. There are some directives that will help encourage more focus on ESG but there is a sense that regulation alone won’t push ESG to the top of the agenda.

Responsible investment in practiceThis chapter explains how some pioneering schemes have adopted responsible investment. HSBC’s DC scheme, together with its chosen manager, built a fund and an index to achieve better risk-adjusted returns. Meanwhile, ESG already forms a large part of the National Employment Savings Trust’s (NEST) investment manager selection process. The scheme is continually developing its ESG initiatives. Investment consultants and charities like ShareAction are also playing an important role in raising scheme decision-makers’ awareness.

How to talk about responsible investmentHow best to broach responsible investment with members? For a start, nobody can agree on a common definition; everyone brings different interpretations into the conversation.

Parts of the investment industry accept “responsible investment” as an all-encompassing expression. This is reinforced by the PRI’s well-focused definition. The good news is that members instinctively understand what is meant by this terminology.

Trustees who have made progress all have one thing in common. Conversations didn’t happen on one day. Instead, they moved forward methodically, taking time to make the right decisions for their membership. To get members engaged, it’s important to make the issues clear, vivid and real.

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Responsible investment has been part of the UK pension fund landscape for over 20 years.

Admittedly it was just a mere dot on the horizon initially, appearing as it did at the Universities Superannuation Scheme (USS) in 1999.

The scheme, then the third largest in the UK, engaged with publicly listed companies in the hope of influencing corporate behaviour to achieve better outcomes for shareholders and, ultimately, its members.

In the intervening decades, responsible investment has come a long way. No more is it on the fringes of mainstream investment. Many trustees are now incorporating environment, social and governance (ESG) factors in their discussions because they consider these factors to be financially material to the scheme (see chapter three).

The Department for Work and Pensions is consulting on the inclusion of social impact when making investment decisions, and already accepts that doing so can have a positive, material impact on risk-adjusted returns.

The public, too, is driving the responsible investment agenda. Almost seven in ten people under the age of 45 said they felt personally responsible for the state of the world, compared to around half of those over 45, according to the DCIF’s research with Ignition House (see chapter two).

Sales of responsible investment funds have grown steadily in the UK since 2007, but they represented just 1.2% of the total UK retail funds market at the end of 2016. Figures for responsible investment are not available for occupational DC funds. Indeed, the Investment Association (IA) says this statistic does not reflect a growing appetite among defined contribution (DC) members for responsible investment funds.

Yet the IA notes that the absence of a standard definition of ESG or responsible investing remains a sticking point.

The IA reports: “One of the difficulties with monitoring the growth in ESG investment is that there is no standard definition of what it means’. And many asset managers would argue they already incorporate ESG factors as sources of long term risk and return into their investment process.

Conflicting interpretations abound about the differences between ethical and responsible investing; we address these in more detail in chapter four. There are significant differences between those who actively avoid companies they believe to have questionable working practices and those who wish to influence corporate behaviour. There are investors who choose to take a moral standpoint when investing and those who see

responsible investment issues as just another financial risk. Each approach comes with its own definition and understanding, which can create confusion.

This is problematic for DC because there are many millions of members with differing levels of engagement and education who must be catered for. A standardisation of terms and a decrease in associated jargon is necessary in order for members to better understand what lies at the heart of responsible investment, and how it affects them (see chapter five for a further exploration of this subject, and ideas on how to make these issues more meaningful to members).

DefinitionsFor this research and to help limit the jargon and confusion that muddies this field, the Principles of Responsible Investment (PRI) – an international network of asset owners and investors encouraging responsible investment - offers a helpful definition:

“Responsible investment is an approach to investing that aims to incorporate environmental, social and governance factors into investment decisions, to better manage risk and generate sustainable, long-term returns.”

The challenge for responsible or ESG investment is in distinguishing itself from socially responsible, or ethical investment. These types of investment apply a moral standpoint to investment decision-making, whilst ESG investment is concerned with managing the risks to the overall portfolio and identifying potential sources of additional return.

For example, an ethical investor might choose to avoid a tobacco company because of the harm smoking does to health. Irrespective of return or risk to the portfolio, the ethical investor will refuse to invest in tobacco companies.

The responsible investor, meanwhile, may also avoid the tobacco firm but it would be on the basis that the industry’s long-term future is jeopardised by a decrease in smoking in favour of vaping, or the threat of successful litigation from former smokers. The argument here is not about the rights and wrongs of smoking, more about the long-term sustainability of the industry.

Driving positive corporate behaviour can have a material impact on returns and the wider environment. Engaging with energy companies, for example, may influence their use of fossil fuels and investment in green energy. Voting against an

An introduction to responsible investmentWritten by Gill Wadsworth

RESPONSIBLE INVESTMENT

Chapter 1

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underperforming chief executive receiving a very large bonus is one example of how investors might engage with governance issues within a company. Investors are engaging with social issues when, for instance, they invest in social housing.

Impact investing is another sub-set of the responsible investment sector. This is where investors try to generate social or environmental good with their investments as well as a financial return. In 2017, the government published a report entitled Growing a Culture of Social Impact Investing in the UK, designed to find ways to make this approach more effective. The government made several recommendations to improve impact investing, and it is likely this area will grow in importance in the intervening years.

Essentially, responsible investing is about using information on key environmental, social and governance issues to inform investment decision-making. This will vary from one fund to another and there is no ‘correct’ approach.

Incorporating responsible investment issues into investment decision-making is no different to assessing any other risk or opportunity. Trustees have a duty to consider every factor that might affect return or manage risk for their scheme members; something that is now reflected in law.

The lawPlease refer to chapter three for a full discussion of what the law says in relation to responsible investment.

A common goalAwareness of responsible investment has grown a great deal in the last ten years, as evidenced by the PRI amassing 2000 signatories from across the investment industry. All signatories adhere to the six principles (see box below) which guides their approach to responsible investment.

However, these common goals do not equate to identical implementation and there are vast differences between how investors tackle this area, as we explain earlier in this chapter.

An asset manager’s investing style dictates the way they engage with the companies in which they invest. Encouragingly though, whatever a fund manager’s investment style, it is clear that responsible investment is increasingly becoming part of the DC landscape.

Active managers incorporate responsible investment considerations into their investment processes, with DC default funds benefitting from this trend. Such managers have a great deal of discretion as to how they choose to engage with the companies in which they invest.

Cost limitations mean schemes must carefully balance active and passive investment strategies when constructing DC default funds. Consequently, the passive manager’s role in providing ESG investment options to DC investors is equally important.

It is likely that instances of ESG inclusion will grow if – as the IA predicts: “Younger savers are often believed to be more concerned about ESG criteria and this may lead to a change in the way investors invest.”

We are starting to see fund managers responding. In 2016 Legal & General Investment Management worked with HSBC’s DC pension scheme to build the Future World Fund which tracks the FTSE Russell sustainable index. The product allows default members access to a sustainable fund [see case study].

NEST, which provides workplace pensions for employers compiling with auto-enrolment legislation, also worked with its fund manager UBS to build a passive ESG investment option as part of its default fund (see case study in chapter four).

The PRI says environmental, social and governance factors are ever shifting. It lists the following characteristics of each, highlighting the breadth of the topic

Environmental Social Governance

• Climate change• Greenhouse gas emissions• Resource depletion, including water• Deforestation

• Working conditions including slavery and child labour

• Local communities, including indigenous ones

• Conflict• Health and safety• Employee relations and diversity

• Executive pay• Bribery and corruption• Political lobbying and donations• Board diversity and structure• Tax strategy

Source: PRI

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Key Players in ESG Investing for DC pensionsPRI Group of investment signatories united in advocating responsible investmentThe Pensions and Lifetime Savings Association pensions and saving lobby group supports schemes in investing responsiblyUK Sustainable Investment and Finance Association membership organisation for the finance industry committed to growing sustainable and responsible finance in the UKFair Pensions charity promoting responsible investment by pension funds and asset managersShareAction charity promoting active share ownershipThe Pensions Regulator oversees and guides occupational pensions schemes in meeting their ESG investment responsibilitiesFTSE Russell provides responsible investment indicesEIRIS Foundation provides research and analysis to help organisations and individuals participate in responsible business and investmentCarbon Trust helping organisations benefit from and contribute to carbon reductionCambridge Institute for Sustainability Leadership helping organisations and policymakers develop responsible and sustainable strategiesThe Task Force on Climate-related Financial Disclosures developing voluntary, climate-related financial risk disclosures for use by companies in providing information to investors

Investment managers continue to innovate. There is a greater interest in factor investing, as is evidenced by the Future World Fund. Factor investing is often described as passive plus or smart beta, where a manager tracks an index but applies greater relevance to the risks from certain factors within the index. For example, companies that have high carbon emissions may have a lower weighting in the fund.

Multi-asset managers are also incorporating responsible investing in their strategies. This might involve applying an ESG score to a universe of companies and avoiding those with lower scores or engaging to effect positive change. As the supply of suitable investment vehicles – such as green bonds – become more available while responsible investment knowledge and experience improves across asset classes, so these strategies will evolve, improve and become more efficient.

Responsible investment has come a long way in 20 years, but progress has been relatively slow. If younger investors choose to engage with responsible investment, they will create an impetus for prevalence of ESG in DC funds in the future. The DCIF’s work with Ignition House shows that there is certainly interest in this topic among younger savers, especially when the issues are explained to them (see p14 of the report.).

Education about the importance of ESG coupled with accessible, affordable investment strategies will be the key. With investment managers continuing to embed issues in their process and interest among savers growing, all the signs point towards a more responsible future.

The PRI’s Six Principles for Responsible investment* • We will incorporate ESG issues into investment analysis and decision-

making processes.• We will be active owners and incorporate ESG issues into our

ownership policies and practices.• We will seek appropriate disclosure on ESG issues by the entities in

which we invest.• We will promote acceptance and implementation of the principles

within the investment industry.• We will work together to enhance our effectiveness in implementing

the principles.• We will each report on our activities and progress towards

implementing the principles.*Investors across the globe have signed up to these principles; the signatory base represents a majority of the world’s professional investors.

First State Investments engages with and has a AUD $256,000,000 holding in the French-listed monopoly provider of rail infrastructure and shuttle services between the UK and continental Europe. This is an excellent, long concession life asset with a compelling customer proposition.

In December 2016 we met with the Company Secretary and Finance Director, regarding corporate governance practices at the firm. The two main issues we wanted to discuss were: (1) the average age of board members and (2) CEO duality.

Of the 11 board members, six are over 70 years old. The company reassured us that it is conscious of this issue and

currently looking to address it – as well as suggesting that one change could be implemented shortly. On the topic of who we would consider a good board member, we highlighted that the US Class 1 freight railroads have done an exemplary job in terms of safety and productivity improvements in recent years. We suggested that introducing a board member with that level of experience could be a positive catalyst for a company like this.

The firm currently has a combined CEO and Chairman, roles we would prefer to see split. The company explained that these roles could be split upon retirement of the current CEO / Chairman from his CEO role. However they intimated

it was likely that this individual would remain Chairman; a move that we are unsupportive of. We believe that the Chairman’s role at any company should be truly independent. Therefore, if this comes to pass, we intend to use our proxy voting rights to vote against it.

The Company Secretary also took the opportunity to share with us how the firm is trying to make the board more independent and diverse. The company currently has four female board members. We welcome greater diversity at board level, as we believe that the ability to draw on a range of skills, perspectives and experiences is beneficial to an organisation. We will continue to encourage moves in this direction.

Case study How First State Investments engages in corporate governance

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In brief• Research indicates strong demand for

responsible investment, once members understand the concept

• Members think responsible investment is already being done on their behalf, and are surprised to learn that this isn’t the case

• Real-life examples are a powerful way to get members’ attention. The pensions industry would do well to learn from the success of the Fair Trade example and to develop an instantly recognisable name and logo to help members easily identify whether their pension money is being used for ESG investing.

MethodologyTo explore DC members’ awareness and attitudes towards responsible investment we conducted a nationally representative online survey of 1,000 current and deferred DC members aged 22-65, supplemented by 15 one-hour in-depth qualitative discussions. The quantitative research tells us what members are thinking; the qualitative research gives insights into why they hold these views. All research was conducted in February 2018.

Almost a quarter of our survey respondents did not know which provider they were with. The vast

majority of those who could name their provider were with a large insurer - Prudential (5%), Standard Life (7%), L&G (7%), Scottish Widows (8%), Friends Life/Aviva (13%) or Aegon (5%). A further one in ten of our survey respondents were members of either NEST, NOW: Pensions or The People’s Pension.

The vast majority of members (65%) in our survey self-reported very low levels of knowledge about where their pension money is invested and were not very confident making investment choices. This is reflected in the high proportion (59%) who have never checked to see where their funds are invested and who have not made any choices on their pension money (70%); actions which are typically interpreted as a lack of interest on the part of members.

Groundswell of interest in ESG issues across all membersThere is a growing body of evidence of an increasing awareness and interest in ESG issues, particularly amongst millennials and particularly related to environmental issues.1 Studies have tended to focus on the general population or on those who are investing money themselves. Our research confirms that these generally observed trends hold true for members of DC pensions as well.

Responsible investment: The member perspectivePrepared by Ignition House

Notes1 Sustainable Signals: The Individual Investor Perspective, Morgan Stanley Institute for Sustainable Investing, 2015 www.morganstanley.com/sustainableinvesting/pdf/Sustainable_Signals.pdf

Figure 1: Current attitudes towards ESG issues amongst DC pension holders

Question A1. How much do you agree or disagree with the following statements?Base All UK adults aged 22-65 with a DC pension (1,061)

Chapter 2

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Members of all ages feel strongly about ESG issuesConsistent with other studies, our research shows that those aged 22-34 are the most likely to report strong feelings about environmental issues. Younger age groups – those under 45 – also feel more personally responsible for the state of the world than their older counterparts. Here, almost seven in ten say they feel this way compared to around half of those over 45. This difference by age has important ramifications for schemes as auto-enrolment brings on board a new generation of young pension savers who will become an increasingly powerful force as time goes on.

However, to categorise environmental concerns as simply an issue for the young would be a huge mistake. Across all age groups, the vast majority of members agreed that they cared about environmental matters and, in fact, there is a core group (around a quarter to a third of members in all age groups) who feel very strongly indeed.

There were no significant differences across the age groups in the other aspects of ESG we explored.

Our in-depth discussions revealed that having children or grandchildren is often a key trigger for members to start thinking more about the future of the planet. This is driven by a combination of factors. Firstly, personal time horizons

increase as members worry about the fate of the next generation of their own family. Secondly, environmental issues now form a core part of the school curriculum which means that young children, in particular, are putting pressure on their parents to think about how their actions will impact the future state of the world.

“At school they do projects and are encouraged to recycle, my daughter will tell me “Oh no, mum, you’ve got to recycle this.” She’s very aware and she’s only four. It puts pressure on me in the long run. I am more aware of it, I suppose, since having her.” Female, Age 22-34

Overall, almost three quarters (74%) of all members agreed it was important to them to protect the vulnerable in society, while four fifths (81%) agree that businesses have a wider social responsibility than simply making a profit. When asked who they think are vulnerable, members in the qualitative research almost entirely focused on vulnerable people in the UK they can relate to – the elderly, the homeless, the sick and disabled and young disadvantaged children. Similarly, when asked about what social responsibilities firms have, they talked about workers’ rights in the UK and local community initiatives. This tendency to focus

Figure 2: Current attitudes towards ESG considerations amongst DC pension holders, by age (proportion who agree with each statement)

Businesses have a wider social responsibility than simply making profit

It is important to me to protect the vulnerable in society

I feel strongly about environmental issues

I feel strongly that businesses should control Executive Pay

I worry about the state of the world and feel personally responsible for making a difference

Question A1. How much do you agree or disagree with the following statements? Note Data shows proportion who strongly agree or slightly agree with each statement.Base All UK adults aged 22-65 with a DC pension (1,061)

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on things that are ‘real’ or tangible to them is a recurring theme throughout this research.

Members overwhelmingly agreed that interest in ESG issues is increasing over time, both for them personally and for society as a whole

Our survey indicates that member attitudes are changing quickly, and although there are some significant differences by age, the direction of travel is the same; people feel more strongly about ESG issues than they did five years ago.

Actions speak louder than wordsIt is very easy to report good intentions in an online survey, and indeed, the very nature of the questions asked is likely to result is a response bias – who would want to admit that they didn’t care about environmental issues? Perhaps a much stronger indicator of how strongly members really feel about ESG issues is in the reported actions they take.

Recycling waste is very much an established social norm, with some members feeling that fines should be imposed on those who break the ‘rules’.

“I’ve done recycling since day one. It’s so easy and I think that more should be done to punish people who don’t recycle. Maybe fine them.” Male, Age 45-54

Sustainable brands are well-established, and just over seven in ten members often (and almost two in ten members always) make this purchasing choice for at least some of their regular groceries. Fairtrade is an instantly recognisable symbol, and clearly signposts to shoppers the choice that they are making.

Far fewer are regularly donating to sustainable causes or seeking employment with sustainably focused or ethical organisations.

Our survey shows that there are some clear inter-generational differences emerging: • One in three (33%) members under 35 always

seek employment with sustainably focused organisations, compared to around one in ten (12%) of members aged 35 and over

• Around a quarter (23%) of members under 35 always donate money to sustainable causes, compared to one in ten (11%) of members aged 35 and over

• around one in four (27%) members under 35 always boycott a brand or company because they disagree with the ethics of their behaviour, compared to one in six members aged 35 and over

Figure 3: Changes in attitudes towards ESG over time, by age (proportion who agree with each statement)

ENVIRONMENT

People are more interested in environmental issues today than they were 5 years ago

I am more interested in environmental issues today than I was 5 years ago

People feel more strongly today about making sure firms are being well managed than they did 5 years

ago

I feel more strongly today about making sure firms are being well managed than I did 5 years ago

People are more interested in Executive Pay than they were 5 years ago

I am more interested in Executive Pay than I was 5 years ago

Question A3. To what extent do you agree with the following statements?Note Data shows proportion who strongly agree or slightly agree with each statement.Base All UK adults aged 22-65 with a DC pension (1,061)

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The media can quickly mobilise members’ views and change behaviourTV programmes and the media more broadly can have a massive and immediate effect on members’ attitudes and behaviour. In the past few months plastic waste has gained attention almost entirely as a result of the impact of the Blue Planet TV series.

“The Blue Planet programme has really raised the plastic issue and I see that a lot of reactions to plastic straws and stuff like that. I know they announced plans to reduce the amount of plastics over the next 25 years, but it should be addressed with a greater sense of urgency because everything is affected. It’s pretty desperate when you see the state of the oceans.” Male, Age 45-54

As a result, members are talking about plastic use and are looking to businesses and government to take the lead in minimising the environmental impact of one-time only plastic products and packaging. Almost 90% of members are examining their own personal use of plastic and looking for way to reduce it.

“I have been thinking about the straws and how we shouldn’t really be using plastic straws anymore, because it’s just really bad. And I probably could do a lot more than I am doing now.” Female, Age 22-34

The basic tenets of responsible investment are readily understood and align well with members’ beliefsThere are many different interpretations of ESG and, indeed, one of the key challenges for the industry will be to create some standardisation to help members understand what ESG is all about. ESG is not a consumer-friendly term and is easy to confuse with ethical investment. For the purpose of this research, we used the term ‘responsible investment’ when talking to members about ESG issues.

Members who took part in our in-depth discussions were asked to say what they thought ‘responsible investment’ was about, before being shown a definition. From the name alone, members were able to articulate what responsible investment is about.

Figure 4: ESG activities (proportion of members who always or sometimes do these things)

RESPONSIBILITY

Question A2. To what extent do you personally do any of the following? Note Data shows proportion of adults who responded ‘Always’ or ‘Sometimes’.Base All UK adults aged 22-65 with a DC pension (1,061)

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“I think it would be about ensuring that the money members paid into a scheme was safe. And to think about where the money is going, not to fund arms deals and that sort of thing, but to make sure that that they invest ethically and if it goes to 50 different places that they would have to really do their due diligence about the companies they are investing in. Female, Age 45-54

All respondents were shown the same definition of responsible investment (see Box 1).

Exploring members’ views towards the assertions made in this statement reveals:• Just 2% disagreed with the statement that better

run companies are better investments• 51% agreed that climate change will adversely

affect long-term investment performance (and, therefore, the performance of my pension scheme investments) if not properly managed, and a further 40% were not sure

• 15% disagreed that investments which avoid investing in controversial industries (e.g. weapons, tobacco, gambling, landmines) are likely to do less well over the long term

• Just 7% disagreed with the statement that long term investment performance will be constrained by the world running out of natural resources and that investment managers should seek to mitigate these issues when investing pension savings

• Only 5% did not agree with the statement that when investment managers engage with the companies they invest in (e.g. attending annual general meetings and voting against excessive pay packages), this can positively influence company behaviour and performance, and ultimately result in better investment performance for my savings

Figure 5: Proportion of members who always do these ESG activities, by age

Box 1. Definition of responsible investment Responsible investment means investing in a way that takes into account not just how companies are managed, but other issues too, from the impact they have on the environment to the role they play in society. People do this because there’s evidence that these issues affect how companies perform over the long term - and therefore what happens to the money that’s invested in them.

For example, if a company you invested in was involved in an oil spill, found to be treating its workers poorly, or accused of bribing politicians in another country, it would damage that company’s reputation and its share price. If that happened, you’d lose money.

Ignoring issues like these might mean you miss out on opportunities too. For example, a company manufacturing hybrid cars might do better over the long term than one making diesel cars. A company that invests in training its workforce might outperform its competitors. A company paying its executives reasonable bonuses might return more value to its shareholders. In each of these examples, considering how the company treats the environment, how it treats people, and how it’s managed, over the long term could enhance the company’s performance and may make you more money.

Recycle waste

Try to reduce my use of plastic

Use public transport whenever I can

Check product packaging for sustainability

Boycott a firm or company because I disagree with the way it treats its workers

Boycott a brand or company because I disagree with the ethics of their behaviour

Buy from ‘sustainable’ brands such as Fairtrade

See employment with sustainably focused organisations

Make an additional payment to offset my carbon footprint when travelling

Donate money to sustainable causes

Question A2. To what extent do you personally do any of the following?Note Data shows proportion of adults who responded ‘Always’.Base All UK adults aged 22-65 with a DC pension (1,061)

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That said, there is a significant proportion of members (30-40%) who have no views either way or could not give an answer to these questions. This indicates that members will need some help in order to make an informed decision on whether responsible investment is for them.

60% of members are interested in responsible investment for their DC pension money, rising to 80% of members aged 22-34

Given what we now know about members’ general attitudes and behaviours, it is perhaps not surprising the concept of responsible investment aligns well with how they would want their pension money to be invested, with six in ten members saying that responsible investment is of interest to them.

“If my pension company did this I would think that they were making the right decisions at a very senior level. That somebody decent was making a stand. I would definitely think that that pension had more foresight than its competitors.”Male, Age 35-44

“I don’t know whether I am that interested in it. I just feel like I am not really that aware about it, but I guess I do want my money to be used in a good way. I don’t want to give my money to

companies that don’t treat people well. I guess I should be more interested in it, and I do find it more interesting now that it’s been pointed out to me how if a company is not acting ethically, it could actually affect me.” Female, Age 22-34

Interest in responsible investment:• Is highest amongst those under 35 - 80% of those

aged 22 to 34 are interested• Increases with knowledge and confidence – to

nearly 80% for those with moderate or h igh levels of knowledge and confidence

• Is strongly correlated to already being in an ethical fund – here, 90% are interested

• Increases with pot size – 79% of those with a pot of £50-£100k and 70% of those with £100k+ are interested

To test whether this interest is real, we asked those who said they were interested whether they would be willing to spend a few hours of their own time to find out more about it. Around half said they would.

Members were very keen to see their pension money doing good Nearly seven in ten members would like to see their money invested for good, rising to nearly eight in ten amongst the 22-34 year olds.

Figure 6: Interest in responsible investment, by age

Question S5. How interested are you in investing your defined contribution pension savings in this way?Base All UK adults aged 22-65 with a DC pension (1,061) Very interested Somewhat interested Not very interested Not interested at all

All respondents

22-34

35-44

45-54

55-65

High

Moderate

Low

High

Moderate

Low

Kno

wle

dg

ea

ble

a

bo

ut

pe

nsio

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inve

stm

en

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Ag

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on

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Younger members, in particular, felt very divorced from their pension money as it is taken at source and they can’t access it for many years. Given this, they would very much like to see the money working to have an impact on society today.

“I love all this. I think that’s good: something that’s going to help us and we’re all going to benefit from in the long-run, because I am not going to get any of that money back for a good while yet. So, I am more than happy for it to go into these projects.” Female, Age 22-34

However, when faced with a very stark financial choice about their money, members are evenly split on whether they would want responsible investment.

Across all age groups, around half of members agree that the sole motivation of pension providers should be to achieve the best possible investment return for their pension savings.

“I possibly would pay more money into my pension if I thought that the returns would be better. But I wouldn’t think that responsible investment would get me better returns, because responsibility and money are two different things.” Male – Age 45-54

Of course, the way that the financial trade-off is framed will have a marked impact on the result. Given there is a body of evidence to suggest that, in the long run, there should be a ‘win-win’ situation. By its very nature, responsible investment should deliver returns that are at least as good - if not

better - than traditional investment strategies. On this basis, we re-framed the question to ask whether members would be willing to accept a lower rate of financial return in the short term to achieve higher long-term financial gains.

Again, just over half of members would be willing to do this and, understandably, this trade-off appeals much more to young members than to those who are close to retirement age. A further one in three are open to persuasion. This positive result is striking, given that present bias is a such a powerful driver of behaviours when it comes to pension decisions.

A core group are willing to accept higher costs and an uncertain outcome Just over a third feel so strongly that they would be willing to pay higher costs for responsible investment, increasing to around half of those aged between 22 and 44. Again, this is a very important result, as behavioural economics tells us that a loss is felt three times more acutely than a gain. Around three in ten are open to persuasion.

The impact of responsible investment may only be felt in the distant future, and the outcomes are uncertain. Nevertheless, many members (44%) are willing to give responsible investment the benefit of the doubt as they feel so strongly about the positive impact their pension money could make. Again, the younger age groups are much more amenable to this than those closer to accessing their DC pension pots; 57% of those aged 22-34 and 52% of those aged 35-44 are willing to invest with uncertain outcomes. A further 40% of members are open to persuasion.

Figure 7 : Proportion of members who believe that the sole motivation of their pension provider is to achieve the best possible investment for their pension savings, by age

Question S10.5 Thinking now in a bit more detail about how your pension money could be used for Responsible investment, to what extent do you agree or disagree with the following statements? I do not want my pension provider to undertake Responsible investment as their sole motivation should be to achieve the best possible investment return for my pension savings.Base All UK adults aged 22-65 with a DC pension (1,061)

All respondents

22-34

35-44

45-54

Strongly agree Slightly agree Neither agree nor disagree Slightly disagree Strongly disagree

55-65

20

“Obviously, I would want to get the best investment possible and the best outcome possible in terms of monetary value, but then if they’re investing in things that I am not comfortable about then I’m ok with not receiving as much.” Female, Age 22-34

Fewer members are willing to take a greater risk with their money, but responsible investment is perceived to be the lower risk option.

Those aged 55-65 tend to be closer to taking their DC money and are therefore not always in a good position to take any risks with their hard-earned pension money. Nevertheless, even amongst this group, almost one in five would be prepared to take more risk if this meant their money was in responsible investment.

The propensity to take more risk is inversely correlated with age, with more than half of the youngest members willing accept higher risk for responsible investment.

A very different perspective emerged from our depth discussions. Here, members had a little more time to reflect on responsible investment to consider what it really meant. Improved understanding meant that these members actually viewed responsible investment as a lower risk strategy.

“I genuinely don’t see this as risky. Perhaps in a sense that there is more money to be made in weapons than in the longer term of looking at something like water security, but pensions are about your future, about what you might live off when you don’t have a job. So, I think that

people are more likely to look at that, rather than what the fund is in today. I just happen to think that the funds that are more like responsible investment are a safer bet. Male, Age 22-34

“I can’t see you losing from this, because you’re putting money into companies that are the ‘good guys’. So, generally, they should be performing better.” Male, Age 45-54

Members believe there is a ‘red line’ already in place, and that their pension money is already being used for responsible investment Members who took part in our in-depth interviews were horrified to find out that, unless they had specified otherwise, there is no ‘red line’ for their pension investments and therefore their pension money is potentially being used for all sorts of things that they feel very strongly against. Some could vaguely recall being asked about ethical funds, but they never really understood exactly what it meant if they didn’t tick the box. Most could not recall even having that as an option.

“I think companies have been doing this already; a lot of investment is based on performance and these are the factors that affect performance. I would certainly hope that my pension provider is already doing this… But I can’t say that I have ever seen an option like this with the pension funds I am with.” Female, Age 45-54

Figure 8: Willingness to accept lower short term financial returns for higher returns in the long-term, by age

By a

ge

All respondents

22-34

35-44

45-54

55-65

Question S10.7. Thinking now in a bit more detail about how your pension money could be used for Responsible investment, to what extent do you agree or disagree with the following statements? I am willing to accept a lower financial return if my money in the shorter term to achieve higher long-term financial returns.Base All UK adults aged 22-65 with a DC pension (1,061) Strongly agree Slightly agree Neither agree nor disagree Slightly disagree Strongly disagree

21

Given our survey suggests that only one in five (22%) of all members believe that they have chosen an ethical fund as part of where their pension money is invested (or have chosen to be in an ethical default fund with other investments), we have every reason to suspect that this misunderstanding is reflective of the majority of DC members.

Indeed, 40% of members think that the people making decisions about how to invest their defined contribution pension money are already doing responsible investment with their pension money; just 5% are sure that this is not already happening.

Significant numbers think they are already in responsible investments This misplaced expectation that pension providers are already doing responsible investment on their behalf perhaps explains why so many of our survey respondents felt that they had heard of responsible investment before, and why a significant number (just over one in ten members, rising to one in four amongst the 22-34 year olds) thought they were already investing in this way.

Member education is likely to swing views in favour of responsible investmentThe results of our survey clearly show that without member education, member views on responsible investment are likely to be finely balanced, and that many members are basing their views on incorrect assumptions.

However, the outcome of our in-depth interviews - where members had a little more time to consider the issues and to understand and reflect on what

responsible investment is all about - was very different. Here, respondents unanimously wanted

responsible investment with their money by the end of the conversation and were happy for this to start today - even if it could only be achieved with a part of their pension pot.

“I’m very interested in this, because I think there is some truth to what’s being said here. Going by what we hear about share prices daily, the minute a company is doing anything that’s disapproved of the share price plummets and when they do good things or keep things on an even keel, it keeps the share price buoyant and stable.”Female, Age 45-54

Members are even more interested in responsible investment when they realise that they actually own real assets through their pension fundOur in-depth discussions revealed that members are very unclear about what ‘investments’ actually are. When they hear the term ‘investment’ they think about stocks and shares going up or down, or the stories about the performance of the FTSE100 that they hear on the News at 10. In their minds, these are very nebulous concepts with no connection to the ‘real world’; investments are simply bits of paper you buy or sell to make a profit, shareholders are the rich and “fat cat city boys”. It is, therefore, not surprising that members take little or no interest, and that investing in a pension is commonly referred to as a ’gamble’ by the members we speak to.

It, therefore, came as somewhat of a shock to

Figure 9: Willingness to take more risk for Responsible investment, by age

By a

ge

All respondents

22-34

35-44

45-54

55-65

Question S10.8. Thinking now in a bit more detail about how your pension money could be used for Responsible investment, to what extent do you agree or disagree with the following statements? I would be prepared to take greater financial risk with Responsible investment than I would with a traditional investment.Base All UK adults aged 22-65 with a DC pension (1,061) Strongly agree Slightly agree Neither agree nor disagree Slightly disagree Strongly disagree

22

the respondents in our in-depth discussions to find out that through their pension money they are, in fact, shareholders and actually own parts of companies, tiny pieces of real estate and chunks of infrastructure, both in the UK and overseas.

They were even more surprised when they realised the sheer amount of money in pension schemes meant that their pension providers were major stakeholders in many of the companies they had regular dealings with, such as Tesco, BP and Marks and Spencer, and that the collective power of all their “tiny” pots could actually influence how those companies are being run. They were pleased to hear that their pension money was being used for large-scale projects and this made pensions somehow feel more “real” to them.

“I wouldn’t have thought that the insurance people, or whoever invests our money, could influence a company. I never thought about it like that. I just assumed a company acts in whatever way a company acts.” Male, Age 45-54

In fact, we followed up with five of our fifteen respondents a week after our discussion. Two respondents had been so affected by what they had found out in our session that they had proactively looked into whether their provider was currently offering responsible investment.

If this connection with real assets can be made clear to members as part of the communication

process, the numbers who are interested in responsible investment are likely to be even higher than those seen in our survey.

Stories and real-life examples are powerful ways to get the message across to members During the qualitative fieldwork, news broke about a scandal involving Oxfam workers in Haiti. Unprompted, members reading the definition in the depth interviews reflected on how its reputation and value has been destroyed due to the actions of its employees and management, and the knock-on effect on the rest of the charity sector. This really helped to bring to life some of the concepts and helped them to understand how they could lose money if this had happened in a company or sector they had invested in.

In our depth discussions, younger members, in particular, also talked about the influence that social media has on their perceptions and actions, with many now using this as their only news source. They felt that in the past it was easier for companies to hide ‘bad behaviour’, or for knowledge of that behaviour to be contained to local markets; whereas today social media has exponentially increased the level of transparency, and issues very quickly ‘go viral’ with consequential global exposure.

The Oxfam case study perfectly illustrates both the importance and power of real-life examples when trying to inform and engage members with ESG concepts. Members became very engaged

Figure 10: Many DC pension members suspect pension schemes are already doing responsible investment, by age

Question S8. Do you think that the people makings decisions about how to invest your defined contribution pension money are already doing Responsible investment with your pension money?Base All UK adults aged 22-65 with a DC pension (1,061)

By a

ge

All respondents

22-34

35-44

45-54

55-65

Yes, they are definitely already doing this

I don’t know, but I suspect they might be already doing this

I don’t know, but I doubt they might be already doing this

No, they are definitely not already doing this

I have no idea

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when they realised that their money could be funding local projects such as housing and infrastructure and were very keen to hear stories about how these types of projects have had a measurable impact on communities.

“I think that would be very good, because that’s specific and not some general statement. So, if you can say ‘you built this, on this date and it’s generated this many positive factors’ then that’s really good.” Female, Age 45-54

All areas of responsible investment are of similar interest, but when members had more time to reflect on the detail in the depth interviews, issues such climate change, human rights, child labour, data privacy and security, anti-bribery and carbon footprints particularly resonated with members.

Responsible investment has the potential to increase trust and engagement, especially amongst younger membersRebuilding trust in pensions is a hot topic, especially amongst the over 50s who are getting ever closer to accessing their pension pots. Providers have spent millions of pounds on initiatives to try to engage members, but with very limited success.

However, from the responses to our survey, it seems that responsible investment has the potential to have a powerful positive impact on how people feel about their pensions and on how much they engage with them.

“Responsible investment might make me feel a bit better about my pension because something good was happening as a result of me handing over 6% of my monthly salary.” Male, Age 22-34

The impact on trust and engagement is likely to be highest for the younger members.

There are likely to be commercial reasons to consider adopting responsible investment

Across the board, members said that responsible investment could be the trigger for them to think about paying more money in to their pension. This effect could be particularly beneficial for the younger members who are likely to be making the minimum employee and employer contributions require under auto-enrolment.

The launch of the Pension Dashboard will increase transparency and is expected to increase demand for pension consolidation. Almost half of members would consider switching their pension provider if they found out that most defined contribution pensions were investing in this way and that theirs was not.

“I would move my money to a different provider if they were offering responsible investment and my one wasn’t or move my other pension pots into the one that would offer me responsible investment.”Female, Age 45-54

Figure 11: Awareness and experience of responsible investment

Base All UK adults aged 22-65 with a DC pension (1,061)

DOING SOMETHING

GOOD

Percentages may not add up to 100 due to rounding

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Most of those who took part in the in-depth discussions felt very positive towards responsible investment and would like their provider to be at the vanguard of adoption.

“It would definitely endorse the pension provider you are with if they are doing this. You would probably take more of an interest.”Male, Age 35-44

Members say they prefer to opt in to responsible investment, but when they understand what this means in practice they often change their mind.

Only one in three (32%) members said responsible investment should be automatically chosen for them. This was a surprising result for two reasons. First, the high proportion of members who currently make no investment choices themselves – preferring to leave it to the experts - and who are in a default fund. Second, the levels of interest shown in responsible investment.

However, it became apparent from our in-depth interviews that members did not really understand this question. Members became very anchored on the word ‘choice’ and felt that this should not be simply imposed on everyone. They were very confused about what an opt in solution would mean for them in practice and often changed their minds once the moderator explained that this would require them to actively select the option themselves.

ConclusionsMembers will need some help to understand how investing actually works. Once this basic concept is grasped, this research indicates that there is strong demand for responsible investment as the way that their money is currently being invested does not align well with members’ stated beliefs and behaviours.

Members are somewhat confused, and many already think that their pension provider is doing responsible investment on their behalf. It comes as a shock to find out this is not necessarily the case. This suggests to us that there is the potential for momentum to build quickly as member awareness increases, especially if the core of highly interested members proactively start to demand action from their schemes.

Members are keen to hear more about the impact their money is having and real-life examples are a particularly powerful way to get member’s attention. The pensions industry would do well to learn from the success of the Fairtrade example and to develop an instantly recognisable name and logo to help members easily identify whether their pension money is being used for ESG investing. With the average member expected to have 11 pensions by the time they retire under auto-enrolment according to the Pensions Policy Institute, the current plethora of names and definitions will simply confuse members further. The concept of responsible investment tested in this

Figure 12: Responsible investment’s impact on how members feel about their pension

Question S13. If you knew that your defined contribution pension money was being used for Responsible investment to what extent do you agree or disagree with the following statements?Base All UK adults aged 22-65 with a DC pension (1,061)

It would make me feel more positive about the way my pension is invested

It would make me feel more positive about my pension

It would make me want to engage more with my pension to find out more about it

I would have more trust in my pension

It would make me want to pay more into my pension

It would make me want to move my pension money elsewhere

Neither agree nor disagree DisagreeAgree

25

research would seem to be a good starting point.Responsible investment has the potential to make

members interested and engaged in their pensions. Moreover, members report that they are more likely to trust their provider if they are doing responsible investment with their money and that they will consider paying more money into a pension – issues which the industry has been struggling to resolve for many years with very limited success.

“Responsible investment would make me feel as though they were trying to do something different. All of these issues are things that affect a lot of people and if you’re trying to

help these people then the money is filtering down and that comes with peace of mind. I think it’s good that they’re thinking outside the box and giving us a different view on our savings.”Male, Age 45-54

Figure 14: Percentage of members who would want to contribute more if their pension money was being used for responsible investment, by age

Question S13.5 If you knew that your defined contribution pension money was being used for responsible investment to what extent do you agree or disagree with the following statements? It would make me want to pay more into my pension.Base All UK adults aged 22-65 with a DC pension (1,061)

Question S13.3/S13.4 If you knew that your defined contribution pension money was being used for Responsible investment to what extent do you agree or disagree with the following statements? Base All UK adults aged 22-65 with a DC pension (1,061)

By a

ge

By a

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All respondents

All respondents

22-34

Agree with “I would have more trust in my pension”Agree with “It would make me want to engage more with my pension and to find out more about it”

22-34

35-44

35-44

45-54

45-54

55-65

55-65

Figure 13: Responsible investment’s impact on trust and engagement, by age

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SummaryThere is little law requiring ESG to be considered in the investment process at present, though neither is there any law preventing it from being considered. Trust-based schemes are required to disclose (through their Statement of Investment Principles) whether ESG has been considered and to describe voting policies applied to the investments, if there are any. Contract-based schemes have no explicit regulations around ESG and are not required to make any statements on it, though this is under active consideration by the government.

A number of other parties have investment-related requirements, including advisors and fund managers. Again, the regulations permit ESG to form a part of the investment or advisory processes, but there is little requirement to do so.

Changes to the EU IORPs directive and remediations proposed by the Law Commission may significantly change the landscape of ESG in the next few years. There are a number of consultations open with the Department for Work and Pensions (DWP) at the time of writing, which are to conclude in summer 2018, and may mean regulations evolve rapidly. However, it is doubtful that the regulatory approach alone can be the main driver for change. These are cautious changes aimed at removing any remaining barriers to a more integrated ESG investment approach rather than compelling wider take-up.

This chapter outlines features of the law and regulations on ESG affecting DC schemes in the UK. Firstly, it outlines the requirements as they exist at the time of writing; and secondly it considers how these requirements may evolve in future.

Current regulationsThe regulations have evolved from a complex set of different requirements and types of law, but very little explicitly refers to ESG.

The requirements on DC schemes relating to ESG can be split into two categories:• Those looking at the investment process from

the perspective of meeting fiduciary duties and behaving as a steward of investments; and

• Those making sure documentation is available to stakeholders outlining their considerations and activities.There are quite general obligations on those

managing DC investments to take ESG issues into consideration in setting investment policies and in their engagement with companies. However well-meaning, these obligations are sufficiently broad to have been interpreted conservatively (e.g. not sufficiently considering ESG) in practice.

The law and regulations for DC schemes come from a number of different parts of law including contract law enforcing the trust deed or the prospectus; regulatory guidance and rules made by The Financial Conduct Authority (FCA) and the Pensions Regulator (tPR); pensions legislation; and judge-made law (“common law”).

Sources of law and regulationTrust-based schemes and insured schemes are set up very differently in law. The complexity of law here creates an environment which can be open to interpretation. In theory, the final interpretation will come down to the courts themselves though the regulatory process is intended to pre-empt these decisions. However, no case has actually reached a court test of DC ESG-related law• Trust-based pension schemes have their main

sources of law in trust law and pensions legislation and are regulated by the Pensions Regulator (tPR). This structure reflects a heritage in defined benefits, meaning that the trustees are the prime investment decision-makers and fiduciary. Master Trusts have recently been gaining in DC market share but have very little in law to distinguish them from other trusts.

• Insured schemes are subject to contract and financial markets law and FCA rules. The FCA handbook is a key source in particular for outlining how investments are managed. Recent changes to FCA rules introduced Investment Governance Committees (IGCs) as a parallel fiduciary to the trustee in trust-based arrangements.Auto-enrolment legislation altered the landscape

somewhat, increasing the responsibility of pension providers in particular. This is both because of the deemed consent implicit in enrolling someone in a scheme and due to the obligation of a pension provider to offer and manage a default investment programme. The introduction of IGCs is intended to reflect this increased responsibility on providers and appoint individuals as a champion for members.

Trust-based schemesThe Pensions Act 1995 defines trustees’ investment powers and responsibilities, but this legislation was set with defined benefit schemes in mind.

The act defines investment powers (Section 34); requires trustees to prepare a Statement of Investment Principles (SIP) (Section 35); and to take proper advice on investment decisions. These are broad investment powers and in principle can

Law and regulation on ESG for DC pension schemesWritten by Nico Aspinall

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be read as saying that any investment that can be described in the SIP can be invested in. However, the trustees are also constrained by the Investment Regulations.

These require trustees to balance the liquidity of the portfolio against its quality and profitability. Although most scheme assets must be traded on regulated markets, “a prudent level” of assets need not be.

Trustee roleIn practice, trustees make strategic decisions and delegate day-to-day investment management.

Trustees must appoint an FCA authorised manager to take “day-to-day” investment decisions, though there is no definition in law of what constitutes a “day-to-day” decision. FCA guidance is that this includes decisions to buy, sell or hold particular securities in everyday management of a portfolio.

Although trustees may delegate, they need to retain effective control, give direction and intervene when problems are identified. The trustees’ role is to determine the overall investment objectives (strategy); appoint managers and to operate internal controls to ensure the scheme is administered according to the scheme rules and the law.

Statement of Investment Principles (SIP)Trustees must prepare and publish a SIP which comments on the influence of ESG topics on investments and on how they exercise shareholder rights.

A SIP outlines the principles governing decisions about investments in the scheme. Trustees must prepare and maintain a SIP and review it “at least every three years” and “without delay after any significant change in investment policy”.

The Investment Regulations provide the detail of the content of a SIP. Under the regulations the SIP must include a statement of the trustees’ policy on:• the extent to which social, environmental or

ethical considerations are taken into account in the selection, retention and realisation of investments; and

• the exercise of the rights (including voting rights) attaching to investments.DC schemes must also prepare a SIP describing

the scheme’s default strategy and this must also include the trustees’ policy on social, environmental and ethical considerations. This is one of the few places where DC schemes are required to publish this information.

Oddly the DC SIP does not need to include their policy on voting rights. This is a slightly contradictory gap between the law regulating trusts and DC defaults. In practice where this is excluded from the default SIP, members are also able to request the main scheme SIP including its voting policy.

Proper adviceTrustees must obtain and consider “proper advice” as to whether an investment is satisfactory.

For existing investments, trustees should obtain advice periodically. “Proper advice” means advice in writing from someone authorised under the Financial Services and Market Act 2000, or the advice of a person the trustees believe to be qualified by ability and practical experience of financial matters.

The Pensions Regulator’s (tPR) guidanceIf trustees think environmental, social and governance (ESG) factors or ethical issues are financially significant they must be taken into account.

TPR issues regulatory guidance to help those involved in the workplace pensions industry to understand their roles and the actions they should take. Code of practice 13 covers trust-based schemes providing DC benefits and the “Guide to Investment Governance” provides more detailed support on DC investment. It was updated in July 2016 and includes a prominent, early section clarifying the responsibilities of trustees in relation to financial and non-financial factors.

The broad themes of this are that:• If trustees think environmental, social

and governance (ESG) factors or ethical issues are financially significant they must be taken into account.

• The pursuit of a financial return is the main concern, but non-financial factors can be taken into account if scheme members share this view and there is no risk of significant financial detriment to the fund.This is a restatement of recent interpretations

of law, principally by the Law Commission, rather than new guidance. However, the guide highlights the long-term nature of DC schemes and that investments are exposed to risks around climate change, corporate governance and business practice. These are potentially significant financial factors which should be considered in the investment process.

The guide also looks at voting. It acknowledges

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that most schemes invest via pooled vehicles but encourages trustees to be familiar with the managers’ policies applying to the funds. For some schemes, particularly larger ones it will be appropriate to influence these policies or set specific voting criteria.

Disclosure to membersESG is only implicitly required to be disclosed. The disclosure regulations enforce sections of a number of Pensions Acts and carry the provisions regarding required communications to be made to members. The regulations are focussed on the reports trustees must produce and none of the requirements are specified as ESG-related. The principal disclosure documents are the SIP and the Annual Report and Accounts both of which must be made available to members on request.

Because the disclosure regulations focus on what trustees must do, rather than what they can do, trustees who have adopted strong investment principles on ESG and voting might include them in many places. However, no trust is required to comment on ESG except on the extent to which it was considered in the investment process.

For instance, trustees who consider ESG to be material to the investment process might provide some analysis in the investment performance report within the Annual Report. Trustees who do not consider ESG to be material would make no mention of it here.

Chair’s statementThe Chair’s statement is not required to cover ESG, but the requirements could change in future.

From 6 April 2015 the Chairs of trusts with DC

benefits have been required to complete

and publish an annual statement that the scheme

is compliant with the requirements of legislation

and operational controls. There are a number of requirements demonstrating that the default has been designed and monitored appropriately but again, none of this is focussed on ESG.

However, in its short life the statement has already been reviewed by tPR to alter how charges should be disclosed so it is reasonable to assume that the requirements will continue to evolve in future. If other regulations impose a stronger ESG approach in future (e.g. IORPS, see below) then it may be that further detail will be required on this topic in the Chair’s Statement.

Contract-based schemesThere are two types of contract-based schemes, which are run by insurance companies: Individual Personal Pensions (IPP) and Group Personal Pensions (GPP). As only GPPs can be workplace pensions and auto-enrolment vehicles (an individual must arrange an IPP) this section focuses on GPPs. A GPP is a series of contracts between staff and a pension provider selected by their employer. tPR oversees the employment element of this, ensuring auto-enrolment requirements are met, and the FCA oversees the product itself.

The insurance company agrees mandates with investment managers who select investments within that mandate. Investment decisions are taken between the provider (in setting mandates) and the investment manager (in selecting investments). Providers of contract-based schemes are subject to a legal regime based on FCA rules and contract law. Investment managers must be authorised by the FCA and are subject to FCA rules. Ongoing monitoring of investments is carried out by IGCs which are discussed in more detail below.

Under FCA rules, pension providers owe “fiduciary-like” duties to members meaning among other things that they must take reasonable care and skill in carrying out the services under the terms of the contract. Unlike trust-based schemes, there is no requirement for contract-based schemes to produce a SIP so there is no strategic statement made as to the principles that inform the design of the default.

Independent Governance Committees (IGCs)ESG is not explicit within the regulatory definition of value for money but IGCs may refer to it.Since April 2015, contract-based schemes must appoint an IGC to provide oversight of the ongoing value for money of the scheme for pension policyholders. The terms of reference for IGCs are set out in the FCA’s Code of Business Sourcebook (COBS) and accompanying policy statement. These include obligations considering:

Under FCA rules, pension providers owe “fiduciary-like” duties to members meaning among other things that they must take reasonable care and skill in carrying out the services under the terms of the contract

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We see more of a focus on documenting whether climate change has been included in the investment process

31

• whether default investment strategies are designed in the interests of policyholders; and

• whether the firm regularly reviews the net performance of investment strategies to ensure alignment with the interests of policyholders.The Chair of the IGC must produce an annual

report summarising the IGC’s opinion on the scheme’s value for money. ESG is not mentioned explicitly in these considerations though similarly to with trustees, the IGC could take it upon itself to include ESG considerations within its definition of value for money.

Investment managersInvestment managers have both trust-based and contract-based clients and their products are regulated by the FCA.Investment managers offer some consistency between trust-based and contract-based arrangements as they are commonly used by both types of scheme. However, in relation to ESG there are few requirements on investment managers which are created by regulation. In practical terms, as the trustee board or provider sets and agrees the investment mandate with the investment manager, they are bound by the requirements of that contract. Both trustees and providers are deemed to be professional investors under regulation, accountable for their actions in setting the mandate itself so the manager has no role in ‘second guessing’ this mandate. This may make it hard for the investment manager to change the fund and impose a higher standard of ESG integration at a later date.

Investment managers do accept a fiduciary duty in relation to the investments they manage but this is framed by the overall need to achieve the fund’s objectives. Within this then, they have a role to consider whether individual securities meet the objectives of the fund, and to manage risks and liquidity of the pool of assets. While there is no explicit recognition in the FCA’s rules on ESG risks, again, if the manager were to consider them to be material to the investment process they would be effectively encouraged to act upon them and document those considerations.

AdvisorsProfessional guidance for advisors is starting to cover ESG topics, but there is no compulsion for their advice to include them.The final link in the chain of DC investment are those able to provide “proper advice” to a trustee considering their investment design. Advisors are bound by FCA rules which require them to be appropriately qualified and to provide impartial

advice. These rules are consistent with other FCA rule-making in that they enable the advisor to raise ESG as an issue in the investment process if it fits with their views or the views of the client, but there is no obligation to include this.

However, at the same time as advisors are bound by FCA rules, they may also be bound by professional guidance and rules provided by their professional or certifying body. In the UK pensions industry for those giving proper investment advice this may include the Pensions Management Institute (PMI), Certified Financial Analyst (CFA) institute and the Institute and Faculty of Actuaries (IFoA) among others. Of these the IFoA has issued a risk-alert on climate change stating that:

Actuaries should ensure that they understand, and are clear in communicating, the extent to which they have taken account of climate-related risks in any relevant decisions, calculations or advice.

Again, there is no assumption that (in this case) climate change has to be dealt with by institutions in their investment process. Instead we see more of a focus on documenting whether climate change has been included in the process at all. The documentation would need to support the conclusion. Going on the principles embedded here, it means that actuarial advisors:• Who consider ESG to be immaterial should be

telling their client that they do and justifying this in the background to their advice; or

• Who consider ESG to be material should be developing ways to include ESG risks into their advice and to document the progress they are making.In either case, this is deliberately more than the

requirement on the trustee or IGC simply to make a statement as to whether they considered ESG in their process. The number of actuaries advising DC trustees or internally within providers is low in comparison to other professions but given other changes (e.g. IORPs discussed below) the principles may need to be extended by other professional bodies or by the FCA incorporating them into the FCA’s rules and handbook.

Coming regulation, consultations and reformsThere are a series of reforms in the pipeline which could add duties to include ESG in investment processes over time. This section considers the likely influences on regulation over the next few years. It starts with the IORPs directive and then considers the set of reforms being considered by the government out of recommendations made by the Law Commission in its 2017 report on social investment. Finally,

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we consider other pressures to reform regulations stemming from bodies such as the Taskforce for Climate-Related Disclosures and from future case law.

Institutions for Occupational Retirement Provision (IORPs) directiveThe timeline for implementing IORPs II may conflict with Brexit, but the intent is likely to be reflected in UK regulation.The recast IORPs directive (IORPS II) was published on 23 December 2016 and came into force on 12 January 2017. European Union member states have until 13 January 2019 to implement the directive, a date close to that of

Brexit. It is likely that the UK government will go ahead with the adoption of IORPS II as it is sympathetic to the goal of improving standards of governance, risk management and transparency in pension schemes. However, there is uncertainty over its adoption and the process to put this into law.

IORPs II applies to all pension schemes, so ignores the differences between trust-based and contract-based provision in the way it is written. To a large extent the IORPs directive replicates existing UK regulation with its requirement to draw up and publish a statement of investment principles, for key jobholders to be fit and proper and to draw up annual reports and accounts. However, the statements made on ESG within the context of risk management are qualitatively different from the current UK regime.

IORPs risk managementUltimately all DC schemes will be required to explain what steps they are taking to manage to ESG risks or why they are not included in the risk management of the scheme.The directive sees it as essential that IORPs (i.e. workplace pension schemes) “improve their risk management” … “so that potential vulnerabilities in relation to the sustainability of pension schemes can be properly understood”. Risk assessments should “where relevant, include, inter alia, risks related to climate change, use of resources, the environment, social risks, and risks related to the depreciation of assets due to regulatory change (‘stranded assets’).”

Furthermore: “Member States should require IORPs to explicitly disclose where [ESG] factors are considered in investment decisions and how they form part of their risk management system. The relevance and materiality of environmental, social and governance factors to a scheme’s investments and how such factors are taken into account should be part of the information provided by an IORP”.

This still allows IORPs to state that they didn’t consider ESG or that they didn’t think the costs of considering it outweighed the benefit on offer, but this statement should be public.

The themes of requiring IORPs to consider ESG in their risk controls continues into the detail of the directive, in the investment, investment policy, general governance, risk management and own-risk-assessment rules. For instance, in the own-risk assessment rules, IORPs are required to carry out and document every three years a proportionate risk-assessment process. This includes:• where environmental, social and governance

factors are considered in investment decisions, an assessment of new or emerging risks, including risks related to climate change, use of resources and the environment, social risks and risks related to the depreciation of assets due to regulatory change.

Law Commission – Pension funds and social investmentThe Law Commission reported on the role of pension funds as providers of capital for social investment in June 2017. In December 2017 the DWP published its interim response supporting many of its recommendations and outlining how it will respond.

The Law Commission’s report forms part of a series of government-commissioned enquiries and reports on the issues of fiduciary duties in institutional investment to understand whether members’ needs are ultimately well served by their savings and how to make policy aimed at improving that.

Of particular concern has been understanding fiduciary duties in relation to ESG investment, what they are and who they apply to. The reviews have looked at whether it is permissible to include non-financial factors in investment decisions on the one hand; and on the other whether ESG issues must be included if they are shown to be material financial issues.

Financial and non-financial factorsFiduciaries must consider all factors they deem to be financially material and can consider non-financial factors if their

Of particular concern has been understanding fiduciary duties in relation to ESG investment, what they are and who they apply to

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stakeholders are likely to share the values.The main debate in the Law Commission’s work has been how to ensure fiduciaries understand the difference between financial and non-financial factors influencing their investment decisions, and we will finish this chapter by focusing on this area. The reason that there has been this focus is that the Law Commission’s research uncovered a misunderstanding of fiduciaries whereby ESG issues were treated as being non-financial and therefore could not be considered. Incorporating non-financial factors was seen as an abrogation of fiduciary duty and ESG was understood to be non-financial. In fact, the intended definition of these terms is broadly:• Financial factors: an issue should be considered

in the investment process if it has a potential impact on returns.

• Non-financial factors: an issue should not be considered in the investment process if it is raised for other reasons, essentially moral or ethical objections. This can be summarised as saying that investment

decision-makers cannot impose their own ethical concerns on pension scheme savers. This is because the primary purpose of the investment, and their fiduciary duty, is to deliver returns to beneficiaries. However, if the trustees have good reason to believe that these concerns are shared with the membership then they may (or indeed should) be included as they form a secondary purpose on a par or higher than the purpose of achieving return.

Non-financial factors may be admissible in the investment process, even if they have not been confirmed by the membership, if they do not risk the investment achieving a lower rate of return or reducing the diversity of investments. This is often referred to as the “tie-break” rule.

The Law Commissions have both been critical of an industry that could be seen as hiding behind an excuse that issues like climate change or workplace reform were non-financial factors and should not be influencing investment decisions. In fact, the Law Commission highlighted that where factors may have a financial affect they must be taken into account in the investment process.

The future path of regulationRegulation is unlikely to be the main driver of change in incorporating ESG into DC investment.Despite the encouraging progress made by the IORPS directive and the Law Commission, there is little prospect of DC schemes being required to include ESG issues in their investment processes

any time soon. It looks highly likely there will be progress in compelling schemes to go through a process of considering whether ESG should be included and disclosing the considerations made, but this will still enable DC schemes to either consider ESG issues to be non-financial or immaterial in the context of wider market risks.

This will not stop other participants, principally the advisors and investment managers serving DC schemes, from taking it upon themselves to advise that ESG is a material financial issue or to incorporate it within their investment funds by company policy. This will likely be motivated by these parties believing that they carry fiduciary liabilities regardless of their client’s position on the topic or because market norms move faster in these markets. Trustees and providers that seek to go against this advice could be opening themselves up

to significant legal risks if they are seen to be acting unreasonably.

Perhaps a more important factor for schemes is a growing awareness of responsible investment issues among younger savers. Young savers clearly feel a greater sense of stewardship for the world than older savers. When they are educated about responsible investment issues, they become even more concerned (see chapter two for the results of quantitative research into this issue). As auto-enrolment takes root and awareness grows, attention is likely to turn more and more to responsible investment.

The “tie-break” rule The trustees of the XYZ Ltd pension scheme are considering whether tobacco companies should be excluded from the DC default fund. On the one hand, a number of the trustees are concerned that a company selling products that damage users is unethical; on the other hand, the trustees note the consistently growing and high dividends achieved by their substantial holdings in this sector. The ethical concern here is a non-financial factor and one likely to cause a financial detriment to members and should not be included in the investment process. The trustees agree to continue to hold this investment.

At a later date, the trustees run a survey of its members and find that there is universal shock and in some cases anger that their pensions make tobacco investments. The trustees see that their concern around tobacco is shared with the members and agree that though it is a non-financial factor which may cause financial detriment to members; because this concern is shared with members they are reasonable in making this exclusion.

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Case study Developing expertise in new technologiesJ.P. Morgan Asset Management’s auto sector specialists from New York, London and Tokyo arranged a specialist internal offsite day to focus on electric vehicles (EVs) in June, with presentations from Iberdrola, Renault, BMW and Nissan, as well as specialist consultants LMC Automotive and battery expert Dr Billy Wu of the Dyson School of Design Engineering, Imperial College London.

Iberdrola estimates that, by 2040, demand for EVs will require 1,900TWh of generation, or 5.5% of worldwide capacity, noting that charging infrastructure will need to evolve from the national grids we see today to integrated “smart” grids, where individual homes contribute via solar panels, wind turbines or hydrogen powercells (the so-called home-to-grid model, or H2G).

Iberdrola’s representatives also called for consolidation in the proliferation of national standards for EV plug configurations and charging voltages. They further observed that a switch to autonomous vehicles in the future will require a shift to cable-less charging stations, where EVs can be charged simply by parking over a wireless charging pad. Iberdrola closed by observing that air pollution from vehicles is the fourth largest cause of deaths worldwide, responsible for 36% of lung cancers, 34% of strokes and 27% of heart disease according to the World Health Organization.

Dr Wu focused on evolving challenges to battery technology, and forthcoming solutions including lithium-ion, magnesium-ion, lithium sulphur and lithium-air technologies, which have the potential to further improve driving ranges and charging times. Wu predicted that this will lead to a dramatic increase in demand for copper, nickel and cobalt, at rising levels of purity, noting that many of these are sourced in locations like the Democratic Republic of Congo under appalling conditions, which led J.P. Morgan Asset Management into a further engagement discussion with commodity producers in the region.

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Case study How HSBC adopted ESGThe HSBC DC pension fund – one of the largest in the UK – is blazing a trail for environmental, social and governance (ESG) investment.

In conjunction with Legal & General Investment Management (LGIM), index provider FTSE Russell and investment consultant Redington, the scheme trustees built a fund and an index which aim to better manage the risks from exposure to ESG issues.

Launched in November 2016, the Legal & General Future World Fund is a factor-weighted, passive global equity strategy. The fund tracks the newly created FTSE Russell index of global companies that score well on quality, value, size and low volatility.

The strategy then applies a climate change tilt by excluding companies in sectors contributing directly to global warming, such as coal miners.

The Future World Fund accounts for the equity allocation in the default fund and saw an initial investment of £1.85bn.

The motivation for taking such a bold step was first and foremost to achieve a better risk-adjusted return.

Chair of trustees at the HSBC fund, Russell Picot, says: “The trustee and sponsor both believe that climate change presents a financial risk to the scheme. We need to do something to manage that risk and it is our fiduciary responsibility to take positive action.”

The second motivation tied into a 2015 pledge by the trustees to limit climate change to the two degrees Celsius limit as set out in the Paris Agreement.

Third, the trustees wanted to see more engagement on environmental issues from its passive equities manager.

The Future World Fund met all three targets in one hit.

LGIM was an obvious choice for HSBC, not just because it was incumbent manager but because it proffered additional ESG engagement services.

Mr Picot says the scheme not only benefited from LGIM’s passive investment experience but also from its climate impact pledge which involves engaging with more than 80 companies that do not make the investment grade.

Mr Picot says: “Not only have we got a financial solution to manage our position on ESG issues, but we also benefit from LGIM engaging with companies seeking to drive positive behaviour. This ties in with our views around engagement rather than divestment.”

The challenge for the HSBC trustees is in monitoring the Future World Fund.

There is something of a contradiction in measuring short or even medium-term performance, since many climate change impacts will play out over the very long-term. Yet, failure to act should the strategy become ineffective, could cost members dear.

Mr Picot says: “The key with the default is to be thoughtful about monitoring and to understand at what point you take action. A fund can have good years and bad years, the question is whether the strategy is still efficient going forward.”

The HSBC fund communicated with members on advancing ESG investment, revealing that feedback from beneficiaries – particularly millennials – was positive.

However, Mr Picot says that since individuals may be disengaged from their DC fund, it is the responsibility of trustees – not the membership - to ensure ESG issues are incorporated into investment strategies.

“We want to get members’ feedback, but it is almost a dereliction of duty for trustees not to take the initiative,” Mr Picot says.

Testament to HSBC’s belief in ESG investing, the company’s £27.5bn DB scheme will emulate its DC counterpart by moving funds into a climate-focused strategy. Advocates of ESG investing hope others will follow suit.

Case study How NEST approaches responsible investmentIn 2017 NEST – which provides workplace defined contribution pension schemes for companies as part of the auto-enrolment legislation – nailed its responsible investment colours to the mast.

The £1.6bn fund launched the UBS Life Climate Aware World Equity Fund together as part of the Trust’s default fund. Committing an initial investment of £130m, NEST says the fund sends a strong message to companies that is expects to see ‘measurable progress towards environmental sustainability’.

However, NEST’s director of investment development and delivery Paul Todd is at pains to point out that investment in the Climate Aware fund is not born out of an environmental position but an entirely financial one.

Responsible investment in practiceWritten by Gill Wadsworth

TAKING A BOLD STEP

Committing an initial investment of £130m, NEST says the fund sends a strong message to companies that is expects to see ‘measurable progress towards environmental sustainability’

Chapter 4

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He says: “The number one reason for investing in a climate aware fund is better risk-adjusted returns. If you can see that corporate behaviour has a risk/return impact, why wouldn’t you manage that in the investment strategy?”

Since the Climate Aware fund is part of the default offering, which like all DC funds is limited to a 0.75% management charge, NEST needs to keep costs down.

The Climate Aware fund tracks the FTSE Developed Index but applies specific rules to the way in which UBS allocates to the companies in that index. The idea is to favour companies that are better prepared for a low carbon economy while limiting investment to those that are less environmentally friendly.

NEST has a 40% higher exposure to companies that generate renewable energy; a 30% tilt to those that are on target to meet their industry carbon reduction targets as well as a 50% reduction in carbon intensity.

Conversely, it underweights companies that have reserves of coal, oil and gas, and those that produce energy from coal, and those falling short of carbon emission targets.

Mr Todd says that in the eight months since the fund has been running, the expected risk/return outcomes have been met.

“The expectations of risk and return have been borne out. Those companies that aren’t taking climate change seriously and who are not managing their transition towards a low carbon economy don’t perform as well as those who are.”

NEST benefited from having size and expertise in building the Climate Aware fund alongside UBS. Other schemes may not be able to build a bespoke fund, but Mr Todd argues that if trustees demand ESG options, the asset management community can deliver.

He says: “Unless members and trustees demand ESG investment options then the fund managers won’t see it as part of their business model. There are many who see offering ESG as giving competitive advantage and there has been overall improvement [in choice] over the last five to six years.”

NEST continues to develop its ESG investment initiative and is looking to expand into alternative asset classes alongside equities.

As part of this, the fund will contact members to establish their opinions on responsible investment and whether they want to hear more about ESG investment.

NEST is also working with the Cambridge Institute for Sustainability Leadership which will gauge savers’ reactions to ESG information and its importance to their DC pension.

Case study Getting trustees engagedMembers of defined contribution pension schemes carry the investment risk. In many cases they do not feel equipped to take investment decisions and, understandably, pass responsibility to professionals by investing in the default scheme.

Yet by abdicating responsibility, it is possible to lose touch with where their money is invested and the impact it can have – for good or ill – on the wider world.

It is often difficult for individuals to encourage the inclusion of responsible investment unless they actively pick their own strategy. Therefore, the onus is often on trustees to recognise the impact of environmental, social and governance (ESG) issues on the fund’s risk/return dynamic.

In response, a charity, ShareAction, aims to mobilise individuals and trustees and educate them on the importance of including ESG in investment decision-making.

The charity has worked with members of the TFL and the CO-OP DC schemes to help them take a more pro-active position on ESG.

For example, over the course of two years ShareAction has been working with the Co-op’s DC pension scheme members to improve transparency and ensure the investment strategy incorporates ESG issues.

ShareAction highlighted where the scheme’s responsible investment policy was lacking and suggested improvements. Notably, the trustees were asked to assess how far investment managers were factoring in climate-related risks.

The assessment noted that the Co-op’s asset managers were signatories of the UN Principles of responsible investment and complied with the UK Stewardship Code. However, ShareAction said, ‘This is not adequate as evidence of risk management as involvement can be aspirational and membership commitments unenforced’, and pushed for further action.

Consequently, in 2016, the trustee hired investment consultant Mercer to conduct a full review of climate change’s impact on the pension fund.

ShareAction also focuses on encouraging schemes to take account of ESG issues in their default funds.

Lauren Peacock, campaign organiser at ShareAction, says that in the rare cases where members do take active decisions about how to invest, the responsible investment options rarely are optimum.

Ms Peacock says: “We want to see more choice for members. Most DC schemes have an ethical

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option but that’s only beneficial if members make an active choice. And some of the ethical options are a bit tokenistic. We would like to see responsible investment as standard in a default fund.”

Case study Investment advisers and the ESG challengeInvestigation by the Principles for Responsible investment (PRI) released in December 2017 found that despite ‘some pockets of excellence on environmental, social and governance (ESG) integration, largely these factors are not incorporated into investment advice’.

William Martindale, head of policy at the PRI, said that consultants may not even have views on ESG, and responsible investment rarely forms part of models on asset allocation.

At the same time the PRI says that pension funds infrequently ask for advice on ESG issues and their impact on investment decisions.

The PRI, and other organisations, are investigating into how pension funds can incorporate ESG requirements into the investment consultant selection exercise. In the meantime, however, if neither the investment consultant nor the pension fund trustees raise responsible investment, it risks gathering dust at the bottom of the agenda.

Despite the PRI’s findings, there are investment consultants that do encourage discussion about ESG in meetings with DC trustees.

Laura Myers, partner and head of DC investment at consultant LCP, says it is typically consultants, rather than trustees, who raise ESG issues.

“It varies between different clients, but generally ESG is something that we raise. We incorporate ESG into lots of different areas through manager selection and talking about the impact responsible investment can have.”

Getting the message acrossInvestment consultants including Mercer and Redington are also proactive in raising ESG issues with DC investors, but they note that before schemes can consider responsible investment they first need to understand the various terms.

Lydia Fearn, head of DC at Redington, says: “The definitions around ESG are not clear. We often need to explain that responsible investment is not about screening or excluding companies. Instead it’s about risk management and getting the most from

investment strategies.”While many DC funds may have a responsible

investment fund available for members making an active choice, it may be less common for ESG to appear in default funds.

The challenge here is in demonstrating that a failure to incorporate environmental, social and governance considerations into investment strategies could be materially detrimental to member outcomes.

Fearn says there is still a lack of data available which would help make the investment case to trustees. However, she notes that in some areas – such as carbon investing – the situation is improving.

Investment consultants will face more pressure to drive the responsible investment agenda in the future, but they cannot do it alone. The asset management community also has a responsibility to provide the appropriate funds and products that suit DC schemes of all shape and size. Thankfully, as we explore elsewhere in this report (see chapters one and six), investment managers are innovating on responsible investment and awareness is growing among scheme members, which is likely to stimulate greater demand.

MAKE AN ACTIVE

CHOICE

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In this chapter, we’ll look at how to talk about responsible investment – first to trustees, and then to members. We’ll explore some reasons why it’s hard and we’ll look at some ways we can make it easier. We’ll illustrate how to start a conversation and how to keep it on track. And we’ll look at how we can move from talking onto doing things, based on good advice from trustees, consultants and fund managers who’ve been there.

Let’s start with trustees. On the face of it, talking to them should be easier than talking to members. They know more about the subject, they think more about it, and they’ve got more sources of advice to call on. So why is it hard?

For starters, no one can agree on exactly what responsible investment isAsk five people and you’ll get twelve opinions.

On top of that, everyone reacts differently when they hear the wordsEach of us brings our own baggage to the conversation, just as we do with every word we hear.

Some add a silent ‘socially’ to the frontIt might be because they want it to be there and they care passionately about the impact their investments have. Or it might be because they dread it being there. They see their job as paying members’ benefits and view anything else as a distraction.

Either reaction would be understandable, but neither is fair. We didn’t even use the word ‘socially’.

Some substitute a different term altogetherYou might have done this already. Did you read responsible investment, and mentally switch in ‘sustainable investment’ or ‘ESG’? If you did, can we still be sure we’re talking about the same thing? As chapter 1 showed, they’re closely related terms, but they’re not interchangeable.

Our conversation is mired in misunderstanding already – and we’re only two words inIn his book Words That Work, US pollster Frank Luntz coined the phrase ‘It’s Not What You Say, It’s What People Hear’. He could have been talking about us.

How could we move past this as an industry?

We could pick a term, define it, and then stick with itIf you think this is wildly ambitious, you can skip this section. Everyone else, bear with us.

Agreeing a consistent term across our industry is difficult, granted. But it’s not impossible. There are plenty of precedents, like settling on ‘defined contribution’ over ‘money purchase’, or ‘annual benefit statement’ over ‘SMPI’.

We could agree on an umbrella term that encompasses everything on the spectrum, from integrating ESG risk factors into the default investment process on one end, to prioritising positive impact ahead of returns on the other. But it would be more successful if we were able to zero in on exactly the approach or investment style we mean, and then agree a term and a definition that we could work with. Could that be ‘responsible investment’?

Call me responsibleOne of the reasons we chose ‘responsible investment’ for the definition we put in front of members was that it’s already accepted in some parts of the investment industry. There’s a well-established body already called the PRI (Principles of Responsible investment). They coined the phrase, they champion it, and they define it in the same way we did.

“Responsible investment is an approach to investing that aims to incorporate environmental, social and governance factors into investment decisions, to better manage risk and generate sustainable, long-term returns.”

Yes, their definition is full of long words. Yes, it’s more about process than outcome. But it’s clear in its focus. This is about risk and return, not about ethics or the future of the planet. That’s a very helpful distinction.

The good news is that members instinctively get what responsible means In research, members were able to define what responsible investment meant surprisingly well, given their level of knowledge. In their minds, it stretched to mean several things, all of them positive. It meant thinking about why schemes invest in the first place – because they want to provide benefits in retirement. It meant thinking about all the things that could affect risk and return – because ignoring those things would be irresponsible. And it meant thinking about the wider context – because everyone wants to retire into a world worth gardening in. Other terms left members confused or limited their focus to one area – the environment, for instance – at the expense of the others. If ‘responsible investment’ is accepted by the industry, and means something to members, why wouldn’t we get behind it?

How to talk about responsible investmentSimon Grover and Rhys Williams, Quietroom

Chapter 5

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The industry is splitSome of the trustees, consultants and fund managers we spoke to in our research couldn’t get past the phrase’s ‘dark green’ origins. Despite efforts to rebadge ‘socially responsible investment’ as ‘sustainable and responsible investment’, or to drop the S from SRI completely, those people weren’t buying it. No matter what supporting arguments we put forward, they felt we were in tree-hugging territory. Some questioned whether ‘responsible’ was even something worth saying – who sets out to invest irresponsibly? Others protested that this was how they’d always done things anyway.

Lots of experts prefer ‘sustainable investment’It’s responsible investment’s closest relative and the most widely-accepted alternative. There’s an unfortunate problem though. It unlocks almost exactly the same associations as responsible investment – just for a different group of people. Put simply, if you’re not offended by responsible investment, you probably are by sustainable investment – not by what it is, or what it means, but by what it’s called, and the message you believe it sends out.

Let’s call the whole thing offIn the ideal world, we’d go for responsible investment. It means more to members and they’re the people we’re here to serve. But we can’t ignore what experts told us about their problems with responsible investment, or their preference for talking about sustainable investment instead.

If there were a stronger consensus round ‘sustainability’ over ‘responsibility’, then it could work. One thing that would help is defining sustainability in the broadest possible way – so it encompasses the idea of investing in companies we believe will endure, business models and sectors we believe will persist over time, and economic activity that we believe will contribute to a sustainable global future. This illustrates perfectly another option that’s open to us – one that’s perhaps more workable.

We could define our terms – so everyone knows we’re talking about the same thingIf you skipped the last section, welcome back.

Whether we settle on one term for the type of investing we’re discussing, or we continue to use several interchangeably, the reality is that we’re still likely to be misunderstood. To counter this, we need to define what we mean by whichever term we use. In this context, it’s not about the industry’s definition. It’s about the scheme’s definition. At a scheme level, when we’re having a conversation on this subject, we have to be explicit about what we’re discussing and how we’re defining it. If we don’t, then we risk misaligning what we say and what people hear.

Box 1. illustrates one way we could do it. Discussing it in a trustee board or investment committee meeting would help to calibrate our conversations, so we’re all talking about the same thing. In reality, most schemes will be closest to one of the first four statements. But what counts is having the conversation and documenting the conclusion.

We could get the ethical conversation out of the way – then move onWhen you’re talking about subjects like weapons or child labour, the conversation gets emotional quickly. When that happens, it becomes harder to divide the professional from the personal, and harder to make good decisions.

Some of the experts we spoke to suggested trustees should swerve the issue completely, focusing just on risk and return and leaving the ethical conversation well alone. But by doing that, you risk leaving a vacuum into which people can project their own assumptions and beliefs. By not talking ethics, you might find yourself focusing on little else.

Box 2. The fiduciary responsibility case – doing it because we have toThe regulation says that if trustees believe environmental, social and governance factors are material to risk and return, then they must consider them in the investment process (see chapter three for more details about what the law says). To build this case, ask your advisers to come back with a view on materiality. What’s the likelihood that environmental, social and governance risks will impact through to cash flows?

TACKLE OBJECTIONS

HEAD ON

Box 1. Where are we on this spectrum? • We invest to get the best risk-adjusted returns, irrespective of

how we get them.• We consider those environmental, social and governance

factors that we believe to be material to risk and return and we integrate them in our investment process.

• We consider all environmental, social and governance factors, irrespective of whether or not they’re material to risk and return and we integrate them in our investment process.

• We invest to get the best risk-adjusted returns, with a positive impact as a nice but not necessary by-product.

• We invest to get the best risk-adjusted returns and to have a positive impact, with those two outcomes carrying equal weight.

• We invest to get the best risk-adjusted returns and to have a positive impact, but we prioritise impact over returns.

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Others told us to have the ethical conversation first. They suggested discussing red lines at the beginning of the conversation but being clear they were going into a specific box that wasn’t about responsible investment. When the conversation moves on, it feels clearer that you’re now talking about something else.

This doesn’t mean you can’t come back to topics, just that when you do, you might discuss them from a different perspective. So, in a conversation about our red lines, we might talk about not wanting to invest in tobacco for ethical reasons. Later in the conversation, we’d look at the investment arguments instead, such as the risk of increased legislation, the threat of litigation or the prospect that tobacco companies might be asked to bear the cost of smoking-related healthcare. With a clearer distinction, the conversation stays on track.

We could establish some clear reasons whyWith the ethical conversation out of the way, it’s time to shift our focus to what’s left – the arguments for and against responsible investment. When it comes to the different cases we could build, there’s one clear front-runner (see Box 2).

The second case in our list could be just as compelling - Box 3. After that, we’re into cases that could be cast-iron or cast-off, depending on your scheme and your point of view - Box 4.

We could tackle objections head onA small but determined minority of the trustees and managers we spoke to felt responsible investment was at best irrelevant, and at worst a time-wasting fad. Here are some pushbacks you might get, and some things you could say in reply.

‘This is not a core activity for us – few schemes are doing it’Few trustees were discussing longevity risk thirty years ago. Now they all are. Responsible investment was the exception ten years ago. Today, it’s an expectation.

‘Anything could happen in the future – let’s focus on good member outcomes’We’re in the future business. If we’re happy speculating about equity risk or interest rate risk, why not climate risk? If they all affect member outcomes, they all deserve our focus. ‘The market already prices this in. What makes you think you know better?’It’s not about one investor knowing better than the market. It’s about all investors pushing the market to know even more than it does today.

THE MORE WE TALK

DIRECTLY TO PEOPLE, THE MORE THE

IDEAS COME ALIVE

Box 4. The reputation case – what would the Daily Mail say?As we’ve seen, scandals hit the share price. But they could damage you too. The Church of England invested £75,000 in payday lender Wonga out of a £5.5bn portfolio – but that decision generated a disproportionate number of ugly headlines. The Archbishop of Canterbury was still apologising a year later. There’s something unsavoury in every index, just as there are skeletons in every cupboard. Challenge your fund managers to bring the risks out into the open.

The sponsor case – what does the company think? You may already be excluding pharmaceutical companies because your sponsor’s an animal charity worried about testing. But are there wider environmental, social or governance issues that they’d like you to think about, because they touch on their values and purpose? Ask them.

The ‘other people’s money’ case – what do members think? Members may not be banging on our doors demanding responsible investment just yet, but our research shows latent demand for it. How would your members feel if they found out other pensions schemes were looking at responsible investment and theirs wasn’t? They might reasonably expect you to have at least looked into it and got some facts and figures that justify your position.

The engagement case – a new reason to care about pensionsPeople told us in research that they’d be more likely to care about their pension if they could get into a conversation about how their money was invested. Not because they wanted to chat about tracking error or smart beta, but because they liked the idea that their money could be achieving something, even though they couldn’t touch it yet. The media offers people an unrelentingly negative narrative about pensions. We have an opportunity to counter that with a good news story about the great things pension money is already doing, and what it could be doing in the future.

Box 3. The investment case – focusing on value, not valuesThis is about maximizing risk-adjusted return. That’s what we’re here to do and it’s the language we’re used to speaking. That doesn’t mean ignoring positive impact. It just means focusing on how you’re going to make money out of it. It’s OK to build bridges with DC savers’ money, as long as they’re toll bridges.

Here’s how the argument goes. Something like an oil spill, or a scandal about labour conditions, or a row over executive pay, can hit companies’ share prices. If those risks aren’t well managed, it will affect what happens to members’ money. Many experts we spoke to also believed that better-run companies would outperform their competitors in the long run, while poorly-run companies always get found out in the end. They discussed the emerging correlation between higher ESG scores and performance. There’s no silver bullet though, so to build this case, challenge your fund manager to interrogate the data on risk and return.

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Box 5. What are our red lines?What’s already on our list of stuff we won’t touch? Might we want to change this list? What would our sponsor want on the list? What would most members expect to see on it?

What do we know? What do we own? What do we know about what we own? How much do we know about where the sources of long-term risk and return are? How can we get a better understanding of what’s going on behind each company’s door?

What do we believe? Do we believe environmental, social and governance factors affect what happens to our members’ money? Which factors are material to risk and return and which aren’t? Which do we believe our members would like us to consider?

What could we do first?What’s the smallest thing we could do to get started? It might be as simple as asking fund managers for data or running a member survey.

What have we learned? How can we monitor the impact of what we’ve done? What data can we access that helps us make decisions in the future?

What could we do next? What should we do now to move things on? It could be asking our fund managers to engage with the companies they believe to be a risk – or it could mean changing the way we invest. Think of it as turning a dial. It doesn’t have to be all the way on or all the way off.

‘You shouldn’t change your strategy based on what’s in the news’Of course you shouldn’t. Unless what’s in the news is a seismic and irreversible change in the way the world works. Also, what about things that aren’t in the news today, but might be next month?

‘To change a company’s behaviour, you need to engage with it, not divest’It’s true you need to engage. But if that doesn’t work, you may need to look at walking away. The key is being prepared to do both. As Jim Collins says in his book Built To Last: ‘Reject the tyranny of the OR and embrace the genius of the AND.’

‘You can’t tell an oil company not to be an oil company’True, but could you persuade it to pollute less? Could you start tilting your portfolio towards companies who don’t pollute at all?

‘This is like organic carrots: worthy bit wonky.’There’s a perception that anything that’s ‘good’ must be ‘bad’ in some other way. In this context, the assumption is that returns will be subpar. But that’s all it is: an assumption. There are other assumptions. A third of the impact investors the FT surveyed last year reported gains of 11% or more – and they’re the fundamentalist wing of the movement. Who’s right?

‘This is like Fairtrade chocolate: nice but expensive.’Putting some effort into responsible investment can increase costs, but it doesn’t have to take you above the charge cap. Managers are getting increasingly competitive in this area. See what’s out there.

We could take the conversation one step at a timeWhen we spoke to trustees who had made progress with responsible investment, they all told us the same thing: the conversations didn’t all happen on one day. They’d moved forward methodically, taking the time to understand the situation, examine the evidence, build a case and reach decisions. Once they’d established where they were, and the direction they could go in, they focused on taking the next step. That meant they concentrated on what they could do, rather than what they couldn’t. And it stopped them deciding to do nothing because they couldn’t do everything.

Box 5. shows how a journey from conversation to action might play out for a scheme.

Moving on to membersThat’s the trustee conversation dealt with. What about members? They don’t think about pensions as much as we do. They don’t know as much as we do. What they do know is often wrong. Most of the time, when we start talking, they stop listening. Ignition House spoke to a DHL delivery driver who gave up reading a letter about his pension when he got to the phrase ‘scheme trustees’. Imagine how he’d have felt when he got to ‘ESG risk factors’.

So, what can we do to get them to listen?

We can tell them who we areOne master trust told us that members’ first reaction on getting their annual statement isn’t ‘Am I on track for retirement?’, it’s ‘Who are you?’. Cover the basics. Who’s talking? What’s their job? Why should they trust their trustees? How can we reassure them their investment managers are on their side? Especially when they think ‘investment managers’ are ‘investment bankers’ in disguise.

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We can tell them where we send their moneyWe talked to four DC members recently. We asked them where they thought their money went. They answered ‘Switzerland’. Why? Because they were sent letters with ‘Zurich’ at the top. We asked them what they thought happened to their money when it got to Switzerland. Their answer: ‘It gets put in a vault.’

Again, we have to cover the basics. If we want people to engage with responsible investment, first we have to help them engage with investment. Where does my money go when it leaves my pay packet? Who benefits? What happens as a result of my money being invested? How does it find its way back to me? (from the vault obviously)

We can make investment as real for them as the contents of their binsOne of the reasons recycling has taken off is because it feels real and relatable. It happens in our front gardens and we’re in control. How can we make responsible investment just as concrete? By giving lots of vivid examples. That means talking about ‘an oil spill’ instead of ‘the environment’, about ‘how companies are managed’ rather than ‘governance’. And it means telling members about everything their money made possible. Once they understand how their money bought a shopping centre, paid for the manufacture of life-saving drugs, or put broadband into villages in North Wales, they might be ready to talk about responsible investment.

We can piggyback on the cultural conversationIssues like sustainability, labour conditions and executive pay are rising up the agenda. We can use that. Ignition House’s research showed that people’s hearts and minds are moved by scandals involving charity workers in Haiti, or programmes about an albatross unknowingly feeding plastic to its chicks. This makes them more receptive to a message about responsible investment. We don’t have to reference things in a heavy-handed way. Sometimes it’s just about choosing when to speak.

We can stop relying on letters to get our message acrossMost of our letters aren’t opened, let alone read. We have to get information out there in different ways. And we have to repeat it. The more channels we use, the more chance our messages have to reach people. Think about websites and webinars, infographics, animations, videos featuring real

people and places, local events. And think about making your newsletter look more like a magazine and less like a press release from the Kremlin.

Research says that the two professions that most subject the public to jargon are actuaries and car mechanics. Like the grease-encrusted geezer who tells you your camshaft has had it, we forget that the people we’re talking to do not live in our world. Also, there are more of them than there are of us. It makes sense for us to try to speak their language, rather than expecting them to learn ours. Otherwise one day we’ll find ourselves face-to-face with that mechanic explaining how we’re advancing towards a consistent regulatory environment.

We can ask members what they wantDon’t guess at what members want from you, ask them. Do they want to know where their money’s invested? Do they want stats about executive pay? Use that information and build on it. Get some members in a room and talk to them.

But we should stop short of full democracyAsking members about what information they want and how they want to be communicated with is one thing. Asking them to validate your investment strategy is another. You don’t ask them for their view on long-term gilt yields, so why ask them to OK your climate tilt?

Remember: they’re what this is all aboutThey’re the hero of the stories we’re telling. It’s their money. People have a right to know what happens to it. Once they do, they may start expecting to have a stronger say in how it’s invested.

The more we talk directly to people, the more the ideas come alive, as they picture themselves investing in a company, making money, missing opportunities. That means talking less about ‘investors’, ‘members’ or ‘people’ in general, and more about ‘you’. It means talking about how this approach benefits them. The pensions industry tends to talk about the process of investment, rather than the point. But for a member, it’s all about what they get at the end. We should talk about responsible investment in terms of providing a better life in retirement. If your savings can also do some good along the way, that’s even better news.

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Chapter 6

How investment managers approach ESG

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Aberdeen Standard InvestmentsEmbedded ESGAt Aberdeen Standard Investments, we take our stewardship and environmental, social and governance (ESG) roles seriously. As we are active long-term responsible investors, stewardship and ESG are fundamental components of our investment philosophy and process.

Stewardship is about understanding everything there is to know about an asset, especially its risks and opportunities. We do this before making any investment, endeavouring to build only the highest-quality portfolios for our clients.

In addition to the review and integration of material ESG factors, we also offer clients bespoke ESG solutions to meet their investment needs. This process is led by our stewardship and ESG specialists for a fully integrated approach.

Putting our clients firstOur approach centres on seeking to protect and enhance the value of the portfolios we manage on behalf of our clients. We do this by fully understanding how the companies we invest in consider ESG issues and encouraging them to put in place robust, transparent management processes and governance arrangements. We challenge our investee companies to meet internationally recognised standards or industry best practice standards, whichever are higher.

A dedicated ESG teamOur dedicated ESG team provides our investment teams with expert knowledge and insights on the material ESG issues for our clients. They also undertake in-depth research, analysis and engagement on any ESG issues relevant to our portfolios.

The UN Global CompactIn evaluating corporate behaviour from an environmental and social standpoint, we use a series of bespoke guidelines based on the four

pillars of the UN Global Compact: human rights and community relations, business ethics, employee relations and environmental responsibility.

Truly active engagementActively engaging with the companies in which we may have a financial interest enables us to learn more about a company’s sustainability strategy and performance

We also seek to encourage best practice standards through this dialogue, as well as by exercising voting rights at company AGMs/ EGMs.

ESG – what we look for in companies• ESG criteria companies which pay close attention

to issues of corporate governance and holistic risk management; ensure compliance with all regulations and laws; and promote good conduct at all times. We expect companies to have robust anti-bribery and corruption policies and practices in place.

• Corporate culture we look for ambitious companies that do the ‘right thing’ for their employees, customers and shareholders. We expect to see the fostering of solid teamwork throughout the organisation.

• People and diversity we pay particular attention to diversity and inclusion within the working environment, a considered approach to training and development and a fair and transparent remuneration policy.

• Looking after their customers we believe that companies who put customers first are most likely to deliver better longer-term results. This means creating quality products and services, being transparent, having sound business practices, and looking after their customers’ personal information securely.

• Delivering for shareholders we expect the companies in which we invest to create value not only for shareholders but for all stakeholders: customers, employees and suppliers.

Important information

Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments.The information contained in this document is of a general nature on the activities carried out by the entities listed below. This information is therefore only indicative and does not constitute any form of contractual agreement, nor is it to be considered as an o er or solicitation to deal in any nancial instruments or engage in any investment service or activity. No warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result ofthe reader, any person or group of persons acting on any information, opinion or estimate contained in this document. This material is not meant to be legal or tax advice for any particular investor, which can only be provided by quali ed tax and legal counsel. This material is not to be reproduced in whole or in part without the prior written consent of Aberdeen Standard InvestmentsThe opinions expressed are those of Aberdeen Standard Investments and are subject to change at any time due to changes in market or economic conditions.

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AXA Investment ManagersTell us about your firmAXA Investment Managers (AXA IM) is an active, long-term, global, multi-asset investor. We work with clients today to provide the solutions they need to help build a better tomorrow for their investments, while creating a positive change for the world in which we all live. With approximately £645 billion in assets under management as at end of September 2017, AXA IM employs over 2,450 employees around the world and operates out of 29 offices across 21 countries. AXA IM is part of the AXA Group, a world leader in financial protection and wealth management.

Please summarise your approach to responsible investmentAt AXA IM responsible investing (RI) is an ethos not just an investment approach. We were an early mover in the asset management space, identifying the important role that finance plays in fostering a society that supports fairness and equity, as well as an environment that can sustain us in the future. These beliefs are core to our identity as a company and we have invested time, resources and assets over many years in a bid to serve that purpose.

We incorporate our RI approach across all of our investment platforms, enabling pension schemes to express their environmental, social and governance (ESG) beliefs across all asset classes. From our judgmental Framlington Equities expertise to our fixed income, real assets, multi-asset and alternatives platforms, we have taken steps to embed ESG analysis throughout our business. In 2017, we were particularly proud to announce that we had integrated ESG factors across our entire quantitative Rosenberg Equities platform, with clients benefiting from the additional scrutiny this brings to our stock selection.

What differentiates your approach to responsible investment?AXA IM has demonstrated a long standing commitment to responsible investing, winning our first RI mandate back in 1998. Since this time we have continually evolved our approach to anticipate client demand and stay ahead of industry regulation. We offer clients a comprehensive range of RI investment options, from simple screening through to ESG integration and, more recently, impact investing focusing on specific issues.

We have developed a set of ESG key performance indicators covering metrics such as carbon footprint, water intensity and the percentage of

women on company boards, to help clients monitor the impact of their investments.

What’s the number one misconception pension schemes have about responsible investment?The misconception that ESG factors, at best, only serve to identify potential sources of risk in a pension scheme’s portfolio. Investors are increasingly recognising the positive benefit ESG considerations can have in delivering financial returns to pension schemes; to invest sustainably for the long term it is just as important to look at the ESG-related opportunities. Structural trends, generational shifts and the strong growth of the ‘Green Economy’ are all developments that we believe, when harnessed effectively today, have the power to help deliver long-term value for clients and create a positive impact on society. This has underpinned our work in developing investment solutions that incorporate ESG considerations across all asset classes.

Can you give us an example of how you have behaved like a responsible investor in practice?Innovative RI fund launches AXA IM’s two dedicated ‘AXA Impact Funds’, our green ‘Planet Bond’ fund, our ‘Human Capital’ fund and the women’s representation ‘MixIn Perspectives’ fund demonstrate the emphasis we place on making RI solutions available to our clients.An active, engaged shareholder We have a track record of using our significant shareholder status to influence positive corporate behaviour. We were delighted to be named in the Top 10 of the inaugural ShareAction ranking of European Asset Managers in March 2017. The study investigated the extent to which asset managers are behaving as responsible investors, addressing ESG issues to better manage risk of behalf of clients.

In June 2017 we instigated a policy of disinvesting from companies that derive more than 50% of their revenues from coal related industries, selling around €165m of assets in our fixed income portfolios and €12m of assets in our equity portfolios. This industry-leading stance recognised the Intergovernmental Panel on Climate Change (IPCC)’s finding that a greater than 2˚C rise in temperatures could lead to significant risks to society as a result of global warming. Our other exclusion policies include controversial weapons, non-sustainably sourced Palm oil and derivatives on food commodities.

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Baillie GiffordTell us about your firm.Baillie Gifford is an independent investment management partnership and has been since 1908. We manage around £180bn for a range of clients around the world. Whether our client is a private investor, DC scheme or public pension plan we have one, simple aim: to add value for our client after fees.

We are wholly owned by 43 partners who all work for the firm. Our structure as an unlimited liability partnership is rare among large investment businesses. It means that, as stewards of Baillie Gifford’s long-term vision, our partners are free to manage the business without the distraction of the short-term demands that external shareholders often bring to the management of investment firms. We are proud of our history but we are always looking forwards: we think the current partners are custodians of the firm for future generations.

Please summarise your approach to responsible investment.We are growth investors and have a stock driven approach, aiming to hold businesses for at least five years on average. We are optimistic, believing a focus on the upside potential for companies is a far more fruitful approach to equity investing than excessive focus on downside.

A research-led approach underpins our philosophy. Our ability to deliver superior returns depends on the quality of our research: we are looking for investments that will provide long term, sustainable growth. This means that we naturally integrate factors into our research that are material to companies’ long-term ability to deliver sustainable growth whether those be environmental, social or governance factors.

We view ourselves as owners of businesses and take our stewardship responsibilities seriously. We actively engage with the companies in which we invest, not only to challenge them on aspects we would like to change but also to support them in achieving their long-term strategic goals. We believe we do our clients a great service by helping companies deploy their capital in returns generating projects, encouraging management to implement well, exercise patience, and act in the long-term.

What differentiates your approach to responsible investment? Our main difference is our time horizon. At Baillie Gifford, we are truly long term investors: we

typically hold companies for five years to ten years but often longer. We must seriously consider what makes certain companies endure.

In terms of responsible investing, we believe it is impossible to take a short-term mind-set when considering many of the challenges that the world is facing. Whether it is climate change, persistent poverty, or income inequality, these are challenges that we need to think about tackling over decades not quarters.

Purpose Complements ProfitsBuilding on our well-established approach to ESG research, in 2017 Baillie Gifford launched an impact investment strategy called Positive Change. This strategy has dual objectives of generating an attractive return whilst contributing towards a more sustainable world. It may appeal to clients, including pension investors, who need to generate a financial return but also care about contributing to the world that they and future generations live in.

We are growth investors and have a stock driven approach, aiming to hold businesses for at least five years on average. We are optimistic, believing a focus on the upside potential for companies is a far more fruitful approach to equity investing than excessive focus on downside.

We believe it is impossible to take a short-term mind-set when considering many of the challenges that the world is facing

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Columbia Threadneedle InvestmentsOur BeliefWe believe that well-governed companies are likely to outperform in the long run and consider a holistic understanding of risks and opportunities associated with certain companies, sectors or themes, as part of generating sustainable returns for our clients. Because of this core belief, our dedicated Responsible Investment (RI) team has worked alongside our investment professionals since 1998, facilitating integration of material environmental, social and governance (ESG) analysis into the investment process.

An integrated approach to ESGWe integrate ESG into our investment process primarily as part of idea generation, research and debate. We support idea generation through conducting and joining company meetings, internal investment meetings, and thematic reviews for macro level ideas. In terms of research and debate, ESG analysis is included as part of all stock review templates, thematic and sector research, and the frequent interaction between the Responsible investment team and regional teams through combined research and engagement meetings. Our approach is underpinned by externally sourced data, research and ratings to help inform our in-house analysis, and draws on the broker community, financial analysis, news and intelligence from the organisations we work with.

Beyond ESG stock reviews, the scope of the research includes preferred holdings, controversial issues and company-initiated dialogue and associated analysis. The focus is on ESG factors that we believe can have a material impact on the company through issues such as regulation, physical threats, brand and reputation and operational costs. We follow a best-in-class approach and assess companies on a relative basis against peers. We also consider charters such as the UN Global Compact and OECD guidelines for multinational enterprises as part of our research. This analysis feeds into various key stages of our investment process, as part of the holistic consideration of investment opportunities and risks.

Engagement – a differentiated approachEngagement and dialogue with companies is an essential part of our stewardship as responsible shareholders. The engagement is informed by the ESG research we conduct, periodic monitoring of portfolios and preferred holdings highlighting risk

flags, and dialogue around agenda items related to company general meetings, as well as company initiated engagements through consultations and road shows. The types of engagement range from longer-term educational issues such as better disclosure, influencing incentive schemes to ensure alignment with shareholders, and ensuring the company has adequate management of issues including community relations, human rights, corruption and bribery, and environmental protection.

We vote on all our funds and those of clients who delegate the authority to us, in all countries/markets. Although we normally hope to support company management, our approach is primarily driven by our focus on promoting and protecting our clients’ long-term interests. In circumstances where companies evidence poor practice and do not provide sufficient explanation and justification on issues of concern, or where we disagree with the rationale and appropriateness of the approach taken, we will not hesitate to withhold support and oppose management.

Inherent in our approach is the ability to provide appropriate screening for clients on segregated mandates, whether thematic, best-in-class or negative. We operate a firm-wide non-investment policy for controversial weapons and are committed to the external debate around responsible investment issues through our involvement in industry forums and debates.

Recognition & AwardsOur approach has been recognised with numerous awards. In the PRI 2017 assessment, we attained an ‘A+’ for the second year running for our overall approach, as well as an ‘A+’ for our approach to incorporation, active ownership, engagement and proxy voting, for the second consecutive year. In 2015, the Threadneedle UK Social Bond Fund won Consumer Ethical Investment Fund of the Year at the Better Society Awards. In October 2015, it became one of only four funds to receive a five-star rating from 3D investing, reflecting its best-in-class status in financial and social performance. We also won Real Estate Manager of the Year at the Global Investor ISF Investment Excellence Awards in 2015 for the Threadneedle Low Carbon Workplace Fund. In 2014, we were awarded the UK Pensions ESG/SRI Manager of the Year, and SRI Manager of the Year at the Global Investor Awards.

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First State InvestmentsFirst State Investments are a global asset management business with expertise across a range of asset classes . We are stewards of over £127.5 billion* in assets managed on behalf of institutional investors, pension funds, wholesale distributors, investment platforms, financial advisers and their clients worldwide. We are committed to providing the best possible outcomes over the long term for our investors.

Our commitment to responsible investment (RI) and stewardship is a common thread which runs through our diverse investment teams, guides the broader management of our business and is integral to our culture. Collectively we continually strive to improve our understanding of Environmental, Social and Governance (ESG) factors as sources of long term risk and return.

Our approach to RI is based upon three strategic pillars; Investment Quality, Stewardship and Employee Engagement. The strategy is underpinned by a strong governance framework and is supported by our specialist RI team. • The RI team engages with the business to deliver

the strategy, which is overseen by the Responsible investment Steering Group. The steering group is chaired by the CEO and is comprised of executive committee members whose role is to monitor, direct and champion RI and stewardship practices across the organisation.

• Each of our investment teams has a lead RI representative who coordinates information flows across and within their respective teams, contributing to thought leadership and assessing new approaches for addressing current and emerging ESG-related risks and opportunities.

• Working groups have been formed from across the business to support the strategy including our Human Resources and Employee Engagement Group, Business and Client Support Group and the Marketing and Communications Group.

• In addition to dedicated forums, RI principles have also been integrated with other business governance functions including: ESG reporting to the Global Investment Committee, inclusion in Risk Management profiles and assurance through our internal audit function.

UK Stewardship CodeThe Financial Reporting Council (FRC) announced in 2016 that it would rank asset managers on the quality of their disclosures and activities.

We achieved the highest tiering – Tier 1 – awarded by the FRC.

Investor Group on Climate Change (IGCC) – Disclosure Working GroupLast year we reported on our involvement with the Investor Group on Climate Changes (IGCC’s) Disclosure Working Group. Through the IGCC we established and chaired the group following concerns we had about the direction of climate change disclosure by investors, and in particular the dominance of carbon foot printing as the primary form of disclosure.

Following a period of consultation the guidance that the group developed was launched on 12 April, 2017. The guide supports the Michael Bloomberg led Task Force for Climate-Related Financial

Disclosures (TCFD) recommendations by providing practical approaches for implementing the principles.

This year we have sought to align the disclosure in our online report with the IGCC guidance and TCFD recommendations.

Re-thinking Performance Measuring investment performance has long been dominated by percentage returns, mostly versus a benchmark. Within this implied zero-sum game, investors can only control what share of the pie they received, not its size or the broader economic, environmental and social outcomes achieved. The way investment performance is measured needs to evolve if it is to reflect the fact that the allocation of capital and use of ownership rights have both real world and real investment impacts.

For long-term investors, understanding how effectively capital is being deployed for productive and sustainable purposes, and the ability to influence better outcomes through engagement and advocacy are critical for achieving a holistic view of investment performance.

Over the last 10 years we have recognised the challenges of rethinking performance measurement and have been evolving our reporting accordingly. In addition to long-term returns, we report on long–term holding retention, turnover, proxy voting, inherent levels of ESG risks and the processes underlying the way they are managed. Our integrated approach to reporting uses quantitative measures, narrative and case studies to provide a more complete picture of our investment beliefs, approach, process and performance.

While we still have much we can improve on, our focus has been to broaden the discussion of performance so that it becomes long-term, socially connected, active and sustainable.

* Assets under management indicated above includes Realindex Investments which is a wholly owned investment management subsidiary of the Colonial First State group of companies. Source: Commonwealth Bank of Australia Financials as at 31 December 2017.

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Franklin TempletonAbout Franklin TempletonFounded in 1947, Franklin Templeton Investments is a US-listed provider of global investment management services to retail, institutional and sovereign wealth clients in over 170 countries. The firm has expertise across all asset classes—including equity, fixed income, multi-asset solutions and alternatives. More than 650 investment professionals are supported by an integrated, worldwide team of risk management professionals and a global trading desk network.

Today we manage £558.2 billion*, of which £134.2 billion* is on behalf of pension funds, insurance companies, endowments, sovereign wealth funds and other institutional investors. Our strong financial position gives us the flexibility to allocate resources to innovation, respond to regulatory changes, and meet operational and reporting requirements.

With over 20 years of experience serving the unique needs of defined contribution plans in the USA, we’ve developed a perspective that helps us to stay at the forefront of workplace investing and retirement trends. Today we manage £26 billion** for DC pension schemes and have DC expertise and investment capabilities in the UK, USA, Canada and Australia.

Our approach to ESGWe make a clear distinction that ESG is different from ethical investing or values-based investing. We do not think it should require a trade-off in terms of performance but instead we see it as a component of risk-based investing. This translates to evaluating potential ESG risks and drivers of return, and assessing whether they are priced-in to securities. Our firm-level approach is to incorporate ESG considerations in a systematic way across all investment groups. A central ESG team coordinates and provides guidance, insights and best practice to the investment groups. Governance factors such as board structure or accounting standards are well understood to impact long-term value. However, issues such as climate-related risks, resource scarcity, demographic shifts or labour standards are less recognised in terms of how they link to intrinsic value, and are becoming increasingly important to understand. Whilst such issues are labelled as environmental and social, we view them as fundamentally economic issues which make them relevant from a risk and return perspective. We are acutely aware that ESG considerations can impact the valuations

of securities and, as such, our research has incorporated analysis of these factors for some time.

What differentiates our approach to responsible investment?Aside from our focus on the impact of ESG factors on economic value, what differentiates our approach is how we apply ESG evaluations across the multiple investment groups within the firm. ESG evaluations are integrated into two of the firm’s key strengths: its research and its risk management processes.

Research ProcessThe manner with which ESG evaluations are applied is tailored by each investment group, reflecting their own unique research approaches. In some cases, proprietary frameworks have been built that use best-in-class ESG data sets combined with our own research to inform investment decision making. For example, Templeton Global Macro Group has developed a proprietary ESG country index to codify and formalise ESG evaluations. As a further example, Templeton Global Equity Group has developed a proprietary climate risk assessment framework that identifies winners and losers amongst companies in the transition to a low-carbon economy.

Risk Management ProcessWe want to ensure the risks we take are understood, are intended, and have the potential to be rewarded. As such we have developed a best-in-class risk management platform of over 100 risk and performance professionals. Within this platform, ESG metrics have been incorporated into the equity risk model to allow them to be viewed through a risk lens in a systematic, structured and disciplined manner.

As the quality and availability of ESG data and tools continues to develop, we believe there are benefits for asset managers who understand the data and how it can be used to further inform their investment evaluation. ESG data can provide a new perspective to uncover hidden risks that lie beneath the surface of balance sheets and financial ratios. Time invested on evolving investment research practices to incorporate ESG will, we believe, be a distinguishing feature of successful firms.

*As at 31 December 2017.**As at 31 August 2017.

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InvescoOur commitment Alongside seeking to provide strong, long-term investment performance to our clients, Invesco is committed to investing responsibly and ensuring a sustainable environment for future generations.

Invesco has implemented ESG strategies for over 30 years and actively promotes and advocates responsible investing. In the UK, Invesco is a Tier 1 signatory of the Financial Reporting Council’s Stewardship Code and an active member of the UK Sustainable Investment and Finance Association, while globally we achieved ‘A+’ ratings in 2017 from United Nations sponsored Principles of Responsible Investment (PRI) in two categories – Strategy and Governance. Last year, Invesco’s ESG AUM grew 12% to US$57bn.

Our approachOur ESG approach is rooted in our investment strategies, proxy voting, active ownership, engagement and other oversight practices to ensure we meet the highest levels of fiduciary and corporate responsibility. We view integrating ESG as an additional layer of due diligence that reinforces our high conviction and long-term approach to investing.

Our dedicated team of responsible investment professionals equip our investment teams with a best-in-class support platform to aid their investment decisions. As stewards of good governance, our investment teams engage with portfolio companies, challenge boards, and drive for change where appropriate. A key foundation of Invesco’s ESG efforts is our proprietary voting platform which enables fund managers to vote in an efficient manner, increase transparency, share knowledge and effectively influence corporate practices.

ESG integrative strategies are available across 10 Invesco investment centres and 19 teams including equities, fixed income, multi-asset, alternatives, real estate, ETFs and bespoke solutions. We outline some examples here:

Invesco Quantitative Strategies manages US$2.7bn in equity ESG AUM and offers several ways to integrate ESG factors within the investment process. Using a multi factor approach, the criteria for selecting securities can be easily applied to tailored universes to meet specific client requirements, such as sustainable investment restrictions. The team engages with companies to identify weaknesses in sustainability management

and discusses these with management to enable the companies achieve a better ESG performance.

Invesco Fixed Income manages US$6bn in ESG assets, achieving an ‘A’ in PRI’s Fixed Income category in 2017. Evaluating issuers based on ESG criteria is integrated into our fundamental research process. Potential investments are screened across several attributes, including exclusionary screening (designated names, industries, sectors) or ratings-based screening (avoiding issuers below a threshold ESG score). The team actively manage, report on progress and engage, ensuring each mandate develops with the investment environment and ESG opportunities.

The Invesco Perpetual Multi Asset team have identified relevant ESG factors based on consideration of global frameworks and external ESG research providers, alongside Invesco’s own ESG specialist team input. ESG factors are naturally amongst those incorporated in a number of stages of the investment process, including research into individual ideas, the formulation of their central economic thesis and within scenario analysis.

Invesco Real Estate manages US$30.8bn in ESG AUM and our global leadership in ESG practices is reflected in a #1 ranking with Global Real Estate Sustainability Benchmark (2017). Sustainability due diligence is undertaken on all asset purchases in the acquisition process. During ownership, the team takes a managed approach to procurement of energy, management of water, waste and recycling, renewable energy, tenant and community engagement and, most recently, health and well-being. IRE has a GRESB Green Star rating and ranks #1 in GRESB’s U.S. Diversified peer group and #1 out of 80 Residential participants globally, earning Global Sector Leader status.

Investment risks The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. Property and land can be difficult to sell, so investors may not be able to sell such investments when they want to. The value of property is generally a matter of an independent valuer’s opinion and may not be realised.

Important information This document is for Professional Clients only and is not for consumer use. All information as at 30th September 2017, sourced from Invesco unless otherwise stated. Past performance is not a guide to future returns. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. Issued by Invesco Asset Management Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority.

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J.P. Morgan Asset ManagementOur Commitment to Sustainable InvestingJ.P. Morgan Asset Management (JPMAM) understands that putting our clients’ interests first means recognizing and managing investment risks and opportunities associated with Environmental, Social, and Governance factors. We have a deep understanding of investing across multiple dimensions with a goal of producing risk-adjusted returns that align with our clients’ objectives. We have been a signatory to the Principles for Responsible investment initiative since 2007 and are committed to incorporating ESG factors into our investment practices, where material.

To drive our commitment, our Sustainable Investment Leadership Team (SILT) is implementing a coordinated strategy for sustainable investing. This team includes senior leaders from all regions with a deep and diverse set of expertise across asset classes and client channels.

SILT’s mandate includes:• Promoting internal best practices, including

identification and assessment of ESG issues • Deepening and broadening current investment

capabilities, including portfolio analytics, measurement and reporting

• Sharing our views and helping clients better understand our capabilities

Our Capabilities are aligned with Client ObjectivesSustainable investing represents a broad set of opportunities and clients may choose to implement their views based on explicit portfolio objectives. With that in mind, we offer an array of investment solutions to meet our clients’ financial goals and non-financial objectives. Many of our core investment capabilities incorporate ESG factors into their analysis with the primary goal of delivering exceptional investment returns.

We developed a framework to define our capabilities across four ESG categories: ESG Integration, Best in Class, Values/Norms-Based Screen and Theme-Based/Impact Investing. Overall, we offer approximately 100 strategies totaling $250bn in assets across these four categories.*

ESG IntegrationSystematic and explicit consideration of ESG factors in the investment decision-making process, such as: Equities: U.S., Global, EM, Global Real Estate, Infrastructure

Best in ClassInvestment in companies based on positive ESG performance relative to industry peers, such as: Equities: U.S., European

Values/Norms-Based ScreenAvoiding certain companies or industries that do not align with investor values or meet other norms or standards, such as: Faith-based investing, Tobacco/firearms screens

Theme-Based/Impact InvestingInvestments based on specific environmental or social themes or assets related to sustainability, such as: Municipals, Aging population, Carbon reduction

Our Approach to Building Sustainable Investments We take an integrated, research-driven approach to sustainable investing, as illustrated in the exhibit above. The precise implementation method is tailored to each investment capability.

Proprietary research and risk management tools are supplemented by third party data to deepen our ESG insight.• Research analysts have deep industry expertise

and knowledge of the ESG factors impacting the cash flows of companies they cover.

• Corporate governance specialists partner with research analysts and drive engagement with an emphasis on corporate governance and, where material and relevant, environmental and social factors.Portfolio Managers draw on these professionals’

expertise, as well as third-party data, to address ESG issues in a manner consistent with their investment strategy. Investment Directors work closely with Chief Investment Officers (CIOs), Portfolio Managers and Risk Management to monitor portfolios and discuss various risk outliers, including those related to ESG.

Portfolio managers draw on this expertise to address ESG issues in a manner consistent with their investment strategy. To uphold the integrity of our sustainable investing capabilities, we follow a three step approach: Commit, Implement and Demonstrate. SILT liaises with Strategic Product Management and ultimately the Asset Management Operating Committee, which is responsible for JPMAM’s overarching strategy and priorities.

* Assets under management indicated above includes Realindex Investments which is a wholly owned investment management subsidiary of the Colonial First State group of companies. Source: Commonwealth Bank of Australia Financials as at 31 December 2017.

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Jupiter Asset Management LimitedBackground to JupiterJupiter was founded in 1985 with the aim of delivering strong performance for investors over the medium to long term through active fund management. We launched one of the UK’s first green unit trusts in 1988 (the Jupiter Ecology Fund) and introduced a dedicated Governance Research Team. Since then we have been at the forefront of responsible investing and the underlying environmental, social and governance (ESG) issues. This helps us to add value for investors across all investments. Our primary responsibility is to our institutional clients who entrust their pensions to our management.

Our approach to responsible investment.Our responsible investment approach is focused on improving investment outcomes. We believe that our responsible investment research can improve investment returns by carefully assessing companies’ abilities to manage ESG issues, and how this may affect financial results. We do not view environmental and social (E and S) factors in isolation but concentrate on demonstrating how these factors impact medium- and long-term investment performance and identify which, in our view, are relevant and material to investment decisions. We integrate this analysis into the variety of investment approaches employed across Jupiter.

We also monitor corporate governance (G) across all our holdings. At Jupiter we act in the best interests of all our stakeholders by engaging with the companies. We believe that by engaging with companies we work in the best interests of clients and exercise our voting rights with care. Our clients are the ultimate owners of the companies in which we invest, and we have a duty to act as informed stewards. Corporate governance can play a role in developing our understanding of companies, making informed decisions and representing our clients’ interests.

What differentiates our approach to responsible investment Our approach has developed over several decades as we have sought to continuously improve our procedures. Based on our experience, we have developed core responsible investment pillars:• Integration: the dedicated ESG specialists and the

investment teams at Jupiter conduct sustainability research in collaboration.

• Financial materiality: ESG specialists focus on

analysing financially material environmental and social factors when researching companies, in support of the investment teams who they work alongside. The ESG specialists have extensive knowledge of environmental and social issues.

• Focus: within active management ESG research on a focused set of financially material ESG issues, across concentrated holdings will improve investment outcomes over time.

• Internal research: the benefit of integration is our research and all our engagement with management is conducted in-house, this ensures it is aligned with and relevant to the investment processes of different teams. We also feed in external sources of information including broker research and information from external ESG research providers.

• Formal oversight: Jupiter has a formal Stewardship Committee. This Committee was established to ensure we deliver a co-ordinated approach to our engagement with companies. The Chief Investment Officer chairs the Committee, which comprises fund managers, the Head of Governance Research, corporate governance and sustainability analysts and representatives from across the business. The Committee looks at trends in our engagement with companies, the issues that are arising and how we can enhance our processes and information gathering. The Chief Investment Officer also chairs our Sustainability Review Committee, which comprises portfolio managers and sustainability and governance specialists. The Committee reviews and prioritises our engagement with companies on specific social and environmental issues and monitors these risks and opportunities across our strategies.

As an example of our approach, the Jupiter Global Sustainable Equities Fund launched in April 2018. This fund fully integrates ESG factors into research prior to any investment decisions. A set of ESG criteria are assessed as part of the evaluation process, with a focus on those most financially material. Post investment, the team seek to engage with and vote on all of their holdings, working closely with Jupiter’s dedicated Governance Research Team. The recent launch combined with our long-term experience of responsible investment management differentiates the institutional capabilities of Jupiter from our peers.

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Lazard Asset ManagementWho we areLazard Asset Management has been managing portfolios and providing investment advice to investors around the world for decades. We operate from 18 cities across 13 countries with a global staff of over 750. Our more than 300 investment personnel manage £164.4 billion across a wide range of global, regional and country-specific strategies—both traditional and alternative—in listed equity and fixed income.

On-the-ground, fundamental research is the foundation of our investment approach. Our investment professionals collaborate on detailed fundamental analysis integrating knowledge across regions, sectors and asset classes to arrive at unique insights. We embed risk management in our portfolio construction, while ESG analysis is integral to our research and decision-making processes.

Our approach to responsible investmentWe recognise that ESG considerations—including a company’s board structure, environmental practices and labour policies, among other factors—can affect a company’s valuation and financial performance. As such, ESG analysis is a critical component of our investment process.

Lazard’s investment professionals thoroughly research and vet companies in their investment universe. We are particularly sensitive to any issues in a business that may impact financial performance. Our analysts are responsible for identifying ESG risks and opportunities as well as sharing their analysis across our investment platform.

Differentiators of our approachLazard’s investment professionals are responsible for incorporating all factors believed to have a financial impact, including, but not limited to, those of an ESG nature, into the investment process. For example, our analysts take ESG into consideration when building an investment thesis rather than outsourcing to a separate ESG team.

Global ESG Research and Analysis• Lazard’s proprietary ESG watch lists, maintained

by the Global Risk Management team, are used by both our equity and fixed income investment professionals to help flag potential ESG issues in the companies or corporate bond issuers in their investment universe.

• We recognise that environmental factors may affect a company’s valuation and financial

performance. As part of this, we developed a proprietary portfolio carbon footprint tool so that the potential impact of environmental factors is integrated into our investment analysis and decisionmaking process.

• Based on the correlation between a country’s bond performance and the strength of its institutions and governance, Lazard’s Emerging Market Debt team developed a scoring methodology to estimate the projected ESG premium by credit type.

Company EngagementOur investment professionals participate in meetings with company management and boards of directors to better understand a company’s business strategy, use of shareholder capital and ESG practices. During these meetings, we may engage with company management on a variety of topics, including ESG issues that may present a potential material risk to a company’s financial performance.• In 2017, our investment professionals

participated in approximately 4,300 meetings with company management and boards of directors. In 22% of those meetings, an ESG issue was discussed with management/the board.

• In many of those meetings, the discussion was elevated to a point where we made recommendations to the management/board because we believed that their ESG practices could have a material impact on the company’s financial performance.

• In instances where our concerns are not adequately addressed, we may escalate them by writing a formal letter or requesting a meeting with the board of directors, or by voting against management at annual general meetings. Ultimately, we may decide to disinvest from the company in question where we believe it is in our clients’ best interest to do so.

Proxy VotingWe believe that as a fiduciary, we must vote proxies based on what we believe will maximise long-term shareholder value. As such, our proxy voting decisions are considered independent of management recommendations.

In 2017, Lazard voted against management on one or more recommendations at 36% of company meetings globally, and voted against 7% of proposals recommended by management. We also supported 63% of shareholder proposals on climate change and greenhouse gas emissions.

Important information

All data contained herein are sourced by Lazard Asset Management or affiliates unless otherwise noted. This is a financial promotion and is not intended to constitute investment advice.The information provided herein should not be considered a recommendation or solicitation to purchase, retain or sell any particular security. It should also not be assumed that any investment in these securities was or will be profitable.Issued and approved in the United Kingdom by Lazard Asset Management Limited, 50 Stratton Street, London W1J 8LL. Incorporated in England and Wales, registered number 525667. Lazard Asset Management Limited is authorised and regulated by the Financial Conduct Authority.References to Director and other titles are Lazard internal titles and may not imply any legal status or responsibility.The contents of this document are confidential and should not be disclosed other than to the persons for whom it is intended.

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Sustainable Investing at MFSMFS Investment Management®MFS® has nearly a century of active management experience, and our results and investment expertise reflect an unwavering commitment to finding the best, most durable investment opportunities for our clients in the years ahead. We offer investors a range of equity and fixed income strategies built on the strength of our global investment research platform. MFS manages £363billion on behalf of our global clients as at 31 December 2017.

MFS’ approach to sustainable investingAt MFS we employ an investment approach that focuses on identifying companies with sustainable, long-term competitive advantages. We believe an essential part of this approach is the integration of environmental, social and corporate governance (ESG) factors into our fundamental research and portfolio construction, as these issues often impact the sustainable value of businesses. MFS’ individual fundamental research analysts and portfolio managers consider all factors that could materially impact the outcome of the investment process, including ESG. Two ESG-dedicated investment professionals support the broader investment team to ensure we are effectively assessing the materiality of ESG-related risks and opportunities. We employ an ESG integration strategy with analytic and systematic elements that enables a clearer understanding of potential impacts to our investment decisions.

ESG in action: Water stress in ChinaSituation analysisMFS emerging markets team developed concerns about a beverage company, which has 80% of its facilities located in areas of water stress and

exhibited concerning governance characteristics.This created uncertainty about the sustainability

of its operations. In light of water-related protests observed elsewhere in China and other EM countries, the team were concerned that disputes with local communities could threaten the company’s ability to operate in some areas.

MFS questioned whether they would be able to maintain an adequate supply of high-quality water for all of their facilities. As a result, we viewed water stress as a material risk for this company and we applied the highest cost of equity (among this group) in determining our internal price target.

Process OutcomeMFS engaged with the company to understand its water management programmes and strategies, questioning their financial and social impacts. MFS asked how the company manages community concerns in areas that are impacted by severe water stress.

We sought to understand the kinds of direct capital investments the company has made to ensure a sufficient supply of high-quality water for its operations.

The company’s responses were solely focused on outlining the local government approvals they had received in relation to town water rights. Their lack of emphasis on community engagement regarding water scarcity issues suggested they had not fully evaluated the social risks to their operations.

Outcome1. MFS maintained its valuation discount on the stock.2. We will continue to engage with the company and emphasise our concerns regarding their management of water issues within the communities in which they operate.

FOR INSTITUTIONAL AND INVESTMENT PROFESSIONAL USE ONLY

Issued in the United Kingdom by MFS International (U.K.) Limited (“MIL UK”), a private limited company registered in England and Wales with the company number 03062718, and authorised and regulated in the conduct of investment business by the UK Financial Conduct Authority. MIL UK, an indirect subsidiary of MFS, has its registered of ce at One Carter Lane, London, EC4V 5ER and provides products and investment services to institutional investors globally. This material shall not be circulated or distributed to any person other than to professional investors (as permitted by local regulations) and should not be relied upon or distributed to persons where such reliance or distribution would be contrary to local regulation. Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its af liates and may be registered in certain countries.

ChairAnnabel Tonry, J.P. Morgan Asset ManagementVice ChairVivek Roy, AXA Investment ManagersImmediate Past ChairRob Barrett,AXA Investment ManagersExecutive DirectorLouise Farrand

E: info@dcif.co.ukdcif.co.uk