Employers choose a DC pension for their staff for different reasons. During the staging of auto-enrolment, the capacity of the provider to manage compliance with regulations was a key criterion for medium sized employers; the capacity to set a scheme up at no cost to the employer drove a million SMEs to Nest.
Today, many of the decisions taken in the staging of auto-enrolment are being questioned. Occupational DC schemes are being asked by Government to assess their value to members, many employers participating in master trusts are concerned they know little about where the money they send from payroll each period- is going.
There are several drivers for this to change.
- Employers want to maximise the value of their spend on workplace pensions
- Trustees need to show they are maximizing value for members.
- Government wants to see pension schemes investing patient capital into the real economy.
- All stakeholders want to make improve the environment, society and governance.
It is quite easy to calculate the cost of running a pension scheme and to measure the outcomes of saving in one scheme over another. But measuring the environmental, social and good governance of a pension pot is not so easy. Infact, it is proving very hard.
The challenge to measure and compare ESG has been a pre-occupation of ratings agencies with organizations such as MSCI and Morningstar now providing ESG ratings. But unfortunately, they do not always provide consistent and authoritative results. A company like Tesla can be both an angel and demon depending on what lens you use to rate it. Making informed choices on subjective ratings is problematic for individuals and employers
Another problem when choosing a pension fund is the unfounded claim of many pension schemes that they will be carbon neutral at any date from 2021 to 2025. These claims are often based on no more than wishful thinking. There is rarely detail on strategies for what meeting these targets will be used and what they will cost.
Reducing an investment’s carbon footprint is not a painless process, it costs money. It requires research, stewardship and it may involve buying and selling assets. This exchange of assets may result in a reduction in the investment return of the fund as will the research and stewardship costs which are born by investors. And this is before the fund managers take their cut for the “value added”. Taken together, these additional costs are known as the greenium.
You would only pay a greenium if you were being rewarded for it and the value for this extra money paid and return sacrificed needs to be justified either in terms of the good done or the extra return attracted. Those entrusted with managing our pensions are not entitled to invest our money unless they consider it economically advantageous to us – “doing good” is not enough.
So how can we tell if a decision to invest in ESG justifies the greenium? In 2016 I decided to split my pension’s investment pot into two, investing one half into a fund which simply tracked a market index. The other half I invested in a fund which explicitly charged me twice as much but promised to invest for better ESG. I have been able to track the progress of each half of my pot. For some time the ESG enhanced fund lagged my tracker but right now the ESG fund is about 2% up. I have earned about three times the extra I paid in fees (my greenium) compared to the market tracker. It’s hard for me to work out whether all this extra value came from ESG but I’d like to think that I’ve had value for my greenium and this simple financial experiment can form the basis of retrospective analysis of the quality of my ESG VFM.
Past performance isn’t the only way to choose a fund for the future. We also need to find a way to discover which of our investments are delivering a positive ESG outcome and which are standing still or worse – delivering fake news. Right now, many pension schemes are enticing us to invest with promises of future carbon neutrality. These promises are easy to make and hard to keep. Now is the time to measure the greenium committed to meeting these promises and to start the much harder task of measuring payback, both in terms of improved ESG and in fund returns.
Thankfully, we have a means of measuring the carbon footprint of a pension fund in financial terms through the disclosure of climate-related risks and opportunities standardised by a globally accepted task force (TCFD). With reliable climate-related financial information, financial markets can price climate-related risks and opportunities correctly and can manage the rocky transition to a low-carbon economy.
We urgently need to use the data available from TCFD disclosures to measure the progress our funds are making and understand whether we can invest both for good and for profit. We will only achieve this by using commonly available information, which is why TCFD is currently our best way of ensuring our greenium is worth it.
But we need to go further than simply measuring the carbon footprint of a scheme’s investment, we need a reliable measure of the impact the scheme is having on society and the good governance of the investments it makes. We are only beginning to get to grips with this. Next Thursday, the FCA and TPR will publish a paper on measures that value the money we spend on pensions, I hope the paper will address this question more fully than can be done here.
If you were a useful adviser you would know that the main outcome that the client is interested in is the % of national average produced Factors such as navigating the BCE charges, obtaining fixed protections so as to manage the LTA optimisation. It might have been maximising inputs by navigating basis periods or encouraging a spouse to pay NI or buying the gap years or making sure there at least ten years of contributions.
Some advisers also look at the wellness of a client, introduce them to regular medical checkups. Telling the client he is obese and that smoking will increase the risk of lung cancer 14 times.
What the views of a normal distribution tell you is that it’s a zero sum game.
Einstein during one of his teaching phases was asked why he gave the students the same questions as the last test. His observation was that the answers had changed.
The solution to the advice gap is that while 6% pay for advice most of them are wasting their money as they are not getting innovation but compliance with rules devoid of innovation and not tailored and failing to produce the desired and targeted outcomes