Like much of the world right now, the defined contribution (DC) pensions landscape is undergoing significant change. A number of factors are driving its transformation but one in particular is growing in momentum – ESG. By that we mean the environmental, social and governance factors that can influence the performance of an investment. Here we explain why ESG is growing in prominence and how incorporating ESG factors can help DC schemes deliver better member outcomes.

The rise of ESG

The DC pensions market has been transformed in the last few years, as it increasingly becomes the primary source of retirement income for individuals. Pension Freedoms radically changed the options available to members at retirement. Meanwhile passive funds have become ubiquitous as a result of cost pressures. Huge consolidation is also occurring, particularly in the master trust space. 

As for the growing prominence of ESG in the DC market, there are two driving forces at play. Firstly, demand for sustainable and responsible investments has exploded in the past few years. Many investors and scheme members are making more sustainable choices in all areas of their lives. So it makes sense that this extends to their finances; more specifically, their pensions. The industry is responding to this by offering more choice, so that people can invest in a way that is sustainable and responsible. 

The second driver of change is that DC schemes face greater policy and regulatory pressures to consider ESG factors in their portfolios. This is a particular focus as the UK government seeks commitment around key sustainability issues. Climate change is a major factor, with the UK committing to being carbon net zero by 2050. It’s also aiming to meet its obligations to international accords such as the Paris Climate agreement and the UN’s Sustainable Development Goals (SDGs). More specifically, from October 2019, UK pension scheme trustees must outline their ESG approach in their Statement of Investment Principles and report annually thereafter.

Asset managers like us have a critical role in helping DC schemes adopt and potentially benefit from an ESG approach.

Embracing ESG in your DC scheme

Changing investor tastes and regulatory pressures are not the only reasons schemes may want to consider ESG risks in their portfolios. Trustees need to also be aware of the material financial impact ESG factors can have on their investments. To dispel a common misconception, ESG investing doesn’t mean compromising on member outcomes.

At Aberdeen Standard Investments (ASI), we have long understood that well-governed companies that look after the ESG aspects of their operations tend to perform better than those that don’t. Consequently, we use ESG criteria to identify potential risks and opportunities that could affect the performance of a company and its valuation. 

Asset managers like us have a critical role in helping DC schemes adopt and potentially benefit from an ESG approach. We can assist trustees in a number of ways.

– Integrate ESG factors in our investment process
– Integrate ESG factors in our strategic asset allocation (SAA)
– Provide ESG solutions in our DC offerings 

Let’s look at each in turn.

Embedding ESG

At ASI, we embed ESG considerations in our investment process and use a number of methods to do this. 

The first is research integration

When our analysts want to fully understand a company, they ensure they consider ESG factors when identifying business risks and opportunities. 

The second tool is engagement

This is where we speak to companies about how they’re managing ESG risks within their business. Why do we do this? Firstly, data in company reports is backward looking. So speaking with company management gives us an opportunity to know where the company is going and its strategies for managing future ESG risks. We can also make recommendations and set milestones with companies to encourage ‘best’ practice, which is encompassed in our ‘active stewardship’ approach.

The third and final tool is portfolio construction

ESG considerations are part of our decision-making process when building and managing portfolios. The way we allocate capital within those portfolios is a result of how we have considered and looked to manage the ESG risks and opportunities of the underlying holdings, among other factors. 

Sustainability in SAA

ESG factors can be incorporated within a scheme’s strategic asset allocation (SAA). Historically, ESG risk management has been bottom-up, so very much focused on company-level ESG ratings. However, there are good reasons to also include ESG factors in long-term, top-down asset allocation.

For one, many ESG risks have systemic implications at asset-class, market and sector levels and fit into wide, global themes. Examples include shifts in corporate-governance quality in a market, exposures to climate transition risks, how demographic changes affect policy, plus many more.

In addition, most ESG risks are structurally long term in nature, so are a natural fit for SAA. We know the transition to a low-carbon society, for instance, requires large-scale change in the structure of economies in the next 30 years. Therefore, both carbon footprint and climate scenario analysis are powerful tools that we can integrate in our SAA process. 

ESG offerings for DC schemes

Previously, one of the hurdles to DC schemes adopting ESG principles was the availability of suitable products but there’s more choice now than ever. 

Trustees and schemes will approach ESG integration in different ways depending on their member views and/or governance constraints. For some schemes, the fact that at ASI we integrate ESG factors in our investment process as standard, and apply this across all funds, will be enough. For those that want to go beyond that, we also have a range of solutions across the sustainable investment spectrum to meet these diverse needs. 

We can offer exposure to specific themes – carbon mitigation, for example. We also have options that target specific ethical, social or environmental goals, as well as impact investing funds that use the UN’s SDGs as a framework. 

More recent additions to our suite of dedicated solutions are our sustainable index strategies. These are a range of equity index funds that aim to track sustainable and responsible investment indices designed by ASI in conjunction with MSCI. 

Final thoughts...

We believe that ESG factors are among the most important drivers of long-term returns, and default DC schemes need to take these into account. At the same time, existing requirements have not changed and investment returns, value, governance and the views of their members also remain in focus. 

Thankfully, trustees have more options than ever to strike the right balance. They can integrate ESG considerations into their schemes in a variety of ways, while aiming to improve member outcomes – ultimately, investing today for a better tomorrow for all.

For all our latest DC insights, visit our DC website and keep an eye out for our regular newsletter to clients.

Alternatively, please contact Fraser Macnair, Client Director, at or on +44 (0) 1313 72 1646

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