Why default funds are essential to help combat climate change

Some changes are easier than others

There can be no doubt that the issue of climate change is important to most people. It has influenced millions of us to change our lifestyles with the aim of reducing our environmental impact. We recently commissioned YouGov to ask more than 2,000 adults in the UK what they were doing to combat climate change, and it was apparent that some life changes are easier to adopt than others. Most people (8 in 10) surveyed consider the issue of climate change important, with a similar number now recycling in a bid to reduce their personal impact on the environment.

Just 2%

Over 50% (6 in 10) of the people surveyed have reduced their energy consumption, while 33% (3 in 10) say they are driving less. However, just 2% say they have opted to move their pension savings to a fund that is socially, environmentally, or morally responsible – even though nearly half of those polled say that they want their pension company to invest ethically on their behalf.

A financially material concern

It is estimated that £2.6tn is tied up in UK pensions. Trustees who run pension schemes like ours are bound by a fiduciary duty to act in the best interests of all members when making investment decisions, and there is a firm belief that climate change will, over time, begin to affect the investment outcomes of our members.

Furthermore, we have taken the active decision to remove (or choose) investments in companies based upon the nature of their business activities. Exclusions typically involve controversial weapons, addictive substances, gambling, and activities damaging to the environment, with tilts away from carbon intensive activities or companies with significant carbon reserves.

Pensions have a huge role to play

The 2021 UN Climate Change Conference (or COP26) brought world leaders together to negotiate and agree on commitments aimed at tackling one of the biggest issues of our lifetime. In preparation for this event, the government unveiled new legislation which puts a greater climate focus on the nation’s pensions.

Chancellor Rishi Sunak announced plans to implement Sustainability Disclosure Requirements (SDRs) that will mean the financial services industry, including pension schemes, will have to tell their savers about their sustainability-related risks, opportunities, and impacts.

Also announced were plans to ensure pension trustees measure and report on how their investment portfolios are aligned with the Paris Agreement.

The important work has already begun in addressing climate change

Like the rest of the pension industry, we’re already working hard on this. For instance, we‘ve taken steps to reduce our portfolio’s net emissions by applying carbon reduction requirements to a portion of the assets in a number of our funds. This reduces carbon emissions intensity and potential emissions from fossil fuel reserves by at least 50% for those assets, but there is more to do, and we are exploring ways of making further reductions.

We’re striving to manage climate risk across our whole portfolio because we believe climate change will become a material risk to members’ pension savings. As most of our members are invested in our default fund, we strongly believe that savers should not be expected to move their money to climate-specific funds and that all pension providers should operate in the best interests of savers by ensuring their default funds invest responsibly and work to tackle climate change effectively. We also believe that this will have the greatest impact on assisting the transition to a net zero economy.

Given that this approach increasingly informs investor preferences, it should not necessarily entail sacrificing returns and should be able to augment the improved risk-adjusted returns delivered by ESG integration.

Making it easier for our members to embrace the benefits of ESG

We didn’t find the survey results surprising; we know our members care about the environment and ESG issues more broadly. In line with industry trends, the majority of our 5.4m members remain invested in our default fund, which integrates ESG considerations. This is important because there is considerable evidence that firms with higher ESG scores are better at managing non-financial risks and are more highly rated by the market. In short, ESG integration can generate better risk-adjusted returns for our members.

The key point here is this: we know that many of our members want us to invest their retirement savings responsibly without sacrificing returns, and we don’t think members should have to take it upon themselves to switch funds to make that happen. That’s why we’ve been focusing hard on integrating ESG into our default fund. The growth phase of our default fund has been rated AA for ESG by MSCI, meaning that it is now classed as a leader in managing the non-financial risks these issues represent.