Published on: 27 January 2011
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Sarah Smart, Chair of the Trustee at The Pensions Trust contributes to FT SchemeXpert Website on a monthly basis. Below is Sarah's fifth article 'ESG means different things to different asset classes' |
The Pensions Trust chair of trustees Sarah Smart looks at the different approaches to ESG in equity and fixed-income funds.
There are two things I would like to see at the end of my hopefully long involvement with pensions and investing.
One is for fund management fees to come down considerably; the other is for environmental, social and governance (ESG) investing to be completely incorporated in the way that all institutional and retail investors invest.
I think there will be a tipping point for ESG investing in the institutional investment world, and I actually don’t think that that point is too far away.
One barrier to a more wholehearted commitment to ESG investment is the question of whether a board of trustees can fulfil its fiduciary responsibility – which is to act in the best financial interests of the members – while fully implementing an ESG investment strategy.
Theoretically at least, this hurdle has largely been overcome in the realm of equity investment.
There is a growing acceptance that ‘sustainability factors directly affect long-term profitability’. But does this argument hold good in the realm of fixed income investment? I’m not so sure.
First of all, the majority of bonds, particularly corporate bonds, are not long-term investments.
Looking through the factsheet of a fund which bills itself as an ESG corporate bond fund, the average maturity of the bonds held is six years and the average duration is just over three years.
Secondly, improved company profitability does not improve the returns from holding its bonds. Yes, it reduces its chances of default (although profit is not the same as cashflow) and should limit their chances of being downgraded by the credit agencies. But it is very tenuous to suggest ESG activities are likely to be a major factor in the performance of a company’s debt in the hands of its bondholders.
Am I arguing, then, that we should not bother with ESG concerns when making our fixed income investments? No, I am saying that we should be very careful about what we expect to happen when we try and implement ESG investment criteria onto our fixed income portfolios.
For instance, many ESG investors do not advocate negative screening for equity investment, as that gives companies with bad practices little guidance or incentive to improve.
However, negative screening does appear to be a key factor of the ESG bond funds currently on the market. This is probably a natural result of the shorter-term nature of the bond instruments.
One such fund claims: “Through this fund, investors can support companies that contribute to sustainable development and avoid those that potentially harm society.”
Laudable aims, but trustees are here to make money for the members, so the fund also needs to perform as well as a fund that does not do any negative screening – quite a challenge when there is no room to hide behind the screen of ‘improved long-term returns’.
Applying ESG investment criteria effectively is not a simple issue. I would encourage all institutional investors not just to blandly say that they apply ESG criteria, but to think about what this really means for each different asset class and to work with fund managers to ensure we develop strategies that help our members and the world at the same time.
Sarah Smart is chair of the trustee board of The Pensions Trust