A new survey finds that a much greater share of pension plans are now invested in funds that take environmental, social and governance issues into account, but some managers and asset classes lag behind. 

 

Nearly a fifth (18%) of mainly defined benefit client pension schemes surveyed by XPS Pensions Group are now invested fully in funds the firm has given a ‘green’ ESG rating, up from just 2% a year earlier, a development XPS attributes to asset managers improving their ESG processes rather than pension funds switching funds. 

The consultancy looked at 227 funds across 53 asset managers this year, assigning a green, amber or red rating based on their philosophy, integration, climate change, stewardship and reporting. Last year, it evaluated 255 funds across 63 managers. 

 

The increase in ESG integration means 47% of assets under management are now in green-rated funds, up from 36% in 2022.

 

 

However, there have been some more worrying changes too, as this year is seeing a greater number of red-rated property and credit funds than last year. 

 

“That is emblematic of the fact that while there has been a general improvement, there remain some laggard managers,” says Alex Quant, the author of the research, which will be published in full later this summer.  

 

The main area in which managers fail is stewardship. “This year we saw more managers unable to provide detailed examples of engagement. It’s a common area of weakness – managers are describing a strong approach or process for engagement, but when we say, ‘Give us an example of a company you’ve engaged with’, the managers that are rated red were typically unable to provide examples, so it raises doubts about that,” he explains. 

 

The consultancy tends to see weaker ratings in real assets including property, infrastructure and private markets. Quant said in these markets, availability of data is often a problem. The fact that data cannot be observed as readily as in listed markets means managers are less able to fully integrate risk factors into decisions, which is why the best managers take a more qualitative approach, he says. 

 

"We do see really compelling and robust approaches. But we have observed for couple of years that real assets lag behind listed markets because of lack of data,” Quant remarks.  

 

“We do challenge managers to do more... Whether it is to engage with tenants or building managers to fully understand environmental and social risks.” 

 

Green-rated managers evidence clear consideration of climate change risk, he says, for example the physical risks based on where properties are located, but there are still more funds rated amber or red than green in this asset class. 

 

The XPS survey looks only at ESG in the sense of risk management, rather than tilting a portfolio towards environmental or social themes, but the boundaries appear to be fluid. 

 

 

The universe of sustainable and impact investment products is highly dynamic and the last 12 months have been no exception to this, says Cadi Thomas, an investment consultant at Isio, noting that the firm keeps updating its expectations of what best in class looks like across all asset classes. "A large part of this is managers’ risk management processes,” she adds. 

 

Risk management tools in particular have developed significantly, she says, with data improvements and analytical tools available to asset managers now being “an expectation rather than a nice-to-have".  

 

“We have seen asset managers utilise specific climate risk tools to quantify physical and transition risk exposure, often proprietary and fed in from external data providers, as well as broader scenario analysis and temperature pathway analysis,” explains Thomas. 

 

However, risk management tools in areas such as nature and social factors are trailing climate, mainly because of a lack of data, she says. “We look forward to seeing progress across the industry on these issues, driven by such initiatives as the [Taskforce on Nature-related Financial Disclosures] and [Task Force on Inequality-related Financial Disclosures]." 

  

Scheme size does not appear to play a huge role in whether the underlying funds are rated positively on ESG, with little variation between small and large schemes in the XPS survey. 

 

However, large schemes have greater ability to design bespoke investment guidelines with ESG considerations in segregated mandates, which is becoming more common, says Thomas, in particular for buy and maintain mandates. 

 

They are also more likely to take positive action to tilt the portfolio, as Thomas says they are typically the ones to put in place net zero targets, which drives investment decisions. The requirement on schemes bigger than £1bn to produce a report in line with the Task Force on Climate-related Financial Disclosures has also increased the focus on climate aware funds, she says. 

 

  

"As part of this, there must be an increasing focus on the risk of greenwashing to identify those ‘good’ funds,” she argues.  

 

 

Regulators around the world are equally sharpening their focus on greenwashing. New and proposed fund naming rules in the EU, UK and US are set to change how products are named and marketed, introducing rules on the proportion of relevant assets that need to be present to be able to use terms like ‘ESG’ and ‘sustainability’. A study by Clarity AI shows the three regulatory regimes differ significantly in their requirements for funds using the term ‘sustainability’ in their name, with just 4% of them complying with all three regimes and the majority (81%) only complying with one, meaning they might have to be renamed. 

 

Requirements for funds with ESG-related terms in their name are more consistent between the jurisdictions. This means that 85% of funds comply with all three regimes, but the combination of the two facts could impact the products available, says Clarity AI. 

 

“This discrepancy could incentivise fund managers to prioritise creating funds with ESG-related terms in their names that can be sold in different markets, rather than adjusting their strategies to meet the criteria for funds with “Sustainability” in their name,” its report says. 

 

How have managers adapted their ESG processes over the last 12 months in your view?