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Workplace Pensions

ESG and your default – financials vs ethics

Gareth Trainor | August 20, 2021

Time to read: 5 minutes

Gareth Trainor,

When it comes to incorporating environmental, social and governance (ESG) factors, which approach is most suitable for a default solution? Gareth Trainor, Head of Investment Solutions at Standard Life, explores the moral versus financial debate.

A default solution needs to work hard – good member outcomes for the broader membership, clear objectives, value for money, robust governance, efficient and easy to implement. Nowadays there’s also greater demand and regulatory requirement to consider ESG factors, coupled with growing member awareness of sustainability issues. Enter the moral versus financial debate.

At Standard Life, we’ve deliberately chosen to focus our new default solution on ESG factors that are likely to influence company performance, rather than ethical considerations. We’re doing this for three main reasons: investment performance, scheme/trustee regulatory requirements, and to appeal to the majority of members. Though importantly, alongside this, we offer options for those members with specific thematic preferences. Let me take you through each of these areas in more detail.

“By focusing on the financial ESG risks that a customer is exposed to, you’re focusing on delivering good outcomes – on the fact that customers, more than anything, want to grow their pension pot.”

1. To help deliver positive financial outcomes to your members

As we’re all increasingly aware of the huge sustainability issues facing the world, responsible investment is in part about ‘doing the right thing’; to allocate capital to the most sustainable companies. And to give everyone a choice to allocate their own savings and investments in a way that can help drive change for the better.

But when it comes to investing, it’s also about looking at the long-term financial risks and opportunities that ESG issues present. In other words, taking these factors into account when considering each and every investment, to help mitigate risks and tap into growth opportunities.

There’s increasing evidence and acknowledgement that ESG factors can have a financially material impact on a company’s operational and financial performance. And in some cases that companies taking these factors into account have been more resilient to market shocks and downturns, and may outperform over the longer term. Though please remember that past performance isn’t a guide to future performance.

If we think about some of the potentially controversial areas that attract strong views, they also carry the potential for considerable financial risk. Examples include:

Controversial weapons: involving cluster munitions, chemical, biological and nuclear weapons, this area poses serious financial, regulatory (including the presence of international treaties) and reputational risk to the companies involved.

Tobacco production and distribution: a sector increasingly on the exclusion lists of institutional investors, it’s up against tighter regulation, greater consumer awareness, falling global sales and potential litigation risks from public health impacts.

Thermal coal and unconventional oil and gas: the most carbon-intensive fossil fuels are at risk of becoming stranded assets due to climate-change action, as well as the rapidly falling costs of renewable energy technologies, such as solar and wind power.

UN Global Conduct violators: in any sector, a company that has made a clear breach of the Global Compact’s ten principles, which cover human rights, labour, environment and anti-corruption, is exposing investors to adverse financial consequences. This can happen through fines or major reputational damage hitting sales of products and services.

Many portfolio managers are making certain key exclusions based on the risks they believe will affect investor performance over the long term. Similarly, they’re tilting towards companies demonstrating better standards of ESG relative to their peers – which we think should be encouraged, as we believe this will support long-term performance for our customers.

“Integrating ESG is about managing long-term financial risks and aiming to deliver positive financial outcomes – it’s not about making moral decisions.”

Setting aside any moral viewpoint, our duty is to maximise retirement outcomes for our customers. To take calculated investment opportunities when available to both enhance returns and mitigate risks. As such, we have to consider ESG factors. There’s also increasing regulatory reason to do so.

2. To help meet your regulatory requirements

The ESG regulatory burden on schemes and trustees has been mounting over recent years. The need to disclose risks, such as climate change, is quickly becoming imperative from a fiduciary perspective – as reflected in the proposed Pension Schemes Bill and growing calls to adopt the recommendations from the TaskForce on Climate-related Financial Disclosures (TCFD). In particular, the proposed Occupational Pension Scheme Regulations 2021 will require:

  • trust schemes with relevant assets of £5 billion or more to come into scope for TCFD reporting from 1 October 2021 – or the day the audited accounts for that scheme year are received, if later;
  • schemes with relevant assets of £1 billion or more to come into scope from 1 October 2022;
  • authorised master trusts and authorised schemes providing collective money purchase benefits (once established) to be in scope from 1 October 2021, or when authorised, if later.

Schemes are also under pressure to reflect the views of members when they plan investments. Customer views can often cross a broad spectrum, so what does that mean for the default and what do you offer alongside it?

3. To appeal to the majority of your members’ needs

Performance is still the top priority for the majority of customers. But most want to achieve the balance of a good return without harming society or the environment. These are the customer views we’re continuing to see articulated in our ongoing responsible investment research. But unsurprisingly, given our membership covers the vast waterfront of views, there’s also a population who don’t want to consider anything other than risk and return.

A default needs to be suitable for the masses. By focusing on ESG factors that can have a positive or negative impact on returns, it avoids being drawn into moral decision-making for members. It avoids taking specific ethical and/or moral stances on issues, which may or may not be in harmony with members’ individual values.  Serving those customers with more specific views or values can be best done within the self-select range (see my point below), rather than trying to create a single solution that attempts to be all things to all people, all of the time.

Even for those unconvinced by the social and environmental challenges, an approach focused on the financial implications of ESG can help to meet the priorities of the majority, which are returns and managing risk. But as a secondary positive effect you also inevitably touch on the big issues that the majority of members do care about from a moral perspective – the avoiding harm bit. So screening out the big controversial industries and practices, and focusing on companies getting ESG right, is an inadvertent benefit for all.

Still appealing to members with values-based requirements

There’s a broad spectrum of interest in responsible investment among our customers. It ranges from those where:

  • ESG is not on their radar at all;
  • to those much more engaged and keen to align their investments to specific ethical goals;
  • or to explore the potential growth opportunities of specific sustainable themes.

Yes these latter groups are, currently at least, much smaller. But they’re no less important when it comes to taking all member views into account.

It’s also likely that we’ll see increasing numbers of members become more keenly engaged in responsible investment issues as awareness and understanding grows. There’s a gravitational pull which isn’t going to change. And while everybody isn’t in the same place, at the moment, there’s a singular direction towards more sustainable ways of working.

So while we need a default to appeal to the majority of member views, we also need to offer a range of solutions members can self-select according to their specific values and interests. Examples include climate, impact, social bond, ethical and religious options.

It’s all about investing in a better future

Defaults have always carried huge responsibility. But they’re even more important in a world of growing sustainability issues that are casting financial, social and environmental uncertainty. As providers, we must make sure we’re doing the right thing but also that we’re serving the needs of our customers.

This means offering a default that balances the challenging mix of delivering positive financial outcomes, meeting regulatory requirements, managing ESG risks, helping drive broad improvement in sustainability, while also appealing to the majority of member preferences.

We believe that in order to achieve all of that, without moral bias, a default needs to focus on the financial implications of ESG. While a choice of options addressing more specific thematic preferences can sit alongside it.

Find out more

At Standard Life we’re committed to a sustainable future and responsible investment, which is already central to our investment proposition.

As the industry evolves, so too are we expanding the breadth and depth of what we offer to clients and customers. As part of this, we launched a passive sustainable multi-asset default fund in Dec 2020.

ESG is applied to our range of off-the-shelf and self-select investment solutions. We also offer a range of individual active and passive funds – also recently expanded – with specific screening and thematic approaches. You can find out more here.


The views expressed in this blog should not be regarded as financial advice.

Any external links provided are for general information purposes only. Standard Life accepts no responsibility for information contained in the site or for the site not being available at all times.

It’s important to remember that a pension is a long-term investment and as such its value can go down as well as up. It could even be worth less than was paid in.

Gareth Trainor

Head of Investment Solutions

Gareth has overall responsibility for Standard Life’s investment solutions covering a wide range of activities including solution design and development, data and reporting, fund and pricing controls and governance.

He is also Chair […]

Read Gareth's blogs


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Find more Workplace Pensions tips and information from the industry experts


Gareth Trainor

Head of Investment Solutions

Gareth has overall responsibility for Standard Life’s investment solutions covering a wide range of activities including solution design and development, data and reporting, fund and pricing controls and governance.

He is also Chair […]

Read Gareth's blogs
Gareth Trainor,

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