NEST CIO Mark Fawcett: ESG is more than a box ticking exercise

Workplace pension scheme updates Statement of Investment Principles

For some commentators and indeed some practitioners, being a responsible investor can be seen as more of a branding exercise or box-ticking process. At NEST, we’ve always sought to do what’s right for our members even where that pushes boundaries.
At NEST our primary objective was to design an approach which provides ambitious but most importantly achievable and sustainable returns for our members. At the same time, as a scheme that acts in members’ interests we have spent a lot of time understanding their attitudes, needs and characteristics and we align our investment approach accordingly.
For NEST, integrating environmental, social and governance factors into our investment processes is a central part of fulfilling that ambition.
NEST has recently updated its Statement of Investment Principles (SIP) and has strengthened its commitment to this belief, stating that: ‘As long term investors, incorporating environmental, social and governance (ESG) factors is integral to the investment management process.’
Coincidentally, the Law Commission also recently updated its guidance on fiduciary duty, requiring trustees to recognise ESG factors in their decision making where they consider such factors to be relevant. This is a welcome step and validates NEST’s approach to date, but we are particularly encouraged not because we think that this is a nice belief for investors to hold, but because the Law Commission’s move acknowledges that in the long term, factoring in ESG concerns can provide real value in positively affecting long term, sustainable returns.
For us, this investment belief is underpinned by extensive research NEST has undertaken on the effect ESG factors can have on returns. In 2012/13 we undertook a major study with FTSE to investigate the existence of ESG stock betas among the 2,000 or so names in the FTSE Developed World Index, which our global equity fund tracks. The study looked to identify different components of common sources of ESG risk alongside traditional betas such as return on market, size and value.The study identified a number of statistically significant ESG betas; namely environmental management; human rights and corporate governance which can contribute positively to the overall value of our investments by offering lower average volatility for a given unit of return. To put it simply incorporating these factors can achieve the same rates of return without taking as much risk.
This research is not the final word on the debate, but what these findings and the Law Commission guidance provide is focus and a lens through which we can evaluate our choices and make our investment decisions.
For example, we have sought and will continue to seek to capitalise on opportunities created by good ESG management and to avoid the negative risks associated with bad ESG management.
Last year we appointed Legal & General Investment Management as our fund manager for investing in UK commercial property. The exemplary environmental and social sustainability credentials of the Managed Property Fund, the major component in the LGIM Hybrid Property Fund, were pivotal in our decision to award them this mandate. We gave environmental and social sustainability a significant weight when making our evaluations because we, like L&G, recognise that key factors in delivering long term returns, such as rental yields and vacancy rates, are influenced by these qualities. The credibility of this fund in environmental and social impact terms convinced us that it merited inclusion in our Ethical Fund as well as our default fund, as one of the building blocks that make up that diversified portfolio.
On the other hand, when entering the emerging markets equity asset class recently, we took steps to mitigate against excessive risk by appointing the HSBC GIF Economic Scale Index GEM Equity Fund as well as the Northern Trust Emerging Markets Custom ESG Equity Index Fund, which screens out companies with poor ESG credentials. This screen focuses particularly on governance, which is important in markets which are high risk not just in terms of volatility but in terms of bribery, corruption, pollution and opaque governance frameworks.

To date, over 80 companies have been screened out from the MSCI Global Equity Index and this is under constant consideration.
These are just two examples of how our investment beliefs have been put into practice so far, but it’s an approach that carries through to all our fund manager appointments.
When we evaluate managers, we look at how their philosophy, investment process and risk management all line up. Are they consistent and coherent? It is surprising how many managers there are where that isn’t the case. We make sure we spend time at the manager’s offices understanding what they are doing and have regular meetings to ensure things stay on track. Our approach to responsible investing really does differentiate managers. Our youngest member is 16 and with the changes to the annuity rules, they could be invested for 60 or 70 years.So we are genuine long-term investors and we care about being responsible owners. Over a year or so, having good governance may or may not make a difference to a stock’s share price, but in the long-term it will. We want our managers to care about this too.
Sacrificing long term impacts for short term investment gains isn’t in keeping with what NEST as a long term investor wants or what our members would expect.
You can find out more on how NEST is delivering against its ESG investment belief, including its voting records, using the search term ‘responsible investment’ at www.nestpensions.org.uk

Mark Fawcett is Chief Investment Officer at NEST