ESG is a crucial consideration for defined benefit plans, but not for the reasons you might think
ESG (environmental, social, and governance) factors are becoming crucial considerations for DB plan sponsors, but it may not be for obvious reasons.
Derisking is the top priority for 46 percent of defined benefit (DB) plan sponsors, followed by surplus utilization (32 percent) and then enhancing governance processes (20 percent) according to Mercer’s Shaping the Future survey of DB plan sponsors.
One key reason that motivates institutional investors to consider ESG factors is ESG investment policy implementation. This is an important step in a robust investment governance framework for asset owners to align their financial, strategic, and sustainability objectives.
Sustainable investment policy vital for risk management
Institutional investors believe a sustainable investment policy is vital for risk management and mitigation.
“All plans, regardless of size, are planning to do more to integrate ESG factors into their investment approach,” says Bonnie Foley-Wong, sustainable investment leader, Mercer Canada. “This was clear in our recent survey of defined benefit pension plan sponsors. In fact, 70 percent of plan sponsors said ESG is vital to their investment decisions. Incorporating ESG factors also ranked as the second highest investment management priority.”
Mercer says sustainability and risk management go hand in hand. Issues such as climate or diversity, equity, and inclusion can pose risks to businesses' financial stability and sustainability and, in turn, impact risk within an investment portfolio. Fiduciaries have a responsibility to consider a wide spectrum of risks and indicators, ensure the resilience of investment portfolios, safeguard assets, and enhance long-term value.
A sustainable investment policy creates long-term value creation by providing guidance and protection for generating investment returns and growing assets. Asset owners that are well prepared to address sustainability risks and opportunities are better equipped to navigate market shifts, regulatory changes, and emerging trends.
In addition, investors must take into consideration stakeholder expectations. More and more, stakeholders are insisting investors do more and act faster in response to sustainability risks and opportunities. Some stakeholders are seeking more data, analysis, and education to inform their view. Good governance means having a robust framework and process that takes into consideration these and other views. A well-defined sustainable investment policy demonstrates an asset owner’s diligence, articulates its commitment to the prudent stewardship of assets with a long-term view, and builds transparency and trust with stakeholders.
The survey reveals how much a comprehensive approach to ESG can support other aspects of managing a plan. Accounting for risks related to climate change while strengthening the governance of a plan go hand in hand, helping to secure plan stability for the long term.
“Our research shows that plan sponsors are seeking ways to use ESG data more meaningfully, now and in the near future,” says Foley-Wong. “Effectively leveraging ESG data can assist with manager selection, monitoring activities, measuring progress, and reporting to stakeholders. Many plan sponsors understand that using ESG data in the investment process is the next logical step.
“We know that the main purpose of a pension plan is to provide a reliable pension income to its members. So, the objective is to generate solid returns in the short and long term, while managing risk. And while ESG factors may be important, there is a lot of noise in the data. Finding the signal is currently not easy. Fiduciaries and key decision-makers need to consider whether and how ESG impacts the financial risk and return of their plans, now and over the long term.”
