Social, Ethical & Environmental Issues

Background

Under the Pensions Act 1995, schemes that require a Statement of Investment Principles (SIP) must include:

• the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments; and
• the scheme’s policy (if any) in relation to the exercise of rights (including voting rights) attaching to investments.

Investment where social, environmental or ethical considerations are taken into account is commonly called ‘Socially Responsible Investment’ (SRI).  The legislation, which came into force on 3 July 2000, does not oblige trustees to adopt SRI policies, but it increases transparency on the issue.

Is Socially Responsible Investment legal?

As a trustee, your primary responsibility is the financial interests of the beneficiaries of your scheme.  There is general agreement amongst lawyers that trustees cannot:

• put their own personal values ahead of acting in the interests of the beneficiaries;
• take account of remote or imperceptible benefits to beneficiaries; or
• follow investment strategies which they are conscious will be to the financial detriment of beneficiaries.

However, trustees:

• can take account of SRI to deliver improved financial returns (this is addressed below);
• are not restricted to acting exclusively in the financial interests of the beneficiaries and should deliver non-financial benefits which are valued by a significant proportion of the beneficiaries where they can do so in parallel with delivering unchanged financial benefits to all beneficiaries;
• can take into account the views of the employer, for example where the employer wishes to see its pension scheme having a policy consistent with its own position on ethical trading or environmental issues, so long as there is no adverse impact on financial return.

Can SRI produce superior investment performance?

One of the arguments put forward by the advocates of SRI, is that over the long term, SRI performance should outstrip performance on standard funds.  The rationale given is that companies which act ethically tend to be better run and are less at risk from expensive lawsuits or the loss of customers (who are growing more aware of these issues).  Historic performance figures are often produced to back up this view.

However:

• The positive attributes described may already be included in the price of the securities.
• Almost any view in investments can be supported by the selective use of historic data.
• Intuitively, one would expect SRI securities to outperform as the issue becomes more fashionable.  Thereafter they would be overpriced and so underperform in the long-term.  This would be exacerbated if SRI became less popular in the future.
• It is not possible to improve the potential risk/return characteristics of a portfolio by reducing the universe of stocks in which the portfolio can invest.
• The companies that generally comply with the SRI criteria tend to be smaller. As such returns can often be higher but also more volatile.
• If the reason for using SRI was to capture the potential for higher returns, then this would not constitute an objective; rather it’s a strategy for achieving the objectives.  Arguably, this is best left to fund managers who can take this into account together with all the other factors that they analyse.

Defined contribution schemes

We believe that it would be even more difficult to justify using SRI funds as part of the default strategy of a DC arrangement than it would for a DB scheme’s strategy, as the members would face the consequences of any underperformance directly.

However, it may be worth considering offering one or more SRI funds as part of the options available to members to choose from.  In our view it would be perfectly reasonable for members to choose to take these issues into account with their own investments.