For too long, ESG has been talked about as if it were something outside our main investment process. Jonathan Stapleton says this must change.
The trouble with ESG is that it has long been associated - in some people's minds at least - with tree-hugging, lentil-munching, sandal-wearing hippies rather than 'level-headed', outcome-orientated investment professionals.
And while direct action by Extinction Rebellion and the activism by Greta Thunberg has increased the profile of the issue of climate change, it has also reinforced the above stereotype. Surely, proper people don't protest?
But so-called ‘proper' people are taking a stand as well. This week the Committee on Climate Change - the statutory body established under the Climate Change Act 2008 to advise the government - said the government must immediately set a legally binding target to cut greenhouse gas emissions to zero by 2050.
It said doing so would be challenging - and mean the end of gas boilers as well as petrol and diesel cars, less meat on plates, a four-fold increase in clean electricity generation and necessitate the planting of an estimated 1.5bn trees.
But what does all this have to do with the investment of pension scheme assets? Surely, trustees should only be focussing on the financial returns of the assets in which they invest?
Yet, as many trustees now realise, ESG has everything to do with the financial returns on offer.
Take car manufacturers as one example. Do you really believe that, with the increase in regulation around carbon fuels, those businesses that don't adapt to a zero-carbon future will be as profitable in 20 years' time?
High-carbon businesses will face increasing levels of taxation, more regulation and, as such, produce lower profits.
And CO2 emissions are only one part of this. Governments are also reacting to tackle a range of other negative externalities that firms are responsible for - as well as a broad range of other environmental, social and governance challenges.
Clearly, businesses that adapt to this new world and tackle these challenges will be more sustainable and more profitable in future. As Richard Butcher says, ESG is all about managing investment risk - and this broad range of ESG risks must be considered in the same way as any other investment risk.
But there are huge swathes of investment where all these risks can't be considered - in the bulk of passive asset management, for instance, where it is generally not possible to underweight a high-carbon stock or sector, or deviate from the index at all.
At a time when the weight of opinion is shifting towards incorporating ESG risks into decision making processes, investors are increasingly switching to passive vehicles where it nigh-on impossible to take such risks into account. This is particularly true in DC where, with a few high-profile exceptions, most schemes are invested passively with no regards to ESG risk at all.
ESG has a real branding problem. As soon as we can stop talking about this as being outside our investment process, and focus on it as an integral part of risk assessment, incorporating it into all of our portfolios, rather than just some of them, the better.
Jonathan Stapleton is editor of Professional Pensions
