Can responsible investment help you plot a course to better long term returns? Paul Todd, director of investment development and delivery, NEST explores

When it comes to being an active and responsible investor, there are potentially thousands of issues schemes could focus on. How can they prioritise their activities to best serve their members?

ESG Sustainable Growth

The process has to start with clarity around what drives a scheme’s approach to investment in general. Like many pension schemes, NEST has a set of investment beliefs that helps the organisation make better decisions about how we invest members’ money. One of NEST’s beliefs, developed from a significant body of evidence, sets out the importance of considering environmental, social and governance (ESG) risk factors. NEST believes that, ‘As long-term investors, incorporating ESG factors is integral to the investment management process.’

So for NEST, considering environmental, social and corporate governance risks and opportunities, combined with being an active investor, is part of how we make the most of members’ pots. We’re clear that integrating ESG risks and opportunities into our investment processes is one of the means we deploy to grow members’ money over the long term.

In NEST’s recently publishing Working for change report we detailed the four key objectives that guide and prioritise our activities as a responsible investor:

  • Better risk-adjusted return: We want to target an improvement in ESG performance where there is evidence that doing so can lower the amount of risk needed in order to achieve a return.
  • Better functioning markets: We want to improve how markets operate and are regulated in jurisdictions where we invest.
  • Support long-term wealth creation: We want to encourage the companies we invest in to deliver sustainable and stable performance to support good returns for our members over many years.
  • Manage reputational risks: We want to protect NEST’s reputation and increase our members’ trust by encouraging companies to act in ways our members can feel confident about.

NEST developed a prioritisation model driven by these objectives. This model helps us to make sure we use our resources effectively when considering which issues to focus on in order to improve risk adjusted return for our members. Over the last eighteen months this approach has identified four broad areas where we analyse company performance. We score companies’ records on environmental issues, social impact, governance issues and financial performance. The model tells us how much of each area contributes to the risk of each company. It also helps us focus on managing the key risks our portfolios are exposed to.

Currently the key ESG risks in our equity portfolio we’ve identified using the model, in order of priority, are:

  • How companies treat the environment - we’re addressing this through a focus on companies’ greenhouse gas emissions that contribute to climate change
  • How companies interact with others – we’re addressing this through a focus on conduct, culture, and staff reward and progression that contribute to employee well-being and productivity
  • How companies lead and organise themselves - we’re addressing this through a focus on audit and dividends that contribute to public and investor confidence and trust.

Naturally, different schemes will have different objectives and, depending on their investee companies and markets, different priorities. As a young and evolving scheme, in NEST’s experience it’s key to have a clear belief in the significance of responsible investment and a consistent framework for prioritising our work given our constrained resources as a low cost scheme. You can find out more on how we are acting on our objectives and risk management framework by reading the full report.

Paul Todd, director of investment development and delivery, NEST