How to ensure your pension pot is being ethically invested

If asked would we support companies that pollute indiscriminately, use child labour or promote inequality, the majority of us would, of course, say no. But the reality is that anyone with a pension probably has at least some of their money invested in companies that do not adhere to ESG (environmental, social and governance) principles.

However, ethical investing as an ethos is now gaining serious traction and not only includes a focus on climate and sustainability-related activities but also on addressing social and governance factors such as modern slavery, child labour, corrupt practices on the part of companies and nation states, and more besides.

The potential to do good with the $60 trillion (€56 trillion) tied up in pension funds globally – approximately €150 billion of it here in Ireland – is enormous, says Ciaran Hughes, director of Ethico, a financial adviser and broker specialising in sustainable investments. According to Hughes, most people are unaware of how their pension pot is invested – a look “under the bonnet” would leave them both shocked and disappointed, he believes.

“The vast majority of pension funds are invested in this traditional way,” he says. “But instead of accelerating climate change, it could be used to alleviate it – or instead of increasing inequality, it could be used to promote equality, diversity and inclusion.”

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Hughes adds: “This money could be used to have a positive impact and supercharge investment into renewable energy, green tech and sustainable infrastructure.”

So-called “negative industries” make up about 10 per cent of Irish investments. “That is, Irish pension savers investing approximately €15 billion directly in oil, coal, gas, weapons, tobacco companies etc,” says Hughes. “And that’s just from pensions, meaning the true figure is much higher.”

According to Conor Grimley, divisional director in investment management with RBC Brewin Dolphin, investors have always been ethically conscious. In recent years, however, climate action initiatives, social awareness and governance standards have served to heighten this awareness and made investors much more conscious of where their money is being invested.

“For investment managers there is a much-improved toolkit of rating systems to capture ethical investing,” he says. “At RBC Brewin Dolphin ethical screening and stewardship are integral parts of the selection process for stocks and funds. Furthermore, we have produced a sustainable investment model.”

Under the EU’s Sustainable Finance Disclosure Regulation there are three types of funds: article 6 includes funds without a sustainability scope; article 8 covers funds that promote environmental or social characteristics (categorised as “light green”), while article 9 represents funds that have sustainable investment as their objective (“dark green”).

There is a broad misunderstanding that sustainable funds do not perform as well as traditional funds. This is incorrect

—  Ciaran Hughes, Ethico

“Many pension funds have rebranded as ‘light green’ or article 8; however, this is a relatively low bar for sustainability,” says Hughes. “Pension savers with sustainability preferences often find that light green does not go far enough. If you want your savings to have a real impact on climate, society and global corporate behaviour you should look towards article 9, or dark green funds, and ‘impact’ funds,” the latter similarly specifically aimed at supporting beneficial social or environmental outcomes.

Categorisation of investments can be very difficult, agrees Grimley.

“There are many grey areas. For example, industrial companies are making enormous strides to demonstrate carbon reductions, water cleanliness and so on but it is very difficult to say how and when certain sectors will achieve optimum environmental status. Hence, investors have choices to make regarding outright exclusion of investments or staying involved so that they can exercise stewardship through shareholder voting rights in order to effect change.”

Hughes notes that there is a “very low percentage” of Irish pension money in dark green funds. And a UK survey of 6,000 people published earlier this year found that less than a quarter (24 per cent) of people are choosing to invest sustainably and back socially responsible firms when investing in a new product, compared with 26 per cent last year and 31 per cent in 2021.

Is this because ethical investments do not perform in comparison to their more mainstream peers? Is it a case of virtue being its own reward or is the grass greener?

There are no cons to choosing the ethical investment route, Hughes says. “Sustainable funds do everything a traditional fund does,” he says. “Maximising returns, risk management, tax relief, charges, diversification etc it just does it in a better way. There is a broad misunderstanding that sustainable funds do not perform as well as traditional funds. This is incorrect. On average, both types have performed comparatively over the long run.”

Grimley says traditional – but ethically dubious – stocks such as fossil fuels, tobacco companies etc are not performing as well as they did in the past.

“By many measures, stock market valuations in these sectors are at relatively low levels,” he says. “However, it is important to understand that many industries with obvious ethical challenges continue to perform profitably and ultimately economic demand continues to require fossil fuels as an essential power source. So the producers will remain profitable until demand changes.”

While, in theory, ethical investing confers higher degrees of investment quality in the selection of investments and there is no reason to believe that ethical investments won’t outperform in the long run, Grimley sounds a note of caution for those seeking to green their pensions and investments.

“High levels of exclusions within investor portfolios could be at the expense of other better-performing sectors and may result in underperformance,” he says. “So ethical investing to the exclusion of all others could mean that investments may not perform as well.”

When compared to electric cars, going vegan and stopping flying, sustainable pensions can have a much greater positive impact. But for ethical investing to become mainstream, pension holders have to make their voice heard, says Hughes.

“The critical point here is that pension providers will make these sustainable funds available but people have to choose to move their money. If everyone stays in traditional funds there will be no improvement or change,” he adds.

In recent years sustainable investing has become very popular elsewhere in Europe, he says.

“It is possible that Ireland will catch up as awareness builds.”