Are managers prepared for greater scrutiny of their social credentials?

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The industry is making strong inroads on climate change factors and many schemes now favour managers which not only engage with issuers, but also allocate to positive contributors. Despite these improvements, trustees continue struggling with social risk and impact factors. There are several regulatory initiatives that are increasing the focus on ‘S’ in ESG considerations – and both schemes and managers should take notice.  

Social factors are a largely overlooked part of the ESG agenda

Most UK schemes are doing a good job complying with the new climate-related disclosures requirements. However, the industry is further behind in integrating social risks and opportunities. As a result, the Department for Work & Pensions (DWP) set up a taskforce to help trustees better manage social factors. This likely indicates that regulators will eventually move from nudging trustees on social outcomes to also requiring social metrics reporting.

The lack of data standardisation is a key obstacle preventing trustees from integrating social considerations into their ESG policy and investment strategy, which the mallowstreet Trustee Report 2021 uncovered. Many schemes are also missing information on some parts of ESG (including the ‘social’ component). 

The industry cannot afford to ignore social risks and opportunities 

Our upcoming Trustee Report 2022, produced in partnership with Janus Henderson Investors, reveals a gap between trustees’ understanding of social factors and their knowledge of climate risks. Indeed, few have dedicated policies for addressing social factors.

Integrating social considerations is also important because, as DWP notes, ignoring this issue exposes schemes to material financial risks and missed investment opportunities.

Fortunately, regulators are helping make social risk factors more concrete by identifying the three key areas for schemes to consider when investing: 

Measuring social outcomes is tricky but current methods provide a useful starting point 

It is currently unclear what specific data trustees will need if reporting on social metrics becomes mandatory, but this does not mean the industry lacks well-established methodologies for measuring social outcomes, on the contrary.

For example, many investors use the social return on investment (SROI) metric to derive a ratio between the benefits value and their initial investment. The impact multiple of money (IMM) is another useful tool because it provides a forward-looking means of estimating the financial value of a social good that results from each dollar invested. 

While these provide a good launch point for evaluating impact, we do not know if they are widely used by UK managers. Additionally, there is a lack of clarity whether these methods are suitable for pension schemes. Regardless, the calls to action from the regulator make it clear that integrating social factors is imperative, which is why managers need to do more in supporting schemes with their data and reporting needs.  

Trustees are interested in investments that deliver social benefits 

The Pensions and Lifetime Savings Association (PLSA) reports that nearly half of pension schemes work with managers that primarily rely on engagement and active stewardship to positively influence social outcomes.

Beyond this, interest in impact investing is growing as well. mallowstreet’s DB Climate Risk Report shows strong interest in investment themes like sustainable infrastructure and water management, particularly from schemes targeting net zero. Interestingly, both themes map strongly with UN Sustainable Development Goals that simultaneously achieve positive social as well as environmental impact, namely #6, Clean Water and Sanitation, #9, Industry Innovation and Infrastructure, and #11, Sustainable Cities and Communities. 

The growing appetite for social impact investments demonstrates why providers should refine their approach to deliver and measure social benefits. Indeed, only applying a standard risk management approach to ESG factors may soon fall out of favour with schemes. 

Managers can take this further by asking trustees directly about their preferences and concerns. This will ultimately make it easier for managers to revamp their messaging and offerings to satisfy schemes’ specific social impact objectives. 

What will we see next for social risks and opportunities?  

The rapid progress on TCFD reporting shows that trustees are increasingly equipped to keep pace with more robust social metrics reporting. However, schemes will be hard pressed to achieve this without sufficient support from providers.  

mallowstreet is therefore planning to in-depth research projects on social impact and impact investing to help the industry identify and address the key challenges and opportunities around integrating social factors. Please contact our team if you are interested in becoming a research partner.  

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