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As the demographic of investors gets younger the focus on impact investing increases. This is investing not solely focused on receiving the largest returns but also generating an environmental or social benefit. In 2020 it was predicted that the market for impact investing was anywhere from $715 billion to $2.1 trillion1 and this figure is continuing to grow. For this reason, many wealth providers now offer “Sustainable Portfolios” with the general objective of these products to match the goals of impact investing. However, to the average investor it is difficult or just time consuming for them to understand if these portfolios meet their investment goals. Especially given that they would have never discussed or thought about what these goals are. Consequently, they are relying merely on the “sustainable” tag.
This problem has been amplified since the government introduced auto-enrolment into workplace pension schemes back in 2012. The number of eligible adults who hold private pensions in the UK has more than doubled from 42% to 86%2. For most members invested in these schemes this will be their only wealth product, therefore they are likely to have less of an understanding of the investments they hold within their pension. Hence with the establishment of the new Consumer Duty regulations it is vital that pension providers ensure members of Workplace Pension Schemes truly understand where their money is being invested.
How difficult is it to understand your investments?
To comprehend how difficult it is to identify what the average Workplace Pension Scheme is invested in, I choose to look at my own Sustainable pension scheme. Spoiler, it’s difficult.
To start, I do not receive correspondence via e-mail or post documenting what investments I hold within the portfolio, as my pensions are exclusively online schemes. Thus, when looking at any of my pensions I am required to log in to an online portal. Obviously, this is not ideal for members who are not technically savvy, do not have the time to log in or can’t remember how to. This creates an initial barrier to accessing information about the scheme & given that between 2018 and 2022 the number of lost pensions increased from 1.6 million to more than 2.8 million3 – it is a real issue impacting members.
Once logged in I had to find the investment summary for my pension pot. This had not been clearly labelled & required me to go through multiple screens to find. The pot itself was initially set up under a default portfolio, as I was not provided the option to select the portfolio at set up. I have since switched it to the equivalent sustainable portfolio.
Within the portfolio was detailed 7 different “sustainable” funds for which my pension pot had been split between. There were no further details included of what each of these funds were, no instruction offered as to where to view any supplementary information, nor link included for any additional details. This does not align to the Consumer Understanding principle of Consumer Duty. Why? Because it does not provide easily accessible information to allow consumers to make effective decisions about their investments.
I am personally aware, due to my Wealth experience, that I can search the funds online to find key information. This was not detailed on the portal and for the average investor, they would not be aware of this being possible and should not have the expectation put upon them.
After completing the time intensive action to gather enough information on each of the 7 funds to understand my current positions, the results were surprising. Included within the top 10 holdings of these funds were companies in industries for oil, aviation, tobacco, mining, alcohol and fashion to name but a few.
Now these industries are not what most investors would consider to be sustainable and would be surprised that any of their “sustainable” investments contained such assets.
So, is there a reason why these funds contain investments that are not seen to be ethically or environmentally sustainable but have been tagged as so?
Investing for Change
The purpose of investing in industries that are not considered sustainable is to encourage change and subsequently more sustainable practices within these companies. It’s a different way to look at impact investing. Rather than invest in companies whose model is to provide sustainable products, it is to invest in the companies that are leaders in the industry by changing their harmful practices. Examples include moving towards being carbon neutral or reducing waste.
The problem is that this is not clearly disclosed to the investor, leaving them largely unaware.
Some providers do offer information around these investment decisions. Nest, the UK’s largest workplace pension provider, disclose on their website that the companies they invest in on behalf of their scheme members is in part to influence their practices, for example stopping arctic drilling & the usage of coal. They also outline that as part of their schemes they will not invest in tobacco & uranium.
Though Nest detail this information, the average investor would not understand what this means in practice. Therefore, it is on providers to ensure they are transparent with their members. This can be achieved through communications targeted at the correct level for the products market, so members understand clearly how their pension is being invested. Additionally, it will allow members to make effective decisions on whether to invest their pensions elsewhere, especially if they do not want to invest in certain industries.
More Flexibility
When investing into managed portfolios, customers will be provided with the options of what they do not want to be invested in. The most popular options for exclusion are companies that are not seen as ethical, i.e. tobacco, alcohol or weapon companies. Companies that are seen as not environmentally friendly are also a popular exclusion.
With Workplace Pension schemes the list of funds that investors can choose from are often limited to a regular portfolio, with different risk profiles and sustainable equivalents. It would be beneficial to investors to clearly outline industries the scheme would be open to investing in, so they can make effective decisions about whether it is right for them. This information is never clearly documented even on the individual fund fact sheet.
If investors understood that none of the options provided met their investment objectives, it could lead to an increase in the variation of products due to increased demand and transfers out of the scheme. This would lead to a shift in hyper-personalisation where portfolios can be created based on much more detailed personal preferences. Coupling this with robo-advice would give the individual investor the opportunity to effectively manage their portfolios, whilst ensuring it is still cost effective for the provider.
What Changes are Required?
Workplace pension schemes need to afford the same opportunities as private pension schemes such as SIPPs would afford to their members. Members should be able to choose funds that meet their investment objectives and furthermore exclude industries for which they don’t want to invest in. This will require more flexibility by the pension providers and if they can’t deliver this flexibility investors should be made aware of other providers who can.
With the new Consumer Duty Regulations Workplace Pensions Providers need to consider that the average member who holds this type of scheme will have lower financial literacy than for other product types. But this does not invalidate their investing preferences and it is upon the provider to ensure they are being transparent and giving the investor sufficient options.
Finally, the provider needs to disclose information that highlights which industries the member could be invested in. This will allow members to make effective decisions such as to move their pension elsewhere or switch to a portfolio/fund that excludes certain industries the member does not want to invest in due to it not aligning to what they consider to be sustainable.
We at Simplify have a deep knowledge of wealth products and have been working with our clients to continue to embed Consumer Duty. Through improving the legibility of communications, we have seen how this can provide real benefit to consumer and expand their understanding of the products they hold.
Get in touch today to find out how we can help you.
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Mike Penny
Consultant