A £6 trillion proposition

Thursday 27 August 2020

If everyone’s pensions were ethically invested they could fund an infrastructure revolution


Swap your Ford Focus for the new Tesla, stop eating meat, cancel next summer’s Spanish getaway and switch your energy supplier to renewable.

These are all reasonable ways to make a personal contribution to combating climate change, but they all draw on your limited time and resources. Fortunately, behavioural economics tries to understand these nuances and find practical solutions without the resistance that change commonly creates.

Why this story?

What would happen if people saving for their pensions were assumed to prefer climate-friendly investments unless they ticked a box saying otherwise?

The answer, according to one Scandinavian bank, could be transformational. When Robert Wavell set about investigating how nudge theory could encourage divestment away from fossil fuels, he stumbled on a £32 trillion gorilla. Giles Whittell, editor

Welcome (back) to nudge theory.

The idea of “nudging” people to encourage change rather than legislating to force it was popularised by the economist Richard Thaler and the political scientist Cass Sunstein. It was brought into government in the UK in 2010 by the coalition government, initially in a Nudge Unit attached to the Cabinet Office and working closely with Downing Street. It has since been privatised and renamed the Behavioural Insights Team, or BIT.

The BIT’s nudgers have already done groundbreaking work on climate. They’ve proposed a meat tax to reduce agricultural emissions, for example, and green license plates to improve awareness of electric cars. But one potentially powerful idea that has not yet been put to the test involves harnessing the power of our pensions.

An Extinction Rebellion protester outside the Bank of England, October 2019

The aim would be to stimulate innovation and fast-track green infrastructure development. The results could be dramatic.

According to calculations by sustainable finance researchers at Nordea, a Scandinavian bank, moving your savings to sustainable funds can be 27 times more efficient in terms of shrinking your personal carbon footprint than eating less meat, using public transport, reducing water use and flying less, combined.

So why not pay all pension investments into ESG-focused funds as a default? ESG Investing requires consideration of environmental, social and governance factors alongside financial ones in the investment decision-making process. Defaulting to ESG funds could funnel more than £6 trillion their way, and would emulate a 2012 UK government policy – led by the BIT – to automatically enrol people into workplace pension schemes. That nudge had spectacular results: 9 million more people now save for their own pensions.

When default rules don’t stick, the reason is usually straightforward. People have clear preferences that run counter to them. But there’s evidence of a strong appetite for more ethically-orientated pensions. A study by Franklin Templeton showed that three quarters of 22-38 year olds don’t think pensions generally align with their values. 45 per cent said they would be willing to make extra contributions if responsible investment was built into their pension. More than half believed responsible investing principles should guide their default investment fund.

Pensions account for 16 per cent of total global assets, worth £32 trillion. About 90 per cent of that currently defaults to “standard” funds, and only 1 per cent of pensions are considered ethical and/or green. If there’s a sense of a huge opportunity being missed here, that’s because there should be.

Greenpeace protestors dressed as orangutans demonstrate against palm oil harvested from rainforest destruction outside the Nestle SA shareholders’ meeting in Switzerland, April 2010

It’s not even as if ESG investing is risky. On the contrary, modelling done by Aberdeen Standard investments concluded that it was possible for most investors “to significantly increase their allocation to climate solutions and reduce exposure to carbon intensive companies, without undermining the portfolio’s ability to meet standard risk return objectives”.

The carbon impacts of money are not widely publicised. More often, people note that ESG investments provide less volatile earnings and lower market risk, and this has proved especially true in times of crisis. More than half of all ethical investment funds outperformed wider stock indices during the recent Covid-19 downturn.

Defaults can achieve policy goals without limiting freedom of choice. They don’t have the stigma associated with tax, and they don’t come with the economic and political obstacles that traditional mandates have to overcome.

They do face hurdles even so. Markets need to boost the supply of ESG funds and prevent them marking their own homework. Recent Analysis from Morningstar found that only 40 per cent of funds labelled “ex-fossil fuel” are actually fossil fuel-free.

For now, a 27-fold increase in our power to limit our emissions may be a pipedream. But with public engagement, support from business and courageous political leadership, we could turn pensions into planetary saviours. Starting with a nudge.

Photographs Getty Images. Illustration by Lizzie Lomax

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