Looking in the Rear-View Mirror

Karen Shackleton, independent financial adviser and recently appointed Chair of the Resonance Board, looks back at impact investment and pension funds in 2017, and has a prediction for the year to come.

When I look back on the latter half of 2017, it seems as if no sooner had one impact-related report been published by government, regulatory bodies and others than another followed in its wake. To say that impact investment was possibly one of the most talked about investment topics of the latter half of the year, is probably not an exaggeration. And it shows no sign of tailing off in 2018.

Some of the key reports that came across my desk included:

– The Law Commission Report on “Pension Funds and Social Investment” (June 2017)

– The Financial Stability Board report on “Recommendations of the Task Force on Climate Related Financial Disclosures” (June 2017)

– The EU High Level Expert Group on Sustainable Finance report on “Financing a Sustainable European Economy”

– The UK National Advisory Board report on “The Rise of Impact” (October 2017)

– The Department of Digital, Culture Media and Sport Advisory Group report on “Growing a Culture of Social Impact Investing in the UK” (November 2017)

– The Department of Digital, Culture Media and Sport and Department of Work and Pensions joint report on “Pension Funds and Social Investment: the Government’s Interim Response” (December 2017)

The latest report in this list, the government’s interim response to the Law Commission’s June report, pointed out that defined contribution (DC) pension schemes are expected to grow six-fold, to £1.7 trillion by 2030. By then, that is likely to be around 15% of the current net wealth of the UK.

As if this number weren’t enough to blow the mind, Towers Watson estimated that the global pensions market reached a staggering $36.4 trillion by the end of 2016. The impact that could be achieved, even with a small proportion of these investments becoming more intentional, could completely change the way that governments seek to address their social and environmental challenges. It comes as no surprise, then, that we are seeing an increasing number of government-sponsored reports expressing support for impact investment.

Looking in the rear-view mirror, I can see some key themes emanating from the Law Commission, the Department of Digital, Culture, Media and Sport and the Department of Work and Pensions, which allows us to predict, with some confidence, the direction of travel for UK impact investment for 2018 and beyond.

Key theme: legislative change will enhance not overhaul

The sense is that current pensions legislation is not a significant barrier to entry to investors allocating to impact investments. The Law Commission report concluded that “the barriers that we did identify were, in most cases, structural and behavioural barriers within the pensions industry.” Their recommendations for legislative change focused more on enhancing, rather than overhauling, the current regulations.

One example was the recommendation to amend the Occupational Pension Schemes (Investment) Regulations 2005 so that the reference to ‘social, environmental or ethical considerations’ accurately reflected the distinction between financial factors and non-financial factors. The government (in its response) agreed with this recommendation and confirmed that trustees “may respond by acting on [social, environmental or ethical considerations] where they have good reason to think members share the concern and it does not involve a risk of significant financial detriment.”

This is an important clarification because it empowers pension trustee boards to develop transparent and efficient impact investment strategies where their members have strong views, provided they can demonstrate that the fund’s risk/return characteristics will not be negatively impacted. As it happens, many impact investments will have low correlation with the traditional asset classes, so in fact they can have a positive effect at the total fund level both from a financial and an impact perspective.

Key theme: more guidance required

A second theme has been a recognition that further guidance from The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) could be beneficial. The Law Commission report, for example, suggested that further guidance would be helpful on illiquid assets. They referred to Australia where pension funds have a high allocation to illiquid assets such as infrastructure (an average 8% in default DC schemes).

TPR’s response to the Law Commission’s recommendation was that “This guidance is not prescriptive, and trustees are expected to adopt an approach proportionate to their scheme’s risk, complexity and size.” Yet many schemes are unprepared to consider illiquid assets because they need to offer daily pricing and daily dealing. The issue for impact managers is that their funds are often unlisted, where capital must be committed for several years.

The need for daily dealing is an interesting one. In a market research exercise undertaken for the DCMS report by Allenbridge (part of MJ Hudson), corporate pension scheme representatives were asked: “Are you aware there is no regulatory requirement that dictates DC funds must have daily pricing and daily dealing?” Over a third of respondents replied that they were unaware of this.

More guidance on holding illiquid assets in DC schemes would be important to firms like Resonance, who are making impactful investments in less liquid asset classes such as property, to house the homeless.

Key theme: more engagement

One of the key themes from the Advisory Group report “Growing a Culture of Social Impact Investing in the UK” was to continue further engagement with regulators, practitioners and investors. The government’s aim is to improve the professional skills of those operating in impact investment, to develop a robust measurement process, to sustain momentum and to improve quality.

Firms such as Resonance, who have been investing intentionally for over 15 years, can lead the way in this initiative by sharing their experience and knowledge, with others, and by helping to set best practice in this area.

Given the government’s key messages, does this mean there will be a tsunami-like wave of investment coming our way in 2018? I rather hope not – I am not entirely sure that would be a good thing for society or the environment. Maintaining best practice across the industry, in the face of massive inflows of capital, would be extremely challenging.

Rather, I believe there is a steady but growing groundswell of investment heading into opportunities that will both deliver a financial return and will achieve positive impact, and this has the government’s full support.

2018 will, I predict, be an exciting year for impact investment.