Jon Cunliffe by Jon Cunliffe |

The size and scale of our assets under management means we have considerable power as shareholders to influence the companies we invest in on our members’ behalf. But what’s the best approach to take with companies that aren’t aligned with our environmental, social, and governance (ESG) considerations – stewardship or divestment?

As an industry, we’re responsible for administering our members’ assets and helping them to grow safely.

It’s important to us that our investment decisions reflect ESG considerations because it helps to deliver capital and income sustainably to our membership; it’s important to our members too; and it’s also the right thing to do.

The carrot and the stick

In our opinion, investing in companies with good ESG practises can help us achieve these goals, but what happens if a company’s ESG practises fall short of our expectations? How can we exert influence to make them change? When we think about how best to achieve this across our investment portfolios, it can be tempting to think in binary terms. For example:

  • Do we work with the companies we invest in (directly and through our asset managers), using engagement to ensure they effectively manage all material ESG risks and then use our voting rights to reinforce this?
  • Or do we disinvest from companies with poor ESG practices? By disinvesting the risks from our portfolio, we could in theory drive down their share prices and increase their costs of capital, thereby incentivising them to up their game in ESG. 

In reality, both tactics need to be adopted. It’s not either/or but, rather, carrot and stick. Both approaches complement and improve on one another. Engagement can be more effective when accompanied with the threat of disinvestment, which should only be taken if engagement has not produced or failed to deliver a beneficial outcome.

Engagement is advantageous when:

  • Divestment may reduce risk-adjusted returns (unless values matter more than returns, which is challenging given that the fiduciary responsibilities of trustees prioritise good returns over other considerations).
  • There is potential to collaborate with other asset owners to significantly alter a company’s behaviour.
  • The problem is how a company conducts its business rather than what it does.

Divestment is encouraged when:

  • Engagement has previously been ineffective, and there is expected to be a modest impact on portfolio risk-adjusted returns if the relevant assets are removed from the portfolio.
  • The potential for the business model to become more sustainable is limited. 
  • A company’s fundamental operations do not correspond with the ideals of its investors (eg, controversial weapons).

Speak softly but carry a big stick

However, some people are opposed to divestiture. The fundamental argument against selling off assets that have a negative impact on the environment, for example, is that the purchaser may be a hedge fund or private equity company simply focused on extracting as much profit as possible from them without regard to popular ESG indicators. Additionally, assets moved from publicly traded to private enterprises may fall off the radar of the public disclosure of sustainability, causing emissions to grow. It’s been compared to throwing rubbish over the fence and hoping your neighbour will clean it up. 

Academic data also suggests that if your objective is to modify a company’s behaviour, engagement is often a better approach to take than rapid disinvestment.[1]

As a result, while not exactly a last resort, the threshold for complete disinvestment must be rather high. We chose to disinvest £226m from firms that did not fulfil our ESG requirements in 2020. The People’s Pension Trustee removed corporations implicated in the production of controversial weapons, severe ESG controversies involving human rights, labour, the environment, and corruption from our portfolios because of the risk they posed to the value of our members’ assets.

Portfolio construction techniques

Furthermore, portfolio construction techniques provide another avenue for incorporating ESG into our portfolios. We employ ESG factors to determine the weight of each firm in our portfolio across our core fund range, including the default option. We do this by allocating to strategies that hold greater weightings to firms with good ESG metrics, aiming for a 20% improvement in the MSCI ESG scores, as well as a 50% reduction in potential carbon emissions and a 50% reduction in carbon intensity relative to the MSCI World Index.

By incorporating ESG in this manner, we can enhance our portfolio’s ESG profile, lower the risks our members face, and incentivise firms that score poorly on ESG metrics to alter their practises without entirely disinvesting and losing our voice.


[1] https://scholar.harvard.edu/files/hart/files/exit_vs_voice_1230.pdf