Pension scheme trustees should challenge their investment consultants to ensure the environmental, social and governance (ESG) practices of their fund managers are aligned to their schemes' objectives, according to XPS Pensions Group.

The firm’s ESG Ratings Review 2021 stated that although the UK fund management industry had demonstrated “strong progress” in ESG risk management, improvements were still needed.

It revealed that 23 per cent of UK investment funds were awarded an ‘XPS green rating’ for ESG, up from 10 per cent last year.

However, it also found that greenwashing remained a risk, with 11 per cent of all funds and 26 per cent of equity funds unable to provide any examples of E, S or G factors being taken into account in investment decisions.

Pension trustees were encouraged to take time to clarify their beliefs and priorities around ESG, challenge their investment consultants to undertake due diligence of their portfolios to ensure fund managers are aligned with these priorities and engage with managers to ensure effective stewardship.

XPS also urged trustees to make changes to their portfolios if needed and consider using sustainable funds that go beyond the minimum expected standards of ESG integration.

There were “clear areas for improvement” for the fund management industry on ESG risk management, according to the report, including the stewardship by fund managers and progression in carbon footprint reporting.

Fixed-income funds were found to be able to most consistently evidence robust integration of ESG compared to other asset classes, while private markets were “beginning to make some headway” in factoring ESG into decisions.

In 2020, 60 per cent of funds references ESG in their investment policies, while this year all of them did.

Commenting on the findings, XPS chief investment officer, Simeon Willis, said: “While the findings clearly show that there is a lot more work to do, it is promising to see that fundamental parts of a good ESG strategy are being put in place across the board.

“Effective ESG risk management must be underpinned by a clear ESG philosophy, and most firms now have this essential foundation in place. But managers must move beyond words to actions for this to matter, and this needs to be consistent across all their funds and be well communicated to clients.”

XPS head of research, Alex Quant, added: “We are particularly pleased to see private markets begin to show signs of progress when it comes to ESG. It points to demand from asset owners for information and change. As scrutiny continues to grow, fund managers will increasingly be compelled to reveal what they are doing in practice.”

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