“The high priests of finance.” That is how one UK-based pension fund trustee recently described investment consultants to Capital Monitor, to stress the huge influence they have in driving retirement schemes’ investment decision-making. They screen and advise on funds and mandates, provide research and advice on portfolio construction, and in some cases compete directly with asset managers by running asset portfolios. 

To put it another way, investment consultants exercise significant – and in some cases potentially excessive – influence, particularly among smaller clients, said the UK’s Taskforce on Pension Scheme Voting Implementation (TPSVI) in its report on pension scheme voting in September last year. 

Yet the likes of Aon, Mercer, Willis Towers Watson (WTW) and their peers are seen as falling well short in an area where they could have a big impact: helping to drive ESG integration and sustainable investment strategies, and ultimately to reduce portfolio emissions, among their institutional client base.  

The pensions industry is moving too slowly on ESG, and consultants are partly to blame, said Alexander Stafford, British Member of Parliament and chair of the all-party parliamentary group for ESG. He was speaking last month at the Pension and Lifetime Savings Association ESG conference. 

A need to step up on ESG

Investment consultants act as a vital conduit in the investment industry but are not stepping up enough on ESG, a former investment consultant turned executive at a life and pensions firm tells Capital Monitor. They are typically not, for instance, pushing pension schemes to engage with their asset managers on ESG matters or helping them to construct lower-emission portfolios.

There are exceptions though, the executive adds, citing London-based Redington as an example of an “outlier”, having been set up with sustainability advice in mind from the get-go.

Investment consultancies do seem aware of the issue, with various companies publishing reports on ESG and engagement and touting the benefits of sustainability. And the UN Principles for Responsible Investment published an asset owner guide to investment consultants and ESG in 2019. 

Nor are investment consultants short of scale: they advise on the allocation of trillions of dollars worldwide. The 14 biggest pension consulting companies earned £1.95bn ($2.56bn) in revenue from their UK business last year according to the latest annual survey by Professional Pensions, published in February.

The former investment consultant thinks the advice shortfall may be a question of consultants sticking to what they know. “It may well be a capacity issue and connected to where their capabilities lie. They would probably rather do something they already know how to do and are comfortable with that makes them money, like liability-driven investing.” 

Consultants’ business model a barrier?

Others suggest that the consultancies’ business model may be a hindrance.  

The investment consulting model – based largely on researching investment managers using a standard finance theory framework – “is being seriously challenged by wider ESG risk concerns”, says Mike Clark, founder of Ario Advisory, a UK-based responsible investment consultancy. 

Systemic change is key, but the incentive structure for investment consultants also needs updating, argues Charlotte O’Leary, chief executive of Pensions for Purpose, a UK organisation that seeks to act as a bridge between asset managers, pension funds and their advisers to encourage the flow of capital into impact investments.  

“In their statement of investment principles, pension funds can add in how they tie ESG objectives to the incentive structure of their adviser and managers, but no one ever does it,” she says. 

In any case, investment consultants should be raising the level of their advice in this area, which is “very inadequate” in many cases, O’Leary adds. 

Similarly, the TPSVI in its September report blames the consultancies’ fee-driven business model and suggests they are not adequately communicating the views of pension fund trustees and asset managers to each other. 

That may come down at least partly to consultants’ conflict of interest between their pension and asset management clients, says the TPSVI paper. There is anecdotal evidence that investment consultants do not want to alienate asset management clients so are not always supportive of trustees who are looking to be more robust on voting issues.  

Regulatory drivers

Some market participants feel that regulating investment consultants’ business in the UK might help matters. No part of their business is directly regulated, despite the huge influence they exert over the pensions industry. 

The UK Competition and Markets Authority had been considering setting rules for the industry after a review in 2019 but so far there has been no movement on that front.  

There should be a minimum standard for investment consultants to hit, O’Leary says, but the key policy would be clarifying how ESG is part of fiduciary duty.  

For their part, UK pension funds and their trustees are unlikely to be pushing hard against the status quo – ultimately, they tend to do what their consultants propose, says the former investment consultant. 

Pension fund trustees – who are often lay people rather than financial experts – rely heavily on consultants’ advice. There is also a lack of scale and human resources at many British pension funds, as the market is highly fragmented. 

esg investment consultants
Anastasia Guha, head of sustainable investment at Redington, says pension trustees’ knowledge of climate change has improved markedly in the past two years. (Photo courtesy of Redington)

Change is under way, though, as both the members and investment executives of pension plans become more sustainability-aware, at least partly as a result of regulation. In addition, in the local government pension scheme segment, the combining of resources and assets in larger pools in recent years means such funds are becoming better able to afford ESG talent and wield influence over their asset managers and investee companies. 

There has been a marked development in pension trustees’ knowledge and discussions around climate change in the past two years, says Anastasia Guha, investment consultancy Redington’s global head of sustainable investment. This has been triggered by recent regulation, such as mandatory Task Force for Climate-related Financial Disclosures (TCFD) reporting for UK pension schemes with £1bn or more in assets and the integration of ESG into statements of investment principles (SIPs), she tells Capital Monitor.

Change is afoot on ESG

Accordingly, investment consultants are seeking to build up their ESG and sustainability expertise and offerings.

The industry has also increasingly been working together to this end. The Investment Consultants Sustainability Working Group (ICSWG), a UK-focused industry group, was launched in September 2020 by 12 consultancies, while the Net Zero Investment Consultants Initiative (NZICI) was set up in September last year as part of the Glasgow Financial Alliance for Net Zero (Gfanz). 

The ICSWG covers nearly the whole UK consulting market, incorporating 17 companies, including the three biggest by revenue: Aon, Mercer and WTW.

The initial core focus of the ICSWG is climate change, but it aims to expand to cover other areas, such as social issues, says Luba Nikulina, global head of research at WTW and chair of the ICSWG. WTW engaged last year in a UK government consultation on how pension funds consider social issues, she adds. 

Guha says it is rare to see consultants working collaboratively in this way, describing it as “self-regulation” and expressing optimism about the future of this approach. 

Moreover, the NZICI will help member firms play their role in the investment chain to drive the fulfilments of obligations to the Paris Agreement, says Nikulina. The members, which represent some $10trn in assets under advisory, commit to embedding net-zero considerations in all their advice.  

That ensures that when consultants assess and appoint asset managers, they hold them to certain standards in respect of their emissions-reduction strategies. For example, asset managers are expected to look at their portfolio companies’ carbon emissions, transition plans and level of alignment with net zero, she says. They also collaborate with other Gfanz groups, such as the Net Zero Asset Managers initiative and the Net-Zero Asset Owner Alliance. 

NZICI members commit to reporting net-zero progress on an annual basis, and there is a delisting mechanism for those that fail to do so. The first reports will come out in early 2023, and the group is also discussing producing one before Cop27 this year. 

Consultants trying to keep up

In response to some of the criticism levelled against her industry, Nikulina says in the “fast-evolving field” of ESG, what is considered good and best practice changes very quickly, “even if you think that you have it figured out”. 

In addition, investment consultants need to appreciate whether pension trustees have the bandwidth and governance to absorb ESG advice, Nikulina adds. “Everyone is trying to find the resources and time to pay more attention on the topic.” 

Whether the UK’s investment consulting industry more broadly will live up to its claims of helping its clients reduce their portfolio emissions and achieving net zero remains to be seen. It will need to go much further than it has already, on current evidence. 

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