Human capital is a “significant area” of risk for defined contribution members in default funds, Sustainalytics associate director Doug Morrow has said.

Speaking at the PLSA Investment Conference in Edinburgh today, 9 March, Morrow noted that over 90 per cent of DC scheme members are in the default funds and therefore they play a “critical role” within DC plans.

Based on the investment portfolios of default funds he explained that human capital, along with other areas such as data privacy and security are the most “significant areas of risk for default investors over the short run”.

This is because human capital is an important value driver for companies, especially in knowledge intensive industries such as banking and finance. However, companies are struggling to retain their workforce. Morrow noted that research has shown that companies with diversity programmes are more likely to retain staff. However, in a typical default fund, 35 per cent of companies have no diversity programme.

On data privacy and security, he said the issue has quickly evolved to one that is economy wide. Despite this, he noted only 12 per cent of companies in a default fund have a really good data security programme and 10 per cent have no policy whatsoever. Furthermore, Morrow said default funds are significantly exposed to climate change. He said passive ESG products are a “cost-effective” solution to reducing this risk.

On ESG in general he said: “In the early days it was about screening out companies…in recent years there has been a tremendous revolution with the main driver being increasing demand from asset owners, and secondly, a growing body of evidence that suggest integrating ESG factors can have positive risk and return benefits”.

Enthusiastically, a poll of audience members at the beginning of the session found that 90 per cent believe that ESG investment is consistent with a pension funds’ fiduciary duties, this figure increased to 95 per cent by the end of the session. Furthermore, energy and emissions and human capital were seen as the main ESG risks by the audience.

HSBC CIO Mark Thompson said with their pension scheme ESG is integrated into all fund manager visits and with new manager they have to be confident that they have a good ESG process. He said everything they do in relation to ESG is consistent with their fiduciary duty.

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