UK defined contribution (DC) pension schemes are "swimming against a tide" of global environmental, social, and governance (ESG) backlash and increasing their allocations to funds with climate targets, according to analysis from Barnett Waddingham (BW).

The research found that most pension providers continued to recognise the financial materiality of sustainability issues over the past year, with a 34 per cent increase in allocations to funds with a climate target in the growth stage since BW’s first DC sustainability report in 2021.

It also showed a “clear and accelerating trend” among DC scheme providers to embed carbon emission reductions into their default strategies.

This shift has gained significant momentum over the past four years, demonstrating tangible progress in aligning portfolios with global targets and the Paris Agreement.

However, BW highlighted that 35 per cent of DC scheme growth assets were exposed to investment managers who have “stepped away” from climate collaboration initiatives, creating a “misalignment” with global asset managers on sustainability.

Indeed, BlackRock, Vanguard, State Street and Northern Trust have all recently exited the Net Zero Asset Managers (NZAM) initiative and Climate Action 100+ (CA100+).

The total assets under management of these firms stand at $25trn, representing roughly a quarter of global GDP in 2024.

These exits are part of a broader trend, with 71 investors leaving CA100+ since June 2023.

BW said this exodus had been triggered by growing anti-sustainability sentiment, particularly in the US, exemplified by accusations that asset managers are overstepping their fiduciary duties, which has even led to legal action by 11 US states.

Nonetheless, BW partner and head of DC investment, Sonia Kataora, said that despite the winds of change blowing in a new direction, DC providers were holding firm and sticking to their guns on sustainability.

“This is critical if they are to uphold their roles as stewards of capital, achieving the best outcomes for members financially,” she added.

Indeed, the firm warned that the industry must find a way forward to achieve the best outcomes for members and has urged it to “embrace complexity” when it comes to ESG.

It explained that high scores in leaderboards don’t necessarily mean providers were driving meaningful change, while schemes scoring more lowly were not always failing their members on climate initiatives.

This means DC providers should not "blindly" reduce emissions, but must regularly reassess their net-zero targets to manage unintended financial risks.

A key test will be interim targets set for 2030, for which providers should not be afraid to “recalibrate accordingly,” BW said, as delivering for members means balancing portfolio decarbonisation with managing climate transition and physical financial risks and, as much as possible, driving lower real-world emissions.

Meanwhile, for those DC providers facing a difference in opinion with their investment managers, BW is calling on providers to improve their monitoring, take more control of voting, and take an active role in reviewing manager decisions and initiatives.

Kataora described it as a “tumultuous time,” both in terms of the global anti-ESG backlash and the "seismic" changes to policy and structure of pensions coming from the upper echelons of the UK government.

“Those pushing for minimum size thresholds for DC providers must remember that scale alone does not guarantee sophistication,” she urged.

“Larger providers can wield significant influence by directing capital away from underperforming managers, and they have a unique position to push for stronger stewardship and set higher standards for responsible investment,” Kataora continued.

“But smaller schemes can also use their powers effectively, focusing their resources on the things that really matter to their members and collaborating to impact policy; some of the leaders of the pack on good ESG are smaller schemes,” she added.

This article was originally published on our sister website, Pensions Age.

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