Removing the behavioural barriers to better Pension Scheme Trustee engagement with Environmental, Social and Governance risk factors

Senior Visiting Fellow Chris Wagstaff writes on how informed and engaged Pension Scheme Trustees can build coherent ESG policies into their investment strategy.

As Trustees of UK occupational pension schemes are well aware, all trust-based schemes now have to set out how they take account of financially material risks. Crucially, these include material Environmental, Social and Governance (ESG) risk factors, notably climate risk, prospectively the most material and systemic ESG risk of all. However, only if the why and the how of managing ESG risk factors is more clearly framed and explained, and the behavioural barriers to more widespread adoption of coherent ESG policies and responsible investment frameworks are overcome, will ESG risk management become an integral component of the trustee risk management toolbox.

When taking a position on managing Environmental, Social and Governance (ESG) risk factors, Trustees are impeded by a number of barriers. Firstly, they don’t always have the available information, or the information framed and explained in such a way, to make an informed decision about what constitutes a coherent ESG risk management policy, or responsible investment framework. However, running a close second is Trustee engagement with ESG risk factors being compromised by myriad behavioural factors - those cognitive biases that enter into individual and group decision making which, if left unchecked, result in sub optimal decisions. Indeed, we should never underestimate the extent to which well documented behavioural biases can hinder our decision-making, dampen our thinking and limit our effectiveness.

Behavioural barriers to Trustees engaging with ESG risks

So what are those very human behavioural factors that impede Trustee engagement with ESG risk factors and their management?

Appreciating that many Trustees do not understand what “ESG” stands for, the first behavioural bias the investment industry has to recognise it succumbs to is the curse of knowledge. Simply put, people often forget what it’s like to not be familiar with a topic and talk in acronyms and platitudes which alienate the intended audience – in this case, Trustees. This is compounded by the false-consensus effect, when people overestimate the extent to which their beliefs, values and opinions are shared by others. Therefore, if Trustees are to engage with what they are being told on how to manage ESG risk factors, the information needs to be presented in simple, relevant and, ideally, scheme specific terms. In short, it’s not what you say, it’s the way that you say it.

Then there’s the fact that none of us are perfect decision makers, Trustees included. In reaching decisions we each operate under conditions of uncertainty and incomplete information which, coupled with limited cognitive abilities, means we are predisposed to overly rely on intuition and taking mental shortcuts. Perhaps unsurprisingly, in simplifying the complex reality of decision making, many decisions tend to be sub optimal. Moreover, given that people act differently in groups than when acting alone, the sub optimal nature of this decision making can often be compounded within certain group structures; Trustee boards and committees included.

Group decision making obstacles to managing ESG risk factors

A combination of the tendency to observe what others do as a cue to our own behaviour, the fear of facing insurmountable opposition from our peers if we mess with the consensus and a reluctance to change things, whether as a result of inertia, anchoring or the status quo bias, can stop an individual Trustee from raising the lack of engagement with ESG risks as a concern if the Trustee board as a whole appears to regard it as a subsidiary matter. The result is that individual Trustees may recognise the management of ESG risks could play a core role in improving the scheme’s risk management but do not believe their peers are sufficiently forward-thinking to revaluate their existing positions. Therefore, the group consensus may not be an accurate reflection of the individual Trustees’ collective views, in that there could be more support than the current consensus suggests.

In fact, the cognitive, or behavioural, impediments to group decision making are manifold with groupthink posing the biggest risk to achieving optimal decisions. Responsible for some of history’s greatest disasters, groupthink, the culmination of unchallenged decision making that results from group homogeneity, or single mindedness, is endemic among decision making bodies with dominant personalities, and little, if any, cognitive diversity and independent thought.

When it comes to group decision making the size and composition of the group is paramount. Indeed, smaller decision making bodies, especially those whose members have defined accountabilities, tend to perform better than large, while cognitive diversity, deriving from differences in gender, age, ethnicity, socio economic, educational and cultural background further optimises the decision making process, through different viewpoints being expressed, genuine challenge and debate. When it comes to group decision making, being different is just as important as being smart, if not more so.

Yet another notable obstacle to optimal decision making within groups is social loafing. People feel less responsible and accountable in groups in that individuals, particularly those who lack visibility and accountability within the group, tend to exert less effort on a group task than when they work alone. Indeed within Trustee board and committee meetings, especially when the group contains dominant individuals, there is often a tendency to sit back and let others in the group do the heavy lifting - the debating, the challenging and ultimately take the big decisions, even if some of these individuals succumb to twaddle tendency – the inclination to speak just to be heard. As Mark Twain once said, “if you have nothing to say, say nothing”. Without individual accountability for the decisions taken, this diffusion of responsibility often means there is a propensity to hide behind group decisions. Moreover, this can also result in riskier decisions than if the decisions had been taken by individual members acting alone.

Then there’s social proof. As social animals we are heavily swayed by others in our actions and opinions and therefore their biases. This is often driven by the, sometimes erroneous, belief that others, particularly the more dominant group members and those we perceive as experts, possess greater knowledge or an informational advantage. Its influence is particularly strong on newcomers to the group or those that consider themselves subordinate to others. As such, exercising independent thought and offering a dissenting view can be uncomfortable when others in the group, not least the more dominant group members, have reached a consensus, even if this apparently widely held view is blatantly wrong and rails against common sense. Indeed, in an environment where fear of messing with the consensus stops individuals with opposing views from raising strong objections will often see illogical decisions go unchallenged. Moreover, the greater the apparent consensus, the harder it is for individual group members to challenge that consensus. The result is, of course, groupthink.

However, group decision making isn’t always destined to be sub optimal. As noted above, small groups that are sufficiently cognitively diverse trump large groups that are not. Moreover, small and cognitively diverse groups, can make collectively wise decisions, more so than if the decision was made by the smartest individual in the group, if four necessary conditions are met. These comprise: individuals acting independently of one another, only participating in the discussion if they have an insight, voting simultaneously and the group employing a mechanism to capture and consider all viewpoints. The two latter conditions are typically performed by the group chair. In exercising strong and unbiased leadership, by guarding against the order in which people speak having a profound effect on the course a discussion takes, and refraining from swaying opinion, a good chair will protect dissenters and independent viewpoints, so ensuring that all perspectives are captured prior to a decision being made. Indeed, a practical and powerful step to alleviate groupthink is for Trustee boards to individually complete questionnaires in relation to their ESG beliefs. After all, it is often the information that individuals fail to share with others that holds the key to arriving at the right decisions. And don’t forget pre-mortems. By analysing what could go wrong before a decision has been implemented can minimise any subsequent decision regret. 

Socialising ESG engagement and overcoming myopia 


Pension schemes are notable for two particular traits: (1) not wanting to be the first mover into a new asset class or investment strategy, and (2) keeping a beady eye on what other schemes are doing.

When it comes to being the first mover, invariably it’s the largest schemes, with the most advanced governance, and who have access to the very best advice and due diligence expertise (especially the ability to price, absorb and diversify risk), who are the early adopters of new thinking. Indeed, many of the very biggest schemes, albeit prompted by regulators and policymakers, have been frontrunners in adopting coherent ESG policies and responsible investment frameworks. Therefore, it probably comes as no surprise that as greater numbers of larger schemes adopt responsible investment principles and the accompanying risk management framework as standard procedure, smaller schemes have started to take note.

This process, of schemes comparing and benchmarking themselves to others, engendering a momentum shift in replicating what these others are doing, is known as socialisation.  Socialisation, which is used extensively in the public policy world, can, through publicising positive social group behaviour, also be used to accelerate the widespread adoption of desirable behaviours by others in that cohort. Indeed, as noted earlier, as social animals our actions are largely driven by the actions and opinions of others, especially those perceived as experts. However, if the actions of the first movers are to filter down in a wholesale fashion, one must correctly frame the desired behaviours so as to create a positive social norm. Only by clearly explaining why and how to manage ESG risk factors effectively and the methodologies that others have successfully adopted will socialisation have the desired effect of creating a collective change in behaviours. After all, there are myriad examples where, because of poor messaging, or framing, socialisation has had the opposite effect.

With the right group decision making structures in place, the resulting momentum shift should allow those Trustees, who have hitherto been wary of being ESG flag bearers, to ensure core ESG risk factors are treated as an integral component of schemes’ risk management. Moreover, as most Trustees tend to be loss averse (partly by virtue of how Trustee fiduciary duty is framed), in that they fear being burned by risks that others have avoided, a more complete understanding of the hidden risks that fall under the extremely broad “ESG” acronym can only accelerate Trustee engagement.

Overcoming myopia

Another common behavioural factor that impedes trustee engagement with ESG risk factors and their management is myopia, or present bias – a predisposition to ignore the distant future in favour of more immediate imperatives. Indeed, in most aspects of life, anything more than two years out tends to fall off the radar. This is particularly true of climate change, the full, potentially cataclysmic impacts of which, have failed to register with most and probably won’t do so until its effects are more readily observable.

This, of course, leaves many pension schemes exposed to risks that may have a material asset and, in the case of defined benefit (DB) schemes, a covenant and/or liability impact – risks that should be identified, evaluated and managed far in advance of their impact materialising. On the asset side of the pension scheme balance sheet, there is a very real risk of financial assets with either prominent underlying ESG risks or strong ESG credentials being materially repriced far in advance of company balance sheets, physical assets and the real economy being impacted. Therefore, as we move from an environment of climate stability to instability, there is a potential first mover advantage of overcoming myopia if these asset repricing risks, which might otherwise compromise the ability to generate long-run sustainable returns, are to be properly managed.

However, if myopia is to be overcome, then the future needs to be made more salient. That is, the future needs to be moved from back to front of mind. In other words, Trustees need to able to better identify with the distant future and understand how those potential risks might impact their scheme and what mitigating actions need to be taken ahead of the curve. 

Indeed, just as public policy measures are used to engender socialisation to collectively change behaviours, so behavioural measures to make the distant future more salient are used by policymakers to overcome myopia. However, when it comes to pension schemes, investment consultants and asset managers also have a pivotal role to play in using these behavioural interventions to improve Trustee engagement with material ESG risk factors and transform short-term mindsets. In fact, as many investment consultants and asset managers have fallen victim to the same behavioural biases as many Trustees, the contention remains that most don’t challenge Trustees enough to reach outside of their comfort zone.

Indeed, because many ESG risk factors, notably climate change risk, take us into new and uncharted territory, and will invariably impact almost everything that we consider today to be “normal”, there needs to be much more informed independent thinking around the topic and potential mitigating actions. After all, herding in uncharted territory is not a wise strategy if standing on a steep cliff and the view ahead is foggy.

Time to remove the behavioural barriers to managing ESG risk factors

While not immediately apparent, we’ve seen that there are some very human behavioural factors that impede trustee engagement with ESG risk factors and their management. Most stem from group decision making dynamics. The good news is that group decision making isn’t always destined to be sub optimal in that very few of these surreptitious cognitive barriers to better group decision making are insurmountable.

Indeed, groupthink, the bias which poses the biggest risk to the adoption of integrating ESG risk factors to investment decision making, and those biases that lead to groupthink, such as social loafing, diffusion of responsibility and social proof, can typically be avoided by moving from a large and homogeneous group of decision makers to one that is smaller and more cognitively diverse. One that welcomes different viewpoints, genuine challenge and debate. As noted earlier, when it comes to group decision making, being different is just as important as being smart, if not more so.

An equally powerful antidote to this most destructive of biases is to seek individual trustees’ ESG beliefs in a decentralised, rather than centralised, fashion to ensure that all viewpoints are captured. After all, it’s the minority viewpoints, those that are often ignored, which hold the key to better decision making as it forces the majority to more rigorously interrogate their own positions. However, as noted earlier, protecting dissenters and independent viewpoints demands strong and unbiased leadership from the group chair.

Of course, improving Trustee engagement with and management of ESG risk factors not only comes down to managing group decision making biases. Crucially, clearer framing and explaining of why and how to manage ESG risk factors, engineering positive socialisation and taking measures to make the future more salient today, will also invariably see more widespread adoption of coherent ESG policies and responsible investment frameworks and ESG risk management becoming an integral component of the trustee risk management toolbox. All of which can only be a good thing for member outcomes, especially those with a long investment horizon.


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