As the economy moves towards low-carbon alternatives, how do pension funds put pressure on those companies failing to keep pace? James Phillips explores
Pension schemes are becoming increasingly aware of the risks, both physical and financial, posed by a warming climate.
Last month, the National Employment Savings Trust (NEST) launched a climate aware fund with UBS in order to tackle their exposure to risky investments in high-carbon companies.
The strategy uses a ‘tilted' approach to investment: Carbon-heavy firms will see pension fund shareholdings reduce, while those working towards a low-carbon transition will see them boosted.
However, the fund does not have an immediate exclusion policy, stopping short of the divestment approach that some advocate and several local government pension schemes have taken.
For trustees concerned about environmental, social and governance (ESG) issues and exposure to high-carbon companies, is divestment or underweighting likely to provide the best results?
As the world shifts towards a low-carbon economy, the benefits of investing in fossil fuel companies or high-carbon economies may become fewer and further between.
As such, there is a degree of risk in being exposed to these firms, and reducing investment in them now can take away some of that risk before it becomes too late.
ShareAction chief executive Catherine Howarth says the only way is down for these companies, so trustees should begin moving investments.
"The writing is on the wall for extremely high-carbon emitting companies and it has been since the Paris agreement in December 2015," she says. "There are listed companies held by pension schemes which are not well-positioned for the transition to a low-carbon economy.
"Defined contribution pension schemes, which are long-term and have lots of younger members, are exposed to long-term risks and should be taking action. Trustees not looking at these factors and taking climate risks into consideration for savers in default schemes are breaching the duty of prudence."
Waltham Forest Pension Fund committee chairman Simon Miller, who is also a Labour councillor for Leyton, says the world is moving towards a low-carbon economy and funds need to keep up.
"Legally-binding carbon targets are a reality both in the UK and elsewhere," he says. "At the same time, the cost of alternatives has fallen dramatically and looks set to fall further, with significant new investment taking place globally.
"Taken together, these developments have made carbon-free investment a much more attractive proposition, but have also increased the risk that funds with significant investment in carbon-heavy companies may be left stranded with assets and sooner than had previously been anticipated.
"Alternatives increasingly not only make sense but deliver on investment targets with real long-term benefits."
Waltham Forest's pension fund has recently embarked on a five-year journey to completely divest from fossil fuels by 2021. It is hoping to remove its 2.2% exposure to high-carbon investments, and instead allocate assets to sustainable equities.
Miller says divestment was both important in terms of reducing risk, as well as improving the general health of the environment and population.
"As a fund, we are clear that we need to have a sustainable and viable fund that delivers for our members," he argues. "It is our view that investment in fossil free is a part of that mix.
"As a London borough that is doing all it can to combat the significant health impacts of air pollution, it would be odd if we did not use all tools at our disposal to do that.
"This includes, where possible and in line with our investment strategy and our fiduciary duties, making certain that our investment decisions do not cut across improvements we are seeking to make for our residents and communities."
Full divestment does help to remove the immediate risk posed by high-carbon companies, but does it provide enough effect to cause the company to reconsider its approach?
PTL managing director Richard Butcher argues full divestment limits the opportunity to persuade companies to change.
"Divestment is quite a negative strategy," he says. "If you dump a company, then you are giving up on it; you are accepting the fact that it will continue to be dirty.
"If what we want is a better world, you've got to engage with them and apply pressure. If you dump them, somebody else will pick them up and they won't care about ESG issues."
NEST has adopted an underweighting strategy for high-carbon companies, as opposed to full divestment, in order to maintain a dialogue with the company and press it to consider its carbon footprint.
By just reducing shareholding, the company may engage with the pension funds, enabling fund managers to push for change in these firms.
If that doesn't work, NEST may then vote against company policies at annual general meetings on items such as remuneration policies to register its discontent.
Howarth welcomes the approach, stating it helps to truly understand a company's position on ESG factors.
"These funds are interested in a dialogue with the investors of these companies to understand whether they have a ‘head in the sand' attitude, or whether they are actually transitioning their business models to be resilient, competitive and successful in a world in which carbon is constrained," she states.
Miller adds that NEST by itself may not be able to influence change, but promotes the strategy to other funds considering tackling the risk.
Yet, if there comes a point where it becomes apparent the underweighting strategy is not working, should funds then move to divestment?
"This is not set in stone," Miller argues. "Funds should move when it is right to do so and there will be numerous factors that inform that decision. But there is clearly a direction of travel and a growing imperative to move and I suspect that underweighting, while important, will only be a temporary part of the investment landscape."
For schemes interested in boosting ESG action in companies they are invested in, the use of underweighting may provide some leverage and result in greater engagement with the company.
Nevertheless, the idea probably requires some widespread take-up to really cause any big changes in approach.
The government will set up an infrastructure bank to support investment and to co-invest alongside investors including pension funds.
The Retail Prices Index (RPI) will be reformed and aligned with the housing cost-based version of the Consumer Prices Index, known as CPIH, by 2030, the Treasury has confirmed.
Estatee agent denies a shareholder’s absence from voting is an issue, finds Minerva Analytics.
In this live blog, Professional Pensions' sister title Investment Week collates all the breaking market news, analysis and opinion on equity, bond and currency movements as well as the impact of trade wars, tightening monetary policy and the Brexit negotiations....
Attractive valuations and prospects for economic recovery support small-caps