Premier Miton’s Head of Responsible Investing
The squeaking wheel gets the most oil?
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
It is estimated that transitioning to a low-carbon, and climate resilient economy, and more broadly ‘greening growth’ over the next 10 years to 2030 will require significant investment and consequently private sources of capital on a much larger scale than previously experienced. With their huge asset base pension funds – along with other institutional investors – potentially have a role to play in financing such green growth initiatives.
The current challenge is whether there are more pressing issues in hand for pension schemes and ESG driven investing must wait in turn? In my view the last 12 months have been challenging for pension schemes. The war in Ukraine and the subsequent oil price shock has meant many portfolios with a focus on investing in low carbon or ‘net zero’ companies have underperformed their benchmarks. This, quite rightly, will always raise questions as part of a pension schemes fiduciary responsibility.
The challenge will be around whether it is in the best interest of a scheme and its members in terms of pure financial returns to structure a portfolio which is focused on investing in rapidly decarbonising companies. The long-term climate benefits of this approach we feel are clear and well documented, but the financial outcomes less so.
Making reporting more than a ‘box check’ exercise
A big shift across industries has been increased climate reporting requirements. The challenge we see for pension schemes is to ensure that the outputs from more resilient reporting is both understood and used effectively in decision making.
Looking at this development, climate reporting for example through the CDP (Carbon Disclosure Project) can take a few years to deliver accurate data and results, so patience is very much key in this area.
The balance between qualitative and quantitative metrics to best describe a portfolio’s characteristics will also take time to develop. As with the now well-established financial risk metrics, as more consistent climate reporting across the market develops, the data will become more stable and will be increasingly useful for pension schemes to support investment decision making.
Sticking to net zero commitments
A number of pension schemes and pension providers have made net-zero commitments in recent years, and support for the UK stewardship code has grown. This is where enhanced reporting and using the data that comes out of this effectively has a massive role to play.
The work around making net zero commitments starts with data and defining key metrics and targets. A clear beneficiary here has been the ESG data providers. For pension scheme portfolios, building a net zero investment strategy often comes to fruition when material asset allocation decisions are made to move holdings from high carbon to lower carbon assets. This can happen alongside increasing stewardship focus on the investments in the high carbon assets, and challenging companies or 3rd party fund managers around their existing climate policies and implementation.
The result of these actions has led to increased flows into sustainable and ESG labelled funds. However, there is a huge amount of pension scheme capital that remains invested in high carbon producing assets. This is arguably due to the uncertainty of returns, the time horizon for those returns and low levels of government support for low carbon focused technology and products. There is a clear lag effect here that as an industry we can work to bridge, but the luxury of having decades of time is not on our side.
In terms of stewardship activities, initiatives such as Climate Action 100+ continue to grow and are leading to better disclosure and commitment from companies, as this is ultimately an investor-led initiative. To build on Climate Action 100+ and use it as a platform for further progress, investor engagement needs to move on from focusing on corporate disclosure to driving material capital redeployment.
Building on new government infrastructure
Quite rightly it is not just the private sector focusing on climate change. There are several climate-related regulatory requirements on the horizon, including the Treasury’s updated green finance strategy.
The update to the UK green finance strategy alongside the new government department of energy security and net zero can potentially be a game changer for the UK and its pensions sector, if it focuses in on encouraging the low carbon sector and supports the required investment in related jobs and skills.
The establishment of this government infrastructure and funding ability could help pension schemes build further long-term confidence around investment in areas such as green infrastructure and innovation in green energy. The new rules on TCFD (Task Force on Climate-related Financial Disclosures) reporting requirements will support longer term investment once the initial reporting requirements are established and working well. The TCFD’s reporting focuses on the impact an organisation has on the global climate. It seeks to make firms’ climate-related disclosures more consistent and therefore more comparable.
Looking through the cost of living crisis
I believe that the cost-of-living crisis will prove to be a positive for climate efforts. Firstly, governments are starting to realise that investing in and supporting low carbon industry can be a boost to economic growth. This has been an important driver of legislation elsewhere such as the US Inflation Reduction Act which we believe will drive a step change in investments in new technology such as Hydrogen and Carbon Capture.
Secondly, at the localised level, companies and consumers looking to reduce energy and food costs, will in turn lower their carbon footprint via more efficient consumption and production.
Thirdly, the establishment of the new government department for energy security and net zero has the cost-of-living crisis at the heart of its mandate: Securing our long-term energy supply, bringing down bills and halving inflation. In addition, we see a growing recognition that renewable energy as well as being a low carbon alternative, with the right infrastructure in place can be cheaper per unit than fossil fuels.
Finally, looking at the social challenges highlighted by climate change we realise the interconnectivity of issues in areas such as air quality, health, biodiversity and wellbeing. The social impacts of climate change need to be considered in parallel and whether this is retraining for new jobs in green sectors or migration from countries with extreme weather, it needs to be part of the climate effort plan at outset, rather than an afterthought.