Local funds find ESG advantages through pension investment pools

Like many asset owners, one of the biggest challenges for U.K. local government pension schemes and their investment pools is how to address ESG issues, starting with the transition to a low-carbon economy.

Many of the LGPS pools have committed to net-zero greenhouse gas emissions in their portfolios by 2050, and some have set daunting deadlines as early as 2030. London LGPS CIV Ltd. chose 2040 to send "a clear signal to all our clients, managers and investee companies about urgently addressing this increasingly material issue," according to its April 2022 policy.

More movement is expected this year, as local pension funds and their pools prepare for new climate-related reporting requirements from the U.K. government. The government has already rolled out new reporting rules on climate risk and opportunities for large corporate pension funds, based on the principles of the Task Force on Climate-related Financial Disclosures. In October, the threshold will be expanded from pension funds with assets of £5 billion ($6.2 billion) to those with £1 billion or more. Local government pension schemes — already required to report on environmental, social and governance factors that could be financially material to investment performance — expect to be next.

The LGPS pool system allows local pension funds that are at various stages of their net-zero journey to pick their pace and approach.

A new global multifactor passive equity fund with a climate focus managed in-house by LGPS Central Ltd., Wolverhampton, was launched with initial allocations from two partner pension funds. The FTSE customized index tilts the fund away from companies with greater carbon emissions and the most carbon-intensive fossil fuel reserves toward those with green revenues. With partner funds having different approaches to ESG, LGPS Central worked with them to determine the mandates for the three subfunds of the global sustainable equities active fund, to fit their respective risk budgets, said Mark Davies, investment director for active equities. LGPS Central has £49 billion in combined assets.

At London CIV, managing £27.9 billion for 32 client funds in London, "the overarching thing is ESG, and particularly net-zero," said CIO Jason Fletcher. The pool offers LGPS fund clients what he calls "a temperature gauge," partnering with S&P Global Trucost to "effectively test the temperature of their portfolios," Mr. Fletcher said. "We have got to make sure we deliver what we say on the tin," particularly before TCFD reporting requirements could kick in, he said.

Within the broader scope of responsible investing, "there is a debate that the funds need to have. Is it exclusion, or is it investing to improve?" said Colin Cartwright, a partner at Aon PLC in London who consults with LGPS clients.

Many of the pools are in the process of answering that question as they set or update responsible investing policies, and some are engaging sustainability consultants to help. London CIV is working with Federated Hermes Inc. to combine policies on corporate engagement and proxy voting, after consulting with partner funds on their goals. "I see it as a service, but when you add engagement, it actually adds to return," Mr. Fletcher said.

The £55 billion Border to Coast Pensions Partnership, Leeds, engages directly with companies through its investment stewardship partner, Robeco, and collaborates with other investors on shareholder resolutions, corporate engagement and other tactics, all with the ultimate aim of delivering more sustainable risk-adjusted returns for partner funds, it said in a recent report.

Border to Coast integrates ESG factors into the investment process, including carbon screens for all equity and fixed-income funds. It also has an ESG monitoring framework for external managers. In an ongoing search for a new £1 billion emerging markets equity alpha fund, managers will be assessed on the integration and reporting of ESG issues and their active engagement with companies.

For its own engagement, "we revised our engagement themes to focus our efforts on areas where we believe we can really make a difference and improve investment outcomes, through managing material risks and working with like-minded investors," said Jane Firth, head of responsible investment for Border to Coast. Its four ESG themes are low-carbon transition, waste and water management, social inclusion and labor management, and diversity.

Brunel Pension Partnership Ltd., Bristol, managing £35 billion for 10 local government pension funds, often collaborates with other investors on shareholder resolutions. Recent ones include pushing the HSBC banking group to set targets to reduce its exposure to fossil fuel assets, and one asking U.K. grocery chain Sainsbury's to introduce a living wage.

In its 2022 responsible investment and stewardship report released May 11, Brunel Pension Partnership moved biodiversity up the priority list, along with climate change, cyberrisk and diversity.

Biodiversity is also an investment risk, the report said, citing that 55% of global gross domestic product is reliant on high-functioning biodiversity and ecosystem services. "The recent launch of TNFD (the Taskforce on Nature-related Financial Disclosures) offers perhaps the first seeds of hope that investors could yet become part of the solution, if they make biodiversity an investment priority," the stewardship report said.

Leveraging collective scale as a pool has allowed Border to Coast "to secure improved access to a wide range of high-quality managers, as well as co-investment opportunities, in a cost-effective and efficient way," said Mark Lyon, head of internal management.

"Equally, our size means we have a stronger voice to engage with managers on responsible investment, supporting the drive to improve ESG disclosures in private markets. We strongly believe that ESG issues can pose material financial risks for a portfolio," Mr. Lyon said.