IS PASSIVE INVESTMENT AN OBSTACLE TO INVESTING IN A SUSTAINABLE WAY?
All LGPS funds have their fiduciary duty to focus on financial returns dinned into them: their primary function is to ensure that contributions are invested so that members receive the correct pension on time. However, we wondered in a blog last year whether sustainability won’t in time become equally as important a goal for pension funds. It is increasingly obvious that planet Earth is struggling to cope with over seven - or is it now eight? – billion humans in a sustainable way. Like every other part of our society, pension funds and investors’ focus on this problem is rapidly becoming more intense. The activists have a point: if we do nothing, today’s companies will wither and funds won’t receive the expected financial returns; or in the worst case there won’t be a viable planet for pensioners to enjoy their pensions on. However, it is not so easy to determine what pension funds can or should do. At Linchpin we prefer to focus on outcomes rather than gestures. That means we are sceptical about divestment: selling oil shares will make no difference to reducing carbon emissions, because the company will continue to operate and its shareholders will by definition be less engaged. And that’s always assuming the exclusion is a genuine sinner – it’s not usually so black and white. For a similar reason we’re also fairly sceptical about carbon off-setting and similar programmes. They may help the feel-good factor but does £100 being donated to plant a tree in Peru really mitigate carbon emissions? How much actually goes to tree-planting? Would the farmer have planted the tree anyway? And when is the tree big enough to make any kind of significant contribution? Even the arguments for electric cars, today’s favourite, are based on partial data. Yes, they emit less carbon at point of use, but does that include those emitted to manufacture, to mine the lithium needed for the battery or to generate the electricity? We can’t help recalling how diesel cars were seen as being cleaner than petrol until particulates started being measured. So what can pension funds do? The first is relatively easy: engage with companies more robustly to improve their sustainability. The Stewardship Code already mandates this but we’d suggest the focus should be concentrated on moving to a better outcome. It is easier where there is some leverage, for example private investments or companies coming to the bond or equity markets to raise money. We’d therefore suggest funds spend more time in these areas, as they are more likely to make a difference. Secondly, measure portfolio ESG profiles over time in order to monitor the improvement. A number of fund managers are developing interesting methodologies which go beyond simply looking at carbon emissions. The data is still partial but the focus in this area means it is improving rapidly. We look for a holistic approach which covers much more than just carbon emissions and we like to see data which shows the impact your investment makes on the real world. For example, how many households does your investment in a renewable energy company provide power for? The most obvious action pension funds can take to make a real difference is to invest in the opportunities – across all asset classes. As the world concentrates on better use of its resources there are bound to be winners and losers, and the winners are going to generate good cashflow for their shareholders. Pension funds investing in them will satisfy both financial and sustainable duties. Here’s where it gets more difficult, though. Passive investment is the enemy of this, simply because indices are weighted towards incumbents. Even traditional active managers tend to use the index as a starting point. “Sustainable” now covers many investment philosophies and some focus more on avoiding the sinners rather than picking the winners. We think that is a markedly inferior course of action. Then, many of the companies representing opportunities are still relatively small, which means that liquidity may be an issue. And of course assets such as renewable energy are already very well bid because it is easy to see how they are the future. So it’s not easy and we know many LGPS funds are thinking along these lines. The challenge if they are serious about this may be to move away from passive or quasi-passive investment, even if it costs a bit more. To find out more, please contact us on 020 3637 6341.