It’s beyond doubt that climate change presents a very real risk to the future investment returns achieved by pension schemes. But deciding what to do about it is complex.
Pension schemes must seek returns for their members and not take too much risk. This, coupled with a belief in the efficiency of markets and passive investment approaches, has led to caution in reacting to climate change.
Climate change is a true burning platform
The longer the industry waits to see how others react, the worse a problem it must react to. The Pensions Minister and DWP have responded to the issue by asking all DC schemes to publish their investment principles on ESG and climate change.
So, what can we do? We know less fossil fuel will be used in the economy in future. Simple reductions to companies with fossil fuel reserves will reduce exposure to the risk of investing in a defunct company. At The People’s Pension, newly authorised as a master trust by The Pensions Regulator, we added a multi factor fund last year into our default which halves its exposure to fossil fuel reserves. We expect to make further and more specific reductions in future, keeping in line with developing research on climate impacts.
How we could use data
Our current analysis is to see whether we can identify companies likely to do better or worse in the future because of the sector they sit in – or how well they perform on keeping their emissions lower compared with peers. This means using data to construct screens to remove companies at risk of being left behind or to identify the companies ahead of the curve who we could invest in positively. Unfortunately, the data on greenhouse gas emissions is patchy because many companies don’t report it. Much may in fact be estimates.
A good example is the auto sector. A factory making cars will create direct greenhouse gas emissions, or ‘scope 1’ emissions, perhaps in the steel making process. The company will also buy energy, which creates indirect, ‘scope 2’ emissions. These are all regularly measured and disclosed, although different industries may still be patchy. These emissions are simple to keep a handle on. ‘scope 3’ emissions are those from just about everything else to do with the product, including transportation to market, product use (including petrol) and product disposal. These are impossible to measure directly and ‘scope 3’ emissions data is estimated. For an investor such as The People’s Pension, it can make a big difference to your investment screening if you rely on ‘scope 3’ data from the company or a data provider.
Good news: things are changing, and data sets are improving
The London Stock Exchange is one of many organisations seeking more corporate disclosure of climate risk and the strategy of the company in response. This gives us more data to react to and may enable us to gain in confidence over time.
At this point the data isn’t useless but at the same time it may not be enough to act with high conviction. We want diversification, so there are always going to be compromises – especially when you overlay wider measures such as ESG scores. It would be nice to find that the most polluting companies are also the worst run, with the worst impact on society, but that may not be the case. Tesla scores lower on governance than its peers, according to some data providers. The trade-off between good governance and electric vehicles isn’t easy.
What we’re doing
We’ll make further portfolio changes and expect to have good progress to report in a year’s time when we publish the implementation of our climate and ESG principles. I’d like to think many if not all in the master trust industry will have made similar progress and that advisers will start to hold us accountable for climate change performance.
Master trusts are natural candidates for innovative climate change investments. That’s because they have a trustee board with a legal duty to act in the best interests of their members – and make their approach publicly available.
Read more about The People’s Pension’s approach to responsible investment.