Outlook 2025: Seeking to improve the sustainability status quo

Pension schemes have already taken substantial steps to mitigate climate change. But the ongoing efficacy of rebalancing and engagement policies can be uncertain, especially over time and when delegated to asset managers.

“We are running out of time to shift our economies off fossil fuels towards a safer future,” says Louise Marfany, director of financial sector standards at ShareAction. “Asset owners cannot afford to sit on the sidelines while asset managers lag in their climate commitments. They have the power and responsibility to demand better.”

Heading into 2025, many schemes are already reevaluating their approach.

Alex Quant, head of ESG research at XPS Pensions Group, says: “We’ve seen a big shift towards a forward-looking focus, ensuring a large allocation to companies closely aligned to the climate transition. That’s been very positive. It’s giving us much better options to put forward.”

Only the very worst offenders should be excluded, he says. “Oil and gas, emerging markets and other high emitters are critical to the transition. We need to ensure they are aligning and are contributing. Stewardship continues to be the most effective lever we have.”

Getting a sense of the scheme’s current climate risk and transition alignment is a “really important first step”, Quant says, noting that historical emissions are not necessarily the most relevant factor.

“Instead, you can position your portfolio around companies that are most likely to achieve decarbonisation, with the most credible and robust transition plans,” he explains.

Moving away from historical data

As companies accelerate their transition plans, their historical emission data becomes less relevant.

“The academic evidence demonstrating the impact of allocation based on corporate emissions is so far limited,” says Brunno Maradei, global head of responsible investment at Aegon Asset Management.

He says investors need to consider how to assess and incorporate the growing body of transition plan disclosures, including the forward-looking elements of targets, strategies and implementation actions.

“It is difficult to assess and compare these disclosures, with limited availability of standards and agreed transition pathways, yet this is the only way to meaningfully allocate capital to positively impact the climate transition,” says Maradei.

From transition to impact

Anna Vӓӓnӓnen, head of listed impact equity at Axa Investment Managers, suggests more can be achieved through impact investing than transition investing. The Financial Conduct Authority’s Sustainability Disclosure and Labelling Regime, which introduces rules for impact funds, “has done a big favour to the industry”, she says.

“It forces fund providers to clearly articulate and clarify their processes,” she says noting governance, non-financial factors and engagement activities.

“We’ve been working to build the whole process around theory of change, making it a systematic process,” she says, referring to Axa’s in-house process based on Global Impact Investing Network recommendations.

“We end up with global leaders that have good liquidity. We look for companies with scalable products that could have a positive impact on millions of people’s lives, or millions of acres.”

The largest pension schemes – with substantial global portfolios – are necessarily exposed to the entire world economy if they are to remain diversified.

The responsible investment lead at one large UK scheme says they meet this challenge by taking the position of a “universal owner”.

“It makes sense to try to create system resilience – and our capital allocation flows from that. Climate instability and financial instability go hand-in-hand and this philosophical point translates into practical activity.”

Amid an “awful lot uncertainty”, the responsible investment lead warns against “creating false precision”. Their pension scheme undertakes scenario analysis that considers the interplay between policy, technology and markets.

Working with asset managers

Aegon’s Maradei says a further challenge is how to meaningfully compare asset managers’ efforts to influence companies.

“All sorts of engagement and voting claims are being made,” says Maradei. “Some of those with the most potential influence might be significantly underinvesting in their efforts to effect change.”

A recent asset manager survey by consultancy group LCP found that responsible investment execution was falling short of client expectations. Managers tended to focus on individual companies rather than lobbying for policy change to address broader challenges.

ShareAction’s Marfany adds: “Asset owners should be setting clear expectations of their asset managers and applying a structured approach to engaging with them and assessing their performance.

“This can be even more impactful is when asset owners come together to collectively present their expectations to managers and give feedback on their performance on social and environmental issues. They should be willing to apply consequences if their asset managers are not delivering.”

How pension funds have developed their responsible investing practices in 2024

• In January, the Pension Protection Fund co-filed a shareholder resolution at the Shell AGM calling for the oil giant to align its medium-term emissions reduction targets with the 2015 Paris Agreement on climate change.

• Local Government Pension Schemes including West Yorkshire and Tyne & Wear have taken active steps to improve their sustainability credentials, as has infrastructure specialist GLIL.

• The Avon Pension Fund revised its net zero emissions target forward by five years following extensive engagement with stakeholders.

• Some of the UK’s biggest master trusts have also reported substantial progress towards decarbonising their investment portfolios.