Making net zero a reality

As pension schemes and asset managers get to grips with turning net zero from a target into reality, complexity is going to increase and greater resources will be required.

An earlier article explained how one long-term implication of asset managers and pension schemes getting to grips with TCFD will be to place an increasing emphasis on stewardship.

And as more of the investment chain adopts net zero goals, that will only add to the pressure to become effective at engagement.

Pension schemes are entering a new era where climate change needs to be at the heart of how portfolios are managed. “That’s the implication of including a net zero commitment,” said Claire Jones, head of responsible investment at LCP.

A recent global asset manager survey carried out by Mercer covering 200 organisations with $30 trillion assets found 35% of those managers have a net zero target, which is an eight-percentage point increase on the previous year. 

But 58% of those managers have a net zero target for less than five percent of their total assets. 

Of those with net zero targets, nearly a quarter of managers will apply that net zero target to more than 50% of their assets, demonstrating a clear commitment and leadership, said Vanessa Hodge, partner and UK head of ESG integration at Mercer. 

“While the number of asset managers taking climate change seriously is improving year-on-year, there is still a lot more to do to ensure this is embedded in the whole investment value chain,” said Hodge.

Asset managers servicing European institutional investors will need to accelerate both their net zero goals and their assessment of climate change as this is a high priority in this region.

Business as usual

Understanding the climate change exposure and the net zero alignment of portfolio of companies needs to become part of business-as-usual for asset managers. 

“It’s the remit of research analysts and portfolio managers to understand what steps these companies are taking,” said Jones. 

Once managers have built that deep understanding of climate implications of their portfolio, the next phase is to build an effective engagement program. 

“Managers will need to help and encourage companies on that net zero journey which will require putting more effort into stewardship,” added Jones. 

Historically, stewardship is an area of investment management which has been under appreciated. 

DC problem

This stewardship challenge will be particularly acute for workplace DC pension schemes which are reliant on passive equities to accumulate wealth for members. As long-term universal owners, engagement is the best way for these schemes to create real world change. 

Data remains a significant challenge. Voluntary disclosures like the ISSB standards will help to create better reporting and more transparency. 

“But speaking to companies about the importance of reporting certain metrics and understanding that data will become increasingly important for asset managers,” said Hodge.

In addition, it will be vital for asset managers to understand a company’s transition plans.

“A company might have a very low carbon footprint but is doing little to reduce further while another with high carbon emissions is doing more to decarbonise,” said Hodge.

Investing in the higher emitting company with a credible plan to transition its business strategy will have greater real-world impact than allocating to the lower emitting firm, even if it makes the carbon balance sheet look shocking over the short-term, added Hodge. 

Getting to grips with these data, transition plans and stewardship challenges will require significant investment. 

Tiffany Tsang, head of DB, LGPS and investment at the PLSA, said: “There is a lot more that needs to be mapped out.” For example, more reporting needs to be shared, information gaps need to be filled and there needs to be more of a focus on transition. 

“All of these gaps in information create bottle necks which makes it harder for knowledge to be passed along the investment chain,” said Tsang. 

“At the moment there is not sufficient resource for stewardship among passive managers,” said Jones. While the largest managers have increased headcount in this area, there is further to go, she added. 

Hodge added: “At the moment many responsible investment teams at asset managers are currently being consumed by regulatory and statutory reporting rather than being used for stewardship.” 

Over time, however, this should improve as many of these reporting requirements are relatively new and should not consume as much resource in the future, added Hodge. 

Edwin Whitehead, director in Redington’s sustainable investment team, said: “Complying with regulatory reporting might feel frustrating but it is an important part of making investment more sustainable.” 

These regulations are designed to encourage more efficient market capital allocation which should make investment chain more sustainable, he added.

There is a question over whether there are enough resources being putting towards good stewardship as well as allocation and divestment to ensure all the sustainable investment tools are being used effectively, added Whitehead. 

Move on from low cost

Passive managers will need to recognise climate change is a systemic risk which is going to be big determinant of financial outcomes for DC members. “The effort put into stewardship needs to be commensurate with the scale of these risks,” said Jones. 

That means workplace DC needs to get away from using cost as the key metric when choosing their passive equity manager and instead be looking for one with sufficient resources to address this challenge.

There are some positive signs asset owners are starting to rise to these challenges. According to the PLSA, UK pension schemes are increasingly committed to net zero with 68% of respondents saying they have a net zero target – up from 50% a few years ago. 

Whitehead said: “Larger pension schemes are more likely to have set net zero targets than smaller ones.” 

That is because larger schemes have more resources and are likely to attract trustees with more experience in this area, he added. 

As sustainable investment is a developing concept, there is a rapid evolution in the best way for investors to address this challenge. That has resulted in different approaches proving popular for a short time before being replaced by another way to address this challenge. 

“Larger schemes are more able to stomach the constant re-evaluation of what is good practice,” added Whitehead. Smaller schemes have become fatigued by this change and are now just following the lead of larger schemes, he added. 

Alignment becomes key

Asset owners are reliant on asset managers to be effective stewards as they are too removed from the day-to-day interaction with companies. 

As engagement becomes more important to asset owners, finding a manager which aligns with the scheme’s interest is going to become even more important. 

Whitehead said: “There is a growing divergence between US and European asset managers on how they deliver on engagement.” For example, US managers are not thinking about transitioning away from oil and gas in the same way as European managers, said Whitehead. 

“It’s going to be even more important for a European asset owner to find a manager which has the resource and thinks the same way you do to deliver in an effective way which meets that scheme’s long-term expectations,” said Whitehead.