Hounslow Pension Fund combats ‘catastrophic’ climate change risk

The Local Government Pension Scheme fund quantifies risk in two categories, “impact” and “likelihood”. Focusing on impact, climate change scored a maximum of four out of a possible four, with scheme officials deeming it as “catastrophic”. 

If left unheeded, it predicts that the scheme would need “ministerial intervention in running service”, as well as a “total service loss of a front-line service for a significant period”, and failure to achieve a major corporate objective in the Hounslow plan”. Hounslow Pension Fund could also suffer a “major loss of reputation”, according to the scheme’s risk assessment.

For the likelihood category, the pension fund scored this as “high” — five out of a maximum of six — as it considers climate change has a more than 80 per cent chance of occurring, representing a potential financial impact greater that £5mn.

Not enough action had been taken globally to merit putting the likelihood of losses due to stranded assets at less than £5mn and at a likelihood of less than 80 per cent

Patrick Kilgallen, Hounslow Pension Fund

This means the scheme gave climate change a total score of 20 out of a possible 24 in 2020, and this has remained unchanged as of March 2022. In comparison, the fund placed Covid-19 at a risk rating of 12 out of a possible 24.

Patrick Kilgallen, Hounslow Pension Fund’s head of investment, tells Pensions Expert that the climate change high-risk rating is due to a feeling that “not enough action had been taken globally to merit putting the likelihood of losses due to stranded assets at less than £5mn and at a likelihood of less than 80 per cent”. 

A steady transition

Kilgallen believes the fund took significant steps that “would benefit the long-term solvency of the fund, while also reducing its exposure to this risk”. 

He detailed the steps approved by the Hounslow Pension Fund panel in March 2020:

1. Transfer the passive global equity portfolio to a low-carbon portfolio.

2. Transferring the residual active segregated global equity portfolio to the London CIV Sustainable Equity Fund.

3. Measure the carbon footprint of the equity holdings of the fund.

In January 2022, the panel voted to include a fourth objective, in which the scheme will transfer its holdings in diversified growth funds to a London CIV Renewable Infrastructure Fund.

Kilgallen says: “Steps one, two and four allow the fund to address this risk, while step three begins to quantify the exposure and profile of the climate risk inherent in the fund’s investments. 

“Having a baseline carbon footprint provides clarity about where the fund is currently positioned, so that the direction of travel is obvious when it comes to future investment decisions.”

Philip Pearson, head of LGPS investment at Hymans Robertson, points out that “there is huge commonality between the methods taken by Hounslow and other LGPS” funds.

“Climate risk is viewed as ‘high risk’ by most LGPS [funds]. However, this is not just a risk but an opportunity for managers of investment, and funds need to be alert to this opportunity,” he says.

Parmenion’s senior investment manager, Mollie Thornton, notes that in general, “moving to more sustainable/lower-carbon portfolios would seem a commendable option”.

“Other options to reduce climate risk and increase exposure to sustainable investments could be through the bonds portfolio, which can be overlooked,” she explains.  

“There are increasing opportunities in fixed income to invest in green or sustainability bonds — for example, issues from organisations like renewable energy and social housing companies, as well as green sovereign bonds.

"Additionally, engaging with companies with higher carbon emissions to ask whether they have set science-based targets to achieve net zero can encourage companies to decarbonise.”

Quick implementation

Changes at the Hounslow Pension Fund began in late 2020. By the end of 2021, the scheme had transferred its passive global equity portfolio to a low-carbon portfolio, as well as moving its residual active segregated global equity portfolio to the London CIV Sustainable Equity Fund.

As of March 2022, the scheme reported it had successfully measured the carbon footprint of the equity holdings of the fund, thus completing objective three. Objective four is still in progress, as it was decided in early 2022, according to Kilgallen.

“It’s pleasing to note that the actions listed above [one and two] have contributed significantly to a 7.4 per cent reduction in CO2 emissions per million pound invested between March 2020 and March 2022,” he says.

However, Pearson notes that a lot of current measurements of climate risk are “uncertain”.

He explains that there are various metrics, including the value of the amount of greenhouse gases produced, which “is a proxy metric” and is not yet able to be “measured across all asset classes”. 

“Reallocation decisions are more difficult when you cannot measure carbon emissions,” he adds.

Is it enough?

A recent petition was put to Hounslow Pension Fund, stating that it was not doing enough to tackle the self-stated risk of climate change. 

Scheme member Mariette Labelle argues that the pension fund is invested in “fossil fuel companies, nuclear weapons investors, and the arms manufacturing sector”, and that “some of the investments violate human or environmental rights”. She calls for the scheme to divest from funds which hold these assets.

Pearson adds: “Most funds are, or have been, under pressure to divest in all oil and gas funds. But whether we like it or not, the economy is powered by fossil fuels.

“The best route of action is to apply pressure inwardly, where alternatively stocks will be bought by someone who does not apply pressure. Blanket divestment policies are easy to say, but they are not positive at all.”