Net zero: How can pension funds make their own commitments?

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The UK has said it will become carbon neutral by 2050. Strathclyde Pension Fund is considering making its own commitment to becoming a net zero carbon investor, one of only a handful in the UK. Why aren’t more funds looking at this – and where could you start? 
 
The £21bn local government pension fund covering Glasgow and the west of Scotland has been one of the most advanced when it comes to managing climate risk, having already published a report in line with the Task Force for Climate-related Financial Disclosures; but it is about to race further ahead, joining master trust Nest, which made a commitment to net zero by 2050 in July this year.  
 
Others are also actively working towards net zero; on Friday, Aviva said it has set a 2050 net-zero target for its own auto-enrolment default funds. The provider also called on the government to pass a law requiring all auto-enrolment default funds to achieve net-zero carbon emissions status by 2050 to help to address the challenge of climate change. 

And in early August, Brunel Pension Partnership, a pool of local government funds in the South West of England, and the Church of England Pensions Board supported the launch of a net zero investment framework by the Institutional Investors Group on Climate Change as part of the open source Paris Aligned Investment Initiative. 
 

Strathclyde to treat climate risk as a separate risk 

 
As part of its review, the Strathclyde fund is considering whether to join the Net-Zero Asset Owner Alliance convened by the UN, but so far, UK retirement funds have shied away from this due to the five-figure membership costs that fund research. 
 
Aside from weighing up the pros and cons of a net zero commitment, Strathclyde’s pension fund committee agreed in March that climate change will be treated as a separate risk and opportunity in developing its investment strategy and structure, and is considering the development of extended carbon analysis. 
 
Richard McIndoe, director of Strathclyde Pension Fund, said the climate change strategy and potential net zero commitment are still in progress. The climate strategy review “has been delayed a little as a result of Covid” but “should reach some conclusions” in the first quarter of next year, he noted. 
 
The review is part of a wider investment strategy overhaul at the fund, and also goes hand in hand with a tender for investment advice.  
 
“There is obviously some linkage between them. In particular, the specialist ESG/climate risk contract will be important in taking forward the climate change strategy,” explained McIndoe. 
 
He said there will be at least two contracts up for grabs before the end of the year, with one for specialist ESG and climate risk support, including engagement, carbon measurement and analysis. Another one or two contracts will be for more mainstream investment advice. The fund is currently finalising the specifications for the exercise. 
 
Much to the chagrin of activists, the fund has again decided that complete divestment from fossil fuels is not the best solution to transition the portfolio, having come to the same conclusion five years ago. 
 
“The climate change ‘solution’ most frequently promoted to SPF by lobby groups is divestment from fossil fuels,” a report for the March meeting states, adding: “The case for divestment has been revisited as part of the current review. The conclusion remains that, given the scale of the issue, the size and pace of the economic transition required, and the scope of SPF’s investment activity, this is not a realistic, effective or satisfactory solution. Divestment also reduces diversification and at best only marginally addresses the risks identified in SPF’s TCFD disclosures. A more far-reaching, measured, and intelligent response is required.” 
 

Private sector funds less inclined to think long-term 

 
But how can funds respond more ‘intelligently’ and achieve a lower implied portfolio temperature? A net zero commitment might not be a natural way of framing the issue for pension funds. 
 
As pension funds’ duty is towards their members, pension funds tend to frame the issue around risk, says Claire Jones, a partner at consulting firm LCP. However, they might have a narrow focus on shorter term risks arising from the transition to a low carbon economy, rather than the physical risks that are expected to manifest themselves later this century if no action is taken. 
 
Private sector schemes in particular have a shorter time horizon if they are closed to accrual, for example. Jones said the way the pension schemes bill has been drafted does not encourage thinking about net zero because the requirement will be for “a policy to manage material ESG risk based on the time horizon of the scheme”, she said. 
 
"It doesn’t necessarily lend itself to the conclusion that net zero is in the interest of the scheme. Which is perverse in a way,” she argued, because it would lead to better outcomes for society, including pensioners. 
 
Many schemes are also targeting buyout in the next 10 years, she pointed out, meaning the issue shifts to some extent to the insurance world. However, “insurers are likely to be invested fairly cautiously”, and those that offer general insurance are likely to be attuned to climate risk, while specialist buyout providers are starting with less expertise. 
 
For those wanting to make a commitment, Jones said the Net-Zero Asset Owner Alliance “makes a lot of sense” because it fosters collaboration. Achieving net zero “is hard” because it’s new, she said. But there are resources that are free – she pointed to the IIGCC. 
 

Is net zero only for large schemes? 

 
Jones believes making a commitment is even harder for small schemes than larger ones, as they have less control over the carbon footprint of their portfolio, given that few pooled investment funds have made net zero commitments. 
 
“There needs to be innovation in the asset management space,” she said, but admitted that “it's quite early days; asset managers have probably not seen much demand for it”.  
 
But new EU benchmark regulations have already led some managers to develop products along those lines, and while these tend to be ETFs, Jones believes it is “only a matter of time” before more pension fund friendly vehicles are launched. 
 
Mike Clark, founder of Ario Advisory, also pointed  to the IIGCC’s Net Zero Investment Framework. "It offers a very practical approach for investors to increase their contribution to tackling climate change whilst stewarding their assets. I commend it to asset owners in particular as they manage the strategic risk of climate change.” 
 
He stressed the importance of the role of a pension fund’s in-house team in taking climate risk management seriously. 
  
“One of the challenges many UK pension funds face is the in-house resources they need to drive the trustees’ work forward. Whilst investment managers, consultants and other suppliers can help, an ambitious and incented executive is necessary to both inform the trustees and drive the necessary work forward, at pace,” he argued. 
 
Any ESG advisers should therefore also have “an ability to catalyse the in-house executive as they raise their ambition of their suppliers". 
 
What is your view on net zero carbon commitments by pension funds?

Claire Jones
Mike Clark
Nick Spencer