The UK’s largest private pension fund, USS has made ground on its path to net zero with effective engagement, measuring the Scope 3 emissions of its corporate assets and bottom-up carbon analysis focused on transition risk in emerging market equities. But investors need policy makers to do much more.
In the last year, the £75.5 billion Universities Superannuation Scheme, the United Kingdom’s largest private pension fund, has invested around £2 billion in renewable energy and clean technologies. The fund now also measures Scope 3 emission for around half of the companies in its portfolio despite poor availability and reliability of Scope 3 data. In another sign of progress, the fund is developing more informative climate scenarios with the University of Exeter in the hunt for insight into how investments might perform under a range of potential climate outcomes.
All steps that have helped USS reduce its carbon emissions intensity by 21 per cent since 2019 says the investor in its latest 2023 Taskforce for Climate-related Financial Disclosures (TCFD) Report, the industry-led framework that helps investors and companies understand and disclose their financial exposure to climate risk.
Engagement pays off
Engagement has been another centrepiece to strategy over the last year. For example, USS says engagement with Cemex, one of the world’s largest cement companies and one of the highest carbon emitters in its portfolio, contributed to the company setting more ambitious carbon reduction targets.
“Cemex is now set to reach its 2030 decarbonisation target five years earlier than planned and has introduced new lower-carbon concrete products,” says Innes McKeand, head of strategic equities at USS. “Higher-emitting companies can have the greatest real-world impact by shifting their ‘business as usual’ models to ones that drive change and push for a lower-carbon future.”
USS has also updated its policies. An updated Stewardship and Voting Policy states its preparedness to vote against the reappointment of directors if it believes a company is failing to appropriately manage or address a climate issue.
“We would expect to do this where, among other things, a company has not disclosed its climate transition plan or when a company is backtracking on previous climate commitments.”
Time for policy makers to do more
USS has built a £500 million sustainable growth mandate that includes investments in electric-powered aviation and carbon capture. The mandate targets high growth, privately-owned businesses that are developing services to help economies decarbonise.
However, McKeand flags the challenges of accessing these kinds of investments.
“We’re always looking for opportunities to increase our investments in climate solutions, but there are limited opportunities out there,” he says, arguing that the problem lies with an uncertain policy environment. “The Government and regulators have a huge part to play here, not least by ensuring a predictable, transparent, and stable regulatory environment for renewable energy assets and by raising energy efficiency standards.”
Managing asset level risk
USS has created Net Zero Working Groups (NZWGs) to drive progress whereby internal teams – the investor manages between 60-70 per cent of its assets in house – assess where reductions in carbon exposures can be made whilst achieving financial returns.
Recent initiatives include reducing emissions in the actively run global emerging markets (GEM) portfolio. Public equities represent approximately 30 per cent of assets and most of the allocation is managed passively against various indices. However, active management in the GEM portfolio includes engagement and voting, as well as identifying and integrating climate-related financial factors into investment decisions.
Here the team conducts bottom-up carbon analysis focused on transition risk to model how climate-related risks can impact the value of a company. The benefit of carbon analysis is that it can be integrated into existing discounted cash flow models, a tool used to value a business. This then feeds into an ESG score and assessment, along with other factors such as emission reduction plans and carbon transition.
Approximately 35 per cent of USS’s assets are managed externally and the firm’s net zero ambitions apply to all its assets, irrespective of asset class and whether those assets are managed internally or externally. In 2022, USS added to its monitoring processes by introducing a set of Gateway RI Indicators for manager selection teams to consider early in the shortlisting and manager due diligence process.
Next Steps
Looking ahead, USS will strengthen its top-down macro analysis by further integrating climate pathways with other macro factors. Elsewhere the investment team will continue to model different climate scenarios and mitigate some transition risks by moving away from standard equity benchmarks. For example, it recently applied a climate tilt to over £5 billion of the developed equities portfolio.
