I don’t know you, so what I say next may not be true … but here goes anyway: your investment beliefs are probably out of date.

If you have revised your beliefs within the last 12 months and have factored in the tsunami of pain that climate change will bring, then please forgive me. You are off the hook.

If, however, your investment beliefs were set five, or more, years ago – when net-zero wasn’t even a ‘thing’ – then I will argue that they need to catch up with a fast-moving reality[1].

In 2022 TAI published a paper titled Pay now or pay later?, which was one of the first papers to argue that climate change was going to hurt portfolio values, whatever we chose to do. Given that kicking the proverbial can down the road appears to be a bankable human trait, we suggested the likely outcome was a rise in temperature of +2.7 to +3C, and a consequent hit to portfolio values of 50-60 per cent.

If that sounds somewhat alarmist consider that “There is a level of warming that will cause a 100 per cent loss of GDP”[2], and therefore a complete loss of portfolio value, even if we don’t know what that level of warming is.

In 2023 we ran an investing for tomorrow working group to delve deeper into these matters. The resulting output was a significantly deepened understanding of climate science, climate scenarios, and the understatement of risk in most of them. In 2024 we ran a ‘sprint’ working group to develop a survey tool that investment organisations can use to determine whether, or not, they need to revisit their investment beliefs.

In addition to a deeper understanding of climate change, we have continued to apply ourselves to the study of systems. We first wrote about complex adaptive systems in 2008 and so have 15 years or so under our belts. We now consider it an idea whose time has very much come. In 2023 we wrote two papers on systemic risk[3], and in 2024, we have launched our systems curriculum to explore the intricacies of interconnected systems and gain valuable insights into how they shape our world[4]. This advance in systems thinking and the assessment of systemic risk is a further argument for a revisit, and possible refresh, of investment beliefs.

So there are two main arguments behind my assertion that most investment beliefs need to catch up with reality: our understanding of climate, systems and risk has taken a big step forward, and, reality is changing rapidly.

To quote from our paper alluded to above, reality “is simply too big and too complex to understand. And so we build models of it, and in understanding the models, we pretend that we understand reality”[5].

Our investment beliefs are a form of model, in that they are a series of statements that seek to explain how (the investment part of) reality works. Unless those statements are freshly agreed it is unlikely they reflect our current (and partial) understanding of climate risk, biodiversity loss, artificial intelligence, interconnectedness and systemic risk.

If we single out climate, then we can also ask whether any public net-zero pledge your organisation has made should also be reviewed. Why? Is it not widely agreed that the world is heading to net-zero emissions by 2050?

Well, on the one hand, it is true that 196 nations ratified the Paris Agreement, which is legally binding. On the other hand, a 2024 survey showed 77 per cent of climate experts (lead authors or review editors of IPCC reports since 2018) believe the world will warm by at least +2.5C[6]. In other words, they do not see the necessary level of action despite it being legally binding. I assume these climate scientists have a better grasp of current climate reality than I do, and so I can use their knowledge to help my own catch up.

In the investment world we then need to translate that knowledge into a form that is more meaningful for our management of portfolios. The expected temperature rise is essentially the same as the scenario I quoted above from Pay now or pay later?, so is TAI’s heroic estimate of a 50-60 per cent portfolio loss (by 2100) our best guide? I was one of the authors of that paper, and we wrote it two years ago. I can’t speak for all the authors, but I know that my own thinking has moved on in that time. I now see systemic risk as a bigger threat than I did back then, and so I would probably factor in the possibility of even bigger losses.

The point here is not what I think, but what you think. I would therefore encourage all investment organisations to ask themselves whether they need to revisit their beliefs and, possibly, any net-zero pledge. We have a survey tool that could help here. I would also encourage everyone to at least check out our systems curriculum materials. As Buddha told us, “what you think, you become” – and we all need to become better systems thinkers.

Tim Hodgson is co-founder of The Thinking Ahead Institute.

The £74.8 billion University Superannuation Scheme (USS) has reported a funding surplus for the first time since 2008, with chief executive officer of USSIM, Simon Pilcher, saying one of the benefits of higher interest rates was it is cheaper to hedge the scheme’s liabilities.

“We took advantage of this opportunity, thus reducing our exposure to interest rates and inflation, which means the scheme is better protected should bond yields fall again,” he says in the USS annual report.

The investor’s 2023 actuarial valuation revealed a scheme surplus of £7.4 billion, allowing lower contributions and the restoration of benefits to pre-April 2022 levels in a turnaround marking the end of one of the toughest period on record for the DB pension scheme.

Less positively, the report also detailed how USS’s losses in troubled utility Thames Water has led to a “serious reflection” on investment in regulated assets in the future. This at a time the UK government is trying to persuade pension funds to invest more in local infrastructure.

“Economically regulated assets should be a good fit for long-term patient investors like USS, particularly where, as with infrastructure, they require long-term investment to address historical challenges,” said Simon Pilcher.

However, he noted that success is dependent on similarly long-term, consistent regulation that recognises the need for that investment and strikes a fair balance between risk and returns over the long term.

“While our overall experience of investing in private markets has been beneficial, we seek to learn the lessons of all our investments – whatever the outcome. Our experience with Thames Water will influence our future approach to investing both in economically regulated assets and more broadly.”

USS remains a shareholder in Thames Water but said that the value of the holding was now “minimal.” Two years ago its stake was valued at £956 million. Further revealing the scale of the losses, he said that since USS first invested in Thames Water in 2017, any profits that might otherwise have been used to pay shareholder dividends were reinvested into the business. “We have not received any dividends or payments of interest on any shareholder loans,” he said.

USS was not alone in this investment with fellow pension funds from around the world experiencing big losses including the Dutch PFZW and BCI and OMERS from Canada (OMERS wrote down its entire 31.7 per cent holding). See Thames Water losses hold lessons on the importance of a comparative view.

Despite losses in Thames Water, USS said private markets as a whole have delivered strong returns to the scheme over an extended period.  Over 10 years to the end of March 2024, infrastructure assets have delivered annual returns in excess of 11 per cent. During the past year the fund exited a number of private investments, generally at favourable prices to where they had previously been marked in its books. New acquisitions included growth-focused private equity, long duration income-generating property assets, and inflation-linked assets like renewables.

Pilcher said that returns across growth assets were generally positive particularly in the US driven by AI-fulled tech stocks. He said the outlook for equities was reasonable, and stated that bond markets are also likely to deliver solid returns now that yields have risen.

The pension fund flagged key risks from climate change and biodiversity loss, geopolitical tensions and the demographic time bomb where fewer people of working age must support rising numbers of retired people. USS employs tools like horizon scanning, scenario planning, diversification, and stress-testing as critical elements to help build a resilient portfolio and respond effectively to events as they unfold.

A developed markets equities team now manages a new £4 billion allocation to a long-term real return mandate designed to provide strong long-term returns at lower levels of risk than the wider equity market. Responsible investment has been built into every stage of the investment process for this mandate. Moreover the low-carbon emissions of the companies owned in the mandate supports the investor’s ambition for investments to be net zero by 2050 meanwhile the concentrated nature of the mandate allows it to hone in on stewardship activities.

Climate planning

USS  has developed four new scenarios in conjunction with Exeter University to better reflect the real-world risks and opportunities that frame climate investment and systemic risk decision making over the short and medium term. The analysis switches the focus away from climate pathways and allows USS to pay close attention to shorter-term changes to politics, markets and extreme weather events when assessing the long-term financial impacts of climate change.

“We took the decision to make this research publicly available for other investors because the real-world impact of climate change could be much greater than previous modelling has suggested. We hope this work will be of benefit to many others and help galvanise real-world action as people understand the costs of inaction associated with the current trajectory towards ever higher temperatures.”

The emissions intensity of the the scheme’s corporate investments is now 39 per cent lower than in 2019 and over half of the reduction seen in 2023 is a result of the  new LTRR equities mandate because the high-quality companies owned in this mandate typically have a very low emissions intensity.

Still the report does flag concerns raised following analysis of the scheme’s investment and advisory performance that covers factors from quantitative risk and return metrics, to qualitative inputs, flagging poorer performance in active management and private markets.

The £30 billion Greater Manchester Pension Fund (GMPF) the United Kingdom’s largest Local Government Pension Scheme is ploughing more money into affordable housing, targeting 30 per cent of its 10 per cent allocation to real estate to the residential sector.

The fund has just invested £120 million in a Legal and General fund that will invest in purpose-built social rent and shared ownership housing (where people buy a portion of a house and pay rent on the rest) that Paddy Dowdall, assistant director, GMPF, says has compelling low risk, inflation-linked income streams alongside measurable impact.

The allocation sits alongside previous investments in the “small” affordable rent sector, where rents are targeted at  30 per cent of tenant’s income and which has similar properties but is not part of the regulated sector.

GMPF has worked with L&G to design the allocation, composition of stock and pricing. “We wanted to make sure it was right for us,” says Dowdall.

A chronic shortage of housing in the UK has resulted in long waiting lists for social housing and young people left priced out of home ownership and Dowdall believes the sector is poised to attract much more institutional investment.

“In the US and Europe, the amount of investment by institutional investors in rented homes is far greater,” he says.

In recent months, Border to Coast, ACCESS and LGPS Central have all confirmed significant expansions of their real estate offering. Meanwhile, LPPI and London CIV have joined forces this year to launch the London Fund, which alongside infrastructure will also invest in affordable housing.

Investing in the social rental sector taps into large and growing tenant demand and constrained supply, he continues. For example, regarding build to rent where properties are built just for the rental market and don’t have targeted rents, he notes the UK’s private rental housing sector is valued at around £1.5 trillion but less than 2 per cent of that stock is build-to-rent compared to about 15 per cent in Germany and 40 per cent in the US.

Tennant demand is also boosted by more people stretching to afford a house and renting for longer. For example, today the average first time buyer age is 34 in the UK compared to 26 in 1997.

Meanwhile, individual private landlords continue to be squeezed out of the market, driven by tighter credit and government policy changes. Buy-to-let investor activity has slowed sharply due to adverse taxation changes including stamp duty and tighter credit, he explains.

“Tax, regulations, and access to leverage will make it much harder for small, private landlords to compete in the sector. There is a clear market opportunity for this provision to be replaced by financial institutions and social landlords.”

Historically, affordable housing in the UK has been financed via public sector housing providers called Housing Associations. Yet these organizations are also dealing with high costs to maintain large portfolios and facing rising construction costs to build new homes. Their affordability of capital is less, meaning social housing is increasingly funded by other forms of capital, says Dowdall.

“You now see a lot of annuity providers in the market.”

The sector offers long-term index linked cash flows. He calls the low net yield “fair” for the risk taken and says GMPF is happy to take liquidity risk given its long-term liabilities.

“Social housing is going to have low levels of voids and rent arears and a high correlation with inflation. The high inflation linkage makes it an attractive investment. It ends up a 6-8 per cent return on an IRR basis.”

GMPF’s seven-person real estate team invest in housing via two different portfolios: a well- established mainstream real estate allocation and a local impact portfolio that includes investments in SMEs and renewable infrastructure where this allocation will sit and where the fund is already financing close to 4,400 new homes which have either been completed, planned or are in development.

Certain real estate sectors may achieve higher yield than social housing, such as higher end residential or office. Yet these investments  carry higher risk because they are linked to the economy. “Occupancy and the level of rent for social housing is not linked to economy doing well in the same way as other real estate sectors giving it diversification qualities.”

GMPF has made a commitment to L&G’s national fund, but Dowdall says the fund would also like to invest to support the Manchester region.

Challenges include problems sourcing affordable homes. It is difficult to buy existing stock or buy new stock at rates that people can afford. The sudden collapse in rental incomes in London due to the Covid pandemic also highlighted another risk.

Japan’s 245.98 trillion yen ($1.5 trillion) Government Pension Investment Fund’s (GPIF) annual survey of listed companies designed to ascertain the stewardship activities of its external asset managers, reveals engagement in Japan remains an uphill struggle.

The survey seeks to gauge the degree of “purposeful and constructive dialogue” between listed companies on the Tokyo Stock Exchange and asset managers, offering a window into the ability of institutional investors to effect change in corporate Japan.

Only 717 firms (33 per cent) of the 2,154 listed companies on the Tokyo Stock Exchange responded to GPIF’s survey request.

Engaging on governance

Since the introduction of Japan’s Corporate Governance Code in 2015 the country has been trying to modernize corporate boards, long dominated by in-house executives. Outside directors currently occupy 44 per cent of the board seats of companies listed on the Tokyo Stock Exchange’s Prime section, up from 28 per cent in 2017, according to a data compiled by the Japan Association of Corporate Directors.

Still, 70 per cent of respondents said they did not receive a request from asset managers to conduct dialogue with outside directors and outside statutory auditors.

The Tokyo Stock Exchange, leading calls for stronger governance, is also demanding listed companies take “Action to Implement Management that is Conscious of Cost of Capital and Stock Price.” This new regulatory pressure is designed to improve underperforming companies, lift valuations and improve capital efficiency.

Although regulatory pressure was cited amongst corporate respondents as a focus of engagement activity alongside climate – only 10 per cent of companies said that they had received a request from their asset managers in the past year to conduct collaborative engagement.

Lacklustre asset manager engagement with investee companies comes as GPIF seeks to widen its manager pool.

The process will see the fund open up to new managers by reviewing criteria that have long-governed selection. Like its stipulation that its managers must have at least 100 billion yen assets under management and a fixed number of years of experience servicing financial products. The fund now says it will accept applications from investment management institutions with “a sufficient track record.”

Disclosure impRoves

Encouragingly, asset manager pressure on companies to disclose in line with Task Force on Climate-related Financial Disclosures (TCFD) recommendation is reaping change. Approximately 90 per cent of respondents voluntarily disclose non-financial information in line TCFD recommendation.

Still, asset manager engagement regarding Task Force on Nature-related Financial Disclosures (TNFD) is much less with only 35 companies responding that they have disclosed information in line with the TNFD – 79 per cent of respondents said they had no engagement from asset managers on TNFD.

Despite challenges around engagement, corporate responses highlight the effectiveness of engagement.

“They [asset managers] understand our company deeply and their advice through engagement is helpful. Many investors tend to hesitate in expressing their opinions to management, but asset managers give harsh opinions directly to the President and CFO. Therefore, the meeting is very beneficial in the sense that management can hear the voices of investors directly. For this reason, they have won deep trust from our CFO,” wrote one survey respondent.

“In particular, they explained frankly their way of thinking behind their ESG analysis and evaluation of our company, which helped us understand the “investor perspective.” We had a frank exchange of views on sustainability. Especially on materiality, we were able to obtain opinions on what institutional investors want,” said another.

Other corporate responses flagged continued short-termism among asset managers.

GPIF runs a policy asset mix of 25 per cent each in domestic and foreign equities, and domestic and foreign fixed income and targets a real investment return  of 1.7 per cent with minimal risks. Investment in alternatives, began 10 years ago, remains under a 5 per cent target at just 1.4 per cent of total AUM. The GPIF has been discussing changes to investment strategy, including its asset mix and will announce a new investment policy at the end of this year to enact through 2025.

The rally in global markets powered record returns at the investor, according to its annual results. Domestic equities are the fund’s best performing investment although the weakening yen lowered GPIF’s asset size in dollar terms to $1.53 trillion compared to Norway’s $1.6 trillion fund. The fund posted a 22.7 per cent annual return for the financial year ending March 31st.

Thailand’s $34 billion Government Pension Fund leads the region’s asset owners when it comes to integrating ESG, focusing on an optimal return for members and a social return for other stakeholders. Top1000funds.com talks to Man Juttijudata, responsible for GPF’s active investment strategy, outsourced funds management and RI strategy about the key challenges – like how to treat EV companies – and how he relies on fund managers for nuanced assessment.

Thailand’s $34 billion Government Pension Fund has developed a leading ESG strategy among institutional investors in the region that integrates sustainability into two thirds of its holdings spanning all asset classes, with the exception of government bonds and hedge funds.

“Our objective is not to just maximize returns,” explains Man Juttijudata, senior director, strategic and tactical asset allocation who is responsible for GPF’s active investment strategy, outsourced funds management and responsible investment strategy, and has been at the fund since 2006.

“We prefer to achieve an optimal return for our members and a social return for all our other stakeholders. We are not investing just for this generation but for future generations too and sustainability is the most important return.”

Sixty per cent of the portfolio is in fixed income comprising Thai government and corporate bonds, global sovereign and corporate bonds, and a smaller allocation to short term bonds and emerging market fixed income.

Risk assets claim the remaining 40 per cent, divided equally between equity (domestic, global and emerging market) and alternative assets where allocations include global real estate, infrastructure, private equity, commodities and two mandates with absolute return managers to support tactical allocation and with a low correlation to other assets.

“The economic cycle between the global and domestic allocation is different and by investing globally we can tap a wider and deeper market that gives us more opportunity to bring back returns for our members,” says Juttijudata.

Weights and scoring

The fund integrates ESG in its actively managed equities by applying negative screens and using an ESG weight and score asset valuation methodology that adjusts the weighted average cost of capital and stocks in the portfolio.

In place since 2018, the methodology scores companies using MSCI ESG data but also draws on additional, local analysis of Thai companies that includes governance data, a particular concern at the fund.

“We seek to assign a greater weight to governance in our investment process. We modify MSCI’s ESG data and scoring processes to integrate Thai-specific data sources to reflect our concerns,” says Juttijudata.

In fixed income, the fund draws on credit research that includes ESG performance, and also applies a negative screening process. It does not currently analyse ESG issues for its sovereign bond holdings, but does invest in sovereign Green, Social, and Sustainability (GSS) bonds which contribute to ESG outcomes.

Juttijudata won’t add any more fossil fuel holdings to the portfolio, but says the fund won’t divest on climate or emissions grounds either – although it does on governance concerns. He argues that divestment only leads to less scrupulous investors buying dirty assets and also worries that the data is too sketchy to inform accurate divestment decisions.

“We are trying to introduce more emissions data and quantitative analysis into our reporting. But right now, we are not confident that the data is accurate enough to make a decision on divestment so we concentrate on engagement.”

Recent engagement wins include persuading companies in Thailand’s power sector to increase efficiency.

“We engage with small cap stocks as well,” he says.

He observes that Thai companies are increasingly open to engagement. Last year the investor engaged with Thailand’s top 10 companies, most of which have a net zero target and have set caps on emissions.

“Companies that export to Europe know that if they don’t do this they may face a tax on their exports.”

Key challenges to the ESG strategy include the oftentimes absence of coherent beliefs around investing in sin stocks like alcohol. He is also struggling to develop the right nuance around stocks like EVs.

“EVs are good companies but lithium mining is ESG negative and you are always going to have this dispute with electric cars.” For now he relies on managers to conduct a trade off in the scoring process.

Looking to the future his focus is on improved reporting on GPF’s climate exposures; extending ESG to all assets in the portfolio and driving higher standards of responsible investment in Thailand, and across the Asian markets.

He says he has no plans to move into impact investment, primarily because he’s worried about the impact on returns.

“We do try to have a positive impact, but if we trade too much of our return we will lose the consensus from members,” he says.

The internal team manages the domestic allocations to Thai equity and bonds. In global investments where the team don’t have the expertise, he outsources and incorporates ESG into external manager selection, appointment, and monitoring processes.

He likes the competitive tension between the internal and external team and despite outsourcing, the internal team is still able to add top down tilts when they see an opportunity between sectors or regions that complements bottom up active management.

He would also like to build out the allocation to risk assets, namely public equity and a new allocation to private debt.

Governments and the private sector are supporting climate technology. Learn why net zero is the future.

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