Next year, Railpen, investment manager for the £35 billion UK railways pension schemes, will focus engagement and AGM voting on affecting corporate change around cyber security, climate transition, biodiversity, workplace treatment and mental health. The asset manager will also enhance its voting and engagement positions on dual class share structures (which give company founders more votes per share) fair pay, the treatment of gig economy workers and modern slavery.

Railpen’s decision to integrate mental health into its voting policy follows research which found that only 13 per cent of UK listed companies’ annual reports discussed mental wellbeing in relation to health and safety or risk assessment, despite the clear materiality of mental health to a company’s ability to attract and retain employees.

An engaged, motivated, and supported workforce is vital for sustainable financial performance, and Railpen expects portfolio companies to engage meaningfully with their workforce and demonstrate a healthy corporate culture, said the asset manager in a statement.

Rather than outsourcing stewardship, engagement at Railpen is in the hands of its own internal team to better align stewardship with its ESG objectives, particularly its ambitious net zero targets. It’s a level of control that is particularly important when it comes to timing engagement and knowing when to escalate.

“This year we have explicitly flagged our expectation that portfolio companies look after their entire workforce, including both directly and indirectly employed workers, and effectively communicate to shareholders the steps they are taking to do so,” says Caroline Escott, senior investment manager at Railpen.

“Our previous research with the CIPD, PLSA and High Pay Centre found that many of even the largest UK companies fail to appropriately discuss their support for indirectly employed workers. This is an issue for many firms, but especially for those in the ‘gig economy’ where it is particularly important for investors to be able to gauge the rights granted and level of support provided to workers.”

The latest voting policy reflects Railpen’s ongoing corporate governance themes of board composition and effectiveness, remuneration and alignment of incentives and shareholder rights, and risk and disclosure.

Pre-declaration

In another step, Railpen will consider pre-declaring voting intentions on specific resolutions. The idea being to send an important signal to the company and the market. “Railpen values open dialogue with companies and therefore will continue to notify companies of voting intentions in advance to support effective engagement, where they are priority holdings,” it said.

A key 2023 priority is ensuring that net zero pledges are turned into real action. Next year’s voting policy also sets out Railpen’s belief that a good transition plan should set out a company’s decisions on decarbonisation and adaptation in a comparable way with clear quantification of interim targets and milestones.

Corporate transition plans should also focus on material actions, activities and accountability mechanisms, account for biodiversity loss, natural capital impact and social impact as key externalities, clearly link targets, financial planning, and capital allocation and, where offsets are used, adhere to best practice principles.

Railpen will also urge portfolio companies to consider how they can better appraise and account for nature-related risk and redirect capital allocation decisions towards nature-positive outcomes. They will consider voting in support of resolutions which encourage companies to address drivers of biodiversity loss.

Although mindful of the ongoing challenges in accessing the best possible data, reporting and analysis of these types of risk is evolving and to support its assessment of companies’ transition plans, Railpen will use its proprietary framework and the UK Transition Plan Taskforce (TPT) best practice guidance.

Cybersecurity

Railpen will also urge companies to do more to counter rising cybersecurity risk. Building on its longstanding engagement with at-risk companies on cybersecurity (both directly and as part of the UK Cybersecurity Coalition) in 2023 Railpen will ask companies to explicitly disclose the governance and oversight structures in place to identify and manage cyber risks, as well as provide timely reporting of any breaches and the measures taken in response.

Where these risks are not deemed to be appropriately managed, the pension fund will vote against audit and other committees, and consider voting against reports.

“The world is constantly adapting, and we need to ensure that we are ahead of major sustainability and governance challenges so we can effectively engage with portfolio companies on behalf of the members of the railways pension schemes. Laying out a clear, defined voting policy allows us to highlight our expectations of performance on key ESG risks in a way that is accessible to our portfolio companies, our external managers, and our beneficiaries,” said Michael Marshall, Raiplen’s head of sustainable ownership.

“In the 2023 AGM season, we will continue to exercise our votes on those resolutions where we believe our vote will have the most impact. We take our role in enhancing the long-term investment returns of our beneficiaries extremely seriously, and doing so in a way that benefits the world around us and the needs of our members now and in the future,” he concludes.

 

 

The credibility of transition plans is under scrutiny because while sustainable investing is booming real world impact is going in the wrong direction. In response investors need to innovate on the nature of investment mandates says Colin le Duc, a founding partner of Generation Investment Management.

Innovating on the nature of investment mandates is the next stage of sustainable investing, said a founding partner of London-based sustainable investment pioneer Generation Investment Management, as rising carbon emissions – despite booming sustainable investing – lead to growing criticism of the ESG universe and its real-world outcomes.

Climate-led or impact investing is the next stage where investors take climate objectives as their “north star” and optimise risk, return and impact, said Generation founding partner Colin le Duc, speaking on the Top1000funds.com podcast.

This is distinct from the old view of sustainable investing which aims to deliver long-term financial returns in a sustainable way, le Duc said. Impact investing enables investors to tackle difficult issues more directly, rather than merely picking the “low-hanging fruit with…investment mandates [that] work today.”

“So, you know, not just investing in de-risked renewables in North America, for example, or not just buying the Tesla stock or whatever it might be,” le Duc said. “You actually need to focus on the hard-to-abate sectors.”

Carbon emissions continue to rise, he said, noting emissions will increase 2-3 per cent this year and are projected to rise up to 10 per cent by the end of this decade, at a time when they need to go down by 50 per cent.

Podcast host Amanda White, director of institutional content at Conexus Financial, pointed out only 10 per cent of capital flowing into climate is going to the solutions for the highest emitting, hard-to-abate sectors that create more than half of global emissions. 

Le Duc welcomed criticism of ESG as part of the “maturation of the sustainable investing and the ESG investing idea and space” and a pushback against greenwashing.

And he praised the “radical transparency” brought by Al Gore-backed initiative Climate TRACE, which moves away from voluntary reporting and tracks the biggest sources of greenhouse emissions for a more accurate– albeit uglier–view of progress on carbon reduction.

Climate TRACE had delivered news that is “very, very bad on actual levels of emissions, which are much, much higher than has historically been reported,” le Duc said.

“Real world impact is going the wrong way, even though sustainable investing is booming,” le Duc said. “So there’s a mismatch there, which I think is starting to play out in all of this greenwashing, and the pushback, and the confusion around what ESG and sustainable investing is.”

But while more reliable data is critical to understand the systemic risk the financial system is running with its carbon dumping, he warned that “perfection can be the enemy of the good,” and that “if we wait for perfection on reporting, every day we’re missing the 1.5-degree window.”

Systems need to be put in place concurrently with fixing the problem, he said, and “being directionally correct is actually better than waiting for perfection on data clarity.”

Unlike harder-to-define measurements such as human health or poverty, climate at least has a well-understood and broadly accepted metric to measure it, which is a ton of CO2, le Duc said.

The United Nations Climate Change Conference, known as the Conference of the Parties or COP, “probably needs a bit of a reboot…but it is the best we’ve got in terms of a global forum to talk about a global issue,” le Duc said, and it would be “extremely dangerous to dismantle it because…there’s no other forum like it.”

Collaboration is critical when facing a systemic challenge like climate change, le Duc said, and initiatives like the Glasgow Financial Alliance for Net Zero (GFANZ) encourage corporates to “put their neck on the line and say: ‘This is what we believe in, in terms of the climate transition.’”

Questions remain about whether these entities will stick to their commitments, he said, particularly in light of the wide-ranging challenges 2022 has brought to global markets, and there are signs some parties are “backtracking” or “push things a little bit to the right.”

With extremely high short-term energy prices, investors are weighing up whether they should “leave money on the table to stick to climate commitments,” he said.

“I think there’s a real focus on credibility of transition plans right now,” le Duc said.

 

Good quality, holistic research is more important than ever when assessing emerging markets investments with a sustainability lens, argues a portfolio manager at Newton Investment Management.
With volatility a strong theme of markets and economies over 2022, some investors have de-risked their portfolios and lost their stomach for riskier emerging markets investments. But a portfolio manager at Newton Investment Management argues emerging markets still offer value if you know how to find it.

Alex Khosla, portfolio manager in the emerging markets and Asia equities team at Newton Investment Management, said emerging markets cover a heterogeneous group of countries where four in every five people live today, accounting for about half of global GDP despite being serviced by about 10 per cent of equity allocations in the world.

There are also compelling reasons for sustainability-focussed investors to be in emerging markets, Khosla said. “Two-thirds of the world’s investment needs for a sustainable future, according to the UN, need to happen in developing countries,” he said.

Speaking with Conexus Financial managing editor Julia Newbould on podcast series Market Narratives, Khosla said Newton begins its search for emerging markets investments by looking at companies and asking three questions: What need is the company addressing? Is the company providing a new or innovative solution to that problem? Can you feel alignment, integrity and competence among the people running it?

 

Newton looks broadly at the industry and its relevance to the country and the region, asking questions like whether the company is investing capital in a way that will lower pricing to consumers, provide a particularly innovative solution or reach a new group.

This could include looking at whether offerings such as food or medicine or travel are a particularly pressing need in the targeted markets. Is the country facing problems with financial under-penetration? Are there negative externalities a venture, such as water intensity or biodiversity risks, and do they outweigh the benefits of the project? Is the company leading or lagging its industry in addressing these problems?

Newton also has well-resourced teams looking more broadly at things like geopolitical risks and their potential impact on different asset classes, leading the group to avoid or be particularly wary about investments in some countries or regions.

“Where you have weak institutions, that can result in things like kleptocracy and things like war, they’re often not great environments for businesses that are looking to try and sustainably solve and address needs in a society,” Khosla said.

Looking at management purpose involves analysing the alignment, integrity and competence of the people at the company, which helps ensure the company stays focussed on sustainable growth.

“Assessing management purpose is very hard, and it’s very qualitative but we do think it’s critical,” Khosla said. “We also think it’s why it’s important to have a team of investors that are trained across a wide degree of skill sets because some of these more qualitative things are difficult for investors trained to build spreadsheets.”

As an example of differentiating companies based on management, Khosla pointed to the solar industry which is increasingly important for renewable energy, and also increasingly crowded. But among the myriad companies in this space, it is a smaller number that are truly committed to innovating to reduce the cost curve, he said.

“Some companies are just there to empire build, and some companies are more interested in scale for scale’s sake, rather than really identifying where they can improve the industry’s cost profile by doing specific things around innovation,” Khosla said.

There are also examples of emerging markets companies “where the owners or the management of that company really found themselves in that industry because of some sort of patronage or some sort of link to a government that wasn’t because of their competence, it was because of other things,” Khosla said. “And we tend to believe that in the very long run those businesses are more likely to be found out.”

Differentiating between companies can be harder in some emerging markets, with limited data or limited voting posing difficulties for sustainability in particular. But these obstacles aren’t insurmountable, Khosla said.

“We do think there’s enough data now to–as long as you work hard and you keep plugging away–to start really trying to track company progress on whether they’re delivering…those sustainability goals.”

Active engagement on sustainability issues can also help drive emerging markets companies in a positive direction, he said, and also gives the investor the chance to analyse the management’s response.

In an interview with Herman Bril, PSP Investments’ new head of responsible investment, Top1000funds.com looks at how the fund is collecting and reporting on sustainability information based on a technology-enabled, data-driven approach that spans a bespoke, green taxonomy for climate investing to ESG scores derived from AI.

Pension funds haven’t attracted the same greenwashing criticism as banks or asset managers. They don’t sell financial products, and don’t have a commercial incentive to exaggerate their green credentials. Still, it’s fair to say responsible investment reports often feature more pictures of windmills and greenery than data or hard numbers around portfolio emission reductions.

Canada’s PSP Investments, which invests C$230.5 billion on behalf of Canadian public sector pension plans, hopes it has broken the mould with its 2022 Responsible Investment Report, notably heavier on reporting, measuring and analysis than environmental storytelling.

The numbers dotted throughout the report are based on a technology-enabled, data-driven approach that spans a bespoke, green taxonomy for climate investing to ESG scores derived from AI.

“There are more numbers than stories in this report,” says Herman Bril, PSP Investments’ managing director and head of responsible investment, in the role since July this year.

Numbers like the $46.5 billion invested in green assets, a jump of $6.2 billion. Or the 14 per cent increase in the number of companies in the portfolio reporting GHG data as per TCFD recommendations to 42 per cent. Elsewhere the report cites a spike in exposure to transition assets by $1.4 billion.

Gathering the numbers is no mean feat. Accessing emissions data in public markets is getting easier, but for pension funds with large allocations to private assets like PSP Investments (where half the portfolio is in private markets) accessing accurate climate data from infrastructure, credit or private equity holdings remains an enduring challenge.

Asset class heads request emissions data from portfolio companies and GPs, which PSP Investments then uses to measure the carbon footprints of its assets in a process complicated by the fact disclosure is still voluntary in many jurisdictions.

green asset taxonomy

Cue new tools to support the process, amongst which a green asset taxonomy is the most unusual. The framework, both quantitative and qualitative, assesses investee companies carbon intensity and the creditability of corporate transition plans, helping measure exposure to green, transition and carbon-intensive assets.

“Not many pension investment managers have produced or published their own taxonomy,” enthuses Bril, who explains that assets are labelled various shades of green, through to brown.

In another approach, PSP Investments has embarked on a composite scoring process, begun in public equity but with a view to rolling it out across private markets.

The scores are based on cherry picked data from a variety of vendors. For example, the team will use governance data from one vendor and dynamic materiality signals from another in a process that builds a much better sustainability risk profile of an asset than buying standard ESG scores off the shelf.

“You can order a plate of spaghetti from a takeaway and not know what is in it – or you can cook your own. You might use the same ingredients, but you will have a much better understanding of the different components and how you put the dish together,” Bril says.

But the scores are not primarily used for decision-making. Rather, they are a source of base data from which the team then performs more research.

“The scores show how a company has performed at a high level and flag where we need to take a deeper dive before we invest,” he says, adding that the scores are an important source of proprietary data.

“We are not in the business of providing ESG scores to others. We do our own homework as active investors and as part of our mandate as a pension investment manager.”

Transition assets

The taxonomy has revealed PSP Investments’ holdings in brown and transition assets as well as assets in hard-to-abate sectors. Although holding them means emissions in the portfolio will likely rise, these assets are an important component of the portfolio and sustainability strategy given they offer the opportunity to engage and encourage corporate transition to science-based emission reduction pathways.

“When we buy a transition asset with initially high Scope 1 and Scope 2 emissions, our carbon intensity goes up. But our approach is to actively engage and encourage using transition plans so that companies transform from brown to green, and reduce actual emissions. If you divest, someone else will be a buyer and nothing has changed in the real economy,” he says.

Bril believes data gathering will get easier. European disclosure legislation will accelerate a trend in transparent and standard emissions reporting elsewhere, even though issues around quality, timing and methodologies remain.

Things are also beginning to change in the US, he says. Like the Biden administration recently issuing new procurement rules that all companies delivering goods and services to the US government must disclose their emissions data.

“This market is worth about $600 billion dollars a year. It is an interesting way to encourage more companies in the US to start disclosing emission data,” he says.

He also believes that technology, particularly AI, will bring ESG reporting mainstream. For example, investors can already measure a company’s digital footprint to gage the extent to which it is looking into ESG exposures or reputational matters.

“The machines may get you anyway,” he says. “Tools are getting much better in identifying if the emperor is wearing any green clothes at all.”

Hub and spoke

In a next step, PSP Investments plans to push the ownership of ESG integration out into the asset classes. A strategy pursued by other investors like Sweden’s AP4 and which CEO Niklas Ekvall recently credited with accelerating and transforming ESG integration at the fund.

Involving a significant cultural shift, an essential element of the hub and spoke model is that it’s coming from the top, evident in the fact Bril’s responsible investment department sits in the office of the CIO, Eduard van Gelderen. “I report to the CIO,” says Bril.

His team of 10 will concentrate on being a centre for excellence and focused on best-in-class ESG, while standard ESG underwriting will be transferred to the asset class teams themselves.

“The assumption will be that anything related to ESG is completely embedded in the investment process and an extension of the investment function, baked into investment like risk,” he concludes.

This was the first COP meeting that I have missed in a very long time. As I watched from afar, I was at first disappointed not to be there in person but as I read much of the commentary about the lack of progress along with ‘the first world problems’ of long queues and bad food, I was at the same time glad to be home watching from the sidelines.

Despite much of the disappointment around the lack of 1.5C commitments and clear language on fossil fuel phase outs along with the slow pace of change, COP still remains the critical multilateral climate convening of nations, and is now attracting an increasing host of finance, corporate and civil society representation which provides a separate stream of momentum alongside the official negotiations.

I have witnessed firsthand many investors rally around COP to make major climate announcements, to update on progress on past commitments and the same on the business side, so we shouldn’t underestimate how important COP meetings are to both governments and the private sector. Without them momentum would be completely lost.

In the post-COP twilight with the initial assessment of pass or fail all written, institutional investors are rightly asking where we are up to at the end of 2023. What has changed and what remains the same?

The divide between aspiration and reality on 1.5C as an achievable outcome has already been noted in many quarters. After last year’s COP, we talked about 1.5 being still alive but on life support, this year many have pointed to the fact that as it currently stands, there is no credible pathway to limit warming to 1.5 degrees with the latest data showing that the world is on track for a temperature rise of between 2.4 and 2.6 degrees by the end of the century. The Inevitable Policy Response (IPR) analysis released during the conference helpfully revealed the policy gap between commitments and action, against both 1.8C and 1.5C outcomes for both developed and developing countries

Another disappointment which was yet again on display at this COP was the delaying hand of the carbon lobby seeking to water down commitments and many would argue that sadly they were successful.

Yet the COP process is still important and it may yet overcome both political and private sector inertia.

Investors looking ahead are aware that next year’s conference in the UAE will see the global stocktake take place, where nations will have to table their climate homework and their progress against their NDCs. I don’t think it takes a great leap of faith to know that many countries will receive a “can do better” on their report cards.

In 2025 COP will see the global ratchet embedded in the Paris Agreement, where the pivotal fight will be about what new national targets should be.

If Australia and the Pacific Islands are successful in their bid to host the 2026 event, additional attention will be on north/south finance and large-scale investment in low-carbon development paths, along with the reality of climate change for many low-lying Pacific nations.

For policymakers the next three to four years will bring relentless pressure to act. Clause IX of the Implementation Plan highlights that $4 trillion annually needs to be spent on renewable energy until 2030, to reach net zero by 2050 and an additional $4-6 trillion a year to achieve a low-carbon global economy.

For investors, the longer-term energy security impetus unleashed by the Ukraine War and the combined impact of US legislative developments are increasingly evident. The Inflation Reduction Act is providing new impetus and will give some confidence that at least part of investor net zero portfolio commitments can be met with increased investor support.

Where we have progress on one side though, unfortunately, much has also been made of the negative effect of anti-climate lobbying at a national level and at Sharm el-Sheikh. Influence Map has been unfailing in its efforts to expose the contradictions between corporate image setting and climate action sabotage. Let’s call it for what it is.

The fossil fuel lobbyists will again be out in force again in the at COP28 in the UAE. But a reckoning will have to come. Investors must redouble their efforts to end the funding of membership and the power of trade associations, think tanks and other third-party organisations that slow policy shifts and investment flows.

COP organisers cannot continue to give free reign to climate deniers and wreckers indefinitely either.

Limiting tobacco advertising was once seen as being an almost impossible task and an untenable restriction on business. Policymakers seeking elbow room need to find the courage to begin restricting and regulating anti climate lobby efforts.

A social license will no longer be a nice to have post 2025.

Silencing the carbon lobbyists will free up space to deal with the fundamental questions of north/south finance, just transition and accelerating investment.

All reasons why COP must step up so it can continue to occupy the climate centre stage.

John Pearce, chief investment officer of the A$115 billion UniSuper discusses his long-term view on China, inflation and the impact on the fund’s portfolio.

China’s ability to escape a “middle-income trap” where population decline has pushed up labour costs making exports less competitive is dimming according to UniSuper’s chief investment officer John Pearce.

“In the long term, I’m a bit pessimistic about China. If you look through history, at countries that have managed to escape the middle-income trap that China is in, it’s got nothing to do with geography or resources. it’s got everything to do with the institutional frameworks of those countries,” he said at the Investment Magazine Fiduciary Investors Symposium in Healesville.

“It seems to me that China’s going in the opposite direction and so we’ve got Xi Jinping, looking much more inward than his predecessors.”

But he recognised there may be “some fantastic cyclical opportunities in the short term… but you’re just going to have to accept that you’re probably going to miss it”.

Rising rates

Rising inflation around the globe has been driven by massive government spending to support their citizens as economies were shut down and travel restricted to limit the spread of the Covid-19 virus before effective vaccines were rolled out.

“We are paying the price for the Covid policies, we’ve been getting the bill and the bill is called inflation,” Pearce said.

The solution is not hiking interest rates aggressively like the US Federal Reserve but to increase the supply side of the equation like opening borders, he said. “We know that governments have to spend but you can’t spend everywhere. You’ve got to ease back on some stuff because there’s just not enough supply.”

“Governments should just look at the supply side of things, cut spending and get out of the way… let nature take its course.”

He also challenged the orthodoxy of central banks maintaining a two per cent inflation target. “Is the world going to be a terrible place if we actually settle at three and a half percent with bond yields at four or four and a half [per cent] and real rates around 50 to 100 basis points? What’s the drama, we’re going to have a decent cost of capital curve, we can get back to sensible pricing of risk,” he said.

One of the most significant impacts of rising interest rates is on balanced options for members. “There’s going to be a much larger role for credit and fixed interest in typical balanced options,” he said.

“The end of financial repression will have a profound impact on portfolio construction. The bottom line is that investors can hit target returns while taking less risk.  To hit a target return of seven per cent in 2000, an investor could hold 80 per cent cash.  In the middle of Covid, you basically had to hold 100 per cent in risk assets to achieve that target. These days you could hold up to 40 per cent corporate bonds, 60 per cent growth assets and get to an expected seven per cent return,” said Pearce.

Internalisation model

UniSuper manages over 70 per cent of its assets internally with a team of less than 60. The main driver was the need to tailor portfolios to accommodate a significant $30 billion defined benefit scheme, though the massive cost savings was another boon for members.

“We always felt that developing an in-house capability to manage a liability driven investment portfolio was much better than just farming out the money,” Pearce said.

“It was always a case of logical incrementalism, this was working well for the defined benefit and we just started applying it across all the other options. A very positive benefit is a massive reduction in costs.”

Pearce said the operational leverage from having an inhouse management capability has meant there was no need to add any new staff to deal with the enlarged asset base after the merger with the $12 billion Australian Catholic Super.

The asset classes that UniSuper outsources to external managers require specialised skills and labour-intensive due diligence processes such as infrastructure, private equity, US high-yield and Asia small cap.

“The governing principle is that you stick to pretty sensible, generic types of assets that don’t require large teams. That’s the model that I’m comfortable with,” Pearce said.