| Investor Profile: Sustainability is key for the Environment Agency Pension Fund |
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| 5.03.2006 | |
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Innovation is often the hallmark of success. The UK's £1.3bn Environment Agency Pension Scheme and its "environmental overlay" is no exception to the rule. The fund has recently been the recipient of four pension fund awards* for its new investment strategy during 2005/06. "We want to invest in the best companies that do and will post the best returns for the fund", confidently states Howard Pearce, the Head of Environmental Finance and Pension Fund Management at the Environment Agency. "Our view backed up by research is that those companies are often the ones that seek to reduce their environmental risks or exploit sustainable environmental opportunities" For that matter, the EA does not screen out sectors or companies on ethical grounds, but has rather put in place an investment policy that favours financially and environmentally robust companies. "We tell our active fund managers that we want them to take account of these financial material environmental risks and opportunities and follow a best-in-class approach wherever possible ", explains Mr Pearce. "If they follow our will, they should be investing in companies that are least risk-exposed or most opportunity-exposed." This is a hands-off approach: the EA does not interfere in its managers' day-to-day business, but rather "encourages" them to invest in such companies. "We are simply trying to ensure financially material environmental risks and opportunities are more fully integrated into mainstream financial investment", says Mr Pearce. "We think that most people will be doing that within the next decade. More institutional investors, fund managers and investment consultants are now beginning to believe that as well", he says, pointing to scientific evidence for climate change and its impact on the economy, and new developments such as emissions trading. This approach, he explains, fits perfectly with the scheme's fiduciary duty of getting the highest returns for current and future beneficiaries "We are concerned about the financial and material risk that are now growing from things like climate change. We want to make sure we don't lose any returns by being too exposed to those risks. On the other hand, we also see that there are financial opportunities from clean technologies, and we want to get the financial benefits out of them." Investment design As a relatively young and immature scheme, the Environment Agency Pension Fund, the only national constituent of the Local Government Pension Scheme, is also unique in the local government pension scheme family in having a relatively good solvency of 94%. Other funds are generally not as solvent points out Mr Pearce, who explains that this situation partly stems from the absence of past contribution holidays, their growing membership, and the scarcity of its pensioners so far. "We have also been financially prudent on how we've managed over the years". The EA strategic asset allocation is 31.5% in UK equities, 31.5% in overseas equities, 13.5% bonds, 13.5% gilts, 5% property, and 5% private equity. Its most recent review of the investment strategy led to a diversification of the fund's assets into property and private equity for the first time as well as a switch from balanced to specialist funds. "Our experience is that balanced funds do not perform as well as expected and that there are fewer choices around in terms of good balanced managers, so we were advised and decided to the move to the specialist manager approach", notes Mr Pearce. Active managers, he says, should use up their entire budget risk and not merely work as enhanced passive managers. Around 40% of the scheme's assets are passively managed by Hermes Investment Management in a mandate composed of UK and global equities as well as gilts, because he says "they are renowned for their robust approach to corporate governance and engagement, and use environmental research from Trucost in the process." "We previously had a higher proportion of passive management funds. We actually increased the proportion of active management when we redesigned our strategy two years ago – increasing our risk in the process. But we also decreased risk and increased potential returns by diversifying into new asset classes such as property and private equity, which are all in segregated funds of funds", says Mr Pearce. Those alternative assets are also subject to the environmental overlay, which is here applied in a slightly different fashion. For instance their private equity manager, Robeco, invests 70% in mainstream private equity and 30% in clean technology funds. One of its property funds, the Igloo Regeneration Fund, invests in disused brownfield sites, and other funds are environmentally assessed and benchmarked by Upstream. The EA Pension Fund also assesses the usefulness non-financial factors. "Our active managers first look at financial fundamentals and then integrate in eco-environmental and sustainability fundamentals, but one of our managers does it the other way round", says Mr Pearce. On top of that, they use various "shadow" SRI indices to track the relative performance of their funds, but stick to mainstream financial indices such as the MSCI World as its formal performance benchmarks. In the end, the implementation of its "environmental overlay" does not preclude the Environment Agency from applying other types of much more common strategies. They are currently looking for a currency overlay manager that will combine passive and active management. They also monitor their fund manager's transaction costs and have a commission recapture programme. J.L. * The four awards are: · Global Money Management Award (Public Pension Fund of the Year) · IPE Award (SRI and Corporate Governance Award) · Local Government Chronicle (Corporate Governance Award) · City of London Corporation (Sustainable and ethical investment and asset management Award – runner up to the Carbon Disclosure Project – of which the EA Pension Fund was a founding member) |
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