It’s hardly surprising that a pension fund for employees working for an organisation charged with reducing climate change and its consequences invests according to strict green criteria. Yet the investment strategy of the United Kingdom’s £2.1-billion ($3.29 billion) Environment Agency Pension Fund (EAPF) definitely has the capacity to surprise. The EAPF posted a total return of 5.1 per cent, double the average 2.6 per cent of the UK’s other 89 Local Government Pension Schemes (LGPS) last year. Since 2009 the fund, which has 22,000 members in England and Wales, has returned a total of 16.1 per cent, again beating most other LGPS schemes. “Our focus on green investments is having a very positive impact on our financial returns,” enthuses its head Howard Pearce, who lives and breathes sustainable investment. Pearce dates his passion for environmental causes from his boyhood near Manchester, when he was unable to boat or fish on the polluted River Mersey.
As awareness of environmental, social and governance issues steps up a gear, the link between ESG strategies and returns has become hotly debated. For Pearce, head of the EAPF for the last 10 years and under whose stewardship the fund has grown to over $3.29 billion from $1.2 billion, the link between ESG and performance edge is glaringly obvious: well governed companies that manage their ESG risks will, overtime, produce more sustainable returns compared to poorly governed companies, he says. Now the fund is radically increasing its green strategy even more. “So far 13 per cent of our fund investment is linked to the green economy and we are on target to increase this to 25 per cent by 2015.”
Getting real with asset allocation
The EAPF’s active fund currently portions 73 per cent of its assets to a growth pool and 27 per cent to a defensive allocation. The bulk of the growth pool, at 63 per cent, is in listed equities but the new strategy will see this gradually pared down. The total equity allocation will fall to 50 per cent in the next few years and increasingly favour actively managed emerging markets – including a mandate managed by First State – in sustainably themed equities. “We have reduced our direct UK holding to a target of around 13 per cent to improve diversification and avoid the stock concentration present in the UK,” he says. “Emerging market equities offer better, long-term growth rates and investing in global markets enables us to access a much wider range of strategies and managers, including thematic sustainability funds.” The growth fund will maintain its 5 per cent allocation to private equity, managed by Robeco-Sam, but in another, sweeping shift, aims to gradually build its allocation to real assets from 5 per cent to 14 per cent.
In what Pearce dubs a back-to-basics approach targeting tangible assets rather than “esoteric financial products”, allocations will be made to property (6 per cent), infrastructure (4 per cent), as well as farmland and timber (4 per cent) with returns targeting at least 5 to 6 per cent annually. “We already invest in property. We now intend to look at investing globally in infrastructure, sustainably managed farmland and sustainably managed forestry. We want these investments to give us capital growth, be a hedge against inflation and climate change.”
Real asset investments will eschew anything that could accelerate climate change including green-field property developments, intensive agriculture, tropical hardwood deforestation and environmentally unsustainable infrastructure. Instead the focus will be on assets like low-carbon buildings, renewables and mass transport networks. These new allocations will most likely be invested via managed funds or possibly in collaborative ventures with other like-minded pension funds, he says.
Elsewhere, the defensive allocation will gradually move out of UK gilts, dropping from 13 per cent to just 5 per cent in the next few years. The slack in the strategic fixed-income allocation will be taken up by a doubling of the allocation to corporate bonds to 28 per cent by 2014. Despite the shift, Pearce reassures that because the fund is structured around allocations oscillating between set ranges it “still has the opportunity” to switch back into gilts “should yields start to pick up.”
Sharing with the locals
Pearce’s response to concerns that the green-investment universe is still limited is suitably swift. “If we cannot find suitable investments to meet our sustainability and financial criteria, we will not invest.” He does, however, acknowledge that high quality managers specialising in these new asset classes are still thin on the ground. The shift in strategy means more allocations, all with ESG managers, are in the pipeline with the EAPF in the final throws of completing an EU-wide tender for a low-volatility global equity allocation and for a real asset manager too. “Our searches are still underway, but we hope to appoint by April 1,” he says. “Some of these new fund management contracts we will set up may be accessible by other LGPS funds.”
In this novel approach the EAPF has hooked up with five other local authority pension schemes to jointly procure and employ specialist actuarial and other advisory services. Through this pooled procurement, local authority schemes don’t lose any control or identity over their fund, consistent with the government’s localist agenda, but the strategy does allow significant cost savings. “Each fund tendering separately would have cost around $940,000 whereas the estimated total cost for the collaborative exercise was around $313,000,” says Pearce. “Going forward, funds should save around 10 per cent annually with reduced day rates, reduced costs for specific work, discounts for doing the same work for more than one fund, and added-value free services. Current estimates indicate a further overall saving of up to $1.7 million over seven years.” If the sharing approach is broadened further it could help shave costs in a fund where “100 per cent” of the assets are externally managed. “Our best performing ESG managers are Sarasin and Generation, both managing active global equity mandates,” says Pearce. The EAPF’s Pensions Committee is responsible for strategic asset allocation, investment policy and the appointment of advisors and managers, but the fund has shaped its new strategy using Mercer and B Finance.
For Pearce, whose career began in the environmental management of river systems and not, unlike many other heads of local authority schemes, in accountancy, following ESG criteria is more necessity than optional extra. He’s notched up many firsts during his time at the helm, including signing up to the United Nations Principles of Responsible Investment in 2006 and becoming the first UK scheme to produce a Responsible Investment Review in 2009. Shifting to a bigger allocation to green investment is an entirely natural progression. “Our priority is to maximise risk-adjusted investment returns but we have also seen significant changes in some corporations’ behaviour and management,” he says.