CalPERS bets on outperformance from growing climate allocation

CalPERS’ Peter Cashion tells Top1000funds.com how the pension fund’s strategy to allocate to climate mitigation, transition and adaptation strategies is allowing it to access an untapped corner of the US market where many investors have retreated because of the policy environment.

The US policy backdrop has led many investors to cut back on their climate investments and internal team specialists. But CalPERS, the country’s largest public pension fund, has built its responsible investment team to 18 and is confident it can generate outperformance from investing in climate solutions and tapping into pockets of the market that others have missed.

“We told the board two years ago that we are doing this to generate outperformance,” says Peter Cashion, CalPERS’ managing investment director for sustainable investments charged with overseeing a Climate Action Plan which pledges to allocate $100 billion to climate solutions by 2030.

CalPERS currently has $60 billion invested across climate mitigation, adaption and transition sleeves in a strategy that Cashion says is also complimentary to the fund’s new Total Portfolio Approach, just endorsed by the board. Climate solution opportunities sit across the entire portfolio from venture to infrastructure and fixed income, where CalPERS has a sizeable allocation to green bonds, he says.

That exposure includes a $5 billion allocation to a customised public equity Climate Transition Index that tilts towards companies that have a transition plan and reduces exposure to those that don’t. Companies’ weighting in the index is determined by the amount of green revenue they generate based on data from MSCI, FTSE, and others. It means high emitters are included in the index because these companies will also have renewable energy assets or use carbon capture technology, for example.

“We do detailed diligence to try to validate that number and if it’s 1,2 or 3 per cent that comes from one of these green activities, we want to give them credit for that.”

Although returns from the CTI over the last nine months have been flat (with CalPERS index) Cashion believes this is too short a time period to extract a negative or positive view of an allocation that is notably more resilient.

In a sign of things to come, and proof that investing in sustainability does generate outperformance, he points to the fact that over the nine months of this year the S&P Climate Transition Index is up 50 per cent compared to the MSCI All World Index, up about 20 per cent.

What is most striking is that this has happened despite the negative policy backdrop in the US, he adds.

Companies that integrate sustainability create value and most companies are continuing to increase their investments in sustainability. US corporates are quieter about their strategy in the press; their public statements on the issue are muted and they have left the various net zero alliances.

But he believes most companies “are essentially doing the same thing” as they were before the Trump administration’s policy roll back that includes repealing regulations from the Environmental Protection Agency and the blockage of funds under the Inflation Reduction Act of 2022.

“It is striking because we’ve had all these negative developments from a policy perspective in the US. But underneath, there are actually a lot of positive things happening, and even in the US there is a huge amount of demand and investment happening,” he says, citing demand for renewables because of the increased need for electrification driven by AI, as well as growth in sectors like nuclear, grid improvements and carbon capture although offshore wind and EVs are struggling.

Outperformance in private markets

In private markets, CalPERS has made investment commitments in 13 climate-focused funds that include stakes in companies developing energy optimisation software, drought resistant crops and battery storage.

Cashion says the team focuses on identifying high conviction managers with leading strategies, and has developed a pacing plan for each asset class. But he says it’s too early to see outperformance in private markets because fund investment is a multi-year process.

However, he is confident that returns will be increasingly propelled by the growing synergy between climate solutions and AI. For example, CalPERS has invested in a company using AI and mobile technology to prevent wildfires before they spread. AI is also driving efficiencies and helping reduce emissions in the mining sector.

“Mining companies are increasing efficiency by using AI to find deposits in a way that also saves on emissions.”

CalPERS’ stake in the UK’s fast growing power company Octopus Energy alongside Australian pension fund Aware Super is another example. The private company’s Kraken AI software, used for customer billing and matching electricity demand to the intermittent output from wind turbines and solar farms, is licensed to other energy providers.

“Identifying companies using AI to increase energy or resource efficiency ahead of other investors is an important theme. Wouldn’t it be cool to be in those companies before they IPO?” he concludes.