A consistently low allocation to private markets, too little exposure to growth and a damaging decision to jettison a home bias in favour of poorly performing international equity have been some of the key contributors to CalPERS weak historical performance relative to peers. Speaking during the latest board meeting in an especially carved-out agenda item, new CIO Nicole Musicco put her stamp on the giant pension fund, laying out errors of the past and her plan for the future.

A hypothetical benchmark composed from peer funds’ performance over the last ten years sheds light on where CalPERS has persistently underperformed. Between July 2014 and July 2018, America’s biggest pension fund lagged peer funds in the index by 2 per cent with most achieving hypothetical annualised returns of 7.6 per cent compared to CalPERS 5.6 per cent.

The reason, she said, was the fund’s over-prioritisation of downside risk. “We constructed a portfolio to limit the downside and with that missed out on a big chunk of growth,” she said. “This is a hypothetical portfolio of peer funds, but the messaging is consistent.” With assets of $439.6 billion, down $30 billion compared to June 2021 and having just posted the lowest fiscal return since 2009 at -6.1 per cent, Musicco stressed it was time to act.

Private markets PAIN

CalPERS consistent failure to allocate more to private markets is the biggest single cause of the poor performance relative to peers. “The private markets programme is the problem,” she said. CalPERS failure to consistently pace capital deployment in private equity – and private markets more broadly – between 2009 and 2018 resulted in the portfolio missing out on between $11-$18 billion in a lost decade.

Still, Musicco insisted the future is bright and that CalPERS can make up for lost time. Many asset owners are currently overallocated to illiquids, but CalPERS, late to the game, has room to invest more. “It’s an excellent time to go into private markets,” she told board members.

This could manifest in an opportunity to backfill and pick up secondary buys. The current environment will also play to CalPERS strength in value investments given today’s focus on traditional corporate metrics like cashflows and margin. CalPERS in-house private equity team is thoughtful, agile, well governed and increasingly sought-after for its ESG expertise. She pointed to a list of excellent partners and CalPERS own, growing reputation as a decisive partner, quick to “give a yes or a no” that will help build out the co-investment programme. “We are in a position to become the first call and invest in needle-moving opportunities from a scale perspective.”

International mistake

Musicco’s historical analysis highlighted another painful mistake: abandoning the home bias. Some years ago, in a bid for diversification, CalPERS ploughed into international public equity. Relative to peers who maintained a home bias, that decision backfired. A source of consternation for board member Theresa Taylor who recalled questioning the decision at the time. “I asked, ‘how come we are overweight international’ and I was brushed off,” she said. “We stayed that way, even though we returned poorly.”

Elsewhere, CalPERS’ factor-weighted segment, added to the strategic asset allocation in 2018, has proved problematic. Designed to reduce the beta exposure in public equities and avoid excess volatility, it has come at the expense of important upside growth. “For an extended period of time, the active strategies have not been working,” she said.

CalPERS historical over-emphasis on downside risk has coupled with the fund not getting paid enough for the risk it did take. Turning the conversation to risk return, Musicco said CalPERS’ frustrating sharp ratio proves the fund has not got the return on risk it should have.

For example, CalPERS wasn’t sufficiently rewarded for its riskier real estate investments. The portfolio is portioned between core, opportunistic and value add, but the latter, riskiest allocation, didn’t always result in expected higher compensation. In recent years CalPERS has transitioned the portfolio back to core whereby the opportunistic and value add allocation (a combined 10 per cent of the portfolio) is dominated by legacy investments.

She said it was still too early in her analysis to clarify for sure if CalPERS had taken on more or less (unrewarded) risk than peers since this would depend on asset class analysis. Still, she said “in general” the fund had taken less risk overall and been paid less for the risk it had taken.

Cultural change

Going forward, Mussico will devote much of her attention to ensuring CalPERS gets sufficiently rewarded for the risk it does take and leans into active risk to fully grasp the value creation inherent in an active programme.

Rebooting active management will involve reviewing the risk budget, deciding what the pension fund needs most from its active programmes. At its heart it requires a cultural shift whereby the investment team are held accountable, but also empowered to take risk, backstopped by innovation and resilience.

“My hope is that we are going to get more focused and accountable regarding active risk,” she explained. “The next chapter of my first year will go on developing the right tools and culture for risk taking. I don’t want us to fear risk taking; if you’re punished every time you won’t be motivated or incentivised, but we also need to get the appropriate level of return.”

She is not just rebooting CalPERS approach to alpha in the equity book. Active risk budgeting will span the whole portfolio, targeting every opportunity to generate value-add dollars. “When we transition to the next phase I want to look at how we apply our entire risk budget across different strategies; how we set metrics, if we are being paid and held accountable. Our behaviour and culture are not focused in this way. Rather than beating the benchmark I want to look at where we are adding dollars to pay benefits.”

Consistent governance

Musicco also stressed the importance of consistency in the investment process. Pulling out of the private markets programme hurt CalPERS dearly, she said. “It doesn’t serve us to come in and out of programmes.” It’s why she will particularly focus on governance and decision making, avoiding stop-start decision making and ensuring the board thoroughly vet the consequences of both investing but also frequent changes in strategy.

This, combined with a philosophy that goes beyond just setting a SAA and pressing the button. She also espoused the importance of a sufficiently robust governance to allow agile decision making that is visible to all investment partners “We need the tools in place to act, rather than just wait it out,” she concluded.

 

Collective engagement is one of the most powerful forms of stewardship, industry figures say, sharing examples and insights into successfully driving change on ESG within some of the world’s most powerful organisations.

For example, Rio Tinto felt the power of collective engagement after it blew up a significant piece of tribal aboriginal heritage in Australia’s Pilbara region two years ago. This was “one of the greatest governance failures I’ve seen in a long time,” said Louise Davidson, chief executive of the Australian Council of Superannuation Investors.

When ACSI met with the Rio Tinto board a week later, she was struck that the board “didn’t really see it as being a big issue,” Davidson said, speaking in a panel discussion chaired by Fiona Reynolds, chief executive of Conexus Financial, at Sustainability in Practice at Harvard University.

ACSI has 26 superannuation funds as members, mostly Australian but some international. ACSI carries out broad engagement programs on members ’behalf, provides some proxy voting advice and researches public policy advocacy.

Negotiations with Rio Tinto went back and forward on the issue for around 18 months, Davidson said, hitting the media headlines and drawing in the Australian Parliament which conducted an inquiry. The issue was escalated from a “pretty pathetic apology statement,” to an internal inquiry; a proposal to dock some bonuses by five per cent, to the ultimate departure of the CEO and senior executives.

This issue came up suddenly and so was not on ACSI’s existing engagement programme. “To have an effective response to an issue like that, you need to leave room within your engagement program for reactive engagement,” Davidson said.

Reynolds–an experienced chief executive officer with a long history working in the funds management industry–noted investors’ approach to stewardship can range from genuine and effective engagement, to simply a tick-the-box exercise. “That just means you’ve been to lots of meetings, but doesn’t necessarily mean that you brought about any change,” Reynolds said.

With the growing list of issues falling under the ESG umbrella, Reynolds asked how asset owners narrow down and focus on their priorities.

Aeisha Mastagni, investment director, sustainable investment and stewardship strategies at CalSTRS, said the pension fund’s strategy has focused on developing a framework looking at three basic things. First is the relevance to the portfolio, and whether the issue poses a systemic risk to the portfolio or is a risk that is very relevant to a lot of industries.

Then the team asks whether they have the tools or the tactics to really bring about change. Lastly, they look at the outcomes they are trying to achieve.

“We want to be able to demonstrate to our beneficiaries that the resources that we are using are really bringing around change and positive outcomes for our portfolio, so it’s really those three things: Relevance; What are the tools? And can we measure those outcomes?” Mastagni said.

How to transition to a net zero economy has become a clear stewardship priority, she said. And another big focus has been having the right people in the boardroom.

Marie Laure Schaufelberger, group head of ESG and stewardship at Pictet Group, said Pictet Group had gone through a similar exercise that involved looking at what areas are financially relevant to the portfolios; whether it impacts the financial assets, and whether there is the expertise and knowledge in these areas. Teams also ask whether they have the capacity to affect change.

This has allowed Pictet to narrow down on four priorities: climate, water, nutrition, and long-termism. She added that having the right partners on the journey is an area that is easy to underestimate.

“You cannot affect change alone all of the time,” Laure Schaufelberger said. “When we look at what’s worked, Climate Action 100+ works. Why? Because you have concerted action, right? Companies can’t say, ‘oh well you’re all sending me 15 different questionnaires with a thousand different asks. It’s very focused.”

Collective engagement may be the future of stewardship, Reynolds said, citing a need to explore the challenges collaborative programs face.

Managing different views and priorities across the membership with regard to collaborative programmes can be one of the challenges, but the power of collective clout is that it delivers a credible and strong voice that can affect significant change, Davidson said.

“Even our largest members might own, say, three or four per cent of some of the big companies in Australia,” Davidson said. “But together, our members own over 10 per cent, sometimes up to 20, 25 per cent, but usually around 10 per cent, so that gives us a really credible and strong voice with which to go to those companies and talk to them about how we think they need to improve ESG practice.”

Resource allocation can be a major challenge, as “in Australia, every big company wants to come and talk to us because they know that our proxy voting advice is influential and they don’t want us voting against their remuneration report or the directors,” she said.

ACSI sets clear engagement objectives and measures progress every six months. When Davidson first began working at ACSI seven years ago, the organisation was concerned about the poor level of gender diversity in boards in Australia.

She wrote to the chair of every ASX200 company that only had one or no women on their board, to say ACSI was concerned about this lack of diversity, and this would ultimately lead to recommendations to members to vote against incumbent directors on those boards.

“I was shocked to discover I had to sign a hundred letters,” Davidson said. “So half of the index had one or zero women on their board. That represented about eight or nine per cent of directors in total. Now we’re at 35 per cent or thereabouts, and so I think that is a really clear example of success.”

Sometimes escalation strategies are called for. CalSTRS had success with the activist and impact-focussed investment firm Engine Number 1 in conducting targeted engagement with ExxonMobil.

Existing tools weren’t achieving the desired results, 8 said. They had tried voting against members of the board, and even voting against the entire board, but still shareholder proposals that had passed were being ignored. Collaborative engagements like Climate Action 100+ had not achieved the kind of commitments they had received from other companies.

“We partnered with Engine Number 1, and I think what we brought to this campaign was really our credibility as a very long-term constructive shareholder,” Mastagni said. “They brought the financial resources in order to source new directors and we ran a very intensive campaign that took up basically all of my time the year prior but we were able to appoint three new board members.”

When engaging in sometimes contentious issues, it is crucial for the investment team to be involved in stewardship, Laure Schaufelberger said.

“You cannot outsource this to a centralised ESG or stewardship team in the organisation that maybe knows the ESG issues really well, but actually doesn’t understand necessarily what’s in the best interest of the company over the long term,” she said.

A focus on the long-term interests and success of the companies differentiates asset owners from NGOs, Davidson concluded.

Innovative blends of private and public capital will be required to solve decarbonisation challenges in infrastructure and make the costs and benefits stack up for investors, said a panel of experts at Sustainability in Practice.

Government cooperation alongside private capital will be required to decarbonise some of the more challenging cases in infrastructure. For example, limited government grants could tip the scales in favour of lower-emissions measures making business sense, argues an infrastructure investment head.

John Ma, partner and head of North America infrastructure at Igneo Infrastructure Partners, the private infrastructure investing team within global asset manager First Sentier Investors, said the group had made significant investments into the renewable power generation sector in recent years, and there is “no shortage of capital within the renewable power space as it stands today.”

However, a “more challenging case” is achieving the emissions savings that can be made by increasing reliance on rail freight and reducing the use of trucks which have a much higher level of emissions per freight ton per mile.

“Looked at from a macro or policy perspective, if we as a society or government, can encourage more of a modal shift from trucking to rail, there will be huge savings in terms of carbon emissions,” Ma said.

On North America’s class-one railroads which carry freight trans-continentally on 100-car trains for thousands of miles, it is a relatively simple business case to replace fossil fuel-burning locomotives with electric locomotives.

The fuel savings alone can justify investing in electric locomotives, with some adopting a so-called “Prius” model where they will have a mix of diesel and electric locomotives driving a train to reduce overall emissions.

But it is harder to make the numbers work for short line freight railroad companies such as Patriot Rail, which Igneo has invested in. These companies connect shippers to the national network via short line routes scattered around the country without a central network, Ma said. Newer electric locomotives are around ten times more expensive than diesel-electric locomotives, and for a line that may be only 50 miles long, the fuel savings aren’t sufficient to justify this.

Other technologies are also in pilot phases, but so far none make business sense for this sector when looking at the bottom line.

This goes to the question of the role of private capital and what the government can do to decarbonise the sector, with both needing to act to make it work. Infrastructure grant programs could reduce the net cost of electric locomotives for railroad owners, and potentially drive down the cost of these units over time.

“You only need to go back to look at the renewable power sector and see what’s happened to solar cells and batteries and wind turbines,” Ma said. “With some catalyst, a bit of support from government, hopefully that cost equation comes down, and over time the cost-benefit will stand on its own.”

Igneo is still assisting with lowering transport emissions through its investment into Patriot by making modest investments in “transloading”. This refers to a factory that is, for example, 20 miles away from the railroad and loads its goods onto trucks because it is not next to the railroad. A modest investment can involve setting up a loading platform that would allow the goods to be taken 20 miles to the railroad, instead of all the way to to their ultimate destination by truck.

Max Messervy, head of sustainability, Americas, at Mercer, said Mercer’s manager research team has been integrating ESG ratings at the investment strategy level since 2010. Mercer uses a rating scale from one to four to rate how effectively and cohesively a particular strategy’s portfolio management team integrates ESG to drive value creation, compared to other peers in its asset class and universe.

This involves things like looking at how ESG data factors into new ideas; how ESG is integrated into portfolio construction and how it is implemented into engagement and proxy voting. It also considers how much support there is from the top down for these various activities, including investment in data software and analyst teams.

Out of 4700 strategies Mercer has rated, 171 are infrastructure-related and over 50 per cent have a rating of one or two, which are the top ratings, suggesting a systematic, consistent approach to ESG.

This significant level of ESG interest shows ESG considerations are essential to the infrastructure asset class, Messervy said.

“Massive construction projects affect communities; they produce environmental impacts that can be mitigated – or not. Ultimately this leans towards questions of social license to operate,” Messervy said.

With electricity, heat and power generation along with transport as the highest emitting sectors, there is a focus on decarbonising these sectors and on shifting energy consumption patterns, Messervy said. It is critical for asset owners to understand if their managers are taking decarbonisation policies into account, and thinking about how the macro-environment might shift if carbon prices are introduced.

The massive flow of capital needed to achieve net zero goals will require record levels of spending, he said.

He noted there will also need to be “massive flows of capital” into emerging markets to achieve the United Nation’s Sustainable Development Goals, and this will require alignment among investors. In private infrastructure and real assets in emerging and frontier markets, “the perception of risk frequently is overstated depending on jurisdiction,” Messervy said. Investors typically have a home country bias with limited allocation to emerging markets, he concluded.

Assessing the credibility of carbon transition targets is multi-dimensional and complex. Investors should be wary of pitfalls such as being “too ambitious on [carbon] metrics” in their portfolios to the detriment of helping to change the real world by engaging with high emitters, said Carsten Stendevad, the co-chief investment officer for sustainability at Bridgewater Associates.

“Too much focus on your own portfolio and not enough focus on the real world in terms of your goal setting is very dangerous,” said Stendevad, in a discussion about investors’ role in the transition to a low carbon economy at Conexus Financial’s Sustainability in Practice Forum at Harvard University.

Industries such as metals and mining are unsustainable in their current practices and critical to emissions reduction as they produce the zinc and copper that are needed in solar panels and electric vehicles, he said, in conversation with Amanda White, director of institutional content at Conexus Financial.

Investors need to look at the impact and potential future impact of the carbon transition on individual companies or countries, not just to figure out the potential risk to their portfolios but also with the aim of proactively deploying capital in a way that is financing the transition, Stendevad said.

“It’s critical to be able to understand at the security level, which company is, so to speak, a part of the solution and which companies are part of the problem.”

Stendevad presented statistics showing the most-carbon-intensive 30 per cent of global market capitalisation represents 90 per cent of corporate emissions and 60 per cent of all emissions. The 20 most emitting companies represent around 20 per cent of global corporate emissions, he said.

Pinpointing these pain points is relevant because these industries are susceptible to policy shocks and direct environmental shocks. They are also the companies that will need the most financing to change.

“They’re also the ones that need most of the financing, they’re the ones that need to change the most,” Stendevad said. “They really are at the centre of the transition story.”

Problematically, when looking at the science-based targets that companies have announced, total emissions aren’t moving much in his projections because most of the companies with ambitious targets tend to be in industries outside of those mentioned above.

“It’s wonderful if a pharma company reaches net zero…but it’s not the most critical thing for the world in terms of reaching net zero,” Stendevad said.

500 top emitters

Most critical, is action from the top 500 emitters, “who by-and-large don’t really have concrete plans,” Stendevad said.

Investors can look at three types of companies that are part of the solution, which he labelled broadly as leaders, enablers and improvers.

‘Leaders’ are not part of the problem, and may have either been “born emissions light” or have made a successful transition. ‘Enablers’ are companies that are critical for other companies making the transition, such as green technology companies and others providing solutions to aid in the transition.

But it is the ‘improvers’ that Bridgewater is particularly focussed on, as they are entities that currently are not sustainable. A key question is whether they are on a forward-looking path to becoming sustainable. Many of the companies in this category will not actually turn out to be improvers, he said.

“This group of companies is very tricky because…you can’t just sit back and assume that everyone is going to figure it out,” Stendevad said.

The challenge for asset owners is credibly identifying those that will turn out to be improvers. Investors also must deal with the potential impact to their own image and carbon metrics by getting involved with these companies which “don’t look good today.”

“So it requires you to lean in to companies that are unsustainable today,” Stendevad said. “It may even hurt your portfolio metrics, carbon metrics and others, but if you care about real-world outcomes, they’re the most important ones for the transition.”

This leads to the pitfall of “being almost too ambitious on metrics, like in my portfolio I want to have a perfect emissions metric by next year.”

An ongoing research effort by Bridgewater over the last five years has involved building a systemic sustainability assessment at the company level. It looks at where companies are now and where they will probably be in the future.

Assessing the credibility of improvement plans is critical. Is there a proven way that this company can reduce its emissions?

“If there is a proven technical way of doing it, but it just hasn’t been done yet, that of course makes a plan more credible,” Stendevad said. “If it’s effectively an unproven technology that we hope will come in 2040 and we will wait until it happens, that makes a plan less credible.”

Credibility

Other questions to ask when assessing credibility include looking at how economic is that abatement plan, and how specific are the targets.

It is also important to look at whether it is reflected in the corporate strategy. “When you actually hear CEOs talk to investors, is this front and centre of what the company is actually doing and talking to markets about?”

Additionally, is it reflected in how the companies are spending their money? Is it aligned with the company’s financial strategy?

Assessing the auto sector, for example, is relatively easy as “it’s pretty clear what needs to get done.” Electric vehicles technology is already proven, and making this transition is realistic, he said.

Conversely, metals and mining is “a much more multi-dimensional and complex industry to assess,” because its products are critical for electric vehicles, solar panels and other technologies that are part of the solution, but its current practices are unsustainable.

An ongoing challenge includes dealing with the inherent ambiguity and imprecision of forward-looking assessments, he said.

Some companies may be doing all they can to transition and may not succeed, while others “will just legitimately say we just don’t know how we’re going to transition.”

“We feel we have enough [information] to start directing capital in this manner. We’re trying to be very humble but [we have] enough to make the relative assessments of who’s on a good track and who’s not.”

A “political solution” is the only way to supply energy needed to warm homes through Europe’s winter, according to an energy sector specialist with PGIM.

There is “no physical solution” to the energy shortage facing global markets in the near term, and there has to be “some kind of political solution,” according to an energy sector specialist with PGIM, the principal asset management business of Prudential Financial.

Today’s shortage of oil and gas has been years in the making, according to David Winans, principal and credit analyst for PGIM Fixed Income’s US investment grade credit research team.

Companies capital spending had been slowing ever since the 2014 oil glut that followed the “shale revolution” in the United States that started around 2006, but when the pandemic hit companies slashed capital to the bone and production finally rolled over.

The OPEC price war and ESG pressures also put pressure on investment and spending levels before oil and gas demand snapped back quickly after Covid-19. Then came the Russian invasion of Ukraine, and now Russia’s cutting off of gas supplies to Europe.

In a podcast discussion with Julia Newbould, managing editor of Conexus Financial, Winans said Europe’s gas shortage cannot be quickly resolved by US exports due to limits to liquefaction capacity. The US also faces its own supply issues due to the reluctance of oil and gas majors to invest heavily in the sector, and other issues such as ongoing legal challenges to pipelines (such as the Mountain Valley Pipeline), Winans said.

While Liquefied Natural Gas is a good alternative energy source, the greatest challenge is in getting it where it needs to be, Winans said. There is “plenty of gas in Canada at low prices,” and Canadian Prime Minister Justin Trudeau had expressed interest in the possibility of exporting gas to Europe, “which is very interesting, considering there’s no LNG export facilities in Canada,” Winans said.

You have to liquefy it, and these facilities take at least two years to build and they’re billions of dollars and it’s too late to do anything about it this winter,” Winans said. Gas pipelines from Africa could be part of the solution, “but once again these are long-term solutions and the crisis is now, so I don’t know what the answer is going to be, but there’s going to have to be a political solution to this,” Winans said.

Renewables will not satisfy aviation demand, trucking, shipping and other industrial uses, he said. They are also “not that great for heating your home,” and will not get Europe through winter.

Newbould asked his thoughts on balancing short term gains with the longer term transition to a lower carbon world.

The ongoing transition to green energy has put pressure on the supply side of the equation, but “oil demand and gas demand hasn’t moved at all,” Winans said, admitting he is not convinced markets have yet seen the peak in demand for fossil fuels.

For investors in the short term, “the money is there in oil and gas,” he said. Longer term, there are questions about the impact ESG considerations will have on supply.

“So, an oil price of $90 a barrel is telling you we need more supply investment now, but the funny thing is the ESG considerations have got many companies, like maybe some of these European oil majors, saying, “we don’t want to make those investments anymore.

“So there has to be some kind of supply response at some point, if you think the demand is going to be there,” Winans said. “And, despite this energy transition, I haven’t seen any clear evidence that demand is really rolling over anywhere, aside from European natural gas which is going to definitely get some demand destruction… globally, it’s still strong. People want this stuff…and we can’t replace all of it that easily.”

There is an overlap between mega-trend investment themes and the United Nations’ Sustainable Development Goals, according to Marc-Olivier Buffle, head of thematic research and client portfolio manager at Pictet Asset Management.

In a discussion about balancing active risk, tracking error and sustainability at Conexus Financial’s Sustainability in Practice Forum at Harvard University, Buffle said thematic investing involves identifying economic activities that are supported by multiple mega trends to identify companies that will grow faster for longer.

“We’re talking about economics…and positive risk return, and then on the other hand, about having a positive impact in terms of society,” Buffle said. “Now, if you look at the growth rate of the companies in our thematic universes over 5, 10, 15, 20 years, you find that the growth rate of those companies is superior to the MSCI world.”

Pictet’s thematic focus on water aligns with SDG number six, focused on clean water and sanitation.

On the issue of data related to impact investing, he cautioned regulators against standardising data too quickly; getting too strict too quickly could stifle innovation.

“We are ready for transparency,” Buffle said. “We are ready to demonstrate how we do business and explain to people how we do it so that people can choose the right things. But let’s not standardise too quickly the kind of data that should be shown by the asset management industry because we are in the midst of an incredible amount of innovation and creativity.”

Also on the panel was Charles Hyde, head of asset allocation at New Zealand Super–a sovereign wealth fund created to help fund New Zealand’s national pension system.

Hyde said in 2016 the fund began a project to better understand climate change and its implications for the portfolio, having taken the view that carbon risk was not being properly priced in the market.

“An alternative way to think about this is that our carbon exposure in the portfolio amounted to an undue risk,” Hyde said. “The term undue risk has special relevance to us because it’s taken from the legislation that underpins our funding –  what we call our mandate.”

Reducing carbon intensity and fossil fuel reserves are the two main targets, focused particularly on the fund’s passive equity holdings. “We don’t have active equity managers, so that makes it a little bit easier to implement this strategy,” Hyde said.

Complexity

A customised solution implemented in association with MCSI complicated the portfolio substantially. It was implemented to the actual portfolio and also to the reference portfolio, the fund’s benchmark portfolio.

“One thing we regret a bit about that decision…was that the reference portfolio is supposed to be a simple and easy-to-implement portfolio [and] low-cost,” Hyde said. “I don’t think that satisfied the ‘simple’ at the end of that project because we had to, as I said, implement a fairly complex set of algorithms to lower our carbon exposure.”

Subsequent work was around climate scenarios, which was “quite difficult work.” Creating the scenarios was challenging enough, but applying those scenarios to specific assets was even harder.

More recently the fund has reconsidered both its purpose and its mandate which included the phrase ‘best practice portfolio management.’

“If you go back six years, we had a purely traditional interpretation of what that means, which is very much in the risk and return space,” Hyde said. “Now we think that addressing ESG considerations [and] sustainability more generally is very much part of what is required in terms of meeting that particular leg of our mandate.”

The fund also broadened its approach from initially taking defensive actions to protect the portfolio from the “external threats out there from the ESG complex,” to the more proactive stance that it was the fund’s responsibility “to be making investments which had a positive impact back on the environment.”

This has included realigning both the reference portfolio and actual portfolio with MSCI Climate Paris-Aligned Benchmark indexes.

Eric Farls, senior portfolio manager and ESG committee member at Maryland State Retirement and Pension System, said the System signed up to the United Nations’ Principles for Responsible Investment in 2008 and encourages the adoption of the UNPRI principles through its portfolio of external managers.

This has involved a range of practices and procedures that must take place before money can be awarded to a manager, including ESG-related questions, manager interviews and discussions of the findings during investment committee meetings.

The fund has more recently expanded its resources by hiring an ESG governance officer who will start next year.