Climate change investing for pension funds – commercial decision or altruism?

Around the world pension schemes control trillions in assets and have the ability to influence the behaviour of businesses. Some schemes, particularly larger ones, such as the US$188bn (€148bn) CalPERS scheme in the US or the £29bn Universities Superannuation Scheme (USS) in the UK, take this responsibility seriously and engage positively within a social, economic and ethical framework. Others, often smaller schemes without the resources or appetite for activism, invest with the sole objective of delivering the best possible financial return for their members without focusing as closely on how corporate profits are generated.
Now that climate change is regarded by many as the single most important issue facing humanity, pension funds have the power to make a real difference to the outcome. If pension schemes invest in businesses which are actively combating climate change and use their influence to help the polluters reduce their carbon emissions it will mark an important step towards a more sustainable future. On the other hand, if the majority of schemes only focus on maximising returns without regard for how they are generated, then the planet will continue to suffer.Do pension schemes have any responsibility at all to invest altruistically or should commercial returns be their only objective? A pension fund exists to pay a retirement income to its members and to achieve this it needs to direct its assets towards investments which will lead to be best possible financial outcome. Any pension fund which refused to profitably invest in leading global companies solely on the grounds that they were environmentally damaging could be open to criticism and challenge from its members. Fortunately, the decision is no longer a polarised argument between altruism and commercial returns. As long-term investors, pension schemes are providing the risk capital which enables companies to make long term investment decisions. Returns from these investments may be affected by different climate conditions, such as rising sea levels, for decades into the future. By acting on climate change now, pension schemes can help to protect the returns from their existing and future investments. In addition, climate change investing potentially offers better returns to pension schemes than a traditional portfolio as companies which will benefit from addressing climate change are likely to be strong performers in the coming

decades. But what exactly is a climate change investment and how can a pension scheme identify and access the ‘right’ sort of companies? Take, for example, the argument about the desirability of biofuels or nuclear power. It is easy to see the challenges which face those with responsibility for setting investment strategy. The option adopted by some larger schemes is to employ their own people to help make these strategic decisions, but this option simply is not open to smaller schemes without the necessary resources. Here, the construction of indices and benchmarks, such as HSBC’s Climate Change Index and the development of funds utilising these Indices, are making effective climate change investment accessible to smaller players. Having taken the decision to engage in climate change investing the issue facing pension funds is whether they should direct all of their assets towards this end or should they invest just a small proportion. Any scheme which accepts the argument that all of its investments will potentially be affected by climate change in the future, should be taking this into consideration when directing all of its capital. In reality, funds have two options. In many cases, this will not be by disinvesting from polluters, but by working with companies to understand how best to use capital to influence change. Alternatively, a fund can allocate assets to climate change in exactly the same way as it allocates assets to, say, UK equities, gilts, commercial property or alternatives. The decision is one of portfolio weighting, whether it allocates five, ten per cent or a different percentage to climate change investment.
Both approaches are legitimate. It is perfectly sensible fora scheme to utilise part of its portfolio to seek profit from specialist climate change investment funds while adopting a longer term investment policy of positive engagement. A scheme’s investment decision will also be affected by its size and resources. A smaller pension scheme will not have the resources of a multi-billion pound or dollar fund, such as CalPERS or USS, to engage with businesses on a long term basis. These funds are far more likely to be able to benefit their members financially, and help to support climate change initiatives, by allocating a proportion of their assets to a climate change fund. There is little doubt that climate change funds have the potential be profitable, and in fact, the returns have already been seen. The HSBC Climate Change Index has outperformed the MSCI World Index by approximately 70 per cent from the beginning of 2004 to the end of 2007. Pension schemes have the ability to influence the outcome of the world’s fight against climate change by helping to direct capital towards new ideas and new technologies and by setting the agenda for long term sustainable investment. For smaller schemes, their contribution is likely to be by investing for profit by allocating assets to pooled funds and other investments designed to deliver returns from companies which generate their income from climate change initiatives. For the world’s largest schemes, the fight will be one of investment policy, using their financial power to positively influence the development of a sustainable global economy, thereby protecting the long term financial future of their members and pensioners.

Ann Ellis is director, sales and marketing at Cowen Asset Management