Active, concentrated portfolios ‘best for pension funds to address climate change’ – research

New academic paper looks at Dutch pension fund sector

Pension funds that want to address climate change should consider more concentrated and actively managed portfolios, according to new paper on the Dutch pension sector co-authored by an economist at the Dutch central bank, De Nederlandsche Bank (DNB).

The report Are pensions funds actively decarbonizing their portfolios? looks at whether actively managed portfolios have lower carbon footprints.

It is a collaboration between the DNB’s Martijn Boermans, writing in personal capacity, and Rients Galema, Assistant Professor of Finance at Utrecht University.

One of the paper’s key findings was that there is “no evidence” that funds are reducing their carbon footprints by divesting “the most carbon-intensive firms within each industry”.

Instead, their decarbonisation efforts were found to be mostly driven through underweighting entire carbon-heavy industries.

The report, however, suggests that the neglected “within-industry divestment strategy” could be more important in the “long-run” in driving the transition to a low-carbon economy by fostering greater competition within industries to reduce emissions.

It could also, the paper adds, result in more diversified portfolios for funds than divestment based on “simple between-industry screening and exclusion of firms”.

“Conceptually, divesting from carbon-intensive industries is an important starting point, but this type of portfolio management may only have limited impact on the transition towards a low-carbon economy”, the report states.

“If pension funds want to create global environmental impact to address climate change, they could benefit from having more concentrated portfolios that are more actively managed.”The Dutch pension sector, which represents over €1.4trn in assets, was chosen for the study as it provided a “unique testing ground”, as many Dutch pension funds have adopted decarbonisation targets following pressure from stakeholders.

Divesting from carbon-intensive industries may only have limited impact on the transition

The report assessed 44 (unnamed) Dutch funds between 2009-2017 and found that while “generally” the carbon footprints of pension fund portfolios are decreasing, those that deviate from common benchmarks – that is, are more actively managed – have smaller footprints.

On top of that, it found that funds that measure and report on their carbon footprints have made even greater strives in decarbonising portfolios.

The report also found no evidence that “active decarbonisation” impairs financial performance.

Its analyses combined security-by-security equity holdings of the Dutch pension funds —obtained from supervisory data—with “securities’ carbon levels, returns and measures of active portfolio management”.

An important limiting factor acknowledged in the report, however, for researchers and investors alike is the “quality and availability of carbon emissions data”, particularly scope three emissions, which covers all the indirect emissions related to a company’s business.

“[I]t is not unimaginable”, the report adds, that regulators at some point will “mandate all publicly listed firms to measure and report their carbon emissions”.