22nd July 2021
Fund position on Responsible Investment and Fund Fossil fuel exposure (updated November 2021)
The Fund has a detailed Statement on Responsible Investment Principles that helps guide decision making and reporting which covers all Environment Social and Governance (ESG) risks the Fund must take into account. The Fund continues to make changes and developments in its strategy and reporting in relation to climate, as well as other ESG risks, but changes do take time to implement and this is a journey for the Fund.
The Fund has made investment decisions that remove all fossil fuel companies from its equity portfolio – 40% of the total strategy.
The Fund has invested £480m into climate solutions as at 30 June 2021.
The Fund has been shortlisted for the Climate Strategy LAPF Investment award 2021.
The Fund were signatories to the Investor Agenda’s 2021 Global Investor Statement to governments on the Climate Crisis, urging governments to rapidly scale up their climate ambition.
Fossil Fuel Exposure
The Fund has steadily reduced the already small share of its portfolio invested in fossil fuel companies. In 2015 it was reported that the Fund had fossil fuels exposure of 6.6% of the portfolio value, this exposure represented 4% of its assets in June 2020 and fell to 1.9% by 31 December 2020, or around £75m. Fossil Fuel exposure under this measure includes any company that generates some income from fossil fuels with a large portion of this invested in utility companies that provide electricity to people’s homes and many of these companies are aligned with the Paris Agreement. Of the 1.9% exposure, over a third should drop away when changes to the investment strategy which have been approved have been fully implemented. The Fund must monitor and manage the risks of the Fund investments and its primary fiduciary duty is to ensure we are able to pay our members pensions when they fall due. The Fund has achieved better than benchmark returns in the last five years and enjoys strong solvency levels where the Fund was 107% funded at the last valuation date, an increase from the 92% in the previous valuation cycle.
The Fund does not directly invest in any specific company; instead, it invests through a combination of holdings in passive index funds and in pooled funds through active investment managers who take considered choices over the underlying companies it invests in with a looking at the financial resilience and return possibilities as well as the ESG credentials of a company. An investment to a passive index means exposure to all companies within the index, there is no ability to divest from any specific company within it, but investors can consider the type of index in which it may want to invest. To divest from a single company within an index fund or pooled fund would require the Fund to divest from the whole strategy which would be costly and could potentially increase the risks to the Fund with a reduced scope for the Fund to invest removing diversification or through less experienced investment teams.
The Funds investment strategy crosses a wide range of types of investment each of which will have different climate risks. Climate risk to the fund is through both physical risk and transition risk.
More frequent or severe weather events – flooding, storms, droughts, wildfires, chronic heatwaves, sea level rise.
Changes to less polluting greener economy – loss of asset value in hard to abate industries or as a result of policy constraints on activities of a business, increased costs of business supply chains, loss of access to materials, regulatory tax penalties.
The Funds investment strategy showing the types of assets are shown below:
Global Equity - 43%
Absolute Return/Diversified - 23%
Debt/Credit - 14%
Property - 8%
Private Equity - 7%
Infrastructure - 4%
Cash - 1%
Climate risk can impact on all of these asset types. For example, in the property allocation there may be physical risk with buildings in areas that may have an increased chance of flooding with extreme rainfall or sea level rises; or transition risks through the cost of retrofitting buildings with heat pumps or hydrogen boilers to replace gas heating systems. Or for example, a port within an Infrastructure portfolio would be affected by atmospheric and marine hazards leading to operational shutdowns and subsequent financial losses. A Global equities portfolio for example could include shares in an agricultural company, a technology company or even an energy provider. Each and every company would face different climate risks; either to their physical geographical location, to supply chain costs and failures or regulatory or policy risk imposing penalties or restrictions to operations.
As a result of the wide-reaching climate risks, the Fund takes a holistic view of its investments rather than focusing on a single company sector and focuses on the quality and ability of the investment manager teams who carry out the detailed research and selected the underlying companies in the portfolio. To do this the Fund undergo due diligence on the selection of a manager; meet and communicate with managers throughout the year to discuss company holdings, decisions, performance and team structures; carry out annual carbon footprinting which also considers companies energy transition plans; carry out an annual ESG assessment of all Investment managers within the portfolio and we are due to start climate scenario analysis of the portfolio.
Also, the Fund consider engagement with companies to align their businesses to aspects such as corporate governance standards, ensure best practice in labour force polices or alignment with the Paris agreement on climate related emissions. A list of the Funds collaborative engagement partners is listed further below and the Fund publishes reports on engagements and voting carried out by managers where we are able to publish this information.
There are also climate opportunities. For example, companies which improve resource efficiency in relation to energy usage, water and waste management can result in better run business with cost savings and competitive advantages. Or investment into innovation in technology can assist the energy transition such as development of electric vehicles, advances in LED technology, geothermal power. Other opportunities can include investment in renewable energy sources such as solar, wind, bio-fuels as to meet global reduction targets energy generation source needs to move to clean energy sources and away from burning of fossil fuels.
The Fund has taken substantial measures in the past 18 months to better align itself with the challenges of climate change and the energy transition and is considered one of the leaders in this space in its actions. These actions include investing 25% of the equity funds, or £480m, in Impact Managers who select companies whose core products or services achieve a positive impact on the environment or socially, or those companies that provide solutions to sustainability challenges. In addition, the Fund agreed to remove all of its traditional passive index equity exposure (where there is unconscious exposure to fossil fuels) moving half of this to a fossil-free smart beta equity strategy that aims for long-term alignment with the Paris Agreement goals and exhibits lower carbon risk with climate solutions and higher ESG scores than the world index. The other half has been committed to a resource efficient index that focuses on companies that more effectively manage carbon, water and waste while excluding fossil fuel companies.
Current Position of the East Sussex Pension Fund on Divestment
The Fund has a policy of Engagement over Divestment. Where engagement fails, divestment is an option as the last escalation point after targeted engagement, voting at AGM’s co-filing resolutions at AGM’s. The Minister for Pensions gave a clear steer in a speech to the Professional Pensions Investment Conference in January 2021 about how he expected Funds to deal with climate-related risks. The approach that he outlined explicitly discourages blanket divestment as a broad strategy, favouring instead strong company engagement among other reporting requirements. The minister reiterated this stance in an interview with the Financial Times on 4 March 2021 where he was quoted to have said “I massively believe that it is perfectly appropriate for trustees to hold stocks in the likes of Shell or BP; I do not want them to divest,” reiterating the importance to drive these companies to find solutions to a net zero future through engagement. This view is also held through other governmental bodies as well as Fund advisers who favour engagement as a tool for asset owners.
Selling an investment in an oil company or a high intensity carbon emitter does not stop the emissions occurring, the shares will be bought by others who may be more interested in quick profits and dividends than influencing change to combat climate change; while demand for these services or products continues the emissions will continue. Changes in direction of oil companies, including for example BP in its successful bid for options to build two offshore windfarms in the Irish Sea and Shell being the first company in the energy sector to submit an energy plan for an advisory vote to shareholders, suggest that the oil and gas majors are starting to take the climate crisis more seriously and supports the Fund’s current view that engagement is a very strong tool in helping influence these large firms and other high carbon emitters in realigning their businesses. These companies may not yet be aligned with Paris agreements, but the Funds focus currently is on the direction of travel.
As a UN PRI signatory, principle 2 encourages signatories to be active owners and incorporate ESG into their decision-making policies and procedures, including engagement with companies and exercising voting rights. PRI advise that “Active ownership is generally regarded as one of the most effective mechanisms to reduce risks, maximise returns and have a positive impact on society and the environment.” In addition, Divestment alone can remove an investor’s voice to be able to influence responsible corporate practice.
It is suggested by some that neither engagement or divestment alone are the solution and that opportunities instead, may be the better approach. Looking for companies that can generate a positive environment or social impact can help provide solutions to the climate challenge. The Fund has been working to reduce its exposure to fossil fuel companies, but not solely with the focus to remove those fossil fuel companies.
Where engagement fails, the Fund has seen its active managers and the new smart beta passive allocation take decisions to exclude certain companies.
There are limits to the influence that we achieve as a single investor and the resources we can reasonably commit. We recognise that progress can be best achieved on ESG issues through collaboration with other investors and organisations. We’re an active member and supporter of several Global and Industry ESG Initiatives.
Principles for Responsible Investment (PRI) We’ve been a signatory to the PRI since 2020 and are working on our first submission on how we implement the six Principles of Responsible Investment into our everyday work to be good stewards of capital. PRI is an important partner, providing excellent guidance on responsible investment and we work closely with them on the future direction of the organisation.
Institutional Investors Group on Climate Change (IIGCC), has the collective weight of over €35 trillion from 275 members and is leading the way on a global stage for investors to help realise a low carbon future. IIGCC helps shape sustainable finance policy and regulation for key sectors of the economy and supports members in adopting active ownership and better integrated climate risks and opportunities into investment processes. The Fund’s Pension Committee Chair is currently a representative on the IIGCC Corporate Programme Advisory Group. The corporate programme focuses on supporting investors to engage with companies to align portfolios with the goal of net zero by 2050. In addition to the Fund’s own membership of IIGCC, the Fund asks its managers to also be members providing a double lock on engagement.
As a member of Local Authority Pension Fund Forum the Fund works together with the majority of LGPS funds and pools across the UK, through the forum, to promote high corporate governance standards to protect the long-term value of local authority pensions. With member fund assets exceeding £300bn, the forum engages with companies and regulators to deliver reforms advancing corporate responsibility and responsible investment. In October 2021 the Funds Head of Pensions was appointed to the executive committee as an LAPFF Officer Member.
Pensions For Purpose is a bridge between asset managers, pension funds and advisers, to encourage the flow of capital towards impact investment. Pensions For Purpose provide high quality expertise and training to Funds on ESG issues. The Fund joined as an affiliate member in September 2021.
Governance and Decision making
If you would like further information on the governance and decision making of the Pension Fund please see our 'About the Pensions Fund' section which provides details on the Pension Committee.