How Derbyshire scheme is using sustainability to generate returns

Last year, the scheme’s investment strategy pivoted towards sustainable holdings. The scheme’s in-house investment management team recommended that assets in North American equities, European equities and Asia Pacific Ex-Japan equities should be switched into sustainable investments.

Dawn Kinley, head of the £5.6bn fund, explains that the scheme is targeting investments “sustainable in financial, environmental, social and governance terms and, where appropriate, that provide solutions to sustainability challenges”.

As Kinley notes, and also included in the council’s climate risk report dated December 8 2021, this is part of the fund’s wider climate strategy, which comprises two primary goals. 

The fund committed to reducing the carbon footprint of its listed equity portfolio by at least 30 per cent relative to the weighted benchmark in 2020 by the end of 2025. These include Scope 1 emissions — which are directly created — and Scope 2, which are indirectly generated.

It also aims to invest at least 30 per cent of the fund’s portfolio in low-carbon and sustainable investments by the end of 2025.

The trustees of the scheme have already achieved the first of these goals. By March 2021, the fund’s carbon footprint had already fallen by 37 per cent. 

“We have made good progress in reducing the carbon footprint of the portfolio in line with our climate strategy and will continue to identify investments which support our aim of achieving a portfolio of assets with net zero carbon emissions by 2050,” adds Kinley.

Performance data evidences how the Derbyshire Pension fund is using sustainability to generate returns for its members.

Between 30 September 2020 and 30 September 2021, the global sustainable equity portion of its portfolio outstripped its stated benchmark almost six-fold, returning 32.8 per cent against 5.7 per cent.

Plus, during the 12 months that followed, global sustainable equities increased 24.5 per cent against a benchmark of 23.4 per cent.

Meaningful change

The Derbyshire Pension Fund, which has 102,955 members, is not the only scheme transitioning to a sustainable focus. Rachel Meadows, client consulting director and head of proposition pensions and savings at Broadstone, is witnessing similar approaches across the industry. 

The move towards sustainable default investment funds is essential to drive meaningful change, explains Meadows. 

“Relying on individual members to not only understand their options around sustainability, but then to navigate the plethora of fund choices available to them to select themselves, and actually take action to make a switch, is a far slower way to increase the adoption of sustainability.” 

The role of schemes is clear due to the inertia being seen at an individual level, with Meadows pointing to the continued low opt-out rates for auto-enrolment as evidence. 

She adds: “Members being ‘on board’ with the idea of investing sustainably, and members having the know-how and bandwidth to proactively make their own individual fund switches are two different things.”

Alexandra Westley, associate director at 20-20 Trustees, is also seeing a slow but growing movement to transfer members’ investments in default strategies to use more sustainable funds.

“With more schemes setting net zero targets, and greater requirements to measure key sustainability data, we would expect to see this trend continue and gain momentum,” she says.

Better returns

Will Martindale, group head of sustainability at Cardano, outlines three “compelling” reasons to invest sustainably: achieving better risk-adjusted returns, identifying new investment opportunities, and anticipating and preparing for sustainability-related policy and regulation.

Regardless of strategy, pension funds must meet the responsibilities of members. In the past, the issue of sustainability may have been disregarded as irrelevant to generating returns. 

This is now not the case, as Jessie Wilson, professional trustee at Dalriada, explains. 

“Returns can be potentially improved by investing directly in companies which address the issues that society is tackling today; for example, through investing in companies enabling the transition to a lower-carbon economy,” she says. 

“Moreover, voting and engagement activity can encourage positive change at all companies in which a scheme invests.”

A pressing need

Recent research underscores the importance for schemes to focus on sustainable practices.

In its ‘Global risk report 2022’, the World Economic Forum found climate change-related risks account for three of the top 10 risks by severity in the next 10 years. The trio being climate action failure, extreme weather, and biodiversity loss.

Martindale says each sustainable investment strategy and decision should be assessed on its own merits. “There are a range of sustainable investment approaches, some of which can appear conflicting. For example, a sustainability strategy that overweights high ESG scores, [and] underweights low ESG scores, compared to a sustainability strategy that overweights low ESG scores then seeks to engage companies to improve,” he says.

Despite the clear and obvious benefits, making the decision to switch members’ savings to sustainable funds is not a decision to be taken hastily. 

As Derbyshire’s investment management team noted in December, “while the investment vehicles required to support a full switch out of the legacy fund should largely be in place by the end of January 2022, there is a risk that product launch delays prevent a full transition”.

While this would provide only a minor setback, Wilson says schemes must consider this when switching to sustainable investment solutions in order to protect members’ interests.

“A sensible time to consider shifting investments into a sustainable fund is when sustainability commitments are considered as part of a comprehensive investment strategy review alongside the liabilities of the scheme, and its long-term funding objective,” she says.

“This way, when investment consultants are formulating a strategy, risk and reward considerations are factored in holistically.”