On the go: The East Sussex Pension Fund was one of the first Local Government Pension Schemes in the country to carbon footprint its portfolio, and also one of the first to explore and adopt a climate-aware index.
The fund is now moving away from passive equities in order to better achieve its environmental, social and governance ambitions.
Speaking at the Pensions and Lifetime Savings Association’s Local Authority Conference 2021, councillor Gerard Fox, chair of the East Sussex Pension Fund Committee, said that when it comes to ESG, the challenges for investment converge most intensely around the use of index funds.
“At East Sussex we reached the conclusion that despite their many merits as part of a diversified portfolio, generic global index funds, which are effectively a slow moving average of the global economy with an inevitable skew towards older industries, carry too much energy transition risk and offer quite limited capacity for engagement or evolution,” Fox said.
Looking to reduce passive holdings, in December 2020 the pension fund announced it had invested in the Storebrand Global ESG Plus strategy: a fossil-free global equity fund that seeks to reproduce the risk and return profile of the MSCI World Index while aligning with the low-carbon transition.
“In the Storebrand ESG Plus, we found a fund that was better aligned to the long-running objectives of the Paris Agreement, which offered a strong tilt towards green revenues, replaced the traditional energy sector with a climate solutions sector, while not creating any unintended consequences for risk or factor exposures,” Fox said.
“Our overall broader approach also took in greater investment in active equity impact funds and reduced exposure to the index in favour of active managers in the round.”
In March this year, the East Sussex Pension Fund Committee agreed a strategic equity allocation approach for its equity mandate to replace the current passive market capitalisation investment.
As well as investment with Storebrand, the mandate will, among others, allocate to the WHEB Sustainability and Wellington Global Impact funds.
Speaking alongside Fox at the PLSA conference, Henrik Wold Nilsen, senior portfolio manager at Storebrand Asset Management, warned pension funds to be selective when investing in index products.
“Index is, in my view, no longer really passive; index is more a distribution method,” he said.
“Index providers have started making lots of new strategies and marketing them as indices, but they are then full of choices that are not unique or completely neutral, so as an investor I would be a bit aware that not every product marketed as an index is really a passive choice in the sense that you don’t have to look at the product in detail and understand your choices,” he explained.
Wold Nilsen pointed to the MSCI World Climate Paris Aligned Index, the MSCI World Climate Change Paris-Aligned Select Index, and the MSCI World Climate Change Index, all of which have very similar names but had varying levels of return in 2020 (18.18 per cent, 22.22 per cent and 20.21 per cent, respectively).
“Not every index fund out there is really that passive. There is a lot of hidden risk in it and you really need to have detailed due diligence to understand the risks you are taking,” he concluded.
