Schemes think long term to tackle future risk

Work stress can keep anyone awake at night, but volatile markets, a bleak outlook for global growth and bargain basement yields are sure to have kept those in the pensions industry tossing and turning during recent months.

Panellists at the PLSA Investment Conference last week told delegates how they are tackling the risks of climate change and sponsor covenants across the UK pensions industry.

There are loads of things you can do when doing your fiduciary job to enhance return per unit of risk but still at the same time commit capital to new areas

Robert Waugh, RBS

Climate risk

The divestment movement gathered significant momentum during the run-up to the COP21 climate change summit at the end of 2015.

Faith Ward, chief risk officer for the Environment Agency Pension Fund, said the fund has come under increasing pressure to divest from fossil fuels – a strategy she said was “not right” for the fund when assessing the broad risk spectrum.

Ward said the fund takes a risk and evidence-based approach to assessing how climate change might threaten long-term returns.

“It is very much hardwired into our perception of fiduciary duty to look after our members’ best interests,” she said.

“We feel we have come up with a pragmatic and risk-based approach to what is quite a complicated issue for the trustee agenda.”

Robert Waugh, chief investment officer at the Royal Bank of Scotland pension scheme, said engagement is the best way to assess longer-term risks to assets, and pension funds can push this issue up the agenda by working in coalition.

From a social responsibility perspective, Waugh said pension funds have the opportunity to commit capital to areas that will help mitigate climate risk.

“There are loads of things you can do when doing your fiduciary job to enhance return per unit of risk but still at the same time commit capital to new areas,” said Waugh. “Divestment and secondary entry I think is a complete waste of time.”

The RBS scheme owns four wind farms and has holdings in sustainable timber and solar power.

In the DC sphere Mark Fawcett, chief investment officer at Nest, said providers are moving away from the more sector-neutral and tight tracking characteristics of earlier indices offerings.

Second and third-generation indices are starting to exclude coal and increasingly focus on companies with a more progressive approach to managing carbon risk.

“We think there is a way to design smart indices that track or actively manage better the long-term risks of climate change,” he said.

Pace of change

Accelerating change in the new world economy will outpace the length of most schemes’ eight-to-15-year recovery plans, Waugh said, challenging schemes to think longer term about the future shape of their sponsor business.

At RBS, Waugh stated, evolving practice in global banking operations and a growing shift into financial technology will have a profound impact on the route forward. He said: “What does the future shape of banking look like for our sponsor?”

The EAPF’s Ward said honest and open communication would reduce the number of “surprises round the corner” for schemes.

With market uncertainty ahead, Ward said schemes should assess whether they are running a disproportionate exposure to their sponsor.

In the DC environment, Fawcett likened managing individuals’ aggregate investment risk to DB sponsor covenant, and said it comes down to diversifying the potential risks that could affect members’ ability to make contributions.