If we want to include impact investing in all occupational pension schemes then we need to consider how we do this not only for those who are auto-enrolled but also for legacy schemes. There is considerable wealth tucked away in closed private sector pension schemes.
As I noted in this post the value of defined benefit (DB) assets is almost double those currently held in defined contribution (DC) pension pots at £3.8bn. It will take several decades for these assets to unwind so they could play a vital role in protecting the planet and improving society.
Debt not equities
Implementing impact investing is very different for DB compared with DC portfolios. That’s because these schemes are heavily invested in fixed income. The typical closed pension scheme has around 50% of its portfolio invested in government debt and around 20% in corporate debt.
DB funds can have a high impact with their corporate debt portfolio. As this is is a source of primary capital, schemes are in an influential position to make demands. Given many of these portfolios are often invested in utility companies because they provide a steady stream of income, schemes’ ability to protect the planet is significant.
A corporate bond manager could, for example, offer a preferential loan rate to a utility company which improves its environmental credentials, which would help to achieve the sustainable development goal of creating clean and affordable energy for all.
Impact and sovereign debt
Integrating impact investment characteristics into a sovereign debt portfolio is, however, much less straightforward than for corporate debt. Encouraging a country to adopt the right sustainable policies is hard for individual investors as it’s difficult to make your voice heard.
But UK pension schemes are in a unique position. As forced owners of UK government in order to protect against interest-rate and inflation risks, they own sizeable sum of these assets. In addition, these assets are concentrated in the hands of three large asset managers.
Some asset managers feel queasy about making demands of governments because they fear it impinges on democratic principles. But as the members of DB schemes are UK voters this should be less of a concern.
While incorporating this type of active engagement is in its infancy, there are encouraging signs. Investors were pleasantly surprised by the level of engagement with the Debt Management Office over the use of proceeds and project selection for the newly introduced green gilts.
Over time is to be hoped this dialogue can be continued and coverage of more mainstream sustainable policies can be discussed for inflation-linked and other government bond issues.
Pension schemes are now reporting on the climate risks and exposures in their portfolios to comply with the Task Force on Climate-Related Financial Disclosures. This includes measures relevant to their gilt holdings which will educate and inform their membership about the UK’s progress towards its net zero goals and serve as another way to inform voters about the issues.