Early days: could UK master trusts pivot away from portfolio decarbonisation?

For pension investors, portfolio emission targets were a means to an end – addressing financially material climate risks. In recent years, when portfolios began decarbonising faster than the world outside them, it prompted a review of climate investment plans.

Transition investing – a strategic embrace of the hard-to-abate – became a key point of focus. A handful of Canadian and European funds have led the way.

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For Britain’s largest pension funds, it is still early days. New analysis from XPS Group, an investment consultant, spotlights the potential shift towards transition investing.

Pivot signs

XPS examined 16 DC master trusts collectively managing over £200bn in assets. Alex Quant, head of responsible investment at XPS, says most funds lean towards portfolio decarbonisation.

“We see the vast majority continue to have carbon emissions reduction targets. Only half made a clear reference to the importance of transition alignment in their strategy, and only two schemes had concrete targets on transition alignment”, he explains.

Of the 16 master trusts the research investigated, two had set a transition alignment target. While that finding points towards a nascent change at best, momentum is hard to miss.

The report notes a ‘change in mindset’, manifested in forward-looking investment considerations and mandates explicitly incorporating a transition alignment expectation.

Quant says underlying investment strategies – climate aware funds for instance – often reflect a preference for transition alignment. Even when portfolio targets are more likely to be the headline number.

If this is in fact early days, precedents could be particularly powerful in shaping the direction of travel. Within Britain’s master trust industry, the People’s Pension offers one such example.

The pension provider, with over £40bn under management, overhauled its climate investment plans earlier this year. It moved its strategic focus away from a top-down 1.5 °C alignment towards a more bottom-up approach. The revamp allowed investment plans to take note of companies leading the transition in sectors with a higher carbon footprint.

“It will be interesting to see if others review their approach”, says Quant.

Climate investing

The shift from reducing financed emissions to financed reduced emissions has a range of investment implications. For one, it could prompt funds to reimagine what investing in climate solutions looks like.

56% of schemes in the XPS research had an existing allocation to climate solutions and 25% were looking to increase it. If transition investing were to be an investment consideration, Quant expects the conversation to move into private markets territory.

Private equity, private debt, infrastructure and natural capital could become part of the mix. “That of course needs to be weighed against other strategic considerations including costs and overall risk / return. Here we think there is a great opportunity for DC schemes to find areas for attractive returns aligned to the long-term shift towards a low carbon economy”, Quant notes.

Transition investing could also lend itself to a higher degree of passive allocations. “Many DC schemes will continue to use passive building blocks because they are low cost, and there are transition-based investment funds available here which can support scheme-level transition-led targets”, says Quant, while noting that proactive engagement on transition pathways could still remain an investor expectation.

For Britain’s master trusts, any capital allocation change is also set against the backdrop of regulatory change. Pensions reforms in the country are ongoing and include not only a push to benchmark performance but also steer capital into the UK’s private markets and the growth assets they house.

It is too soon to tell the exact nature of regulatory impact on capital allocation, Quant says. For now, if a transition pivot is to occur it will almost entirely be voluntary and market-led.

To that end, XPS senses momentum. Looking forward, DC climate capital allocation could be due a revamp. All else equal, transition-aligned investing could become increasingly common.