How can mature DB funds integrate climate investing into their portfolio?
For trustees in DB funds approaching the endgame, it may be tempting to think that long-term climate risk planning no longer matters. Cadi Thomas, head of sustainable investments at ISIO disagrees
Discussions around the endgame solutions for DB pension schemes are evolving, and trustees must act proactively to integrate ESG considerations into their strategies, whether preparing for a near-term insurance transaction or investing over longer time horizons.
Regardless of a scheme’s objective, all material financial risks, including those linked to ESG, must be evaluated as part of the trustees’ fiduciary duty.
As run-on strategies gain popularity, there may be a greater scope for trustees to have a real-world impact with their investments through less stringent liquidity constraints, while tackling longer-term risks head-on.
However, ESG risks are not confined to distant horizons. While some challenges, like the chronic impacts of a changing climate, unfold gradually, others, such as potential regulatory shifts or sudden market disruptions, can materialise unexpectedly. A “Minsky moment” , a sudden collapse in asset prices that happens when investors realise all at once that too much risky borrowing has built up during a long period of calm.
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We may see a Minsky moment unfold if, for example, there were to be a sudden introduction of strict carbon taxes, triggering a sharp market repricing of assets, particularly for carbon-intensive industries which are highly exposed to this risk.
Trustees should take a holistic view of ESG risks across their endgame strategies, over both short and long-time horizons, regardless of the pathway chosen.
The flexibility to introduce new asset classes will be impacted by investment horizons and is most likely to be suitable under a run-on scenario. However, a portfolio resilient to climate transition risks, adaptable to regulatory shifts, and aligned with member/stakeholder expectations, could maintain the flexibility to pivot between endgame pathways - whether this is insurance, consolidation, or run-on.
Run-on
A run-on strategy offers schemes greater opportunity to deliver real-world impact through investment choices. By prioritising reintegrated credit and equity strategies and adding flexibility to LDI mandates with green gilts, there is scope for schemes to strengthen their sustainability alignment. A run-on pathway can also enable meaningful impact through private market and semi-liquid allocations, such as renewables or social housing, while supporting more effective stewardship over the longer-term.
Consolidation
Given the nascent nature of this pathway, ESG integration should be considered in the context of the specific consolidator being explored. Trustees may consider reviewing the consolidator’s investment philosophy and stewardship priorities prior to moving to the consolidated portfolio.
Pre-insurance
When pursuing an insurance solution, primary considerations should be focused on low‑risk assets and carefully assessing insurer capabilities. Ensuring sustainable low‑risk credit can help mitigate against Minsky moment risks, whilst segregated mandates may avoid sectors that insurers find challenging. Flexibility in LDI through green gilts, robust evaluation of insurers’ ESG integration, and awareness of unintended private market consequences are also essential considerations.
At insurance
Insurers’ approaches to ESG integration vary widely, from deeply embedded sustainability frameworks to a relatively ‘hands-off approach’ relying heavily on external asset managers’ processes.
For pension schemes at the insurance stage, a key question is therefore how much weight a scheme should place on an insurer’s ESG credentials when selecting an insurance partner? Schemes that proactively align with ESG aware insurers may also be better protected from a pricing perspective, for example, portfolios that are more resilient to ESG risks may be less exposed during any future Minsky moment. Whilst consolidation and pricing pressures mean ESG factors cannot always be prioritised, a structured review of each insurer’s sustainability practices enables more informed and balanced decision-making. Contractual mechanisms may help ensure alignment, particularly as expanding insurer participation may enhance negotiating leverage.
Conclusion
The strategic discussion of insurance, run-on, or even consolidation, may be one of the most important decisions a trustee makes. Whichever endgame route is to be targeted, there is a level of ESG integration that can and should be implemented to improve the resiliency of assets and hence minimise future volatility, whilst protecting long-term value for members.
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