Decarbonisation beyond equities: why Avon Pension fund considers natural capital

In its latest responsible investment report, the £5.8bn Avon Pension Fund, a local government pension fund for Bath and North East Somerset in the South West of the UK highlights that it has made significant progress on its road to net zero. The fund, which is  part of the Brunel Pension Partnership Pool, reported a 63% reduction in absolute emissions in its listed equity portfolio compared to its 2019 baseline. 

Nathan Rollinson, investment manager at Avon Pension Fund, highlights the process made but also warns that this “will become harder to repeat as time goes by.”

Avon has set itself a target to reduce the carbon intensity of its listed equity portfolios by 43% by 2025 and 69% by 2030, as part of a broader commitment to achieve net zero financed emissions across the entire fund by 2045.

Speaking to Net Zero Investor, Rollinson credits the “significant upfront efficiency gains” in the fund’s listed equity portfolio to “major asset allocation decisions made by the fund”.

“We came out of emerging markets, we came out of parts of the UK market and simultaneously upped our allocations to the Brunel’s Paris-aligned and sustainable equity portfolios. That really helped us at the outset of this journey,” he said.

Currently, Avon has £720m invested in global equities, £667m invested in sustainable equities and £1.5bn in Paris-aligned equities.

However, “the big efficiency gains that we have seen are going to be harder to replicate as time goes by. We have made the big asset allocation decisions and arguably done what we can in that space,” Rollinson says.

To continue decarbonising, Avon’s focus will shift towards working with asset managers and engaging with companies to encourage them to decarbonise, he adds.

Despite this, I do have “concerns” around the broader policy backdrop, Rollinson says, “particularly around the rollback of some disclosure requirements. Those sorts of developments are not helpful but fundamentally, we don’t think there is a trade-off between investing sustainably and generating attractive returns”.

Corporate bond challenges

In addition to decarbonising its equity portfolio, Avon Pension Fund aims to reduce emissions in its £180m corporate bond portfolio by 60% by 2030. Rollinson explains that the fund plans to achieve this reduction using a weighted average carbon intensity (WACI) approach.

However, decarbonising a bond portfolio can present challenges due to pension funds’ limited influence over issuers. Despite this, having a large asset manager that oversees both debt and equity products can be advantageous, Rollinson says.

“We have clout when engaging with underlying issuers.

“We are also supportive of incentives such as ESG ratchets; something we’ve seen Brunel take a lead on in private debt especially.

“The progress in reporting in credit portfolios has come on significantly over the past couple of years and part of the reason we feel confident in extending our climate targets across the portfolio; not confining them just to listed equity,” Rollinson explains.

Investment in ‘restorative strategies’

Yet, Rollinson highlights that “decarbonisation is only one side of the equation that will help us meet our 2045 net zero target, and that more capital will need to go into climate solutions and natural capital”.

Currently, the fund has committed £447m to sustainable infrastructure, including renewables and energy transition assets, and has invested in natural capital through the Brunel Pension Partnership’s Cycle 3 infrastructure portfolio.

Looking ahead, the fund plans to allocate an additional £100m to £150m to natural capital investments in 2024–25.

“We see a real opportunity to go beyond the more well-known areas of sustainable forestry and agriculture and move into restorative strategies as well”.

“The final product isn’t nailed down yet, but it has to be net nature positive, and it has to be best in class,” Rollinson says.

The further natural capital allocation is set to form as part of Avon’s existing 32% strategic allocation to illiquid assets, with Rollinson suggesting that Avon’s “preference” would be to further allocate through its pension pool.

“Natural capital for us complements our existing exposure and makes sense both from a decarbonisation and transition perspective, as well as stacking up from risk and reward perspective as well,” he adds.

Carbon credits scepticism

One of Avon’s existing investments is Aurora Sustainable Lands, which owns 1.6m acres of forestland, primarily naturally regenerating hardwood forests in the eastern United States. Natural capital assets like forestry often underpin the creation of carbon credits—tradeable certificates representing reductions or removals of CO₂.

When asked about Avon’s view on carbon credits, Rollinson responds: “We are not averse to carbon credits; we appreciate there is a lot of uncertainty and scepticism around the credibility of credits and offsets more generally.”

However, “If we were to invest in a project deriving some form of return from credits, it would need to stand up to scrutiny for instance by demonstrating permanence and evidencing emissions reduction through clear and robust criteria.”

Carbon credits are a topical issue, with one of the significant outcomes of COP29 being the breakthrough on Article 6, setting standards for a UN-convened centralised carbon market. Alongside this, a key challenge will lie in providing clarity on how countries will authorise the trade of carbon credits and how registries tracking these will operate.

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