Something synthetic: Why Avon picked BlackRock for its climate equities strategy

Avon has a net zero target for 2050 in place and plans to cut two-thirds of its carbon emissions for its equity portfolio by 2030.

In total, the £5.4bn Local Government Pension Scheme (LGPS) fund, which invests on behalf of members from Bristol, Bath & North East Somerset, North Somerset and South Gloucestershire, has now invested more £1bn in Paris-aligned equity strategies. It has a net zero target for 2050 in place and plans to cut two-thirds of its carbon emissions for its equity portfolio by 2030.

The news stood out because the LGPS fund is part of Brunel Pensions Partnership, which not only offers its own passive low carbon equity strategy, but also has a reputation in the pensions industry for its strong stewardship stance around climate change.

Moreover, Avon describes itself as committed to the pooling process and has formally pooled all its listed assets in 2021.

This raises the question: Why has the fund opted for a separate mandate with BlackRock, which has been in the firing line of climate activists, rather than going trough the pool’s existing passive equity strategy?

A dash of derivatives

The answer boils down to liquidity management, as Nathan Rollinson, investment manager at Avon Pension Fund told Room 151. While BlackRock has a vast range of equity products branded as “climate action” or “sustainable”, the mandate Avon opted for is structured as a total return swap, referencing Paris-aligned indices.

The new BlackRock mandate has been appointed within the pool, with a Brunel appointed manager, Rollinson stresses. He explains that it required greater levels of customisation due to Avon’s specific risk management framework.

As a derivative-based product, it has been designed to release liquidity to support other aspects of Avon’s investment portfolio.

“Holding a significant cash allocation is sub-optimal from an investments perspective. So instead of investing in a standard equity product (such as Brunel’s passive equity strategy) which ties up capital, we get equity exposure ‘synthetically’ via derivative instruments. This allows us to benefit from equity-like returns and at the same time releases cash for collateral,” Rollinson explained.

“We’ve structured this in such a way that embeds climate fully. Not only do we get Paris-aligned equity exposure through this new product but the cash that is released is invested in a climate-aware cash fund.”

Separate mandate

This means that the strategy is a pooled commitment running through Brunel, but run as a separate mandate, Rollinson explains.

“We as Avon Pension Fund have worked collaboratively with BlackRock – Brunel Pension Partnership’s appointed risk management provider – to implement this highly bespoke strategy.

“Due to the nature of the strategy, the process is slightly different to how we invest in Brunel’s other pooled products, requiring close collaboration between fund officers, our external investment consultants and the manager” he adds.

Liquidity management has been high on the agenda for LGPS funds, not just due to the onset of monetary tightening and the experience of the LDI crisis, but also due to the inflation linked nature of LGPS pension benefits.

For Avon, this has meant an adjustment in its strategic asset allocation. “Liquidity budgeting informs how much the fund can reasonably afford to invest in illiquid holdings in order to benefit from the ‘illiquidity premium’, without compromising future outgo requirements. 

Following the extreme market volatility as a direct result of the Coronavirus pandemic, the fund prioritised short-term cash flow requirements over private markets commitments, opting to phase in its commitments over the medium-term rather than commit the full long-term target amount at outset, the fund said in its latest investment strategy statement.