In Europe and the U.K., where growing regulatory pressure to align portfolios with the Paris Agreement climate targets make the use of environment, social and governance factors “as much an opportunity as a threat,” Barry Kenneth, CIO of the Pension Protection Fund, says his fund does not have ESG investments; rather,“ESG is one consideration.”

Yet ESG is at the core of the fund’s derisking strategy, which aims to reduce risk in the £39 billion ($48 billion) portfolio by about 20% on an absolute basis, while rebalancing between liability-driven investment assets and non-LDI assets. The PPF is 140% funded, and more than 50% of the portfolio is managed internally, up from zero when Kenneth became CIO in 2013.

Kenneth reports to CIO that “over 99% of our total AUM are now managed in line with a relevant ESG policy, with the remaining 1% now operating in wind-down mode.”

To accomplish climate-related goals, the fund has partnered with Dutch technology and management firm Ortec Finance to gather climate-related data for every asset class in the portfolio. The partners will assign a temperature score to every company in which the fund invests—in both public and private markets—so that the PPF investment team can see “how the portfolio’s position today aligns to Net Zero and the Paris Agreement,” Kenneth says. “This is helping us improve our understanding of ESG data and make more informed decisions about the portfolio.”

“I don’t understand how [any investor] can commit to Net Zero [carbon emissions] without doing this kind of research,” Kenneth says.

Collecting this kind of data helped to inform the PPF’s decision to increase its investment in forest land by 20% to approximately £1 billion, with key sustainable forestry assets across Australia, New Zealand, the U.S., the U.K., Ireland, the Baltic and the Nordic regions. Kenneth says the fund sees sustainable forestry as one of the few viable, nature-based solutions to deliver carbon sequestration and help mitigate carbon dioxide emissions.

Kenneth points to PPF forestry investments in Australia and New Zealand that he believes have potential for carbon sequestration and, in the next year, as trees are cut, there is land available on which windmills producing clean electricity can be housed, making that investment even more valuable.

Along the same lines, the fund has changed to a new climate-aware listed equity benchmark. The FTSE Custom All-World Climate Minimum Variance Index is helping the PPF recalibrate its overall equity portfolio exposure to carbon-intensive companies and, as such, reduced the carbon footprint embedded in their index by more than 75%, without impacting the fund’s core investment approach or performance, Kenneth wrote in the application for the CIO award program.

“This new index considers three constraints in its construction to mitigate some exposure to climate-related risks,” Kenneth wrote. “What I want to ultimately do is limit our exposure to significant contributors to climate change whose management quality is also considered to be lagging in the industry. Our benchmark means we remain engaged with companies who are critical to the energy transition whilst also identifying those who do not seem prepared or able to adapt to a net-zero world. The index helps me limit fund exposure to individual climate laggards, rather than exclude whole sectors.”

Incorporating ESG also means taking a long-term view forward on all investment decisions. For example, Kenneth says when considering investments in office real estate, the PPF team wants to know if the post-pandemic work-from-home trend expands, “Can that office building be used for another purpose?” Kenneth asks.

In private market ESG considerations, Kenneth says it is critical that the PPF navigate the “minefield of information” from different providers, with varying reliability. So the fund determined its beliefs and works with managers, in funds of one where possible, to get those PPF beliefs—regarding climate in particular—into the deal documents.

“We try to get our clauses into the documents at the time of investment and engage with the underlying [general partners],” Kenneth said. “If they don’t sign up to our minimum standards, we just can’t invest with them.”

Noting that the focus on ESG is more commonplace in Europe, Kenneth said the PPF’s European private equity managers do not find it difficult to comply with the standards and information transparency demands, while, “it is a bit more difficult in the U.S., but we get there.”

—Amy Resnick