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Impact Investing

IPE special report May 2018

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Innovative approaches clinch joint awards

The Environment Agency is the leading public body for improving the environment in England and Wales, and its pension fund strongly believes that this corporate mission should also permeate its own investment strategy.
The scheme's aim is to obtain optimum risk-adjusted returns, and it believes that sustainable environmentally responsible investment (SERI) is the way to achieve this. It therefore runs an innovative environmental overlay across all asset classes in its €2bn-worth portfolio.
The approach was developed after research identifying non-traditional sources of risk and value. The research showed that positive financial benefits come from investing in companies committed to good corporate environmental governance.
The fund has achieved encouraging results from the first year of this new strategy, with a return 0.8% above its customised benchmark return. Furthermore, the first-year performance on its active global equities SRI mandate, run by Sarasin Chiswell, was 9% above its benchmark.
In 2005, the pension fund replaced its balanced managers with eight specialist fund managers carefully evaluated in terms of potential financial returns, risk, price and ability to put into practice the fund's environmental overlay strategy and corporate governance requirements.
Two more managers were appointed this year, one to run a £50m emerging markets equity mandate, and the other in charge of an overall fund currency overlay strategy.
These fund managers must vote the scheme's holdings in accordance with established corporate governance codes. They submit regular reports on their financial performance, as well as on engagement with companies. Decisions to abstain or vote against management must be justified, and if necessary, the fund reverses its managers' voting.
The use of SERI and the environmental overlay strategy is monitored by dedicated inhouse staff.
To help other pension schemes, the fund also shares information on what it does to increase its financial returns. It also promotes research showing the impact of environmental governance on the performance of pension funds.
The scheme has already started preliminary environmental footprinting of its equity mandates and is investigating how these tools might be applied across the whole fund in future. It has recently signed the UN Principles of Responsible Investment and encouraged its fund managers to do likewise. Its future work and research programme includes reviewing and ‘green' benchmarking itself with other responsible pension funds.

Highlights and achievements
In a major revamp, the EA pension fund has hired new specialist managers to replace its balanced mandates, and to run an innovative environmental overlay across the whole portfolio. Managers must engage with companies they invest in, and vote in line with corporate governance codes. Their investment and engagement activities are monitored by an in-house team. Part of the fund's work is to promote greater disclosure of environmental performance.

SAUL, the Superannuation Arrangements of the University of London, has also won the award for its success in tackling a common problem for many funds - a deficit. The 2005 actuarial valuation revealed a deficit - on a solvency and an ongoing basis - as well as a gap between the actuarial assessment of the costs of future benefit accrual and the joint employer and member contribution rate. Both had to be funded through investment returns.
Following the valuation, SAUL changed its investment strategy, in four phases. First, the investment committee took advice about the likely rates of return on all asset classes in the medium to longer term. The committee opted for caution, judging that the medium-term outlook was for lower returns than those experienced in the 1980s and 1990s. It also considered that bonds were very poor value, and likely to remain so.
The committee then assessed the strength and the sensitivities of the employers. The conclusion was that the employers, as university colleges, were unlikely to close down, so had strong covenants. However, the employers were very sensitive to volatility in contribution rates. 
The committee then considered the fund's liability profile. This showed that retirements of existing members would peak in 15 years' time. A long-term cash flow forecast suggested that even at relatively low rates of actual return (6% pa) the deficit never became ‘real' - ie, when benefits were due but there were no more assets.
Both these analyses meant that any investment strategy could be planned for a relatively long-term horizon. This in itself was an innovation.
In a second groundbreaking move, the committee concluded that rather than use the traditional rigid division beteen equities, bonds, property, cash and alternatives, assets should be split between risk-reducing and return-enhancing. It also decided that all assets should be liquid, because of the risk of future employer restructuring.
The final strategy has allocated 35% to risk-reducing assets, such as UK gilts and index-linked bonds. However, because bonds are currently poor value, one-third of this category is allocated to assets such as high-income equities, which are not bonds, but behave like them.
The return-enhancing allocation is split between traditional equity strategies and absolute return mandates. Assets include alternatives, and European and Asian equities held within three unconstrained-type equity mandates. There is also an active currency overlay mandate.

Highlights and achievements

SAUL has tackled both its deficit and the threat of a future restructuring by an innovative approach. While the fund could take a long-term horizon, a key requirement was to keep the volatility of returns within a reasonable range. The strategy looked at the life span of the liabilities to assess the timing of deficit crystallisation. Secondly, it considers assets as part of a continuum, rather than in separate boxes. And finally, it uses currency overlay and unconstrained investing.

 


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