FRR and PUBLICA are among the growing number of European pension funds developing proprietary benchmarks to achieve their sustainability objectives  

Benchmarks should reflect an investor’s value and strategy 

Salwa Boussoukaya-Nasr


Fonds de réserve pour les retraites (FRR)
Salwa Boussoukaya-Nasr, chief investment officer

  • Total assets: €21.3bn (as of end 2022)
  • Equity portfolio: 40.2% of total assets (9.7% Europe, 6.3% developed markets ex-Europe, 4.5% emerging markets, 19.7% option-covered developed markets)
  • 2022 return: -10%
  • Location: Paris

Fonds de Reserves pour les Retraites (FRR) is the French government-owned state pension reserve fund. Set up in 1999 to buttress the pay-as-you-go state pension system, it started investing in 2004. As at end-2022, FRR’s total assets amounted to €21.3bn, with 40.2% in equities, mainly in Europe or other developed markets. 

There are 30 equity mandates, and FRR is also invested in six emerging equity funds. All these mandates have sustainable objectives and reporting requirements, as have the fixed income mandates. 

In 2014, FRR was the first institution to join the Portfolio Decarbonisation Coalition after the founding members, and the institution participated in the creation of the MSCI Low Carbon Leaders (LCL) indices with MSCI, AP4 and Amundi

The goal was to achieve a significant reduction in the portfolio’s carbon footprint, and its fossil fuel reserves, within a limited tracking error. FRR only focuses on climate benchmarks. 

“Within environmental, social and governance (ESG) investing, the E has always been our priority,” says Salwa Boussoukaya-Nasr, FRR’s CIO. “Furthermore, S and G indicators can be very different for each data provider, which can be a significant problem if the manager does not use the same provider as the one supplying the data for the benchmark.”

FRR uses two standard sustainable benchmarks and three customised climate benchmarks based on standard versions. It started with two passive mandates benchmarked on the LCL, one for European equities and the other for US equities.

“We no longer use the LCL benchmark because we switched to various smart beta benchmarks for our indexed equity mandates,” says Boussoukaya-Nasr. “When selecting them, we make sure the carbon footprint of these indices does not exceed that of benchmarks weighted by capitalisation.”

She adds: “All our passive or indexed equity mandates aim to optimise the index replication by applying a carbon footprint reduction target and other ESG enhancements to key performance indicators, such as green activities and enforcement of FRR exclusions rules, within a given limited tracking error.”

At present, only the passive equity managers have been given a climate benchmark, and all of these are obliged to enhance several ESG KPIs relating to it. 

When there is no suitable ESG benchmark, FRR uses a standard version but requires the manager to decarbonise and reach ESG goals in other ways.

Benchmarks for active managers 

According to Boussoukaya-Nasr, FRR is still considering whether to use the EU’s Climate Transition Benchmark or Paris-Aligned Benchmark (PAB) for its active management, but several factors have deterred it from proceeding.  

“The main difficulty in selecting sustainable benchmarks comes from the construction methodology, the quality of the data – and its variability from one provider to another – and the scope of the data itself, for instance, the use of Scope 3,” says Boussoukaya-Nasr. “The KPI calculation may also differ considerably from one provider to another, with little correlation.” FRR always uses benchmarks from an outside provider. 

“Performance from using a climate, versus a standard, benchmark is strongly correlated to oil and gas performance”

Some providers already include ESG filters in their standard benchmarks, but if not, FRR works alongside them to create a customised version.

“The main objective of our sustainable benchmarks is to reduce the carbon footprint of the standard version of the same benchmark, but there are no specific exclusion criteria,” says Boussoukaya-Nasr. “However, it may happen that a company making heavy emissions sees its weight reduced drastically, or even placed at zero. On the other hand, FRR requires all its managers to comply with its other exclusion policies covering tobacco, non-conventional weapons, and so on.”

FRR appointed two providers of extra-financial analysis to supply the ESG data, and it also requires extended reporting from its asset managers. It works with asset management companies and extra-financial data providers to improve ESG data calculation methodologies and practices.


FRR only focuses on climate benchmarks

“Using sustainable benchmarks is a clear communication signal as to where our priorities lie and what our strategy is,” says Boussoukaya-Nasr. “It also helps to reduce the tracking error from implementing our responsible investor strategy, leaving more space for stockpicking within the universe.”

On the other hand, she says, it hides the relative performance of ESG versus the standard benchmark: “However, if this standard benchmark does not fit with the strategy of the investor, its performance is irrelevant.”

Standardisation needed 

But what FRR has learned is the huge importance of data accuracy and transparent reporting when using sustainable benchmarks. 

“We have also realised we need to standardise the data calculations and methodology to reduce the evaluation gaps between providers,” observes Boussoukaya-Nasr. “But it is also possible to manage responsible investments without using a sustainable benchmark, if the asset managers have a clear mandate. In that case, referring to a standard benchmark makes it easier to assess the ESG outperformance, that is, the relative performance from bets in the portfolio aimed at improving its ESG characteristics.” 

She says that using sustainable benchmarks has not affected the portfolio’s financial returns – with one obvious exception.

“Performance from using a climate, versus a standard, benchmark is strongly correlated to oil and gas performance,” she says. “When this sector performs poorly, the climate benchmarks fare well, otherwise they underperform the standard benchmark. This is where the manager’s role is important in creating value through portfolio construction and stockpicking.”

As for the effectiveness of sustainability benchmarks for investors generally, Boussoukaya-Nasr says: “They reflect the institutional investor’s values and strategy, and contribute to increasing awareness of the asset management ecosystem – managers, data providers, companies and even the governance function – to sustainable investing.

Interview by Gail Moss


Climate-efficiency overlay

Frederik von Ameln


Frederik von Ameln, senior portfolio manager 

  • Total assets: CHF 39.4bn (€40bn) 
  • Equity portfolio: 10% of total assets for closed pension plans (4% domestic, 6% developed markets), 32% for open pension plans (6% domestic, 20% developed markets, 6% emerging markets)
  • 2022 return: -9.6%
  • Location: Bern

There are no formal legal requirements to consider ESG aspects in the management of pension assets in Switzerland, but incorporating ESG considerations as part of strategic risk management is considered best practice in the Swiss pensions industry. Publica, the largest pension fund in the country, implements its sustainable investing philosophy in developed and emerging market equities through what it calls a “climate efficiency overlay”. This entails managing the risks but also taking advantage of the investment opportunities generated by climate change. The pension fund, which invests around CHF11.5bn (€11.9bn) in equities, developed its bespoke methodology for index construction in 2019 with MSCI, the fund’s index provider for the equity portfolio, using key data provided by Carbon Delta, now part of MSCI. 

At the time, Publica was looking for an independent source of forward-looking metrics on climate-related risks, driven by quantitative models. “Providers might give you emission scope and carbon footprint data on companies, from which you can derive carbon efficiency metrics. But these metrics are mostly backward-looking. We were looking for something more forward-looking. Furthermore, a lot of ESG scores, at least at the time, were derived from data generated by analysts. We wanted an approach that was driven more by quantitative models and less by analysts’ inputs,” says Frederik von Ameln, senior portfolio manager. 

Von Ameln points out that data compiled by analysts might be subject to bias. The pension fund was looking for a model to be uniformly applied to all stocks in the investment universe. “We wouldn’t claim to have a purely objective approach: the choice of models and parameters is indeed subjective. But any modelling or [parameter] errors are uniformly applied to all companies, while an analyst’s bias is only affecting the company that analyst covers. As data and models improve over time, i.e. become more accurate, so should the results derived from them,” he adds.  

Three-prong approach 

Carbon Delta uses a model-based approach providing forward-looking metrics, according to Von Ameln. The key metric for Publica is called Aggregate Carbon Value at Risk and includes three components. “The first component gives an idea of the costs and financial risks associated with the transition to a greener economy in terms carbon emissions. It considers policy and regulatory aspects. Company data is linked to transition scenarios with complex models linking warming scenarios and carbon pricing. Simplified, one could say that this component quantifies the expected costs for a company assuming that climate agreements are met. Then you can look at each company and relate the estimated costs to its balance sheet,” von Ameln explains. This provides an idea of the capital that is at risk due to the transition. 

“Our mindset is to exclude as little as absolutely necessary”

The second component of the aggregate climate value at risk metric relates to technology. It is based on the idea that some companies hold valuable patents related to the climate transition. “These are companies that are likely to benefit from the transition, thus potential winners, because they have relevant patents. They can provide access to technology to make the transition happen.”  The third component is a physical risk metric. It is based on a vast database of company locations, which is then linked to extreme weather scenarios. It uses certain global warming scenarios to gauge how extreme weather events can impact companies. 

The components are then aggregated to the key Aggregate Climate Value at Risk metric for each company. This and other metrics are then used to optimise Publica’s equity investment benchmarks. “The optimisation constraints are at the heart of the bespoke part of the index, reflecting our ambition level in terms of climate value-at-risk reduction and our risk appetite in terms of tracking error. The result of this optimisation is what we call climate efficiency overlay.” 


The pension fund has redefined its coal-based exclusions

The climate efficiency index does not exclude any companies based on the aggregate Climate Value at Risk or other metrics, as exclusions are handled in a separate step. This restriction represents one of the optimisation constraints. Other examples for optimisation constraints are limits on how much sector or style exposures can deviate from those of the parent index. Another example is turnover constraints for the optimisation. Through the lens of conventional equity metrics, the resulting climate efficient index looks very similar on an aggregate level compared with its parent index, avoiding “pushing it to extremes”. But, zooming in, individual company weights in the climate efficient index can divert significantly from those of a standard index. “While conventional index metrics are very similar, we see a massive improvement in carbon footprint, for example, which is much lower in the climate efficiency index compared with the parent index”, says Von Ameln. The climate value at risk in the equity portfolio of Publica is much lower, at 30-50%, compared with the normal equity index. 

While the climate efficiency overlay is restricted to avoid excluding any company, exclusions are handled separately, with proprietary filters applied to the investment universe. Exclusions are based on different criteria, but are seen as the last resort. “We believe that we can have more impact if we are invested in a company and engage with management. Our mindset is to exclude as little as absolutely necessary”. 

Exit from coal 

Publica is a co-founder of the Swiss Association for Responsible Investment (SVVK ASIR), which recommends exclusions to its members. This year, the pension fund has also redefined its coal-based exclusions, using data from the German not-for-profit organisation Urgewald. Urgewald provides data on company level, on the share of coal-based power production or revenue, absolute coal production, coal-fired power generation, and on the expansion plans in coal-based power generation, coal mining and coal infrastructure.  “We now consider Urgewald’s Global Coal Exit List, whether a company has credible plans to exit coal and whether we are directly or indirectly engaging with a company. The motivation to exclude coal-based companies is to address long-term financial risks, similar to the climate efficiency overlay,” von Ameln says. According to Publica, coal companies are less likely to adapt to the green transition in the future than fossil fuel companies such as oil and gas. 

Interview by Luigi Serenelli