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IPE special report May 2018

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Evergreen mandate takes root

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Mark Mansley and Faith Ward of the UK’s Environment Agency Pension Fund tell Jonathan Williams about the scheme’s plans for an ‘evergreen’ sustainable equity mandate and discuss how investment management agreements of indefinite length will spread

The Environment Agency Pension Fund (EAPF) has long been in the vanguard of sustainable, long-term UK investors but last year’s announcement that it would tender an “evergreen” equity mandate nonetheless caught the eye of many in the industry.

The suggestion of an indefinitely renewable mandate was bold because it was almost impossible under the regulation governing local government pension schemes (LGPSs). Its emphasis on sustainability also came ahead of the UK’s Law Commission clarifying in July that fiduciary duty allowed pension investors to consider the impact of non-financial matters on returns.

Faith Ward, chief responsible investment and risk officer at the £2.4bn (€2.9bn) scheme, points out that the approach now ruled as legal by the report was one the fund has been “entertaining for the last decade”. Mark Mansley, the fund’s chief investment officer, echoes this, stressing that where it may have previously been the view that the EAPF was “pushing the boundaries” of fiduciary responsibility, its behaviour was now accepted as “very much central” to the concept. 

Pushing ahead with the £250m evergreen sustainable equity mandate, either administered as a segregated mandate or held within a pooled fund, Ward and Mansley both believe the formal tender is only the first step in a long process. 

At a glance 

What: global sustainable equity, integrating ESG considerations
Mandate size: £75m-£250m (€93m-€310m)
Vehicle: segregated portfolio or pooled fund
Benchmark: to be decided after discussion with manager but mainstream or absolute return benchmark possible
Timeframe: indefinitely renewable “subject to continuing satisfactory performance (financial and non-financial) and added value for the fund”

Mansley says that, in addition to a new investment management agreement (IMA) that will codify many of its demands, the fund is working on a more informal explanatory document for managers. “What we are looking to do is have what we call a covenant with the managers,” he says. “It won’t be a legally binding document but it will lay down our expectations and the sorts of things we will try to do.”

He stresses it is not about short-term performance, and that monthly communication does not need to be about returns but about what action the manager took during the period and the motivation behind this. 

Additionally, changes to the team and the potential risk of style drift within the mandate will be monitored. “It is a much broader evaluation but we’ve realised you need to be a bit more explicit with managers about that as the source of things we will look for.”

Mansley says that, despite the LGPS regulation’s requirement that managers can be fired within a month, they should not be expecting such behaviour from the EAPF. He explains that it has previously worked with underperforming houses to fix the mandate, rather than re-tender. 

“What we are trying to do in our IMA and our documentation is make it clear that just because we can terminate [a manager’s contract] at short notice doesn’t mean we will want to and doesn’t mean we will,” he explains.

“It is about having a relationship that properly functions, with the hope that it would be a seven to 10-year relationship.”

Under the skin
The ability to pursue a long-term, sustainable equity mandate has also been made possible by the growth in the market, Ward adds. “The perception of what constitutes sustainable equity has broadened and the number of managers who are able to fulfil that tender is much wider than it’s perhaps been in the past.”

She says this has been made possible by the increased recognition of how environmental, social and governance (ESG) matters contribute to returns.

Despite the EAPF recently being told that it would not be “progressive” for it to sell its fossil fuel-heavy holdings – in a report commissioned by the fund and authored by Trucost –  Ward says she would be “quite surprised” if the sustainable mandate contained any significant carbon risk as it will sit within the 25% of fund assets it has earmarked for sustainable investment.

Fossil fuel exposure would be part of a more mainstream mandate, she argues, adding that listed companies included in the sustainable mandate are unlikely to only consist of those with a sustainable or green product. The expectation would be for asset managers to get “under the skin” of listed companies to fully understand how these function. 

“It’s more about how it goes about its business rather than necessarily the output,” says Ward. “We feel that this approach has broadened the scope of what would constitute a sustainable equity and what would contribute to a non-sustainable economy.”

Mansley explains how the fund will not be prescriptive about the types of companies that can be included. “Otherwise, you have arguments about what constitutes material exposure. It’s much better to take a risk-based approach.”

The initial tender was first envisaged as a framework agreement accessible to all LGPSs but the idea was abandoned after the recently concluded consultation by the Department for Communities and Local Government left the local authority sector uncertain whether it would be forced to consolidate asset management in collective vehicles, or even be allowed to continue with actively managed mandates.

However, Mansley says the fund will share its experiences with other councils, particularly if it settles on pooled vehicles it believes could be of interest to the sector as a whole. 

Additionally, the EAPF is aware of how the sustainable and long-term nature of the equity mandate should inform the rest of its holdings. “We will be doing a rolling programme of updating some of our other IMAs, reflecting this best practice over the coming years,” says Mansley. “We will try to get them all up to speed and moving forward on this basis.”

Mansley accepts the EAPF will not be the only one pushing ahead with such sustainable mandates, which were the focus of a working group within the UN-backed Principles for Responsible Investment. The CIO, who was part of the working group, says it revealed “a range of views” about what elements should be included in such a mandate.

“As this whole long-term debate evolves, there will be a number of different approaches. We are perhaps trying to make our own contribution to that debate to show what the field is like for us, but also learn and share from others.”

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