AP1, one of Sweden’s big-four national pension buffer funds, has linked up with asset manager LGIM to launch a new fossil-free emerging markets equity index fund, with an innovative construction that it said will help drive change in companies’ ESG behaviour.

The result of several years’ work by the two partners, the new fund – the L&G Emerging Market Equity Future Core [Index] Fund – is being launched today for institutional and wholesale investors in Europe.

AP1 declined to say how much it was investing in the passive fund, which aims to push companies to improve ESG behaviour both by rewarding them with higher index weightings and using engagement and voting.

The investment product is the latest in a series of ESG funds the Swedish pension fund has prompted asset managers to create, as part of AP1’s strategy to promote broader responsible investment across the investment industry while accessing products tailored to its needs.

In March, AP1 adopted the policy of excluding all fossil fuels, becoming the first Swedish pension fund to do so.

Tina Rönnholm, external partnerships and innovation at AP1, told IPE: “We want to be carbon neutral, and this is a target we will reach, but we know that excluding fossil fuels will not be enough to achieve carbon neutrality – by exclusion we don’t change emissions in the real world, and it is the companies that must transition.

“We need true active ownership to drive change and to help this transition which is urgently needed. Time is flying by and we don’t have that long until targets must be met,” she said.

LGIM said the fund is part of a new generation of index funds it is developing, which integrates ESG and “leverages LGIM’s active ownership capability and engagement with the underlying companies in the index, including through the use of voting”.

In these funds, it said capital would be allocated based on how well companies scored on ESG criteria. Those with good scores would get a higher weighting compared to their market capitalisation, while those with poor scores would be weighted down, the firm said.

Tina Rönnholm at AP1

Tina Rönnholm, AP1

The ESG scores companies receive are fully transparent, LGIM said, giving firms clarity on what they need to do to improve.

The new fund tracks the Solactive L&G Emerging Markets Future Core Index, which was developed by LGIM and is calculated by the German index provider Solactive.

The index includes large and mid-cap companies across 26 emerging markets, and applies exclusions in the energy and tobacco sector as well as product exclusions.

These relate to nuclear power generation; assault and controversial weapons; coal and thermal coal; tobacco production and retailing; oil sand extraction; recreational cannabis; gambling; and repeated violation of the United Nations Global Compact principles, LGIM and AP1 said.

Volker Kurr, head of Europe institutional at LGIM, said: “We are pleased to have joined forces with AP1 in combining our respective areas of expertise in responsible investment to bring this strong proposition to market.”

Colm O’Brien, head index EMEA at LGIM, said his team had worked to link a passive ESG product with engagement and voting.

“We set about creating our own ESG scores for companies and linked this to capitalisation by increasing a company’s score - and therefore their weighting – if they are doing well on the criteria we have set,” he said.

This creates a clear incentive for companies to improve their ESG behaviour, and the change this encourages is further prompted by LGIM’s engagement and voting activity with the businesses, he said.

Colm O’Brien at LGIM

Colm O’Brien, LGIM

Rönnholm said the LGIM product was a “dream come true” for AP1.

“We started with a blank piece of paper a few years ago and wrote down what our vision for passive exposure would look like.

“We went around the world and were often told this couldn’t be done, but now we have found a solution with our long-term partner in passive investment,” she said.

Rönnholm said the developers wanted to be able to offer companies a carrot, by being fully transparent on what they needed to do to improve, as well as the stick of voting.

Kurr said LGIM had very deliberately chosen a UCITs pooled vehicle for the fund to make it widely available for institutional investors.

“I think there’s clearly a demand from other pension funds and asset owners,” he said.

A month ago, AP1 unveiled new fossil fuel-free investment strategies for emerging markets and global high-yield that Paris-based quant manager TOBAM had developed at its behest.

This followed news at the beginning of September that the Swedish buffer fund had prompted Somerset Capital Management to create a fossil fuel-free ‘Future Leaders’ fund, which was to invest mainly in medium-sized businesses operating primarily in emerging markets.

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