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14 December 2020

Divest or direct? Pension funds weigh their options in the climate crisis

These huge institutional investors are under pressure to ditch fossil fuel investments, but some are taking a more active role in changing energy markets.

By Philippa Nuttall

In March 2017, Waltham Forest Council in London held £53.4m in investments in coal, oil and gas through its pension fund. Each of the 16,500 current and former workers who were members of the council’s pension scheme had more than £3,000 invested in fossil fuels. But this was about to change: the previous year, the council had become the first local authority in the UK to announce the divestment of fossil fuel holdings from its pension funds.

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Divestment can mean the selling-off of stocks, bonds or funds for any reason, but it most commonly refers to the sale of assets that are seen as incompatible with long-term, sustainable investing. Climate campaigners see it as one of the best ways for big organisations such as universities, religious organisations or public bodies to stop funding fossil fuels. In the case of pension funds – which invest on behalf of people decades in advance of them drawing their pensions – the questions of environmental and financial sustainability are clearly linked.

But does it work?

Divestment is not quick or easy to do. It has taken Waltham Forest five years to reduce its investments in fossil fuels from 8 per cent of its pension fund to 0.5 per cent (the council says it is confident this figure will be zero by the end of March 2021). Clyde Loakes, deputy council leader, says phasing out fossil-fuel investments is “not as easy as you think”, even over several years. “Pensions are complicated, and there are lots of risks in changing the direction of a pension pot. People want reassurance their investments are safe.”

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But for pension funds that want to invest in the transition to a clean-energy economy and ensure a decent return for investors, there is also the question of whether they could have more influence as shareholders.

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Lauren Peacock is the campaigns manager at ShareAction, a charity that promotes responsible investment. While Peacock suggests that “perhaps [investors] should not sell their shares in BP or Shell”, which have committed to achieving net zero emissions, “pension funds should not be investing in Exxon” (which has made no such commitment).

This is not simply a way to show approval for one company’s actions. Shareholders have a number of levers to pull, “such as refusing to purchase debt, or voting against directors”. “We support divestment as a means of last resort,” Peacock explains, “but investors should first lay down clear expectations when it comes to climate action.” When all else fails, however, the departure of a large institutional investors can be a significant threat. “Divestment can send a strong public signal that companies failing to comply with the Paris Agreement are not investable.”

Katharina Lindmeier, responsible investment manager at the UK government-backed National Employment Savings Trust (or Nest), takes a similar stance. With nine million members, Nest is the UK’s biggest pension fund. It, too, has begun divesting from fossil fuels, but Lindmeier says divestment is only “a small part” of its climate change policy, and is considered a “last resort” by the trust. “Rather than divestment, we prefer to engage and get companies to change,” says Lindmeier. “If we divest, someone will simply buy the shares – and then we have no real-world impact.”

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Investment’s role in mitigating climate change is also a matter of funds “investing in good stuff”, says Peacock. This is very much the path chosen by pension funds in Denmark. To help meet the country’s ambitious goal of reducing greenhouse gas emissions by 70 per cent by 2030 compared to 1990 levels (the UK is aiming for a 57 per cent reduction by the same date, although it has recently announced a more ambitious target), private Danish pension funds will invest more than $50bn in large-scale clean energy infrastructure, such as offshore wind, green stocks and bonds, and energy-efficient construction, over the next decade.

Torben Möger Pedersen, CEO of the €34bn Danish pension provider PensionDanmark, says there have been “broad discussions in the pension funds industry about what we should do about climate change, and whether divestment or engagement with fossil fuels companies and getting them to commit to more climate funding gives the greatest impact”.

“The main conclusion,” he says, “is that if you want to have impact on the real economy you should abstain from divestment, and use your position as a shareholder to actively engage and form coalitions that can move companies in the right direction.”

One example of this is Denmark’s largest energy company, Orsted. Under its previous name, Dong Energy, the company relied on fossil fuels until – partly supported by direct investments from Danish pension funds – it invested heavily in new wind-power generation to become the world’s most sustainable company. Pedersen also points out that Shell shareholders have now linked the bonus pay of the company’s senior management to the Paris Agreement. Divestment may offer moral satisfaction, says Pedersen, but engagement brings results. “Having a clear conscience does not have real-life impact.”

Funds should still divest assets that don’t make financial sense, as they would in any situation. Pedersen says coal, as a technology that science shows is incompatible with climate action, is simply a bad bet. “Coal companies will be increasingly out of business, and so this is also the right decision for risk.”

Similarly, Nest will continue to pull its investments out of tar sands and thermal coal, but this decision is as much about ensuring “sustainable long-term returns” for members as it is about climate change. “Climate change affects the risk and return of a pension scheme,” says Lindmeier. With legislation increasingly demanding that pension funds and other investors disclose the amount of climate risk to which their portfolios are exposed, all funds are focusing more on investments that meet environmental and social governance criteria.

To properly manage risk, pension funds need to invest in a diverse portfolio, and the growth of clean-energy assets presents an opportunity, says Pedersen, who believes the choice of “green” investments will grow in the coming years as more companies meet the criteria. “Actively engaged shareholders can move food production, agriculture and transport in the right direction,” he says.

Despite these arguments, progress in getting the pension industry to align with net zero “is too slow,” says Tony Burdon, CEO of Make My Money Matter, a UK campaign for pension funds to be invested in building “a better future”. To speed up change, Burdon would like net zero investment strategies to be made mandatory in the UK in the upcoming Pensions Schemes Bill, which is currently making its way through parliament. “If UK pension funds with nearly £3trn invested need to halve emissions by 2030, they need to start doing so now,” he says. “Pension fund commitments to net zero amount to around £200bn, leaving 90 per cent of UK pension finance still to act.”

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