Private equity is the most popular way for UK pension funds to make impact investments, but a wider geographical spread and greater attention to additionality would improve effectiveness, according to Pensions for Purpose.
UK pensions funds regard private equity investment as the most effective way to create impact, but a tight focus on UK investments and a limited understanding of the importance of “additionality” in impact strategies are undermining overall impact, according to a study from Pensions for Purpose (PfP) and commissioned by asset manager Columbia Threadneedle Investments.
The research shows that 60% of local government pensions and defined contribution (DC) schemes surveyed view private equity (PE) as the best vehicle for impact. However, only 43% of pensions funds polled had invested in impact-oriented private equity, a discrepancy that PfP said indicated there may be unmet potential within the sector.
The study includes views from 17 UK pension funds – mainly local government pension schemes and DC master trusts – as well as five investment consultants.
PfP said the research “dispels the myth that impact investing necessitates a compromise on returns”, as it showed that risk-adjusted returns were the main consideration for pension funds investing in impact private equity. Impact-focused pension fund allocations screen a PE fund’s impact first when selecting managers, without reducing their expectations on market-rate returns, according to the study.
Respondents said the main drivers for their impact PE investments were securing a more sustainable future which benefits their portfolios (33%), pursuing a solid risk and return profile (25%), raising member engagement (17%), moral imperatives (17%) and aligning with the UK government’s ‘levelling-up’ initiative (8%).
Karen Shackleton, chair of Pensions for Purpose said that, while most pension schemes see private equity as the best vehicle to make impact, “there’s still room for growth in understanding concepts like financial additionality”.
Additionality is beneficial impact that would not have otherwise happened without a given investment, and, as such, is complex to assess, despite its importance. PfP said additionality should be considered as a critical factor in pension funds’ investment decisions, but often was not and that most pension funds surveyed did not seek it. The study said there was potential for more education on additionality among pensions trustees.
PfP also suggests a focus on UK impact investments was restricting the impact of pension fund strategies given that pressing issues such as the energy transition require global responses.
“We advocate a global perspective on impact investment to meet crucial targets such as the net-zero transition. Asset managers can be pivotal here, by creating innovative strategies that make impact private equity accessible for DC schemes within their fee boundaries,” Shackleton said.