A study by the UK’s Pension for Purpose platform found that 92% of active managers don’t use climate indices to benchmark their carbon metrics, despite their funds being marked as ‘climate focused’
Scant use of climate impact benchmarking and a lack of benchmark standardisation are making it difficult for UK pension funds to assess the merits of active climate-focused funds, according to a report from Pensions for Purpose, an information platform.
The survey – Industry Trends in Climate Indices – found that only 8% of active climate-focused funds offered by leading asset managers were benchmarked against a climate index – either a climate transition index (5%) or a Paris goals-aligned index (3%).
For the rest, 73% of active climate-focused funds were benchmarked against a market capitalisation index, rather than a climate index, both from a financial and climate impact perspective. A further 19% were not benchmarked at all. The report is based on a survey of 24 asset managers with over $32 trillion in assets under management.
Karen Shackleton, chair of Pensions for Purpose, told Impact Investor that one main reason given by active fund managers for avoiding climate impact benchmarking was a desire not to exclude lucrative but potentially climate-friendly investments from their portfolios
“They don’t want to narrow the opportunity set down, to be constrained by a climate index’s constituents,” she said. Fund managers were wary of missing out on “transition alpha” investments in companies currently excluded from these indices, but which were poised to take climate change measures that could boost their value in coming years.
“That’s a legitimate reason, but I’ve thought for some time that impact reporting and measurement should be separate from financial reporting,” said Shackleton, who has worked in the UK finance sector for over three decades, and who sits on the Advisory Council of the UK’s Impact Investing Institute, among other posts.
She sees benefits in the model used by fund managers such as Baillie Gifford. Typically, they benchmark the financial performance of their investments in the sector against a market capitalisation index, but assess climate performance against a climate index, such as the MSCI index.
From that, they derive a carbon budget for the fund, but can still invest in a wider spectrum of companies, so long as they stay within that budget.
“They idea is that we know we can’t exceed that carbon budget, but how we spend it is up to us. It works just as another constraint on investment, just like constraints on individual stock holding or sector exposures,” she said.
The picture was different for passive climate change funds, 81% of which do benchmark against some form of climate impact index. That much higher proportion is largely because investors in passive funds are seeking a specific type of longer-term climate impact investment, so climate benchmarking is often an integral part of the fund manager’s offer.
But even combining the data for both types of funds in the survey, 49% of active and passive climate-focused funds used market capitalisation benchmarks, rather than climate benchmarks, and 10% used no benchmark at all.
Little benchmark standardisation
The research also underscored the lack of standardisation in climate benchmarking – another factor which makes it difficult to assess the green credentials of a given fund. The survey found 142 different climate carbon benchmarks were used across 212 funds covered.
While greater harmonisation in climate impact measurement would be useful, Shackleton said the divergence was understandable, given the constantly shifting terrain of climate goals and assessment techniques, as companies are asked to increase the scope of their carbon reporting over time.
Some asset managers also prefer to tailor benchmarks to meet their specific goals.
“This is a really fast-moving space. we’re all on a very steep learning curve and the data is changing rapidly,” Shackleton said. “One passive manager told me: we have a lifespan of around three years for the benchmark we use in our climate funds. By then, we know the market will have moved on and we’ll be looking at another index range.”
Shackleton said she believes the report highlights how important it is for pension funds to be clear about what they’re trying to achieve.
“It comes back to spending time thinking about your investment beliefs, and what your goals are with climate action, because that will direct you towards a certain group of indices, eliminate others and make your job so much easier,” she said.