Interview | Rachel Neill
portfolio. It is about being sensible and say- ing: “Our job is to ensure that our mem- bers have good retirement outcomes.” ESG and sustainable investing are all about long-term thinking. In other words, ESG as a risk management tool was arguably a big- ger factor in the decision-making as mem- ber engagement. If we are going to properly manage financial risk for the long term, then ESG criteria should be part of the investment decision making process in the default fund. But you are right, the self-select ESG option had a limited uptake. To be fair, we did not go in with a big bang launch, it was very much a soft launch. That said, it did have a bigger uptake than I thought it would.
Will that require significant change? Yes and no. The decision was part of a broader strategic review of our portfolio. The new asset allocation will be moving to 80% equities, 20% alternatives. The equity portion is where the ESG funds are going to be on offer, certainly when it launches. Maybe over time we could include other asset classes.
The equity portfolio will be invested in the Legal & General Future World fund range, which we are using on our platform. So, it is just saying: “Well, can we use a Future
members as low as possible. We did not want to do a bulk switch. When it’s fully embedded, 71% of our default fund will be ESG integrated.
What’s the timeline for the transition? Because of the transition approach we are taking, it could take six to 12 months. It will depend on inflows because we are not doing a straight up switch. We are doing it by adding new contributions and asset allo- cation. It could take a little bit longer, but we should have started the transition in early Q2 2019.
How does that transition work in practice? With bonds you could just hold them until they mature but how do you transfer out of an equity index?
Because we invest passively, we effectively hold the index. In the UK fund, the bench- mark is not the FTSE100 but an ESG com- pliant equivalent. So, it depends on how the benchmarks are set up.
How do passive investment funds apply ESG criteria whilst mirroring a benchmark? We have a responsible investment policy that our trustees have signed off. Within that there are two key elements. One is that
Smart Pension’s current default fund.] In December last year it agreed to tie executive pay to how successful it was in cutting car- bon emissions. That was because institu- tional investors were saying: “We are hold- ing your stock, but you are not doing enough to tackle climate change.” In terms of being able to integrate ESG criteria into passive funds, the push radius is on the engagement side as opposed to divestment. After all, if you divest, you simply sell to someone else who has to hold the invest- ment, and you also lose your “vote” or influence.
Does the mandate with LGIM differ from the vanilla Future World fund on certain criteria?
It is very much in-line with the Future World fund range. Having said that, every master trust will have different require- ments in what they are expecting from their managers in terms of reporting, the stewardship code, that sort of thing. Our requirements for any fund house will always be independent from the asset man- ager. They are based on our own criteria and LGIM’s standards are in-line with that.
If you decided to divest from a sector, such as tobacco, for example, and the Future World fund had it in its standard portfolio, could you take it out?
When it’s fully embedded, 71% of our default fund will be ESG integrated.
World Fund building block to give us the geographical exposure we need in the default?”
Where do bonds fit into your 80%/20% equity/alternatives split?
Bonds, or active fixed income more gener- ally, are considered under our alternative asset class. The ESG component will be pri- marily on the equity side. We are implementing it as a slow transition from our current default fund into the new default fund to keep transaction costs for
we have some exclusions. These include the ones that you are probably familiar with and would expect, e.g. violators of the UN Global Compact or companies that gener- ate the most significant proportion of their revenue from coal, cluster ammunitions, that sort of thing.
The second part is around active ownership and engagement with companies. As the fund manager, Legal & General does the engagement with the companies. One good example is what happened with Shell last year. [Shell is one of the top 10 holdings in
20 | portfolio institutional | December-January 2020 | issue 89
I would imagine so, but we have not had that discussion. The Future World funds we are using at the moment are index track- ers and because British American Tobacco is part of the FTSE100 it is part of the port- folio by default.
If the trustees decided to divest from tobacco, we would either find another fund manager who could accommodate that or work with LGIM to accommodate the trus- tee requirements.
But for the time being there is not a huge need to tailor the portfolio? Absolutely. That may change, of course, when the alternatives allocation becomes more embedded. Along with the trustees, different calls may be made in which case discussions will need to be had.
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