How are you influencing Nest’s ESG strategy?
I have been with Nest for just over 13 years, so quite a long time. ESG has been at the core of our investment approach since our inception, and I’ve helped develop our responsible investment approach, integrating ESG across our strategies. That includes addressing a range of ESG priorities that we have been thinking about.
A lot of our work has been driven by a belief that ESG issues are likely to be financially material over the long-term and will impact member returns at retirement if we do not address them. The ESG priorities we focus on are primarily climate change, human capital, technology and, more recently, natural capital and sustainable food. These are issues we have selected because we feel there is a clear link to financial materiality and that they align with our members’ views and expectations.
One example of that is the climate-aware tilt across your global equity portfolio. How does this affect your investments?
Essentially, it just means managing our members’ money in-line with our investment beliefs and their expectations. It is also in-line with our fiduciary duty, considering that climate risk is likely to have an impact on member returns at retirement. That is why we put a lot of emphasis on risks like climate change, which we believe are likely to play out over the long term.
We have built a climate-tilting approach for our developed and emerging market portfolios to reduce exposure to the riskiest companies from a climate perspective. This includes companies that are not on an upward trajectory of carbon emissions, companies that are not committed to decarbonisation or are not reporting to their shareholders on what they are doing. These are the companies that we look to be underweight while investing more in companies with better disclosures and transparency.
That means you are not necessarily divesting from energy companies as such, but instead focusing on companies that are doing better?
We focus on the transition, rather than divestment. We are trying to encourage companies to make those changes and to be more transparent in how they are managing those risks. We want them to put out a robust plan of how they will implement those changes over the short, medium and long term.
We are focussed on engagement, with companies directly and via fund managers. We have engagement programmes with some of the biggest laggards and
where these companies have not met our objectives, we divest. Last year, we divested from several companies [Exxon Mobil among others] on the back of poor progress and a lack of willingness to engage.
Many energy companies have benefited from the surge in wholesale prices. How has the energy crisis affected your portfolios with a climate tilt?
From a climate standpoint, our strategy has performed as expected. Obviously, we are generally underweight the fossil fuel sector, but we are trying to be neutral or overweight on the companies which are showing progress towards the 2050 milestones. It is not like we have a blanket policy on being underweight on energy.
We were underweight Exxon but slightly overweight Total, which has set targets, improved their reporting and started talking about a just transition. We try to identify leading companies within the energy sector, which we can continually engage with. We do not have a blanket approach to energy and we are
not any worse off than the market. It has been a tough environment for climate strategies. But we are focussed on long-term sustainable returns for our
members and the short-term geopolitical risks should not distract from that.
Does a climate tilt pose a risk of higher exposure to other assets, such as US tech, which might lead to unwanted portfolio concentration?
We are sector neutral, but the FTSE Developed index is skewed towards US tech. That is the nature of the market. So we have a high exposure to US tech, but we are balancing that out with exposures across other asset classes. In private markets, we do not have much tech. Where we see specific issues unfolding in the sector we try to manage them through engagement.
For example, we are members of the Ranking Digital Rights Initiative and engaging with companies on things like data privacy, human rights and governance. We are active in engaging with US tech companies where we see those risks.
Are you planning any changes to your strategy as a result of the energy crisis?
No, our underweight is quite marginal and we tend to not make short-term decisions on the back of short-term geopolitical factors.
We have talked a lot about equities, but in 2022, Nest announced significant private equity mandates. What does ESG integration look like in that asset class?
Private markets, specifically private equity, are slightly more challenging. This is an asset class where ESG risks are quite prevalent, but there is an issue around data and transparency. It is something we are focusing on with our fund managers. We are trying to build a picture of where ESG risks are across the portfolio. We engage with general partners (GPs) to get information on the ESG risks of the underlying portfolio companies. And our fund managers are committed to getting as much relevant and material information from GPs as possible.
We are building up our levels of disclosure, which has been quite difficult in private markets. These are not publicly listed companies, so they do not have the same level of scrutiny as publicly owned companies. We are on a journey to build better transparency and, once we get a fuller picture of where the risks are, engaging with those GPs.
Our fund manager has started to incorporate ESG requirements within the side letters to GPs. At the point of selection, the GP has to demonstrate that they are engaging with the underlying holdings and are asking for more information in relation to ESG policies and practices. It is work in progress, and most investors within this space are on a journey towards fully embedding this, but it is important that our fund managers work with us on this.
We have also seen new FCA [Financial Conduct Authority] rules come through which are capturing more companies. So far the focus has mainly been on larger public companies, which is why it is important to appoint managers that are engaging with the underlying portfolio companies to get good quality, consistent data and start generating good reporting frameworks.
It is quite important that we are targeted and prioritised with this. We have to focus on the most material issues.
Climate change is your key ESG priority, but how are you planning to reduce greenhouse gas emissions in your portfolios by 2025?
We have committed to reducing emissions by a third with a baseline of 2019. We have several pillars within our policies that help us with that target. We already discussed the climate aware strategy, which has a 35% decarbonisation target within that mandate. We have made progress within equities and are in the process of setting up netzero alignment strategies across other asset classes. That involves decarbonisation targets for the short, medium and long terms.
We are also stepping up our climate engagement with companies, looking at how they are positioned. We are engaging with them where disclosures are lacking, or if they do not have robust strategies that meet the targets they have published. For us it is important to achieve realworld impact through engagement, rather than just decarbonising our portfolios because that does not make the blindest bit of difference to real world emissions. It is important that we move with the market and take the market with us on this journey.
Another strand of our work is through advocacy. We spend a lot of time engaging with policymakers to help set out a range of regulations and new reporting requirements that form better policy disclosures for our investee companies on what “good” looks like.
We are part of the Transition Plan Taskforce, for example, to set up transition plans for different sectors across the economy and investments in climate solutions and allocating capital into renewables. It’s important that we do not just think about risk, but also tap into the opportunities.
The flipside of focussing on real world impact is that it might become harder to meet your target. Will you meet it?
We are on track to do so in terms of where we are positioned with the Climate Aware fund, which is where a lot of our decarbonisation is coming from. It just so happens that the mandates we have elsewhere do not lend themselves to being heavily invested in fossil fuels. A lot of our carbon emissions are generated from our equities. Other strategies are naturally quite low in carbon, but that does not mean we are not working with them. At the moment, it does not look like we need to make radical decisions to meet the target.
You didn’t attend COP27?
Not this year. On the emerging market side, obviously the event was in Egypt this year. We are part of a group looking into how investors can support an emerging market transition. It is important that investors do not overlook the importance of emerging markets in their transition plans. The market has a different pathway to net zero, it is more carbon intensive but in order to reduce real world emissions, it is important that emerging markets are part of that
transition.
What are the main topics you engage on and how could this change in 2023?
It is a tough economic backdrop for our members at the moment. We will continue to focus on the long-term. Climate change will still be a key focus
but there are other areas of interest, for example, human rights on the back of the Russia-Ukraine war. We are thinking more about the companies and countries that we invest in. We are considering human rights more.
We have done a lot of work on low pay, which will continue to be a focus going forward. We have campaigned for a living wage. That is set to continue, particularly with the tough financial situation in the UK. It’s important that where companies can, they should pay workers fairly. There are always new things on the horizon. We are also stepping up on stewardship, but climate change and workforce conditions are going to be key.
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