Good for climate, good for you
A couple of years ago, your clients were petrified that government would force their retirement funds to direct a big slice of their accumulated savings towards public sector infrastructure projects, using some-or-other form of prescribed assets regulation. This fear has since dissipated thanks to National Treasury’s more flexible approach to retirement funding asset allocation, as set out in regulation 28, which allows retirement fund trustees to steer up to 45% of assets under management towards infrastructure projects.
Climate change and inequality, major SA risks
As concerns over the impact of climate change grow stronger, and the country gets to grips with the consequences of inequality and poverty, the discussion has evolved from whether or not retirement funds should seek environmental and social impact to one that focuses on how they should achieve it. And nowadays, there is broad consensus among allocators of capital that pension funds can make a big dent in the financing shortfall for climate-focused projects. FAnews asked Sanlam Corporate for their view on the intersection of the pension fund industry and impact-focused investment opportunities in private markets.
“Pension fund assets make up most of the assets in South Africa, and there is no doubt that institutional investors can make a significant contribution to financing climate-focused projects,” said Ashley Daswa, Senior Investment Specialist at Sanlam Corporate: Investments. Per the Association for Savings and Investment South Africa (ASISA) the total assets under management in domestic pension funds stood at around ZAR4.6 trillion at end-December 2022. “Pension funds have a significant role to play in tackling climate change through the investments they make on behalf of members,” he said. “By investing in climate-focused projects, pension funds can play a role in catalysing international finance; promoting economic growth; and skills development, among others”.
There is also a growing realisation among asset managers and retirement fund trustees that climate-focused investments offer portfolio benefits such as lower return correlations and lower volatility compared to other asset classes. It is, however, difficult to decide how much of the 45% allocation limit to use. Tshegofatso Sekgwele, Investment Specialist at Sanlam Corporate: Investments, pointed out that one could not make sweeping statements about the percentage of assets a pension fund should allocate towards climate-focused projects. “The exposure should be dictated by the return and risk profile of the funds, amongst other things”. Some guidance is available from the legislation and tools which assist pension funds in understanding why climate-related considerations might matter.
ESG in pension fund regulation
As an example, regulation 28(2)(c)(ix) under the Pension Funds Act requires that retirement funds consider environmental, social and governance (ESG) factors, including climate change risks, in assessing risks and opportunities that may materially affect the sustainability of the fund. “Pension funds, in consultation with their asset consultants, should construct asset portfolios which take into consideration the long-term nature of their liabilities and seek to match them with assets that would be able to withstand the impacts of climate change,” Sekgwele said.
The good news is that respondents to the 2022 Sanlam Benchmark Survey show an increased appetite for using fund’s assets to tackle climate change. The percentage of respondents who did not have climate change considerations as part of their investment strategies decreased from 51.2% to just 25% over the last two years, and for employers participating in umbrella funds, from 57.0% to 34%. “These are positive changes that show an increasing number of participants are engaging around the impact of climate change on their portfolios,” she said.
Retirement fund trustees have a fiduciary responsibility to ensure that their members are educated about a wide variety of issues including the allocation of assets towards impact and sustainability projects, and how ESG factors are incorporated into their investment decisions. But in practice, trustees find fund members to be rather stand-offish. “Many members are apathetic or disengaged with their investments, so will most likely not care how much is allocated to impact and sustainability, focussing instead on investment performance,” said Daswa. He pointed out that while trustees were responsible for educating their members via workshops, seminars, and online platforms, not enough was being done to educate trustees. The solution, possibly, is to rely on professional trustees in the umbrella funds environment.
Challenges to sustainability linked asset allocation
FAnews grilled the experts on the main arguments for and against allocating bigger slices of a retirement fund to private market infrastructure, specifically to achieve climate-related impact. According to Sanlam Corporate, some of the key challenges raised by retirement fund clients include:
- Liquidity: The illiquid nature and long lock-up periods present in most private market infrastructure assets limit the investment amounts invested in these assets. This is important, especially where policyholders expect access to funds at short notice. Fortunately, the involvement of development finance institutions and banks earlier on in projects has the potential to create a secondary market for such investments.
- Fees: High fees are a challenge, as are making allowances for fees within current fee structures; transparent fee structures and the creation of tradable instruments has assisted in addressing this issue.
- Infrequent valuation: Reporting requirements are less stringent than are those of traditional asset classes, as such performances are not standardised, and it becomes difficult to compare different managers. The introduction of tools and resources such as the Green Finance Taxonomy may assist in standardising reporting and disclosure practices in this space.
- Education and information: Alternative, private market assets are complex, and there is not enough education and / or information to enable decision makers to adequately evaluate the inclusion of such assets in a portfolio. The introduction of knowledge sharing and education platforms for trustees, such as those supported by BATSETA and the International Finance Corporation, aim to address these issues.
- Higher project risk: Corruption can be a concern when dealing with government or government-linked entities.
- Investment risk: Pension fund trustees have the fiduciary duty to ensure good investment returns to members… To a large extent, the returns on private market strategies diverge significantly, so there is the risk that performance hurdles are not met.
- Regulatory risks: There is a greater need to consider whether the outcome of an infrastructure investment is closely linked to any future regulatory change, such as land reform. This is especially challenging given the long-term nature of these strategies.
- Interest rate sensitivity: The impact that a change in interest rates could have on an infrastructure investment must be considered, especially if it is highly geared.
Can green bonds solve the issues?
To wind up the discussion we asked what type of products might be used to improve retirement funds’ access to impact opportunities while addressing liquidity, return and volatility concerns? “Given that listed instruments are observable on an exchange and largely understood, the creation of ‘listed market access to sustainability funds’ for funding climate-related projects may address some of the challenges,” said Daswa. “But South Africa has been a slow adopter of these new instruments”. In practice, instruments such as green, social and sustainability bonds function like traditional vanilla bonds with the exception of being linked to specific sustainable key performance indicators or performance targets.
There are a range of issues that need to be addressed including lack of knowledge and experience in the field; the relatively higher costs incurred with issuing these instruments; and the lack of a green government bond curve against which these instruments can be priced. “The size of the green bond market within the JSE is relatively small, limiting the liquidity of the market and making it more challenging for issuers to sell their bonds,” concluded Sekgwele. “Issuers of green bonds also face the challenge of regulatory uncertainty and the high cost of obtaining certification to prove that their bonds meet environmental standards”.
Writer’s thoughts:
It seems absurd that retirement fund members would be opposed to some of their pension fund assets being allocated to impactful infrastructure projects; until you consider the consequence of a liability or return mismatch on their long-term financial outcomes. Are you concerned that environmental and social ‘noise’ is detracting from your clients’ retirement outcomes? Or does the asset management industry have everything under control? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
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