A “Climate Aware” Default Fund for UK’s NEST

The UK’s government-backed defined contribution pension plan – NEST – has adopted a climate aware fund as its default option. The fund, managed by UBS Asset Management and developed in partnership with NEST, will apply a positive tilt to companies identified as vital to combatting climate change. The fund uses climate related forward looking metrics to identify companies in areas such as renewable energy or those firms making changes to transition to a low carbon economy.

It also applies a negative title to reduce investment in companies that emit heavy amounts of carbon, have fossil fuel reserves or that are not making necessary changes to meet emission reduction targets. The fund also focuses its voting and engagement activities on improving companies that need to adapt their business models to meet climate change goals.

NEST’s new default fund lists specific targets for its investments – at least 40% higher exposure to companies generating renewable energy and supporting technology compared to the FTSE Developed Index, a 30% tilt to companies most aligned to meet industry carbon reduction targets in line with the two degrees scenario, and a 50% reduction in carbon intensity.

Could such a product become a new default option here in Canada? There’s definitely room. All registered pension plans in Ontario are now required to include information on whether ESG factors are incorporated in their Statement of Investment Policies and Procedures – but it’s a challenging prospect for smaller pension plan sponsors that might not have access to tools and strategies that balance the need for returns with ESG criteria.

We talked about this at this recent roundtable on ESG that I hosted for Benefits Canada where plan sponsors discussed the challenges that DC plan sponsors have in this area.

Funds like NEST’s represent an interesting step forward for defined contribution plans tasked with integrating ESG into their investment approach and into the options available to plan members – but these products need to deliver the right level of risk-adjusted returns at a reasonable cost.

If they can deliver on that promise, we might just see some big changes in the default options of Canadian DC plans.