As pension funds and pools actively seek green investments that offer good returns and help fulfil ESG targets, Jason Holland assesses strategies and methods for investing in climate infrastructure, and looks at what the future might hold.
While a commitment to creating positive environmental and social change for communities is driving decisions to invest in climate infrastructure, the ability to get a good return on that investment remains the number one priority. There is always a balancing act in any investment plan.
South Yorkshire Pensions Authority’s strategy in this area, for example, not only looks to reduce emissions overall but also capture the upside from the climate transition, according to its director George Graham.
“We seek to achieve this through developing a specific exposure to renewable energy – 5% of the fund – in excess of that which would come through simply investing in a range of infrastructure funds,” he says.
“We have also allocated 5% of the fund to climate opportunities which we will deliver through investment in Border to Coast’s Climate Opportunities product, although we have a couple of legacy investments which fall into this category which includes things such as alternative fuels such as hydrogen and technologies to support decarbonising the grid.”
“We have also allocated 3.5% of the fund to Natural Capital in our latest strategy review recognising that we will need to offset residual emissions.”
Compelling Opportunities
South Yorkshire is part of the £58bn Border to Coast pool, and the allocation to Border to Coast’s Climate Opportunities product raises a topical question: is it best to invest through pools or individually as a pension fund?
Bedfordshire and Staffordshire pension funds appeared to defy conventional thought when they upped their allocations to sustainable infrastructure earlier this year with a joint investment of £80m into asset manager Gresham House’s Sustainable Infrastructure (BSIF) strategy. UK Chancellor Jeremy Hunt had previously set out a target in July that all LGPS assets should be pooled by March 2025 – and some LGPS funds that have placed illiquid assets outside their pools could find this target challenging to meet.
Bedfordshire, like South Yorkshire, is part of the Border to Coast pool, and manages just under £3bn in assets. Staffordshire is part of the LGPS Central pool and the fund manages £6.8bn, having only recently started to invest in infrastructure.
The £80m investment in the BSIF is intended to help accelerate the deployment of “profitable, real asset-based solutions to key environmental and societal challenges facing the UK”. Gresham House has reported “strong interest” from other local government pension schemes and institutional investors in the strategy.
Bedfordshire Pension Fund is hoping its commitment to the strategy will help it build the East of England’s “reputation as a green leader”. Fund chair Doug McMurdo says: “The scale of infrastructure investment required presents compelling opportunities to help develop the critical assets that will improve lives and deliver lasting local economic and environmental benefits.”
Staffordshire Pension Committee chair Mike Sutherland also notes dual goals of the investment – highlighting the strong potential financial returns and the alignment with the fund’s commitment to sustainable investment.
“We view this allocation as complementary to our core infrastructure exposure and allows us to meet our commitment to place-based impact investment here in the UK,” Sutherland says.
Portfolio Diversification
For Graham at South Yorkshire Pensions Authority, the only reason his fund would make a new investment outside the pool “would be if there wasn’t a product that met the requirements of our strategy”.
South Yorkshire Pensions Authority currently has more than 70% of the fund invested in products provided by Border to Coast “with the clear intention of this rising to 95%”.
“We are committed to the success of our pool and frankly we do not have the resources to undertake the work necessary to select and effectively oversee and manage a large number of individual fund investments, nor are we able to negotiate on private market fees in the way the pool is able to,” Graham adds.
Wandsworth Pension Fund, like Bedfordshire and Staffordshire, recently took the decision to invest independently in climate infrastructure, rather than through its pool London CIV. This was largely motivated by a need for portfolio diversification, according to Paul Guilliotti, assistant director financial services at Richmond and Wandsworth Councils.
Last year the pension fund announced plans to invest up to £80m in two energy transition funds based on non-traditional renewable projects. One of these funds – the Octopus Energy Transition Fund – is investing £70m in ground source heat pump business Kensa Group – as part of efforts to replace polluting gas boilers with eco-friendly heat pumps.
Wandsworth Council has also pledged to reduce its pension fund’s investments in fossil fuel-based industries and switch funds to green energy projects. Guilliotti says the investment “meets the fund’s investment objective and delivers real benefits to society. Our approach is to ensure we have a fully diversified portfolio aimed at achieving net zero by 2050 without impacting on returns or undertaking unnecessary risk.”
On the fund’s wider strategy and decision to go alone, he adds “We are invested heavily in infrastructure in general and have got targeted allocations towards a renewable infrastructure mandate. Our committee members are looking at other ways to potentially enhance that investment. Yet to top up within the pool wouldn’t really have been appropriate because the funds that they have are very much focused on generational assets, whereas we wanted a much broader diversification.”
“If you are already reducing your options by going for renewable infrastructure as opposed to infrastructure in general, you are going to have to find an appropriate mix.”
The Right Strategy
From a pool perspective, Border to Coast is committed to a long-term approach to investing and to achieving net zero across its investment portfolios by 2050 or sooner. The pool’s private markets portfolio includes around £1.4bn of capital that has been committed to investments in climate solutions [as of 31 March 2023].
“As part of our net zero commitment, we are investing in infrastructure and technology solutions on behalf of partner funds to support the transition to a carbon-free economy,” reports Ian Sandiford, head of investments (alternatives). “We estimate that at the end of our latest reporting year, £6.9bn of the equity and fixed income portfolios that are covered under our net zero roadmap were invested in such solutions.”
In terms of private markets, Border to Coast provides partner funds with exposure to climate-focused infrastructure primarily through two of its investment strategies: Infrastructure and the aforementioned Climate Opportunities.
“Our Infrastructure strategy provides exposure via renewable energy specialists and generalist managers with a strong renewable energy vertical. The strategy combines operational and development and construction phase assets, typically in more mature technologies, such as solar, onshore and offshore wind, and grid infrastructure,” explains Sandiford.
“Our £1.35bn Climate Opportunities strategy provides our partner funds with a range of investments which support the energy transition, pathway to net zero and decarbonisation more generally. The strategy invests across private market asset classes, including private equity and credit, natural capital and also climate-focused infrastructure.”
Climate Opportunities is more focused on the delivery of new assets and technologies which support the energy transition and decarbonisation, so has a predominately greenfield focus, Sandiford says.
“The approach is to invest via co-mingled funds, but within Climate Opportunities, these are all specialist strategies. Managers need to demonstrate how their strategy supports decarbonisation and provide reporting of decarbonisation outcomes over the life of the fund,” he adds.
“Climate Opportunities invests across more mature energy transition technologies, but also supports investment in less mature and emerging technologies. As well as wind and solar developments, underlying investments in the portfolio include hydrogen, and carbon capture and storage projects.”
There are many reasons to invest in climate infrastructure via pools rather than go it alone, Sandiford believes. “As a customer-owned, customer-focused organisation, our purpose is to make a difference for the LGPS by using the strength of our collective scale to deliver innovative and cost-effective investment opportunities that enable our partner funds to implement long-term investment strategies. As one of the largest LGPS pools in the UK, we have a stronger voice and, working in partnership, we aim to use that voice to improve value for money, expand access to investment opportunities, and strengthen governance and risk management.
“Pooling has provided the scale and internal resources to deliver a diversified climate strategy, which individual partner funds may have found more challenging to deliver alone.”
Don’t Pick the Betamax
Investment in climate infrastructure among pension funds – whether or not they go alone or through pools – continues to gain momentum.
At South Yorkshire Pensions Authority, Graham says the fund is aiming to invest as far as possible through the products provided by Border to Coast.
“There is a wide range of underlying projects from what might be regarded as conventional wind and solar projects to businesses which transform waste into alternatives to leather, to businesses which use AI to enable process plants to reduce emissions through process automation and businesses which look to employ alternatives to petro-chemicals in everyday household cleaning products,” he says.
“What we are looking to do is support activity which will accelerate the transition by making alternative ways of doing things more widely available.”
Graham expects a “slow evolution” among pools and funds to larger scale co-investment or direct investment, which he says “is a sort of natural progression as the pool of capital to deploy becomes bigger”. Beyond this, he also expects to see the development of a small number of more niche products, like Border to Coast’s Climate Opportunities fund, “which will allow funds to tilt portfolios in particular directions but also continue to allow investment with smaller more niche managers who have always played an important role in the LGPS investment ecosystem”.
There are big opportunities in “being just behind the front edge of the transition wave, in the optimum place for a surfer, if you like” he says, citing the advantages of being an early mover. “Those companies that are early into particular transition fields will harvest returns and be able to take advantage of market growth before others enter the market. Clearly this creates the opportunity for the patient long-term investor, which we are, to capture significant upside,” Graham states.
Border to Coast believes climate-focused infrastructure can offer an attractive opportunity for long-term investors with an ability to accept illiquidity, but “it is not without complexity”. Sandiford says “Operating strategies, energy market dynamics and revenue models need to be considered carefully. Pricing has been challenging in certain markets and technologies in recent years and a broader climate-focused investment strategy allows capital to be allocated to more attractive opportunities.”
Individual investments present different benefits depending on their own characteristics, but climate-focused infrastructure can offer long-term, contracted cash flows with inflation linkage, he reports.
The main challenges lie in finding investments at the right scale and at the right stage of development, Graham thinks. “From a risk point of view we want to be investing in things that we know work and have a market rather than in ideas that need to be developed,” he explains.
“Similarly in a rapidly evolving field like this there is always the risk that the fund manager picks the Betamax rather than the VHS, which is why careful selection and a thought-out and careful approach to portfolio construction are necessary. All of these are issues that can be managed, it just requires thought up front.”
