Sustainability and innovation are often linked, according to Canadian pension fund OPTrust. We spoke to Alison Loat to discover how this influences the fund’s investment decisions.
Historically, the conversation around sustainable investing has focused predominantly on the negative. How do we avoid disaster, whether it is reputational, humanitarian or ecological?
But increasingly institutional investors are talking about the opportunities the move towards a more sustainable and fair future will present.
The energy transition towards renewables is a clear example of this as it will require vast investment in new infrastructure.
But also themes such as toxicity and plastic waste are increasingly addressed through innovation, whether it is through new techniques to recycle discarded plastics or the development of cleaner materials.
Canadian pension plan OPTrust decided to make this link between sustainability and innovation explicit by creating the role of Managing Director of Sustainable Investing and Innovation.
The C$23 billion fund appointed Alison Loat to the role in 2019 and tasked her with “building on OPTrust’s existing responsible investing (RI) foundation, renewing the organisation’s climate change strategy, and building an investing program to allocate capital to opportunities at the intersection of sustainability and innovation”.
We recognise that there are a number of sustainability themes that impact our ability to fulfil our pension promise to members, including the future of work and longevity, but we ultimately chose to start with climate change
To narrow down this brief into investable themes, Loat decided it was best to start with one key issue, rather than address all of the world’s problems at once.
“We recognise that there are a number of sustainability themes that impact our ability to fulfil our pension promise to members, including the future of work and longevity, but we ultimately chose to start with climate change,” she says in an interview with [i3] Insights.
“Climate change is unquestionably important and COVID obviously has accelerated the attention there, but we also felt it was an area where there would be enough maturity and investment opportunities for a liability-driven, pension plan style of investing.”
But first she needed to figure out what investment opportunities were already covered by the fund’s broader investment team.
“We wanted to make sure we were investing in areas that were complementary and not duplicative to things that were happening elsewhere,” she says.
“For example, we have an infrastructure team that’s been investing in renewables for many years, 14 to be exact, so that’s not a logical area for us to spend time on.
“We also invest out of something called our incubation portfolio, which was built by our CIO, James Davis, as a way for teams to pursue opportunities that might not fit into their traditional asset class.
“Here we were free to look everywhere and so we spent a fair amount of time thinking that through. We have been focusing largely on the private equity space, focusing on growth or later-stage ventures, depending on the sector. Pre-buyout is really where we’ve found the most interesting things thus far.”
Loat and her team have cast the net wide and have researched funds in the agriculture and forestry sectors, and funds that include companies that offer nature-based credits, but have also researched innovative business models.
“We’ve been looking at circular business models that really are trying to undo the kind of disposable culture that we have and the waste associated with that. We’ve spent some time looking at plant-based businesses and we’re obviously looking a little bit in the energy space, while being mindful of our colleagues’ work there as well,” she says.
Loat prefers to work with fund managers that don’t have a large book of institutional clients.
“We have been focused on finding a fund which has enough of a track record that it’s going to give us comfort given the maturity of our plan, but also where we will be among the first institutional investors in their LP (limited partner) base,” she says.
“For us, as a mid-sized fund, that’s really important because it gives us an opportunity to get more information and be part of their growth going forward. We’re trying to find partners that can grow with us.”
How to do ESG in private equity is less clear for a number of reasons, but interestingly it's an area where, because of the ownership structure, the governance can be much more aligned
But while environmental, social and governance (ESG) integration has been honed to a fine art in the public equity space, it is less straightforward in the private equity sector.
“How to do ESG in private equity is less clear for a number of reasons, but interestingly it’s an area where, because of the ownership structure, the governance can be much more aligned,” Loat says.
“I think there’s a really exciting opportunity for private equity to leapfrog some of the efforts underway in public equity.”
In addition to her own investment program, Loat’s team is also building on OPTrust’s broader RI program.
In 2020, the team developed a cross-portfolio approach to strengthen responsible investing integration in externally managed investments. The Responsible Investing Partner Evaluation – or RIPE – framework, which will be used to identify relative strengths and weaknesses across the portfolio, scores prospective investments across four core areas: RI policies and governance, RI integration, active ownership and stewardship, and RI reporting.
“We designed a kind of sample policy that our portfolio managers can use to talk about ESG with our external partners to better outline our commitment to responsible investing,” Loat says.
“For our investors, it’s a tool to help us see around the corner and see what is coming to identify areas where there may be gaps or weaknesses.”
Additionally, to support greater structure in the fund’s approach to ESG for all of its directly held private equity and infrastructure assets, the team developed a new ESG policy that the investment team can use to interact with companies.
Loat gives an example where the team worked with one of its infrastructure portfolio companies and investment partners to shape the ESG policy and identify what the main projects are, whether it is environmental stewardship or diversity and inclusion.
They then try to elevate these issues on the priority list of management.
“A lot of those tools that public equity investors have honed and developed are starting to trickle into private equity,” Loat says.
Diversity and Ethnicity
Last year was not just the year of the coronavirus pandemic, but also the year where people gained more understanding of the implications of systemic racism. The Black Lives Matter movement brought the widespread inequality to the fore in an unpreceded way and made it into a global movement.
OPTrust responded to this by reviewing its policies and practices through a diversity lens, including refreshing its proxy voting guidelines to emphasise their commitment to diversity and inclusion.
“COVID has really accelerated our understanding of the inequities in society. And I think in a large part because of whose pensions we manage, the public sector and charitable sector workers in Ontario, OPTrust has always been very attuned to diversity and inclusion,” Loat says.
“We actually already had quite a bit in our policies around diversity, but a lot of that was focused on gender. That’s the area where we had expressed targets of 30 per cent [female representation on boards]. We’ve been a member of the 30% Club for a long time.”
COVID has really accelerated our understanding of the inequities in society. And I think in a large part because of whose pensions we manage, the public sector and charitable sector workers in Ontario, OPTrust has always been very attuned to diversity and inclusion
The fund asked itself the question whether it should extend its policy on gender to ethnicity and introduce targets for ethnic diversity in companies, but ultimately decided not to go down this route.
“We asked: ‘Should we be more explicit about other backgrounds and diversity?’ We opted not to be explicit about what that means because we are a global investor and what’s diverse in Canada and Australia may or may not be considered diverse in Japan, Europe or Africa,” Loat says.
“It is one of those areas where I believe being too prescriptive is probably not appropriate.
“We do vote against directors if their nominating committees are not putting forward women or don’t have plans on diversity and how they’re going to improve. And there is an active discussion about whether people should be more intentional around ethnic and racial diversity, but we felt that it was a little early.
“Governance takes time to evolve and so we felt that was probably a little bit too aggressive, but that’s something we certainly are monitoring.”
Net Zero Carbon
It has been a busy year for Loat and her team. Last month, the Canadian pension plan released its “2020 Responsible Investing Report”, which shows just how much effort the fund puts into its sustainability program.
Apart from developing a sample ESG policy and reviewing its guidelines on diversity and inclusion in proxy voting, last year’s list of initiatives also included updating its Statement of Responsible Investing Principles and conducting carbon risk assessments, measuring the carbon footprint of its public equity, fixed income, private equity and infrastructure portfolios.
This last issue is an important step in addressing the level of carbon emission in the portfolio. OPTrust hasn’t set targets for carbon reduction yet, but is currently collecting the data for establishing a starting point.
“We are in the midst of renewing our climate change strategy now. We have not yet set targets, but obviously that is on the agenda and, quite frankly, one has to have the baseline data in place before you can meaningfully set emission reduction targets,” Loat says.
“There is a lot of conversation around reducing emissions and eventually moving towards net zero, but you can only do that, of course, if you understand what your emissions are today, across your portfolio.
“This is an extremely complicated thing [to do], in part because you have the emissions that you yourself produce, as well as the emissions in your supply chain, and they’re not all counted in the same way.
“In private assets often that information isn’t collected at all, while the issue in other sectors is that emissions are hard to abate, so that’s things like cement or steel. This is especially relevant to emerging market assets, namely China.
“So we’ve hired an organisation to help us do that [collect the data] and this is an art as much as a science still, and obviously there’s a lot of pressure to improve the data and improve the techniques.
“Some of our peers have actually said that they will not be declaring any targets because they think the world is going to move to net zero before 2050 and declaring targets might actually be distortionary [to this process].
“[But] we are working to refine the way that these numbers get calculated and, more importantly, understand how we want to start managing them and bringing them down over time.”
For a guide on ESG issues in Australia and New Zealand, please see here.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.