Now:Pensions’ Keith Guthrie on ditching third party managers and new stewardship strategies

UK defined contribution fund Now:Pensions has undergone a significant overhaul of its investment strategy, including breaking ties with most of its existing managers in a bid to meet its net zero targets as Net Zero Investor can reveal.

Now:Pensions, which manages some £4bn in assets on behalf of 2 million members stands out in the UK’s DC market because offers its members access to one key investment strategy, the Diversified Growth Fund, which subsequently evolves into the Retirement Countdown fund as members age.

The fund, which is part of Cardano has set a net zero by 2050 target which includes halving its emission by 2030 from a 2019 baseline. Net Zero Investor caught up with the fund’s head of sustainability Keith Guthrie who joined in November 2023 to find out why this involved parting ways with some managers, why he is wary of proxy voting and how the fund plans to invest now.

While Guthrie opted not to disclose the names of the managers in question, according to Now:Pension's 2023 Implementation Statement, the fund was invested with BlackRock and Legal and General Investment Management. 

Many DC master trusts offer their members an ethical fund, but you don’t have that option. Is the thinking behind it that all your assets are managed in an ethical way?

Yes, exactly, the trustees have very strong sustainability beliefs and those are embedded into the whole offering. The objective is to make all parts of the portfolio as ESG focused as possible. We don’t really believe that there is a separation between thinking about investing and sustainability.

The implication of that being that a sustainable investment is also a better investment?

Yes. We believe that you need to focus on risk-reward and real-world impact. In most cases, they reinforce each other. I am not saying that every single sustainable investment offers a great return and that every single investment that offers a great financial return is going to be sustainable. There are a few areas that we do exclude on real-world impact concerns. We are not investing in sustainable investments that offer below market rate return because we have a return objective that would deliver good member outcomes, it is not a philanthropic exercise.

There are investments that have too negative a real-world impact that we will not invest in them regardless of how attractive the financial returns are. But we believe there’s enough opportunity where the two overlap.

You have a net zero by 2050 target in place, including halving your carbon emissions by 2030, how are you going to achieve that?

It is very important to emphasise that the objective of the trustee is focused on real world decarbonisation, the objective is not to decarbonise the portfolio and to forget what is happening in the real world. What we really want to focus on are companies that are adapting to a lower carbon world.

They might have a negative carbon footprint today, but they can transition, and they have put a plan in place to transition. For example, one of the TCFD objectives is to outline the percentage of the portfolio that has a Science Based Targets initiative (SBTi) target. That shows us that there is a credible plan in place for the portfolio to transition to net zero by 2050. 

Can you give examples of companies that are not moving fast enough?

Cardano’s view is that the likes of BP and Shell are too slow in their pace of transition and having previously engaged with these companies, they are now excluded from the portfolio.

There are others, for example OMV that is more credible in its transition plans. We will continue to engage with these companies.

How does your stewardship approach work in practice?

The trustees have been concerned about whether the portfolio is closely enough aligned with their sustainability priorities. Is there enough consistency between the way third party managers are voting, engaging with the business and the portfolio? Having consistency across all these areas is quite important.

When Cardano allocated to third party managers, each manager had a slightly different approach to engagement. For example, how they engaged with and voted on companies with the fossil fuel exposure.

A big part of our focus was on how the managers do stewardship and engagement. How were they engaging with those businesses? Which oil and gas companies are moving with enough vigour and with the necessary momentum to support the transition to net zero?

For example, if you engage with the business and it is not decarbonising, are you then voting against the directors? If they fail to act, do you have some sort of portfolio consequence in place? Are you comfortable with the financial risks you are now exposed to? How quickly do you decide to no longer be invested because the financial risks are no longer acceptable, or when do you decide to continue to own a stock?

This is why we decided last year to bring the portfolio inhouse so that Cardano can ensure consistency between the engagement, voting and portfolio decisions. In the new equity strategy, we exclude exposure to thermal coal.

We don’t have a blanket exclusion on other fossil fuel companies because we recognise they are still needed during the transition but Cardano do end up excluding many of these because after years of engagement it is Cardano’s view that they are not sufficiently committed to the transition.

This means you have ceased to invest with some managers because their stewardship approach was not aligned with yours?

NOW:Pensions has recently decided that it will be transferring assets from its current passive third-party equity investment managers, bringing the portfolios under the direct management of Cardano.

This decision has been driven by two core motivations, namely enabling us to better meet our members’ needs as well as have a greater impact on our stewardship principles through our direct investments.

Interesting, can you name the managers you are no longer working with for the time being?

We can’t disclose the names of these managers. 

What is the scale of assets that are impacted by the shift from third-party managers to Cardano’s in-house team?

Previously around 30% [£1.2bn] of the portfolio was allocated to third-party equity managers. In addition to moving this inhouse to Cardano, we have increased the total exposure to physical equities to around 65% of assets. This much larger allocation allows us to have greater influence when engaging with companies.

You mentioned that there had been inconsistency between managers and the fund on stewardship. Could this not have been addressed through split voting?

I am very much against split voting, this could become a race to the bottom, to the lowest common denominator.

Asset managers will offer this as a service to their clients and some clients will take this, but the asset manager is then unlikely to engage with those companies about really changing. If the asset manager says to the company “some of our clients want you to change and some don’t” that sends a seriously confusing message. All that is going to happen is that they will get a few votes against them.

I am quite worried that this is being presented in the industry as a really positive choice for investors, but it is disassociating the voting from the company engagement and the actual portfolio.

Instead, it is important that trustees are selecting their asset manager based on the basis of the manager’s stewardship and the consistency with voting, as they will be acting on trustees’ behalf. If you want a good voting policy, you should be selecting a manager whose stewardship goes along with that.

So split voting is essentially a way for asset managers to abrogate themselves from their responsibilities?

Exactly, that is a 100% right.

The NOW:Pensions trustees work together with Sustainalytics to implement an additional layer of stewardship on the portfolio. Sustainalytics have a division which focusses on engagement with companies, so in addition to the asset managers doing that engagement, we have also been doing that engagement. But while we can engage with the businesses, the third party asset managers were still doing the voting and giving their own engagement messages to companies, so the choice of asset managers was crucial. In the new approach of Cardano directly managing the investments this problem goes away.

What other changes have been made to the strategy?

We have further improved the sustainability characteristics of the portfolio. This includes the core allocation to the new inhouse enhanced index equity strategy that focuses on investing in companies that are adapting or contributing to the transition to a more sustainable society, including objectives to target net zero carbon, net zero deforestation and water neutrality and more exclusions of harmful activities.

This is complimented by an approach to stewardship, voting and engagement with the companies in the portfolio in-line with the trustee priority themes that will then feed back into the portfolio construction depending on the outcomes of the engagements. Exposure to green and sustainable bonds has been maintained.

As part of these changes, we have also integrated new asset classes into the portfolio, such as high yield bonds and, in the future, we are intending to invest in private markets. It is likely that in future third-party managers may still be used in these other parts of the portfolio. An important aspect of third-party manager selection will continue to be the manager’s approach to stewardship and engagement.

Do the changes to the investment strategy affect Cardano Group as an entirety or just NOW:Pensions?

The change in investment strategy is specific to NOW:Pensions. Cardano work with a broad range of clients who have different investment strategies. The investment philosophy applied to Cardano’s other clients is the same, for example a similar approach to direct equity investment has been deployed for Cardano’s UK Defined Benefit fiduciary clients though the NOW strategy is tailored for the NOW trustees.

We have a well-established and long-standing relationship with Cardano, the investment manager for NOW:Pensions and with the support of the trustees, we have worked closely with Cardano in recent months to review NOW:Pensions’ investment strategy, part of which focused on increasing our commitments around the number of sustainable holdings within the portfolio.

The benefit to working together in this way ensures that engagement, voting, escalation and portfolio activity are aligned. This allows NOW:Pensions to directly address issues that are important to the trustee, namely the three priority sustainability strategies; living wage, gender equality and climate change, as well as focusing on the long-term investment goals of the portfolio and driving good member outcomes.

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