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Real assets and the net-zero pathway
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The sustainable forces driving change in real assets
The real asset green premium explained
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meet the teams
To be truly sustainable, funds need an active approach
The active ESG dimension
Responsible recovery?
Changing gear following the pandemic
The ESG Observatory
How TwentyFour’s Observatory took on the ESG data challenge
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Our range of responsible solutions, services and fund
ESG overlays and the danger of stifling performance
The sweet spot
Can we get responsible investing right?
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ESG’s tipping point
Why fixed income can be key to pushing for positive change
s pension schemes come under increasing pressure to consider how climate risks and wider sustainability factors affect the financial performance of their
investments, the appeal of real assets as an asset class able to deliver long-term income streams, diversification and enable ESG alignment has increased over the past year.
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By investing in real assets, pension funds are able to support the economy, create jobs and invest directly in assets that support the climate change transition.
“Net zero commitments are set to revolutionise the world of long-dated real assets”
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real assets & esg
For professional clients only, not suitable for retail investors. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Where funds are invested in real estate / infrastructure, investors may not be able to switch or cash in an investment when they want because real estate/infrastructure may not always be readily saleable. If this is the case, we may defer a request to switch or cash in shares or units. Investors should also bear in mind that the valuation of real estate is generally a matter of valuers’ opinion rather than fact. Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. 220904 - 31/08/2022
And with global commitments outlined by the first ‘net zero’ G7 in Cornwall this year, the world of long-dated real assets, which are heavily exposed to climate risks, are set to be reshaped.
The heart of a transition to a green economy
How the real asset 'green premium' is helping institutional investors meet long-term sustainable goals
Past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested.
For professional clients only, not suitable for retail clients. This is a financial promotion and is not investment advice. The views expressed are those of the contributors at the date of publication unless otherwise indicated, which are subject to change, and are not investment advice. Issued in June 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.
he growth of responsible and sustainable investing is changing the shape of the investment industry and could prove critical in
supporting the transition to a lower carbon and more socially just world.
For Professional Clients only
This Spotlight guide explores how pension schemes can exploit real assets’ green premium as they seek long-term sustainable investment solutions capable of delivering returns. With insight from Aviva Investors' Ed Dixon and Mark Meiklejon, we explore the role of real assets in future proofing portfolios, and driving real engagement.
Mark Meiklejon on the Aviva Investors’ Climate Transition Real Assets Fund
How can pension funds use ESG to futureproof portfolios?
But does it need to watch its step?
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The government estimates that the opportunity for investment from the private sector to facilitate this revolution could be three times as large. But this is just the tip of the iceberg, as huge investment will be needed across the world to reach the Paris Agreement goals.
green economy, with a large proportion of the £12bn pledged by the UK government under its ten-point action plan for a green industrial revolution¹ covering areas such as real estate, renewable energy, and transport.
ntil recently, environmental, social and governance (ESG) investing has focused on the equity market. But attention is now turning to real assets. This trend is perhaps unsurprising. Real assets sit at the heart of the transition to a
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“The UK government’s push to decarbonise the economy offers huge opportunities for investors comfortable with looking to new and emerging sectors”
Embracing the green-tinged premium
By investing in real assets, pension funds are able to support the economy, create jobs and invest directly in assets that support the climate change transition – all while honing in on the prospects of long-term investment returns. Taken together, this is known as real assets’ ‘green’ premium, explains Aviva Investors’ Ed Dixon
New areas of opportunities
Due to the long-term nature of these investments, real assets represent an investment opportunity for long-term investors, and therefore pension funds too. At the same time, investing in areas such as green real estate and infrastructure could help pension funds meet their ESG commitments and reduce climate change related risks across portfolios.
Recent legislation in the UK mandates pension trustees evaluate and report on climate risks and opportunities. It is likely that pension schemes with over £5bn in assets will have to report in line with the recommendations from the Task Force on Climate-related Financial Disclosures (TCFD) from October 2021. This is particularly pertinent when it comes to real assets, with the long-term investment commitments easily lasting until 2030 and beyond.
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One of the attractions of real assets, compared with traditional equities or bonds is the fact you are the owner or lender of the investment in question. Ultimately, ESG is usually ingrained in these investments because managers are so much closer to them and incorporating ESG considerations is a fundamental part of an asset manager’s duty to their clients.
For Dixon, his attraction to this sector has been fuelled by a decade-plus long green career. He joined Aviva Investors in 2019 as head of ESG, Real Assets and brought with him a wealth of experience from the private sector. He had held senior sustainability roles at commercial development company Landsec, construction firm Mace and retailer Marks & Spencer. In addition, Dixon is a graduate of the Sustainability Leadership Programme at Harvard.
Sources.
“There's a much bigger impetus in real assets investing to look at how ESG is being integrated with current financial products to ensure that the risks are being mitigated, the impacts are being minimised, and the positive outcomes are being supported,” says Ed Dixon, head of ESG, real assets at Aviva Investors.
The focus on sustainable investors is only set to grow as asset managers and pension schemes come under pressure to focus on ESG metrics when choosing where to investment.
Green premium opportunity
While renewable energy and wind and solar powered projects have proved popular with investors over the past decade or so, a combination of regulatory pressure and growing concerns about long-term issues such as climate change are now driving interest in broader real assets as well. Dixon believes the asset management industry should be ruthlessly focusing on this opportunity, not least because analysis has proved the existence of a ‘green’ premium.
The EU Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021, aims to improve financial industry transparency and consistency on sustainable investments and associated processes, discourage misleading claims about an investment’s sustainability credentials, and encourage the integration of financially material sustainability risks into the investment process. It obliges certain financial market participants to make what can be complex sets of disclosures. It is one of several measures the EU is using to create a common framework for sustainability and to reorient capital flows, with the aim of easing the transition to a more sustainable economy.
(1) United Nations, Report of the World Commission on Environment and Development, Our Common Future, 1987
explore our summary of the forces now shaping the market
“The move to quantify everything could really be dangerous if it ends up removing that human layer of judgment”
Royal London Asset Management is one of the longest-established responsible investors in the industry. So, what does its experienced team think are the most fruitful paths and potential dead-ends in the latest market developments?
who has lived with a teenager knows that fast maturation comes with challenges and a few wrong turns.
he world needs responsible and sustainable investing to mature and grow so that it can drive beneficial change more quickly. But anyone
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For Mike Fox, Head of Sustainable Investments, the overarching positive change in the last few years is that “responsible and sustainable investing has an influence and cultural acceptance it simply never used to have.”
According to Fox, who runs RLAM’s sustainable fund range, “the corporate world now understands the potential financial benefits as well as the social benefits of responsible and sustainable investing – a big shift because if a company believes it might get higher valued equity and cheaper debt from improved sustainability practices then its philosophy is going to move pretty rapidly.”
Words worth
Researching reality
Hamilton Claxton says that a parallel trend is also now clear. “The conversation is moving on from ‘what is the financial ESG risk of my companies or my funds’ to ‘what is their direct impact on sustainability’, in addition to any financial risk implications,” she says. This shift is changing the approach of the Responsible Investment team – who work not just with Fox’s sustainable funds but across RLAM’s investment universe.
“We're thinking more broadly about how we can research, describe and measure the direct impact of large corporations on the world,” she says, “and we’re looking at new information in new ways.”
More broadly, the availability of sustainability data is gradually improving and there is increasing pressure from investors and regulators to use that data to back up claims about sustainability.
“Sustainability analysis is on its way to becoming a lot more numeric versus qualitative,” says Fox, “though it’s a change we don’t always agree with philosophically.” Hamilton Claxton explains: “I'm a sociologist by background so my starting point is that not everything that can be measured matters, and not everything that matters can be measured.”
Fox thinks there is a danger that numbers will take priority over more subtle word-based judgements. “Words are inconvenient because they're unstructured – you can't spreadsheet them and they can mean different things,” he says. “If you're trying to come up with a low-cost, scalable solution, words are a nightmare – you just want a set of data to crunch and create a sustainable portfolio around.”
“But we're buying companies that exist in the real world,” he says, “and to think that you can entirely numericise those companies during the sustainability analysis and attribute no value to the words that provide context to the sustainability numbers is, I think, profoundly wrong.”
Words, however, can themselves be a problem at the point of sale. “We're at this really messy part of the market’s evolution,” says Hamilton Claxton, “where there's lots of ‘funny’ marketing going on – clients are confused, some fund managers are confused – and regulators want to get their arms around that for good reason.”
Social spirit
Stricter regulatory definitions and disclosure rules are now arriving, but the team wonder if these could prove to be a double-edged sword. “The challenge is whether the regulators can really capture all the nuances of sustainability within those narrow regulatory definitions,” says Hamilton Claxton.
“The way we run our sustainable funds is very much in the spirit of the Brundtland report published in 1987,” she explains, “in that it is all about the net benefit to society and taking a holistic view, rather than targeting the deepest green in purely environmental terms. It’s frustrating that the new EU Sustainable Finance Disclosure Regulation (SFDR), for example, uses a definition of sustainability that, to us, seems in many ways green with a bit of social tacked on the side.”
His experience as an in-house sustainability expert has allowed him to see first-hand how the private sector is dealing with the move to sustainable business models, and in many cases is leading the way on largescale goals like decarbonising operations.
Seizing opportunities
Last year saw some of the most ambitious commitments from large companies to date, including a pledge from Apple to reduce the impact of all of its devices to net zero by 2030. The same year, Microsoft and Facebook made pledges of their own to become carbon neutral or even negative (Microsoft) within this timeline. These commitments will filter through to how these companies use their office spaces, their energy use, travel policies and all the way across the value chain.
On the flipside, Dixon says that the UK government’s push to decarbonise the economy also offers “huge opportunities for investors that are comfortable with looking to new and emerging sectors”, which he believes will be “leading the charge” in the years to come.
He also sees a “real value opportunity” from searching for the green premium in real estate. The built environment contributes around 40% of the UK’s total carbon footprint, with the decarbonisation of existing buildings a huge priority on the road to net zero. This creates opportunities to invest in improving water and energy efficiency, waste disposal and enhancing the environmental credentials of existing builds, as well as supporting sustainable construction projects.
ESG data challenge
However, real asset investing is not without its challenges. Assessing the ESG credentials of less liquid assets, such as infrastructure, or unlisted markets such as private equity, can be difficult due to a lack of data.
Dixon says: “I'd like to see more commonality across private markets and real assets in the way that you measure your ESG risks and your impact, both through a transaction in terms of forecasting your impact but also verifying and understanding those transactions over their lifetime.”
This challenge is being addressed, with the development of industry ratings and benchmarks, such as the Global Real Estate Sustainability Benchmark (GRESB) for real estate and infrastructure. GRESB provides standardised sustainability data — on property companies, developers, infrastructure funds and assets — to institutional investors. These standards can provide investors with more certainty that their portfolio of real assets is meeting their sustainability objectives, as well as delivering attractive long-term returns.
This increased transparency will help demand for ESG real assets to grow as we head into 2022, particularly as pension funds are starting to realise the long-term potential of this asset class.
Hydrogen
Electrification of transport
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Estimates of energy-related investment required by 2040
Percentage of total energy related investment total that will relate to real assets such as renewable power distribution networks, transport and buildings
Did you KNOW?
Assets positioned to thrive in the new net-zero world will perform stronger than those that fall behind
Some €28trn of investment is required across the EU to support the green transition
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(1) The ten point plan for a green industrial revolution - GOV.UK (www.gov.uk)
(2) International Energy Agency estimates
(3) Aviva Investors’ 2021 Real Assets House View - Aviva Investors
(4) How the European Union could achieve net-zero emissions at net-zero cost, McKinsey, December 2020
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Ed Dixon Head of ESG, real assets at Aviva Investors
Carbon capture technology
Mark Meiklejon Head of real assets global investment specialists at Aviva Investors
(1) (1) The ten point plan for a green industrial revolution - GOV.UK (www.gov.uk)
The forces driving change
As net-zero commitments are enshrined in law around the globe, Aviva Investors' Ed Dixon believes climate change will be one of the driving forces for the real assets sector as the world is faced with “a truly existential threat for the first time in modern civilisation”. This overarching force is set to shape real asset investing in many ways over the coming decade. We explore this, as well as the post-pandemic implications for real assets, below
(1) Climate Change Committee, “The sixth Carbon Budget, The UK’s path to Net Zero”, 2020.
The first is regulation resulting from global efforts to cut CO₂ emissions and stop the devastating effects of climate change. Whether this means the de-carbonisation of heat, transport, buildings and electricity, Dixon sees these regulatory changes influencing all aspects of real asset investing, creating both risks and opportunities for long-term investors. For example, in the UK, buildings accounted for 17% of emissions in 2019 and the Climate Change Committee recently estimated investment of £2.8bn¹ per year is needed to decarbonise commercial buildings.
Regulatory decarbonisation
The global energy transition
These efforts will also result in a global energy transition, which could see a carbon tax imposed on carbon-intensive industries to drive assets into greener alternatives at a faster pace. Already, more than 110 countries have made a commitment to become carbon neutral by 2050. Institutional investors are also making pledges, with the Aviva Investors’ Real Assets Study finding that 92% of global insurance and pension fund investors are committed to achieving net zero.
Existing and proposed legislation will put the onus on asset owners to account for the sources of climate risk in their portfolios and find ways to mitigate it. The physical and transition risks of climate change will affect real asset holdings, such as energy and fossil fuels. At the same time, a growing number of areas, such as carbon capture and storage technologies, will require financing. Opportunities are also being created across other, less obvious areas of the market, including renewable-only energy suppliers, efficient energy suppliers and buildings, and sustainable transport.
Renewable technology
Meanwhile, technological innovation is driving down the cost of renewable energy, making it a more viable investment option. In fact, according to the Exponential Roadmap report, “by 2030, renewables hold the very real promise of abundant almost-free energy”. On the other hand, carbon-intensive investing is set to be more expensive as carbon pricing schemes are becoming more mainstream.
Shifting portfolios towards investment in renewable energy sources can help pension funds manage transition risk in portfolios while also maximising returns. According to a study by Imperial College London and the International Energy Agency , renewables investments in Germany and France yielded returns of 178.2% over five years, compared with -20.7% for fossil fuel investments. UK green energy investments returned 75.4% versus just 8.8% from fossil fuels over the same timeframe.
Post-pandemic sustainable initiatives
The third key theme in real asset investing will come from the societal changes resulting from the Covid-19 pandemic. This is likely to drive differentiation in performance within the asset class itself.
“Covid-19 has been a short sharp shock that's created a massive impact on society in a really short space of time,” says Dixon. “But the shift to working from home, the shift to more local supply chains, a slight reversal in globalisation, these are trends that were starting to happen anyway and they've just been accelerated.”
Given these changes, investors can expect strong performance from areas such as logistics, data centres and e-commerce, which have benefitted from a shift to digital and online, while investment in sustainable buildings is set to continue growing.
The pandemic also drove an increased focus on the social aspect of ESG, with European pension funds responding to Aviva Investors’ survey naming employment and skills (34%), diversity and inclusion (33%), and human rights (33%) as some of the most important focus points for their investment strategies. In the real assets space, this translates to increased interest in energy efficient real estate and social housing, as well as education and healthcare infrastructure.
In the long-term, Dixon says that being aware of these macro trends, while also “understanding your back book and mitigating downside risks” can create strong portfolio performance for real asset investors with long-term liabilities, such as pension funds.
(2) UN News, The race to zero emissions, and why the world depends on it, 2020
(3) Energy Investing: Global Risk and Return Comparison, 2020
Real assets’ net-zero pathway
Today almost all institutional investors are committed to achieving net zero. But if companies are looking to decarbonise their business over the next 20 years, expect to see radical change. Aviva Investors reveal the impact of the net-zero pathway on real assets
Real assets are directly responsible for a large proportion of the carbon dioxide in the atmosphere. For example, direct emissions from buildings, power and transport account for 60% of all emissions in the UK¹. As a result, the decarbonisation efforts create huge opportunities for investors, from financing new building projects, to investment in green building materials, to allocating to renewable energy grids.
Why are real assets so impacted by the net-zero agenda?
The inevitability of the need to decarbonise throws the question of divestment and legacy assets into sharp focus. According to research², 80% of the world’s coal reserves are ‘unburnable’ under a 2°C warming scenario. Dixon says there is a need to “look at [the] back book” and “to take into account the long-run implications of the cost of carbon”. This is particularly important on the debt side due to legacy investments that cannot necessarily be changed. If investors are to avoid exposure to transition risks, the question of divestment must also be considered.
What are the risks of not divesting?
It’s not only the exposure to coal that is in the spotlight; investments in areas such as gas infrastructure, for example, are also exposed to these risks amid a major switch to renewable energy. Questions will also have to be asked on the real estate equity side, says Dixon.
We chose six engagement themes back in 2019 with the intention of keeping them for at least two years and then reviewing. They are climate change, which everyone across the industry is doing; social and financial inclusion, which is important for us as a mutual and also through some of our exposures to financial services in the bond space; the circular economy, which is new to us as a theme and which will also help us tackle things like biodiversity; corporate governance; diversity; and innovation and technology in society.
Can you tell us about your key engagement themes and how you approach them?
The technology in society theme offers all sorts of tricky issues that Mike Fox, our Head of Sustainable Investments, and I talk about a lot. At what point are technology companies part of the problem and not part of the solution? How might AI algorithms affect people's ability to get insurance or their human rights? Our approach to this theme is not wholly developed but it is something we are committed to tackling.
Which theme is looming larger on your radar now than a year ago?
“If you imagine an infrastructure or long-dated real estate investment, that could be a 20-year commitment,” Dixon explains. “If we say we're going to be net zero by 2040, then this is a timescale in real assets and private market investing that we need to consider right now.”
“There's going to be a real hardening across poor performers that are sitting at the bottom end of the [real estate] portfolio,” he says. “Assets where we don't see a value opportunity to renovate those buildings, to refurbish them and to make them compliant with our net-zero pathway.”
The move to net zero will create new investment opportunities in areas such as carbon capture and storage technologies, renewable energy infrastructure, electric vehicles and financing green projects, to name a few. For example, according to a report by PwC³, around £40bn per year will need to be invested in new low carbon and digital infrastructure over the next decade. Another report from ShareAction found that investing in decarbonising real estate today could save the industry $1bn.
What investment opportunities will the move to net zero create for the real assets sector?
To incentivise the green transition, Aviva Investors is offering financing or direct ownership of carbon removals for its real asset investment clients, such as forestry or carbon credits. It has also committed to invest £2.5bn in low-carbon and renewable energy infrastructure and buildings and deliver £1bn of climate transition-focused loans by 2025. The opportunities for pension funds to participate are vast, and the pressure is on to reach the UK government’s ambitious targets within the next few decades.
(1) Department for Business, Energy & Industrial Strategy provisional UK emissions 2019
(2) Meeting two degree climate target means 80 % of world's coal is "unburnable", study says | Carbon Brief
(3) Unlocking-capital-for-net-zero-PwC-Nov-2020.pdf
(4) Decarbonising-Real-Estate.pdf (shareaction.org)
Aviva Investors’ net-zero real asset commitment
Aviva Investors has committed to support its clients to transition their real asset investments to net-zero emissions by 2040 and to balance any remaining emissions by offering financing or direct ownership of carbon removals, such as forestry or carbon credits.
Since 2015, Aviva Investors has already contributed to a 62% reduction in carbon emissions, having invested £500m a year in low-carbon and renewable energy infrastructure including solar, wind and energy centres.
Its sustainable lending strategy was launched in 2020 through £200m of climate transition-focused debt investments in utilities and real estate.
Its smart buildings programme has delivered over £1.8m in avoided energy costs for occupiers.
Its 2025 commitments include investing £2.5bn in low-carbon and renewable energy infrastructure and buildings; delivering £1bn of climate transition-focused loans; and reducing real estate carbon intensity by 30% and energy intensity by 10%.
This commitment to carbon neutrality – where all carbon emissions produced by human activity are removed from the atmosphere or avoided altogether – will inevitably lead to greater scrutiny of new investments and the way they are structured, says Dixon.
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“There is a huge impetus to invest in real assets, since you get this perfect storm from a scheme point of view because of the low correlation [to other asset classes], higher inflation protection, and higher return potential,” he says. “It’s a key thematic from a client perspective, being able to access a product that can help with both [returns and ESG commitments].”
assets global investment specialists at Aviva Investors, explains that pension schemes are increasingly looking to achieve their return objectives while also meeting explicit ESG targets set by trustees and the regulator.
core focus on income and long-term capital growth coupled with ESG integration underpins the thinking behind the launch of the new Aviva Investors Climate Transition Real Assets Fund. Mark Meiklejon, head of real
“We wanted to launch this fund as this structure, which allows us to provide more liquid access to some of these longer-term, higher value direct assets, and with a sensible level of liquidity”
'DC has been chronically underserved by illiquid capability – this strategy changes that'
Aviva Investors’ Climate Transition Real Assets Fund launch aims to plug a gap in the market for exposure to climate-change focused real assets in a relatively liquid structure – an area pensions schemes have shown great interest in as they try to meet increasingly stringent climate commitments, says Mark Meiklejon
Managed by a team from across Aviva Investors’ Real Assets platform, the new Aviva Investors Climate Transition Real Assets Fund targets a return of net 8% annually over rolling five-year periods, investing in direct real estate, direct pan-European infrastructure assets, and direct timber and forestry assets, with some limited exposure to liquid assets. The fund is aimed primarily at UK defined contribution (DC) pension schemes, alongside wider institutional and advisory wholesale investors across Europe.
Meiklejon explains that the nature of direct real asset investments means the managers have “full control” over ESG integration within the strategy. With listed assets or external third- party funds, part of this control is delegated externally to other management teams. As such, one of the aims of the product is to “connect customers to their own assets more”, while offering a return level that is attractive in the current environment.
In practice, this means the vehicle is daily priced, but traded monthly, with a limited amount of redemptions available in every six-month period. Since redemptions are staggered, Aviva Investors believes it will be able to match inflows and outflows more easily, avoiding the sorts of problems experienced by open-ended property funds in the UK over recent years.
Targeting assets that help accelerate the transition to net zero is a key aim for the fund, which seeks to reach net zero by 2040, while also adhering to explicit social goals and reporting carbon savings year-on-year. The real asset sector holds multiple opportunities for the fund to achieve these targets.
Meiklejon believes the fund’s structure makes it a perfect vehicle for pension schemes. The vehicle is structured as a UK Non-UCITS Retail Scheme (NURS) and will be a Fund of Alternative Funds (FAIF), investing into underlying asset-class specific Luxembourg RAIF vehicles, some liquid assets and forestry. The fund has been seeded with approximately £425m which, combined with the ability to leverage up to 50% of loan to value, will generate approximately £950m of investment capital to deploy.
A liquid structure
“We wanted to launch it as this structure, which allows us to provide more liquid access to some of these longer-term, higher value direct assets, and with a sensible level of liquidity,” says Meiklejon.
My starting point is that not everything that matters can be measured
“In those broker conference calls,” she says, “I told companies that we can now buy algorithms and data sets that are scanning presentations, marketing documents, and news releases relating to your company to tell us what the sentiment is on your company, in real time.”
“With real assets, it’s the built environment, so we can directly contribute to carbon savings in the market by developing infrastructure assets to help that transition,” explains Meiklejon.
A focus on nature
Within infrastructure, this involves developing renewable infrastructure assets, such as solar and wind, but also social infrastructure assets, such as fibre broadband. On the real estate side, however, the approach is more akin to helping brown industries transition to green. This translates into buying inefficient real estate assets from a carbon usage point of view and refurbishing them into much more carbon efficient buildings, for example by using heat pumps and solar panels.
The emphasis of the strategy is, however, multi-faceted, with the fund one of the first of its kind in the industry to offer investors direct investment in nature-based solutions. For example, real asset investments will be supplemented by proactive “afforesting” – planting new forest to generate not just an investment return, but also a direct carbon benefit.
Initially planted within the UK and expanded into Europe later, Meiklejon explains this is a “relatively small part of the portfolio, but the carbon efficiency is very significant”.
The Covid-19 effect
The fund is the fourth launch in the Aviva Investors’ Climate Transition range and comes as Aviva Investors itself announces plans to become a net-zero carbon emissions company by 2040, the most demanding target of any major insurance company in the world.
Having launched the fund in the middle of the pandemic, Aviva Investors is acutely aware of how the crisis has affected real assets sectors. Within real estate, offices and retail spaces are going through a structural change, while sectors like logistics, data centres and power storage have grown exponentially. Within infrastructure, the focus is continually shifting from transport sectors towards renewables and the pandemic has only accelerated this.
However, the timing of the launch has allowed the firm to help clients position for these structural shifts, while also tackling carbon emissions. “The market has evolved so much and so quickly, that it is really fascinating to look at it from a new investment point of view,” says Meiklejon.
“The massive gap for us, and for the industry as a whole, is that the DC market in particular has been chronically underserved by any illiquid capability or product.”
Aviva Investors says its new climate-change focused real assets strategy can directly contribute to carbon savings in the market
the new Aviva Investors Climate Transition Real Assets Fund. Mark Meiklejon, head of real assets global investment specialists at Aviva Investors, explains that pension schemes are increasingly looking to achieve their return objectives while also meeting explicit ESG targets set by trustees and the regulator.
Jonathan Platt Head of Fixed Income
In fact, real assets are at the heart of the three-pronged challenge in transitioning to net zero: decarbonising the heating and cooling of buildings, transportation, and power. As such, pension funds must be aware of the climate change risks their real asset portfolios are exposed to and have concrete strategies in place to mitigate these.
require sweeping changes to various areas of the market, encompassing buildings, transport, and infrastructure – all components of the wide and varied real assets investment area.
o far this year, a third of the UK’s largest companies¹ have signed up to the United Nations’ Race to Zero campaign. The UK government recently committed to cut emissions by 78% by 2035². These commitments will
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“Once an investment is made, a constant process of engagement and improvement is necessary to ensure assets meet rigorous criteria”
ESG integration has become a must-have for a growing number of investors and a crucial ingredient to futureproof portfolios. Yet the key is not just choosing investments but staying invested and – most importantly – staying engaged
Aviva Investors' Ed Dixon says that ESG considerations in real estate also include wellbeing factors, such as “how cheap that building is going to be to operate compared to another building down the road, the quality of the build, and whether it's going to be affordable to maintain over its lifetime”.
Meanwhile, bringing a real estate portfolio in line with net-zero targets will have profound implications on the investment market itself, according to Dixon. It will mean investors are more focused, only buying assets where there is full confidence they can be decarbonised in time, as well as refurbished and redeveloped. Or, alternatively, disposing of everything else in your portfolio that isn’t managed in line with the pathway to net zero.
He gives an example of a transaction Aviva Investors conducted with a listed REIT, which involved three key performance indicators (KPIs) to incentivise the company to deliver on ESG targets by promising a cheaper cost of debt in return. He explains that “if they deliver all of those things after year one there's an opportunity to agree another set of KPIs which can become more aspirational and increase the ambition on both sides. Again, they would benefit from a cheaper interest rate.”
In the private debt market, Aviva Investors positions itself as a responsible lender and launched a Sustainable Transition Loans Framework last November which includes a commitment to originate £1bn in sustainable transition real estate debt by 2025. One of the ways to do this is by providing loans with a covenant forcing the borrower to commit to ambitious targets and report on their progress over the lifetime of the loan.
For asset managers, the key in ensuring such long-term investments stand the test of time in a portfolio for pension investors isn’t just about ‘choosing’ the right asset to invest in. In fact, as sustainability increasingly becomes the centre of the investment agenda, more work is being done after an investment has been made in terms of ongoing engagement and campaigning for change.
Driving engagement
For example, once the investment is made, a constant process of engagement and improvement is necessary to ensure the assets continue to meet rigorous criteria. In real assets, this is particularly important since assets and liabilities tend to be long-term – sometimes as long as 50-60-years.
Data doubts
She welcomes some aspects of the drive to quantify – clients like it and she can use data to try to prove to them that RLAM is doing what it says it is doing. “But it cannot be the end goal because data can be biased, incomplete or simply wrong. The move to quantify everything could really be dangerous if it ends up removing that human layer of judgment,” she says. “And how do you begin measuring a company's lobbying activities, especially if those activities go against what it says in public that it is doing?,” she asks.
Downside protection
For long-term investors such as pension funds, this creates an opportunity to marry their long-term liabilities with their sustainability goals, particularly given the rigorous reporting requirements on climate risks coming into force in the UK³. The engagement approach can help pension funds mitigate future ESG risks resulting from climate change, public controversies, and regulation.
Dixon says there is a “huge amount of forthcoming regulation” in the real estate market which “is causing poorer quality assets to be less attractive and perhaps even illegal in some cases to rent thanks to EPCs and the MEES legislation”.
Dixon explains that engagement is a key element of the transaction process. From his point of view, engagement is about delivering ongoing benefit, not just a short-term positive impact, and this means “really baking it into the very fabric of the transaction”.
Finding these quality assets, whether in real estate or real assets more generally, requires a rigorous process of embedding various ESG considerations across the investment strategy to identify the long-term winners and losers in each sector.
But, according to Dixon, the idea of using ESG to drive better quality investments and ‘futureproof’ portfolios is only increasing, and long-term pension fund schemes are beginning to realise this. Key trends such as the climate change transition, which is transforming the way some industries grow, means pension funds are keen to not miss out on a largescale economic shift and investment opportunity.
“We need to be protecting ourselves against downside risk, looking at those poor-performing assets from a financial and a non-financial perspective, and exiting from those to maintain performance for our clients,” he says.
An approach that combines divestment from legacy assets that can create a drag on performance, while simultaneously positioning the portfolio to take advantage of future trends, such as the move to renewable energy sources or electrification of vehicles, can ensure strong reliable returns and downside protection for long-term asset holders.
Decarbonising buildings
Transportation
Power
Three net zero challenges
Percentage of global institutional investors expected to increase ESG real-asset investments over the next five years
The percentage that had increased their focus in the previous five years
(3) UK government presents pension fund climate risk governance, reporting regs | News | IPE
(2) UK enshrines new target in law to slash emissions by 78% by 2035 - GOV.UK (www.gov.uk)
(1) Third of UK's biggest companies commit to net zero - GOV.UK (www.gov.uk)
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