Climate-friendly investments by defined contribution (DC) pension schemes in the UK have grown by 23% since 2021, as per analysis from consultancy Barnett Waddingham.
However, the ‘at retirement’ phase remains a concern due to a lack of sustainability progress driven by a fixed income blind spot. The analysis reviewed the asset allocation and sustainability ambitions of 22 default DC pension strategies.
As of December 31, 2023, 86% of leading DC pension schemes have set targets to reach Net Zero by 2050, with 18% of these targeting 2040. According to Barnett Waddingham’s annual research, 15 investment solutions offered by these schemes aim for Net Zero by 2050, four by 2040, while three have no current Net Zero targets.
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About 81% of the schemes with net zero targets have committed to achieving interim goals, often aiming for a 50% emissions reduction by 2030. Interim targets can significantly impact net emissions, offering more substantial reductions over time compared to schemes without these milestones. For instance, a scheme targeting Net Zero by 2050 with interim 2030 targets could achieve a 30% net reduction over the next 26 years, compared to a scheme aiming for 2040 with no interim targets.
Most providers use index-tracking funds to incorporate sustainability, which Barnett Waddingham analysed as appropriate for managing climate transition risks. However, the research highlighted more innovative strategies, such as investing in green bonds, impact equities linked to the Sustainable Development Goals, and opportunities addressing both societal and environmental needs through renewable infrastructure, real estate, private equity and natural capital.
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As members approach retirement and shift to lower-risk investments, many schemes have yet to implement sustainability strategies for fixed income markets. Currently, only 20% of fixed income assets have built-in emissions targets, excluding government bonds. This is worrying as bonds are a significant source of climate risk, with corporate bonds alone contributing up to 50% of fossil fuel financing.
According to the researchers, by neglecting bond investments, DC pension schemes could expose themselves to potential legal risks. With fixed income markets evolving significantly, schemes should expand their sustainability efforts beyond equities to ensure better outcomes for members.
According to Sonia Kataora, partner and head of DC investment, Barnett Waddingham, to advance, three actions are needed. First, providers must enhance transparency and offer detailed sustainability reports. Second, they must clearly define which sustainability risks and opportunities they manage across their portfolios, including equities and other assets. Third, stewardship must align with voting and engagement to maximize benefits. Only with clear articulation and transparency can members understand how sustainability affects their savings, she added.
