The Bank of England Pension Fund is, after years of holding almost only low-risk bonds, in the process of overhauling its portfolio to include higher risk assets and in doing so takes into account environmental, social and governance factors. The fund has also appointed a custodian and is set to appoint new managers with the help of its advisers.  

 

The Bank of England, the scheme’s sponsoring employer, is currently in the process of ramping up its activities in relation to climate change risk as COP26 nears. In May, it published a discussion paper on greening its corporate bond purchasing programme, and a month later, it provided a Climate Biennial Exploratory Scenario to explore the financial risks posed by climate change for the largest UK banks and insurers.

 

   

Now its pension fund is starting to address ESG in its portfolio. Having so far held primarily fixed interest and index-linked gilts and some Network Rail linkers, it is planning to broaden its investments, advised by XPS Pensions Group. 

 

The trustees had training on ESG and, consulting the Bank, reviewed the investment strategy. They agreed to start the process of broadening the fund’s portfolio to generate additional financial return and to reflect ESG considerations in their investment decisions, the 2021 annual report states. 

 

 

The planned changes will “increase the prospective return on the Fund’s portfolio, which includes accepting a slightly higher level of risk”, the report states, noting that the trustee will appoint additional investment managers, having already hired Northern Trust as a custodian. For the past 14 years, the pension fund has employed only Legal & General to handle almost its entire assets. 

 

Manager selection will be “one of the main ways in which the updated policy is expressed” the trustees note, adding that “during the reporting year, the investment managers for the Fund’s new investment strategy were recommended by XPS using various criteria. A fundamental requirement – in acknowledgement of the Trustee’s Responsible Investment policy – was that the investment managers needed to incorporate ESG factors within their decision making to a high degree”. 

 

The fund’s recently updated statement of investment principles, apart from the gilts and bonds mentioned in the annual report, also names non-sterling investment grade corporate credit, hard currency emerging market debt and illiquid secure income assets like senior infrastructure debt, senior commercial real estate debt, private corporate debt and amortising long-lease financings among the fund’s preferred investments, but it is not clear if these are the new higher risk assets the scheme will expand into. 

 

 

The scheme saw its funding level increase to 104% in the 2020 valuation, up from 101% three years earlier, and had a report on the central bank's sponsor covenant, potentially leading the trustees to consider taking on slightly more risk.

 

The government’s planned reform of RPI could have been another and potentially powerful consideration in the decision to change the investment mix. The scheme will be impacted by the Treasury’s plan to align the retail price index with the lower consumer price index including owner occupiers’ housing costs from 2030, unless a proposed judicial review by three other pension schemes scuppers it. In 2020 the fund held about 60% of its assets in index-linked gilts and another 31% in corporate index-linked bonds. 

 

The pension fund broadly applies uncapped CPI increases for deferred and pensioner liabilities in the career average section but offers uncapped RPI increases for final salary pensions as well as accruing CARE liabilities. The closed final salary section includes more than 10,000 members, while about 6,000 are in the CARE section. 

 

 

ESG is a topic most pension funds will be grappling with at the moment, due to new requirements for large schemes to produce climate risk disclosures, as well as implementation statements. 

 

Nick Spencer, adviser at sustainability specialists Gordian Advice, said understanding climate change and broader ESG factors is a critical element of fiduciary duty. 

“It is not only for understanding risks but increasingly a differentiator to enhance returns. And whilst one should always be wary of PMs and chancellors offering to spend other people’s money, there are some great investment opportunities that can offer both good returns and support society’s recovery from Covid,” he said. 

 

Others argued that when it comes to ESG risks, the Bank’s pension fund will look to be a leader in climate risk management among UK pension funds. “Whilst the fund is in theory independent of the Bank, any actions it takes will be seen in the context of the Bank’s leading role, often through the [Prudential Regulation Authority], in the regulation of climate financial risks,” said Mike Clark, founder of sustainability consultancy Ario Advisory. 

  

Clark said that it seemed as if the Bank’s proposed greening of the corporate bond purchasing programme were to be reflected in the pension fund’s investments. 

  

“What we are starting to see amongst pension fund leaders is a much sharper focus in the engage/divest debate when it comes to bonds. There is often a strong desire to continue engaging around equity holdings, but there is a greater willingness to reduce bond holdings in fossil fuel companies, especially at longer maturities,” he said. 

  

Mike Clark

Nick Spencer