Future World Multi-Asset Fund: Q&A

Transcription

1 For Investment Professionals Future World Multi-Asset Fund: Q&A The Future World Multi-Asset Fund has been designed for pension investors who wish to go further in integrating environmental, social and corporate governance (ESG) factors into a genuinely diversifed strategy. The fund aims to be straightforward and transparent in its approach, utilising our Corporate Governance team s expertise by investing in Future World index funds that track LGIM-designed ESG indices. 1) What is the fund s objective? The investment objective of the fund is to provide longterm investment growth through exposure to a diversifed range of asset classes (excluding physical property), while refecting signifcant ESG issues into the fund s investment strategy. 2) What is the fund s risk and return profle? The fund targets a more conservative rate of return than that of developed-market equities over the long term, with two thirds the volatility. The fund aims to meet the criteria of the ABI Mixed Investment 40-85% Shares sector, which will be used as a comparator for the fund s performance. We believe the fund can achieve a similar expected return and risk profle to the existing Multi-Asset Fund (MAF). 3) How will the fund achieve its objectives? The fund is constructed with a focus on strategic asset allocation, with the aim of providing access to multiple sources of return that are diversifed across asset classes, economic regions and currency exposures to limit the adverse effects of any specifc risks. 4) Why is the fund appropriate for DC schemes? The fund has been designed as a default option for defned contribution (DC) schemes that wish to fully integrate ESG factors into their long-term investment strategy. We believe it is essential that the fund s expected return and diversifcation are similar to those of the existing MAF, particularly for DC trustees who are considering using the Future World MAF as their default. The fund has the same focus on strategic asset allocation and effcient index investing while at the same time seeking to improve the ESG profle of the underlying investments. We believe that the fortunes of investors with long-term investment horizons, such as DC schemes, are intrinsically linked with the health of the global economy and the societies in which their investee companies operate. The methodology underpinning the Future World index funds is designed to reduce exposure to certain ESG risks, and capture ESG opportunities, thereby investing in companies that we believe are better equipped to deliver sustainable, long-term value in a rapidly changing world. The fund takes advantage of the effciencies of index investing. The vast majority of the portfolio will be invested through index building-blocks. Because these will be PMC funds, they will beneft from tax and cost advantages. These underlying funds are selected based on their ESG credentials where possible and where the risk-and-return profle is maintained. Many of these funds track LGIM-designed ESG indices that tilt towards companies that score well against ESG metrics and away from those that score poorly. This is the primary way in which the ESG objectives are refected into the fund s strategy (for more detail, please see question 11). Finally, for DC schemes, the use of the Future World MAF provides the opportunity for greater engagement with members on how their money is invested and the impact they are making through their pensions. In our view, this creates greater alignment with member values and culture on ESG issues, while maintaining a clear focus on the expected fnancial returns and diversifcation required for a default fund.

2 5) Why is LGIM launching the fund now? The Future World MAF and, indeed, the Future World range is a natural evolution of LGIM s long commitment to ESG issues. We are launching the fund to meet current and future demand for ESG strategies within DC and defned beneft pensions and offer schemes greater choice. This demand comes from a number of sources, including the increased recognition that the consideration of long-term ESG risks and opportunities is part of a scheme s fduciary duty. The successful incorporation of an explicit ESG approach in the fund can, in our view, improve long-term fnancial performance and meet clients growing appetite for investments that better refect their values. FIDUCIARY DUTIES AND BEST PRACTICE GUIDANCE Over the past few years there has been growing guidance and clarifcation from regulators and industry bodies that the consideration of ESG factors is part of the fduciary duty of UK pension trustees and pension schemes. While explicitly considering ESG factors in investment decisions is perhaps not universal for UK pension trustees at present, the industry is heading in this direction. The Pensions Regulator has recently updated its code to nudge schemes towards this approach by emphasising risk management: Most investments in DC schemes are long-term and are therefore exposed to the longer-term fnancial risks, the regulator says. These potentially include risks relating to factors such as climate change, unsustainable business practices, unsound corporate governance etc. These risks could be fnancially signifcant, both over the short and longer term. You should therefore decide how relevant these factors are as part of your investment risk assessment. Similarly, the Pensions and Lifetime Savings Association has emphasised the natural alignment between pension funds interests and responsible investing. Pension funds are long-term investors who want the companies they invest in to fourish on an ongoing basis, and to have a positive impact on the wider economy, the association says. There is a growing recognition that integrating environmental, social and governance considerations into investment and stewardship practices can achieve better returns for investors. VALUES We anticipate that certain schemes, where the corporate or member ethos is more aligned to ESG values, will prefer our investment approach to those that do not incorporate ESG factors. We also expect a benefcial impact on DC member engagement when ESG considerations are included. This is especially the case for millennials: research has shown that 85% of this cohort would like future investments to refect their social and environmental values 1. Crucially, most academic and industry studies suggest that incorporating ESG factors into the investment process does not necessarily result in sacrifcing or detracting from performance returns or diversifcation, which is particularly important in the selection of DC defaults 2. 6) How will the fund differ from the existing MAF? The Future World MAF refers to ESG factors in its objective, whereas the existing MAF does not. The Future World MAF seeks to meet this objective via the use of Future World index funds, which track LGIM-designed ESG indices that tilt towards companies with better ESG scores and away from those with poorer scores. The Future World index funds will be used in the Future World MAF s core equity and credit holdings, and potentially other asset classes over time. In some asset classes, such as developedmarket government bonds, non-future World index funds are used as we believe an ESG approach may not be meaningful. The Future World MAF s asset allocation will be based on that of the existing MAF, but we will make adjustments to refect the ESG characteristics of different asset classes. We will also consider adjusting the allocation for any differences in exposure created by the underlying Future World index funds. These allocation differences are likely to be small to moderate, as we believe tilting at the security level to be an effective way to achieve an improved ESG profle. 1 Bank Of America Merrill Lynch Equity Strategy Focus Point 18th December

3 The existing MAF continues to beneft from LGIM s incorporation of ESG factors across the business. LGIM takes its stewardship responsibilities seriously, devoting signifcant resource and time to engage and infuence through our active ownership approach and the work of the Corporate Governance team. The Future World MAF will further beneft from LGIM s active ownership through the incorporation of the Climate Impact Pledge and the alignment between the design of the Future World index funds and the engagement and voting activity undertaken by the Corporate Governance team. 7) In what structure will the fund be available? The fund will initially be available in a PMC structure, available for UK DC and DB pension clients only. 8) Will the fund become the new default for Mastertrust? The existing MAF is the primary default fund for Mastertrust, a full-service offering that enables employers to outsource the governance and administration of their DC pension schemes. Members will be invested in the fund for the majority of their working lives and will be prompted to consider their options from age 50 onwards. From this point, they may choose to move into one of our lifestyle strategies, which all have a three-year de-risking period. The trustees of Mastertrust, who continually monitor the appropriateness and the suitability of the default solution, are independent of LGIM. 9) What are the Future World funds? The Future World philosophy encapsulates how we view our responsibilities as a large asset manager and a steward of our clients investments, by considering ESG factors. It incorporates how we engage with companies, develop innovative products, evolve our investment process and manage risk to deliver sustainable long-term value. We believe this is the way asset managers should think about their obligations to their stakeholders; sustainable investing should be mainstream within the industry. The Future World funds are for clients who want to express a conviction on ESG themes, depending on their different investment styles. The funds extend our approach to responsible investing across a broad array of asset classes and strategies. 3 Source: LGIM, as at 31 March ) Who will manage the fund? The fund will be managed by the Asset Allocation team, which has over 35 years experience of managing multiasset funds and oversees more than 45 billion in such strategies 3. The lead fund manager will be Bruce White. The day-to-day implementation of the fund will be conducted by the Allocation Strategy Management team, with the Index team managing the index building-blocks. 11) How are ESG considerations refected in the fund? We follow an integration approach within the fund, whereby ESG and investment considerations are evaluated together; as such, ESG is effectively another investment dimension. To aid portfolio construction and the reporting of ESG impacts, we will use a balanced scorecard, which sets out more specifc objectives in terms of the exposure to ESG factors, various investment dimensions and the impact on key metrics (such as the reduction of carbon footprint). We begin with an asset class-by-asset class evaluation of ESG considerations. Where it is feasible for an asset class to be invested via a Future World index fund, and where it can make a material difference, we will use the fund. This is the case for the Future World MAF s core equity and credit holdings, due to the higher percentage of the fund that is allocated to them as well as the risk they represent within the fund. In addition, the availability of data means a comprehensive set of ESG factors can be applied. We will use Future World equity and credit index funds that track LGIM-designed ESG indices in these core markets (for more detail, see questions 12, 13 and 19). We do not believe that ESG considerations are suffciently material to be applied to developed-market government bonds, which account for about 15% of the existing MAF s holdings. At this stage there is insuffcient data coverage to allow the use of ESG indices in in global small-cap equities, listed real estate, infrastructure and private equity. High yield debt has some ESG qualities incorporated through the active management of this asset class. Emerging market debt is an area where there may be a material beneft in applying ESG considerations, and will be subject to further analysis as well as the possible development of a Future World index fund in the future. 3

4 For the asset classes where ESG index strategies are not used, we will invest in the same (or similar) underlying funds as the existing MAF, re-evaluate on an ongoing basis and consider incremental changes to target weights. We will conduct offsetting adjustments elsewhere to preserve the fund s overall risk/return characteristics if necessary. It should be noted that scoring forms only one part of how we integrate ESG factors into our investment processes. In addition: As active owners, we seek to advance our clients interests through encouraging positive change on ESG issues at the companies in which we invest, through engagement with them and collaborative work with other investors and regulators Through our Climate Impact Pledge, we are engaging with some of the world s largest companies to help them be better prepared for a low-carbon future 12) How are the ESG indices constructed? For the LGIM-designed indices, we work with an index provider, Solactive, to construct them based on our methodology, ESG scores and constraints. Solactive also acts as the calculation agent for the indices. The process begins with us determining: Robust data management and governance controls exist around the construction of the indices. The methodology, index construction process and maintenance are the responsibility of the LGIM Index Design Governance Committee. This committee has representatives from the Corporate Governance, Solutions, Index and Asset Allocation teams. 13) How is ESG scoring conducted by LGIM? Following signifcant input from our Corporate Governance team, we have developed a methodology by which to score companies on ESG criteria. The approach is rules-based, transparent and easy to understand. The scores are made up of indicators that are fnancially material, have a clear ESG impact and are of most importance to long-term investors for which quantifable, disclosed and reliable data are available. We use what we believe are the most appropriate metrics for judging these indicators, based on data supplied by the providers we deem to be the most reliable. We analyse each of the ESG indicators in light of the distribution and availability of data. LGIM s engagement and voting policy was the starting point in translating the raw data to a score; by directly linking our active ownership activities with the scoring process, it sends a clear message to companies regarding our expectations on ESG practice. An ESG scoring methodology a rules-based approach that scores companies on data from a number of leading providers The selection of the starting security universes from Solactive; for example, what duration exposure should be targeted and which types of issuers should be included in a corporate bond index An index construction methodology: we use a power tilt approach, where each company s weight is tilted according to its ESG score and initial index weight We then group the indicators together into a number of themes for example, board diversity or human capital and weight them according to our view on their relative importance. This provides a score for each theme. In turn, the themes are grouped together and weighted as four overarching pillars : environmental, social, governance and transparency. We include transparency at this fnal stage because it helps us to determine the quality of company disclosures. The scores for these pillars are then weighted and used to calculate an overall ESG score for the company, ranging from 0 to 100. Constraints are applied to limit the increase of any individual security s weight, and on the maximum and minimum sector differences versus the initial index, to ensure diversifcation is preserved 4

5 14) On what criteria are LGIM s ESG scores based? The criteria underpinning the scores are aimed at identifying companies that can deliver sustainable, long-term value. They are based on the following factors: Environmental the potential negative impact on companies exposed to climate change and the shift to a low-carbon economy; companies with green revenues receive a higher score Social diversity (representation of women in company boards, management and workforce); and human capital (policies to ensure companies do the right thing for workers and communities) Governance a range of criteria that indicate best practice in terms of investor rights, board diversity and high-quality audit Transparency criteria to encourage the publication of comparable and high quality ESG data. The LGIM Index Design Governance Committee is responsible for the scoring methodology. The asset allocation of the fund will be based on the target allocations for the existing MAF, with adjustments to refect the ESG characteristics of asset classes and also to adjust for any differences in exposure created by the Future World index funds. We expect these differences to be small to moderate. The target weights and rebalancing ranges will then be applied to the fund by the LGIM Allocation Strategy Management team. Reporting and attribution of the Future World MAF will also be comparable to the existing MAF, in addition to the components represented in the Balanced Scorecard. 17) Are corporate bonds treated differently to equities? From an active ownership perspective, our engagement with companies is undertaken both as an equity holder and as a bondholder. However, as a bondholder there are no ordinary voting rights. Within the ESG scores, we look at the ultimate issuer, as it is more likely that there will be an industrial parent with fnancial subsidiary than, say, a fnancial parent with industrial subsidiary. 15) Will the scores be published? It is essential that companies understand how they are being incentivised or penalised within the fund. Therefore, LGIM s ESG scores will be published on our website. Our commitment to publicly disclose the scores of individual companies means there is a tangible incentive for companies across the market to respond to engagement and improve their ESG practices, thereby improving the market practice overall. 16) How will asset allocation be conducted within the fund? The Asset Allocation team will establish target weights for the equity and credit index funds, as well as for the other asset classes, with the goal of achieving comparable expected return and risk characteristics to the existing MAF. These targets will be reviewed on at least an annual basis (likely to be quarterly) and there will be no short-term tactical asset allocation. For corporate bond indices we apply constraints on the extent to which the tilts can change the issue weights (a single bond), issuer weights, sector weights, and the weights to a number of maturity bands. 18) What is the regional impact of the ESG tilt? We have constructed the Future World equity index funds, the Future World MAF s building blocks, on a region-byregion basis. This can then be weighted up by market cap to form a Future World All World index, or weighted according to the regional preference of the Future World MAF. The Future World credit index funds are also constructed on a region-by-region basis in sterling, US dollar and euro credit markets. We have constructed the indices on this basis to control for differences in governance and regulation. The regional differences between ESG factors are taken into account in the weights of the Future World MAF. 5

6 19) What index building-block funds will the fund use? LGIM will establish regional equity and credit index PMC funds to track Solactive L&G indices. These index funds may be accessed by external pension clients, and will also be the core building blocks for the Future World MAF. The following funds will provide the core building blocks for the Future World MAF: Equity Index building blocks Future World North America Equity Index Fund Future World Europe ex UK Equity Index Fund Future World UK Equity Index Fund Future World Asia Pacifc ex Japan Equity Index Fund Future World Japan Equity Index Fund Fixed Income Index building blocks Future World GBP Corporate Bond Index Fund Index Solactive L&G ESG North America Index Solactive L&G ESG Europe ex UK Index Solactive L&G ESG UK Index Solactive L&G ESG APAC ex Japan Index Solactive L&G ESG Japan Index Index Solactive L&G ESG GBP Investment Grade Corporate TR Index We expect to launch the Future World USD Corporate Bond Index Fund and EUR Corporate Bond Index Fund in Q ) What is the Climate Impact Pledge and how will it affect the fund? The pledge is our commitment to encouraging and accelerating the transition to a low-carbon economy for the long-term beneft of all companies and their investors. Through our research, we have identifed the largest companies that are critical to the shift to a low-carbon economy and rank them against criteria such as commitment to the low-carbon transition, board composition, strategy and transparency. We then engage with them to improve their scores and help them strive to be the best in their sectors. Companies that consistently fail to meet our minimum expectations may be excluded from the Future World range, including the Future World MAF s underlying Future World equity and credit index funds. Moreover, in the all other LGIM managed funds that remain invested in those companies that have not met our criteria, including the non-future World funds held within the portfolio, we will vote against the board chair until we see satisfactory change. This approach is a powerful tool to drive better company behaviour and raise standards across the market. For more information on the pledge, please visit our website. 21) How does the fund approach divestment/exclusion? Future World funds seek to invest in companies in a way that encourages them to operate more sustainably over time. Companies that take ESG factors into account should provide long-term value in a rapidly changing world, in our view, at the same time as avoiding risks to their business models. In the case of the Future World index funds, we believe that remaining invested in companies that do not score well against ESG metrics, albeit at a lower weight, is useful to keep a seat at the table and continue our engagement efforts. In very limited cases, where the minimum global standards of business best practices are not met, the funds can reduce holdings signifcantly or not hold them at all to avoid being exposed to companies with elevated concerns over sustainability. In the Future World index funds held by Future World MAF, pure coal miners, manufacturers of controversial weapons and perennial offenders of the UN Global Compact (UNGC)* are not included within the investment universe prior to index construction. Together, these three groups of companies form the Future World Protection List, which we use to manage this process in a transparent manner. 6

7 In addition, the fund may divest from companies under our Climate Impact Pledge if they do not meet the required standards after a specifed period of engagement, as detailed above. *The UNGC is an initiative setting out 10 globally accepted principles in areas related to human rights, labour, environment and anti-corruption. 22) Is the fund s approach the same as ethical investing? Ethical investing typically involves the blanket exclusion of whole sectors from a portfolio, traditionally motivated by moral judgements or concerns, such as tobacco, gambling and alcohol. By incorporating ESG factors into investment decisions, as part of our approach, there is less emphasis on moral judgments and divestment. And by drawing on independent data providers, our approach allows us to go beyond the headline focus on bad sectors, to drill down to the company level. Within the fund, we seek to tilt towards companies that excel on ESG metrics, ranging from board diversity to carbon emissions. For example, we can remain invested in fossil fuel companies, but prioritise those that lead their peers whether by owning less carbon-intensive reserves (e.g. more gas than oil or coal), or by diversifying into renewable energy. This approach recognises both that the world will continue to require fossil fuels in the short to medium term, while sending a signal to companies that they need to transition to a sustainable future. This process is consistent with our voting and engagement, which aim to create positive change at the companies in which we invest. 23) What are the fund s costs? For members of the L&G Workplace DC scheme, there will be an OCF of 0.16% (excluding platform fees). For PMC clients, the OCF will be 0.30% for schemes with under 25 million invested in the fund and 0.25% for those with more than 25 million in the fund. The fund has a higher OCF than the existing MAF because of the costs to LGIM of designing the underlying ESG indices, managing the Future World index funds and reporting on them. We believe the Future World MAF s cost is still highly competitive. 24) What are the advantages of LGIM playing a role in index design? By helping to design indices ourselves, we can produce indices based on customers requirements through combinations of sleeves for example, based on ESG factors; underlying themes; or individual metrics. This fexibility means we can offer clients a great deal of choice. The process also enables us to deploy intellectual property we have accrued as a leading provider of index funds for decades in addition to the expertise of the Corporate Governance team, whose ESG principles underpin our current index-design activity. Moreover, our involvement in index design helps us to control costs for clients. 25) What is Solactive? Solactive is a Germany-based index provider that focuses on tailor-made indices across all asset classes, which are developed, calculated and distributed worldwide. It is also active in licensing broad benchmark indices. Over 400 international clients, including major investment banks, exchange traded fund (ETF) providers and asset managers have worked with the company. More than 350 ETFs are linked to its indices and over $100 billion is invested in products linked to indices calculated by Solactive, as at March 2018*. LGIM conducted detailed due diligence on Solactive as part of the LGIM index design project. *As at March

8 Important Information There are no guarantees that objectives will be achieved. This document should not be taken as an invitation to deal in Legal & General investments or any of the stated stock markets. Legal and General Assurance (Pensions Management) Limited ( PMC ) is a life insurance company and carries on the business using a linked policy ( the Policy ), it is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The policy is divided into a number of sections ( the Funds ). Legal & General Investment Management Limited is authorised and regulated by the Financial Conduct Authority, it provides investment and marketing services to PMC. You may not get back the amount you originally invested. The return from your investment is not guaranteed and therefore you may receive a lower or higher return than you anticipated. Past performance is no guarantee of future performance. Our charges may change. Tax rules and the treatment of income and capital gains could change in the future. Infation will over time reduce the value of your investment in real terms. There will be a variation in performance between Funds with similar objectives due to the different assets selected. The degree of investment risk depends on the Funds you choose. In extreme market conditions it may be diffcult to realise assets held for a Fund and it may not be possible to cancel Units at short notice. We may have to delay acting on your instructions to sell or the price at which you cancel the Units may be lower than you anticipated. The value of a Fund s assets may be affected by uncertainties such as international political developments, market sentiment, economic conditions, changes in government policies, restrictions on foreign investment and currency repatriation, currency fuctuations and other developments in the laws and regulations of countries in which investment may be made. Document issued by Legal & General Investment Management, One Coleman Street, London, EC2R 5AA. M1716 8