We believe strongly that environmental, social and governance (ESG) issues can affect the financial performance of the companies in which the fund invests. As a signatory to the Principles for Responsible Investment (PRI), Lothian Pension Fund commits to integrating ESG considerations into investment analysis and decision-making processes (Principle 1). Our approach is set out in our Statement of Responsible Investment Principles and aligned with our fiduciary duty to members and employers.

We assess investments with a view to meeting a required level of financial return in the context of achieving an appropriate level of diversification and risk management. ESG issues are considered as part of that assessment. ESG considerations form an important element of investment risk and opportunity, and there is evidence that the shares of companies with improving ESG ratings can outperform those that are simply highly rated (“Can ESG Add Alpha”, MSCI ESG Research, Nagy, Kassam & Lee - June 2015). As such, engaging with companies to improve ESG practices can lead to better long-term outcomes for the fund.

The fund’s internal equity portfolios are actively managed using both fundamental and quantitative investment processes. ESG issues are formally assessed as part of the due diligence process before shares are purchased, supported by research from a specialist third party service (currently MSCI ESG Research), which provides ESG specific data, analysis and research to help identify the risks and opportunities that companies face. This ensures that consideration of ESG issues can be applied to the investment process using data that has been collated in a consistent manner. For our internal sovereign bond portfolios our investment managers analyse ESG reports and respond to government and market consultations, either directly or with our collaborative partners.

During the selection process of the fund’s internal property investments, we assess the environmental efficiency and sustainability credentials of properties. In conjunction with the appointed property managing agent, we ensure that ESG opportunities and risks are considered at every stage of the ownership cycle. ESG performance, particularly Minimum Energy Efficiency Standards, are incorporated into portfolio strategy through asset management plans for owned assets and all new investment acquisition appraisals.

We believe that investing responsibly requires the exercise of voting rights and should also involve active engagement with investee companies. Consequently, we have a policy of engagement with companies rather than a policy of exclusion or divestment. We consider divesting from or excluding entire sectors as inappropriate as the transition to a low carbon economy will affect some sectors more than others, and within sectors there are likely to be winners and losers. We also engage with governments and regulators to address system- or sector-wide issues.

We contract with an external voting and engagement provider to undertake much of our voting and engagement activities. We generally support our provider’s voting recommendations, but our internal equity team scrutinise their recommendations and do, infrequently, vote in a different way. We work closely with our provider in our collective approach to engagement, reflecting the areas of stakeholder interest and concern. Through working collaboratively we're able to have a stronger voice when engaging with our investee companies. We are also an active member of the Local Authority Pension Fund Forum, which engages with companies on behalf of the majority of Local Government Pension Schemes across the UK.

The fund’s external managers are also selected and appointed after due consideration of their approach to incorporating ESG considerations into their investment analysis and decision-making processes. We monitor the managers’ implementation of their approach on a quarterly basis alongside all other investment matters and review the PRI transparency reports of external managers and their product-level TCFD reports, where available.  Our ambition is to appoint managers who will not subscribe to new financing for companies or projects assessed as having a business plan that is incompatible with the aims of the Paris Agreement. We also invest in climate solutions, most visibly through allocations to renewable energy and environmental services projects in our infrastructure portfolio.

Lothian Pension Fund has a long history of taking ESG issues seriously and it will continue to do so. We regularly report on our voting and engagement activities, and these reports can be found in the responsible investment section of our website. We also publish our Engage Ezine which provides insight into our approach to ESG and responsible investment activities.