Cushon Master Trust’s Consideration of Climate Risk

Introduction

The Cushon Master Trust’s (CMT) approach to climate risk integration is driven by three different elements that we think need to be considered to combat the impacts of climate risk. This approach has been developed to:

• Support CMT Trustee climate target setting, in particular within the TCFD report

• Enhance how CMT engages on public policy

• Explain the integration of climate risk mitigation in our investment strategy

• Aim to improve member outcomes via investment returns and via member engagement

CMT believes financial markets have not accurately priced all climate risks. Markets appear to view climate risks as static based on short-term time horizons, whereas the impacts of climate risks are most significant over the medium and long term. Furthermore, the financial models used to calculate the impact of climate risk on asset values (called integrated assessment models [¹] have limitations, as evidenced by the large gap between their output and the output of climate science models.

We believe that when these risks are properly priced by the market, significant gains and losses are likely to manifest. These repricings are expected to take place within our long-term investment horizons of 10-20 years, but CMT notes that there are substantial difficulties in accurately predicting the timing of these repricings. We believe the management of these long-term risks is in our members’ interests. This also reflects the Trustees desire to enhance investment returns, and impact the world that members retire into.

CMT's approach has three dimensions: 

The three dimensions of CMT's approach

Portfolio decarbonisation

Cushon Master Trust Trustees have agreed portfolio decarbonisation targets for the Cushon Sustainable Investment Strategy. Most notably, an 80% reduction in the Scope 1 and 2 emission intensity (carbon footprint) by 2030 compared to a 2022 baseline [²]. This target is supported by a manager by manager, mandate by mandate decarbonisation plan, which demonstrates mandate decarbonisation trajectories that are intended to drive this target, and excludes carbon offsetting. For more detail on each mandates’ climate integration please refer to the Responsible Investment Policy.

CMT notes that any decarbonisation trajectory will be neither linear nor smooth, but as of 2024, CMT has already achieved a 78% reduction. This is reported in more detail within the Trustee’s TCFD report.

These reductions are driven by engagement policies via our managers, by exclusions and portfolio tilts (subject to tracking error limits) and by investment in net carbon negative asset strategies.

Decomposition of Decarbonisation Pathway

With a 75% allocation within the Cushon Sustainable Investment Strategy, the allocation to global listed equities will drive CMT’s portfolio’s decarbonisation. The global equity mandate (where the scheme takes its equity exposure) was designed to have an immediate 60% emissions reduction at inception in 2022, followed by a 7% per annum additional reduction. This is achieved by being substantially underweight in carbon intensive sectors such as Oil and Gas, and subsequently overweight in lower carbon intensive sectors (for scope 1 and 2 emissions) like Technology, Financial Services and Healthcare.

CMT notes that Scope 3 emissions are not captured within the 80% reduction target. Data on Scope 3 emissions is not yet robust and there is significant uncertainty in modelling scope 3 emissions at a company level. CMT intends to include scope 3 emissions in targets as soon as practically feasible, but we currently don’t have access to sufficient robust scope 3 data.

Real-World decarbonisation

CMT notes that portfolio decarbonisation does not necessarily reflect or lead to real-world decarbonisation, whether that portfolio decarbonisation is achieved by disposal or by exclusion. Both can in fact have negative impacts on real world decarbonisation.

For example, the disposal of high-carbon assets does not stop the asset generating emissions, and there is no guarantee that a new owner would work towards decarbonisation. Equally, excluding such investments up front can block an investors’ ability to drive change.

CMT is supportive of real-world decarbonisation because we think a successful transition to a low carbon economy (while this is by no means guaranteed) is in CMT members’ long-term interests.

CMT supports real-world decarbonisation through its managers’ engagement policies, through its allocation of capital to transition leaders in hard to transition sectors and via investment in low carbon energy, Natural Capital and other transition assets.

For instance, the CMT currently allocates to the Lombard Odier TargetNetZero Corporate IG Bond Fund. Lombard Odier has designed a comprehensive company-level, forward-looking emissions model. It has identified and sees an investment opportunity in companies that don’t necessarily have low emissions at present but have a credible decarbonisation trajectory.

Another example of contributing to real-world decarbonisation is the investment into climate solutions. As part of the 15% target allocation to private markets, CMT finances the Bury St Edmund’s Low Carbon Farming project. The thirty acres of greenhouses and ancillary infrastructure are a world first in capturing waste heat from the nearby Fornham water treatment works, and by way of ground source heat pumps, injecting the previously wasted heat into the greenhouses, growing crops sustainably.

Low Carbon Farming Project in Bury St Edmunds

Across the portfolio of investments CMT is involved in numerous renewables projects in addition to the above low carbon farm. Within private markets in particular, the CMT benefits from the opportunities generated by the transition to a lower carbon world. The map below shows all relevant renewable investments: 

Locations of UK renewable assets

Portfolio resilience 

CMT believes that the principal objective of climate risk consideration should be to support the construction of portfolios that are resilient under different climate scenarios. It remains unclear to what extent a transition to a low carbon economy will occur, at what point and with which level of temperature rise. These uncertainties imply the construction of a portfolio that is resilient under different climate scenarios and that can be tilted towards certain outcomes as they become more likely. A portfolio that performs under a successful transition to a low carbon economy with under 2°C of warming will be very different to a portfolio that performs well under a delayed and disorderly transition with 3.5°C of warming. A failed transition presents different challenges again.

CMT believes that portfolio resilience is not the same as either portfolio or real-world decarbonisation. For example, a low carbon factory or property on the Florida coast is just as exposed to hurricane risk as a high carbon one.

Currently, CMT’s investment strategy is more aligned to a successful transition to net zero at around 1.5°C of warming and is more exposed to the risk of a failed transition. To hedge some of the outstanding transition risk the Trustees of CMT have recently approved an allocation to Natural Capital. Natural Capital supports real-world decarbonisation (peatland restoration etc), portfolio decarbonisation (it’s a low carbon asset) and portfolio resilience. The latter is provided by Natural Capital’s positive correlation to increases in the price of carbon because of its capacity to generate carbon credits. This therefore provides a partial hedge against potential losses elsewhere in the portfolio likely to be caused by increases in the price of carbon.

We are now in the process of exploring Natural Capital mandates with different characteristics, such as varying exposures to commercial forestry and engineered solutions like peatland restoration, rewilding, and carbon capture & storage. The longer-term aim is to allocate c.5%+ to natural capital, further expanding our investments into climate solutions.

At the same time CMT notes that continued investment in a successful transition requires policies from governmental and intergovernmental bodies that will deliver that successful transition. CMT notes that the government’s policy framework remains a work in progress, and CMT will engage with policymakers via industry associations as far as it is able to do so.

We have a number of projects underway to improve the resilience of our portfolio under multiple climate scenarios. 

1. We are working with NatWest and the University of Exeter to agree a series of different climate scenarios we will use to test the robustness of our portfolio under those different scenarios.

2. We are working with Transition Risk Exeter (TREX) and the Universities Superannuation Scheme (USS) to better measure our portfolio exposure to both transition risk and the physical risks of climate change:

   • The current standard approach to measuring physical climate risk (Integrated Assessment Models) has limitations due to heavily discounting the impacts of climate change in the future. This project aims to overcome many of these limitations by integrating known climate tipping points and modelling of extreme weather events into risk assessments, and ultimately link this to potential revenue impacts on businesses.

   • On the transition risk side, energy mix and regional carbon tax policies, combined with company emission data, are elements of the modelling. Scenario design can then be used to estimate the associated carbon tax liabilities of companies based on their emissions and other transition risks to which they are exposed.

Our expectation is that these projects will help us to improve the resilience of our strategy to climate risks under different scenarios.

Conclusion

CMT believes that when managed effectively these three elements help us to integrate climate risk and opportunities into investment decision making and thereby aims to improve member outcomes. It is important to do this as climate change is a systemic risk to the global economy and financial markets and it is an issue that cannot be ignored. CMT will continue to evolve its approach and disclose climate-related considerations on an annual basis, we believe this will contribute towards a better climate strategy.

Appendices

Cushon Master Trust is regulated by The Pensions Regulator with PSR number 12008536. Cushon MT Limited is the sponsoring company of Cushon Master Trust and is registered in England and Wales with company number 12366412.

This paper is intended for professional advisors.

The default strategy of the Cushon Master Trust is the Cushon Sustainable Investment Strategy. This invests in funds managed by third parties. This raises the following particular risks:

• The third-party fund manager is responsible for the selection of underlying assets (such as equities, corporate fixed income and sovereign bonds), and therefore the determination of the ESG related characteristics of the overall fund (for example, the carbon intensity of the fund is determined by the underlying assets held within the fund) and thus CMT is reliant on the decisions taken by the third-party fund manager.

• The availability of fund-level ESG related data relies on fund managers disclosing their fund holdings to data providers. This data might lag, causing our ESG reporting to reflect data that is potentially no longer accurate (for example, the carbon intensity of a portfolio might have changed due to a change in underlying fund holdings that is not yet reflected in the data used by third-party data providers).

• We rely on third-party fund managers to accurately disclose their holdings, and on data providers to accurately aggregate equity and fixed income data up to the fund level. Any errors in this can impact CMT’s own reporting to clients.

[¹] Integrated assessment modelling tries to link the main features of society and economy with the biosphere and atmosphere. Studies have found that they typically discount the future impacts of climate change at relatively high rates

[²]This baseline is defined as the weighted average carbon footprint of broad market indices weighted by the Cushon Sustainable Investment Strategy’s growth phase asset allocation.