The Barclays Bank UK Retirement Fund: Integrating ESG factors into a DC Default Diversified Growth fund

In January 2021, the Barclays Bank UK Retirement Fund (UKRF) announced the integration of ESG factors and climate risk into its £1.3bn Diversified Growth Fund (DGF). The DGF, managed by BlackRock’s Factor Based Strategies Group, is the main building block within the default option of the UKRF defined contribution (DC) scheme and is also available as a self-select investment option. Its integration of ESG factors and climate risk aims to reflect the trustee’s responsible investment (RI) policy and introduces explicit focus on and application of ESG factors into investment decisions to try to better manage risks, including climate change, and generate sustainable, long-term returns for members.

What are the changes and what do they mean in practice?

The DGF is a diversified multi-asset fund with wide-ranging underlying investments. The overall expected return and risk targets for the fund remain broadly unchanged, along with other key investment restrictions and guidelines under which it operates on a day-to-day basis. The focus of the investment process and portfolio construction on top-down macro risk factors (economic growth, inflation, real rates, credit, emerging markets and liquidity) is also preserved.

What changes is the bottom-up selection of the underlying investment assets, where ESG characteristics now sit alongside other investment criteria, such as market capitalisation, country, sector and currency, that are used when making decisions within the DGF portfolio. The DGF manager, BlackRock, will screen investments to identify material ESG risks, as well as future growth opportunities, and position portfolios accordingly. For example, screening will reduce exposure to companies with high carbon emissions, excessive executive pay or limited diversity and inclusion, while increasing investments in assets that conserve natural resources and businesses that integrate with communities in which they operate. BlackRock will also continue to vote and proactively engage with the entities and markets in which it invests on behalf of the trustee on a range of issues including transparency on ESG risks, climate change and the transition to a lower-carbon economy.

Why this approach?

There is compelling evidence that sustainable business practices lead to better investment decisions, mitigate risks and, ultimately, create better outcomes for members. This is a belief that is firmly held by both the trustee and the investment management team of the UKRF. Hence, as the fund aims to deliver the best possible overall outcomes for its members, its managers are committed to taking action and the recent DGF changes reflect the implementation of this belief.

UKRF expects that investments with improved ESG characteristics will face fewer risks and perform better in the long term compared with investments with weaker ESG characteristics and less focus on sustainable long-term practices. Responsible investments have been on the managers’ radar for some time, as the UKRF signed the Principles for Responsible Investment in 2015. In its view, ESG-related considerations are clear and present investment risks, and these factors should not be afterthoughts, but rather be actively considered in both strategic and day-to-day investment decisions. Market participants have become increasingly aware of and sensitive to ESG risks, and that will adversely affect assets and businesses with relatively weak ESG characteristics and unclear plans to improve the sustainable aspects of their operating model.

In 2020, the trustee surveyed UKRF members about their views on RI and related matters, finding interest among those UKRF members who responded in this increasingly important area (see Responsible Investment survey results). As a consequence, UKRF introduced enhanced ESG characteristics as additional investment criteria for the DGF that will be used to screen investments.

What were the outcomes, benefits, challenges and next steps?

The changes to the DGF are an example of the progress UKRF has made integrating its responsible investment policy into investment practices. It will continue to integrate responsible investment considerations within the fund’s strategic and day-to-day management processes and decision making, aiming for improved risk-adjusted returns over time.

UKRF expects this integration to both reduce forward-looking investment risks – through enhanced protection against ESG risks including climate change – and also lead to better investment returns and, hence, better risk-adjusted outcomes for members over the long term.

Exercising voting rights is an important mechanism in the equity space and UKRF is keen to use those voting rights and apply the principles of the UK Stewardship Code. It is also building its active engagement on the credit side. This is important in the context of the DGF, a complex multi-asset fund, but also for the UKRF’s DB scheme. With £35bn in DB assets and a significant exposure to traded and private credit investments, UKRF is committed to extending its stewardship and engagement responsibilities to material and long-term strategic holdings for the DB scheme. As such, the UKRF recently appointed EOS at Federated Hermes as a dedicated engagement specialist to maximise its influence as an active owner through proactive engagement (and voting, where applicable) with investee entities, regulators and markets within its DB scheme.