Sebastian Cheek reveals how large investors are implementing RI strategies, with a new focus on the long-term performance that better suit pension fund investment horizons
The last 10 years have witnessed a sea change in companies’ understanding of how environmental social and governance (ESG) factors affect their business operations.
Financial institutions in particular have sought to focus on this area by linking it to the long-term performance that suits their pension fund investment horizons.
We believe that long-term responsible investing is essential to a successful personal accounts investment strategy
This attitude shift has been given added impetus by an increasing dedication to this area by scientists and world leaders – the inauguration of Barack Obama springs to mind here – and the meltdown of the financial system, which has made investors look more towards core values.
Large investors have increasingly developed public responsible investment (RI) strategies and are now more open about how they are implementing them. Mercer European head of responsible investment Emma Hunt said RI momentum is gathering as some institutions act as beacons to other investors who might want to invest in RI but have been held back by fiduciary duties and concerns about performance.
“Having these leaders has given the industry a real push. Asset owners, such as big pension funds like the Environment Agency Pension Fund which has a very good RI strategy, give other pension funds more strength,” said Hunt.
The allocation by pension funds to socially responsible investment (SRI) is generally small, but general awareness of how to approach from a portfolio point of view is increasing rapidly, explained SEB Merchant Bank co-ordinator, capital markets, Christopher Flensborg.
“People are aware of how to invest,” said Flensborg, “but at the moment allocations as a figure is a single percentage – but in terms of a change of attitude to portfolio allocations, investors are much more aware of the impact the investment has.”
One thing that has helped in this is the UN Principles of Responsible Investment (UN PRI), which is a framework that enables investors to consider environmental social and governance issues when making investment decisions.
In the UK, a survey conducted by FairPensions in April of the 30 largest pension funds in the UK, showed 35% of the UK funds quizzed use UN PRI signatory status as a criterion in fund manager selection and 25% use climate change competence as a criterion.
Mercer’s Hunt said: “The rise of the UN PRI has really helped create a framework for many pension funds, asset owners and managers. For a lot of pension funds it is still something to aspire to, because the principles are quite strong but they set the direction of where those funds might be going.”
Watson Wyatt investment consultant Jane Goodland agreed: “UN PRI has had a significant impact in bringing ESG into mainstream investment. It has attracted a large number of signatories and is a good platform for exploring and sharing best practice.”
SRI has mainly been adopted on a global scale by the large public pension funds, although there is a slower but steady uptake from the corporate funds. It is certainly playing a bigger part in portfolio construction and manager selection, although traditionally there has been less pressure on corporate funds to conform.
“The public funds were the first to get into this, then the occupational funds because, although they are associated with a profession, it is not a single employer,” said F&C head of governance and sustainable investment, Karina Litvack. “Scandinavia, the Netherlands and Switzerland have seen a lot of occupational funds obtain active ownership, but in the UK it is more dominated by local authority funds.” Indeed, Dutch fund PGGM was one of the first subscribers to the UN PRI.
The FairPensions survey alluded to above found that more than half (55%) of the UK funds surveyed said that a fund manager’s ability to comply with a responsible investment policy and to show transparency in investment practices was essential.
UK Sustainable Investment and Finance Association (UKSIF) chief executive Penny Shepherd agreed public sector schemes have taken the lead in responsible investment. However, there remain a number of major international companies who are corporate responsibility leaders but their pension funds are not fore frontal in this area.
“Traditionally there has been a disconnect between the views of the company and the practices of the pension fund,” said Shepherd.
Pension scheme trustees are integral to leading the way in this discipline, as illustrated by UKSIF’s report issued in June entitled Responsible Business: Sustainable Pension. The report looked at the RI policies of UK corporate pension funds of companies listed on the FTSE4Good index. One of the key outcomes was the view that responsible investment leadership should come from trustees.
“A group of responsible investment champions is emerging among UK corporate pension funds,” said Shepherd, “and they have told us that trustee leadership was driving that change.”
In fact, leadership and collaboration between global institutions is one trend Mercer’s Hunt highlighted as a cost effective and efficient way to undertake RI activities.
“We have noticed responsible investors are keen to collaborate on projects whether in research, analysis, or engagement opportunities,” said Hunt. “This trend is really gaining pace as asset owners get to know each other.”
Two firms that have worked together in this area are fiduciary management firm SEI and F&C Investments. SEI has appointed F&C to engage on their behalf in respect of the securities held in SEI’s funds. As SEI head of European institutional solutions Ashish Kapur explained: “The responsible engagement overlay goes across all our equity funds for European investors. It doesn’t affect the way we invest but allows us to engage on environmental and corporate governance issues on a consistent basis across all our funds and in all regions.”
F&C’s Litvack added: “SEI puts together different combinations of fund managers to suit each client; we then put their funds onto our system and we vote the shares as the AGMs and EGMs occur, in addition to engaging with the companies on ESG matters that are not subject to a vote.”
Shareholder influence in voting on ESG issues can play a big part in SRI. The California Public Employees’ Retirement System (CalPERS) information officer Clark McKinley explained: “CalPERS commits capital to external managers who obtain share leverage in public companies that show promise of improved share value once corporate governance practices are adopted.
PGGM has a similar practice. “We talk about ESG issues with the companies and use the shareholder interest to gain a more responsible investment policy,” said PGGM spokesman David Uitdenbogaard.
However, McKinley also noted that CalPERS does not choose to divest in companies because “we’ve never found divestment a sound strategy for attaining desired changes by companies; we do better by using our shareholder leverage to advocate change”.
In fact, last month’s Global Pensions 100 Panel echoed this belief. The panel were asked: Have you divested from companies operating in tumultuous countries as a way to mitigate risk? 84.7% answered ‘no’ and 5.3% answered ‘yes’.
The survey came not long after The New York City Pension Funds divested $10.8m from companies with businesses in Iran, while the New York State Common Retirement Fund said it would divest $86.2m from companies in Sudan and Iran.
Personal accounts in the UK
Last month, the Personal Accounts Delivery Authority (PADA) in the UK held consultation on the investment strategy to be used for personal accounts, expected to be introduced in 2012.
One of the topics under discussion was the extent to which RI should be a part of the investment strategy for personal accounts. UKSIF’s response to PADA’s discussion paper – Building personal accounts: designing an investment approach – read: “We warmly welcome PADA’s interest in the role of responsible investing in protecting and enhancing long-term returns to the benefit of scheme members. We believe that long-term responsible investing is essential to a successful personal accounts investment strategy.”
UKSIF also suggested the personal accounts scheme:
- signs and implements the PRI;
- collaborates with and learns from other pension schemes for cost-effectiveness;
- applies responsible investment across all fund choices and asset classes;
- builds responsible investment into the selection and assessment of fund managers;
- considers a gradual approach to implementing responsible investment as a reasonable way to deliver cost-effectiveness and benefit from future economies of scale;
- explicitly recognises that responsible investment helps the trustee corporation to fulfill its fiduciary duty and ownership imperative.
The biggest challenge with SRI, according to SEB’s Flensborg, is explaining to investors that implementing RI does not cost. “People have a belief it costs a lot and are afraid of doing this allocation,” he said.
There is also the commonly held view that engaging in investments that consider ESG factors somehow limits return capabilities; a notion Goodland was quick to dismiss.
“There is an historical perception that to do anything in this space means you are foregoing returns, which we believe is an outdated perception. Some trustees still think it is about excluding investments from your portfolio on ethical grounds,” she said.
Due diligence is another big challenge because to be proactive and allocate money to SRI there is a lot of research and following up of investments required. “Combining the products with active dilligence is a key element for investors, especially at the moment when people are saving money,” said Flensborg.
Tim Sharp warns the DWP's plans for collective DC risk establishing an inhospitable environment for the lay trustee
This week's edition of Professional Pensions is out now.
The government is in talks with the UK and Irish pensions regulators over how to protect members of cross-border schemes in the event of a no-deal Brexit.
The equalisation of guaranteed minimum pensions (GMPs) is at least two years away from being completed, and could take longer than four years for some schemes, a poll has found.