Swedish pension buffer funds have emerged as bellwethers of socially responsible investing, as Gill Wadsworth reports
Scandinavia boasts a strong reputation as a pioneer in environmental policy and has long championed the need to promote positive sustainable and ethical behaviour; a stance clearly reflected among the nation’s pension funds.
The public AP funds in particular are seen as market leaders in environmental, social and governance (ESG) issues, and were among the first to sign up to the UN Principles for Responsible Investment (UNPRI).
The AP funds’ position on responsible investment is underpinned by Swedish law, formulated in 2001, which dictates they take environmental and ethical considerations into account in their investment activities “without deviating from the overall objective of a high rate of return”.
The four largest AP funds have since collaborated to create the Ethical Council which engages with companies to drive positive behaviour in areas concerning human rights, labour law, the environment, corruption, and special weapons. The idea being that through cooperation, the funds have far greater influence than when operating independently of one another.
Ulrika Danielson, a spokesperson for AP funds 1 to 4 told Global Pensions: “ESG issues are implemented both by integrating these issues into policies and processes and by identifying and engaging in corporations that have breeched international convention that Sweden has signed.”
She added: “These corporations are identified through a screening process provided by an external service provider. The Ethical Council, which is a collaboration between the First-Fourth Swedish National Pension Funds, has a dialogue with 10 to 15 companies that have been identified.”
In 2008 the Swedish government commissioned a review of the efficacy of the national pension funds in implementing ESG considerations into overall investment strategy and the impact this had on returns and risk management.
The report concluded that while more needed to be done to integrate ESG into portfolios and greater resources should be dedicated to following up corporate governance issues, returns had suffered no negative impact from following a more sustainable strategy and administration costs had not risen.
The report adds: “In a number of cases, the activities of the AP funds – and of other investors – have led to improvements in the companies owned by the funds and also to closer consideration of environmental and ethical issues in these companies.”
The AP funds follow a strategy of both negatively screening out companies and sectors and, more recently, engagement.
Richard Tyszkiewicz, senior director of business development for Northern Europe at consultant Bfinance, said: “Ethical investing usually follows a progression. Pension funds start by screening out companies or sectors. Then the next logical step is to take it further by becoming an active investor and engaging with companies and influencing them.”
The Ethical Council follows a systematic approach which begins with examination of the funds’ holdings, followed by a closer investigation of any investee companies believed to have violated international conventions. The council then engages in dialogue with companies and applies additional pressure where necessary to avert poor behaviour, such as raising resolutions at annual general meetings and cooperating with other investors. Where the engagement has the desired effect, companies are removed from the council’s watch list. However, where engagement fails to avert behaviour likely to jeopardise investor returns, the target is recommended for exclusion.
Danielson said: “Once we have decided to exclude a corporation, the shares are sold and no new investment in this company is allowed.”
Earlier this year, Israeli defence company Elbit Systems was dropped from the AP1-4’s portfolios following persistent involvement with the construction of a separation barrier around the West Bank. The Ethical Council had engaged in lengthy dialogue with the defence firm yet constructive discourse had failed to achieve the desired result.
Ethical Council chair Annika Andersson explained: “The work of the Ethical Council is based on a rigorous process where dialogues with companies are our main tool. Staying on as a shareholder to continue the dialogue produces visible results, but it also requires resources and patience. As a last resort, the Ethical Council may recommend each fund to exclude the company if the dialogue fails to produce the desired result. This is now the case with Elbit Systems.”
Elbit joins a fairly short list of companies in which the AP funds will not invest ranging from engineering firms to cluster bomb manufacturers.
In terms of engagement and cooperation with other investors, the AP funds recently joined forces with ABP in the Netherlands and the New York City Pension fund to force US mining company Freeport McMoran to hire a director with demonstrable environmental expertise.
In an annual general meeting held in June this year, AP1 head of ESG, Ossian Ekdahl said: “Freeport does not currently have an independent director with environmental expertise and designated responsibility for environmental matters – yet environmental management is critical to the company’s future success.
“We believe it would benefit the company to address the environmental impact of its business at the most strategic level in a similar manner to the way it has addressed human rights – by appointing a specialist to the board.”
This marks the second occasion on which the AP funds have attempted to get Freeport McMoran to make such an appointment and the outcome of this latest engagement is yet to be known.
However, the Ethical Council, alongside other institutional investors has prevented Grupo Ferrovial from conducting construction work in a conservation area in Poland; forced PetroChina to improve safety and environmental procedures; and improved anti-corruption procedures at defence firm Thales.
In terms of measuring the success of their ESG strategy, the AP funds prefer to think about how they have shaped company behaviour as opposed to focusing on returns.
Danielson said: “Success can be viewed from many perspectives. The Ethical Council’s engagement strategy with a focus on dialogue has shown that this is a good way to influence corporations. We think it’s a success when we have ended a dialogue because the goals have been achieved.”
Part of the reluctance to focus on figures is because, given the long-term nature of pension funds, it is too early to measure the relative success of their ethical investment policy and they are anxious to get caught up in looking at short-term performance.
Bfinance’s Tyszkiewicz said: “The objective from the client point of view is not really motivated by extra return; rather they want to comply with ESG policy and get the same performance as they would get from a normal non-screened portfolio. Pension funds want decent performance but they don’t view ESG or SRI as boosting returns in the short term.”
Second, the conflicting reports and endless debate about whether ESG helps or hinders performance continues to muddy the waters. Consequently the prevailing view remains that ESG, at least, does not harm returns.
The 2008 Swedish government review of the AP funds’ ESG strategy concluded: “It could at least be claimed that there is no evidence that ‘sustainable’ financial investing would be systematically worse from a yield view point than conventional investment.”
This view is supported by evidence from investment consultant Mercer which pulled together 30 research projects covering SRI fund performance and found there was no real link between ESG strategies and financial return.
Mercer’s European head of responsible investment, Will Oulton said: “There will always be some debate about where ESG works and where it doesn’t. We looked at a range of studies and found there is no additional risk from investing in this way and in many cases it enhances returns.”
Eventually, however, since the Swedish pension funds’ ultimate goal is to make an adequate return, they will have to demonstrate how responsible investment has added value.
In the meantime, the biggest challenge for AP funds carrying out an ESG strategy is applying the appropriate level of resources. The spokeswoman already describes the ESG undertaking as “a resource and time intensive method”, yet the government has made clear its expectations for further commitment in this area.
The 2008 review stated: “The funds need to invest greater resources in their work on ESG issues. They must build up a larger body of analytical skills of their own so as not to be too dependent on consultants. Corporate governance efforts, too, including dialogues with companies, require resources. It is vital that functions already in place – using the resources currently at the funds’ disposal – deal with these issues actively and in a committed way. The key to success is the integration of financial analysis and sustainability aspects.”
In response, the Ethical Council appointed a secretary general to coordinate company dialogue, support investor initiatives and help develop future strategies. The council also took part in numerous PRI initiatives throughout 2009 demonstrating a greater propensity for cooperation with other investors.
The Swedish public funds continue to lead the way in ESG and are viewed as a core market by consultants and fund managers alike for responsible investment. Facing continued pressure from the government and as a result of their own impetus, ethical investment will remain at the centre of future strategies. However, while the funds’ aim remains laudable, pension scheme members will undoubtedly want to see empirical evidence of positive performance if they are to continue supporting an ethical approach in the future.
Nick Martindale looks at how HSBC is helping its 40,000-strong UK workforce get to grips with their personal finances.
Pi Consulting and IC Select have launched a service to provide advice and support to pension schemes tendering fiduciary management mandates.
Nearly nine million employees aged 45 and over are "sleep-walking" into retirement, unaware of how much they need to save, according to research from Aviva.