A recent gathering of responsible investing exponents shone a light on how some of the world’s biggest pension managers and sovereign wealth funds are embedding environmental, social and governance risk management into their portfolios – and how they can do more.

Delegates at the Principles for Responsible Investment’s global PRI in Person conference, held in Berlin from September 25-27, 2017, were challenged to push harder to make their organisations live up to the obligations of being a signatory to the PRI.

This message was driven home particularly strongly by Christiana Figueres, the convenor of Mission 2020, who challenged PRI signatories to invest 1 per cent of their assets in clean technologies and renewable energy by 2020.

“We have run out of time for anything that is gradual or marginal, we need to step up exponentially if we are to protect the global economy,” Figueres said. “We don’t want to be caught unawares or in a systemically uninsurable economy.”

The PRI, founded with the support of the United Nations in 2005, describes itself as the world’s leading proponent of responsible investment. Signatories to the PRI pledge to incorporate environmental, social and governance (ESG) factors into their investment and ownership decisions.

Signatories have a total of about US$70 trillion ($92.6 trillion) under management, making them an influential force for creating change within the companies and markets in which they invest.

Figueres, who was the executive secretary of the UN Framework Convention on Climate Change and was instrumental in COP21, further challenged delegates to announce their 1 per cent commitment to renewables within one year, when a Climate Action Summit will be held in California, hosted by Governor Jerry Brown.

“We are at a very important transition stage in the global economy,” she explained. “We now have $320 billion per year invested in renewable energy and technologies. A growing number of shareholder resolutions are asking for disclosure of the carbon risk and the risk to the value of the company in the future. And the amount of money in green bonds will move to about $100 billion this year, up from $8 billion only a few years ago. All of those data points show we are moving in the right direction in decarbonising the global economy and shifting capital from carbon intensive investments to lower or no-carbon investments.”

She said, however, that this transition can’t be elastic or drawn out infinitely. In particular, she said there are two firm boundaries to keep in mind.

First, earth’s atmosphere can take only another 600 gigatonnes of carbon emissions before crossing a dangerous threshold.

“We’ve already put up 1200 gigatonnes. If we go beyond another 600, then there will be huge implications. We are putting 40 gigatonnes up each year now.”

But there is also a boundary for the rate of decarbonisation.

“The global economy can’t decarbonise by much more than 6 to 7 per cent per year,” she said. “This means we can take that 40 to net zero by 2050. If the economy had infinite adaptability, we could move to zero immediately, but it doesn’t. These are very tight boundaries.

“Putting together all of those numbers, you come to the conclusion that we need to take advantage of the fact we’ve had three years of flat emissions, and actually begin to bend the curve of emissions down. It is out of the question to stay at 40 gigatonnes per year. The point at which we need to bend the curve down is 2020, only three years from now. We need to [cut] 50 per cent of emissions every decade [to get] to net zero by 2050 – that is the prudent rate of descent to protect the economy.”

Investors, she said, can play a more extensive role in the prudent decarbonisation of the economy.

She congratulated the PRI, and its signatories to the Montreal Pledge, which she said was instrumental in giving governments the confidence they needed to negotiate the Paris Agreement.

Institutions that presented case studies to the PRI in Person event demonstrating how their investment teams are making progress on integrating ESG thinking into their portfolios included: Japan’s Government Pension Investment Fund (GPIF), Sweden’s Second Swedish National Pension Fund (AP2), the Netherland’s ABP, France’s Établissement de retraite additionnelle de la fonction publique (ERAFP), the California State Teachers’ Retirement System (CalSTRS) and the California Public Employees’ Retirement System (CalPERS), plus Cbus Super.

GPIF goes granular

Japan’s ¥145.7 trillion ($1.7 trillion) GPIF is actively promoting ESG integration at all levels of its investment chain.

GPIF chief investment officer Hiro Mizuno told the audience at PRI in Person that because the fund outsources investments, ESG integration can be done only through the chain.

“We work hard internally to consider ESG in our asset manager evaluation,” Mizuno said. “We are encouraging our passive managers to set up as active stewards. They hold a lot of our voting shares and they need to consider ESG in their business activities. We are one of only a few asset owners to change our mandates to passive managers according to the quality of their ESG activities.”

Such ESG factors should be a part of all asset classes, he said.

“We have a 25-year investment horizon, we spent a lot of time on finding managers to generate good alpha, but at the end of the day…the financial system has to be sustainable,” he said. “It’s important for us to make sure we affect the whole investment chain and it becomes more sustainable by taking ESG into consideration.”

Mizuno said the fund was looking at engagement with index vendors, whose indices also play an important role in making sure the investment chain is more sustainable.

“Performance is measured by traditional benchmarks, but we need to change that to enforce alignment with ESG priorities,” he said.

GPIF has three explicit expectations of managers, outlined in its stewardship principle guidelines.

It asks managers to become signatories to the PRI or explain why they don’t need to do so; it expects managers to integrate ESG into their investment decisions; and it asks managers to engage with companies on serious ESG issues. The fund also has recommendations for other asset owners, to help forge a sustainable financial system.

“Short-termism is not just a problem at corporate or asset manager level, but also at the asset owner level,” Mizuno said. “I encourage all asset owners to stop producing quarterly reports. It’s hard to step back from that because it seems like going backwards in transparency.”

AP2 & CalSTRS commit

Speaking alongside Mizuno, Eva Halvarsson, CEO of Swedish pension fund AP2, said integration means having a sustainability lens throughout the organisation.

“To be successful, you have to have commitment from the top,” Halvarsson said. “We are very lucky to have that. Every board meeting, management meeting and meeting with our staff we talk about sustainability. It’s commitment and culture. This is part of our DNA at AP2; everyone is engaged with these issues. I’m a strong believer that this should come from within. These are not issues just for the ESG department.”

AP2 is the second of the Swedish government’s five pension funds, with SEK 336.3 billion ($52.7 billion) in assets under management. Halvarsson said the fund’s motivation for ESG integration comes from an investment imperative.

“The investor with the best and most information can make the best investment decision. You need a new kind of information,” she explained. “One of our most important values at AP2 is constant improvement. If we are to achieve that, we need to learn a lot of new things…You can apply that in working with ESG.”

Meanwhile, Chris Ailman, the CIO of the US$214 billion ($282.3 billion) CalSTRS, told PRI in Person delegates that ESG is an integral part of every asset class and every stage of the investment process at the fund.

CalSTRS has individual teams for each of the three sub-sectors of ESG – environmental, social and governance – with the belief that specialists are needed to deal with the complexity of the individual issues in each sub-sector.

“We have at least one or two staff people who are E, S and G within every asset class,” Ailman said. “If you look at the things that will affect us, things like demographics, urbanisation and climate change, they are different when you look at different asset classes. We are constantly monitoring how we have done on the integration.”

ERAFP urges teamwork

Philippe Desfossés, chief executive of the €18.5 billion ($28.7 billion) French fund ERAFP said it’s important for investors to pay attention to “anything that might derail your mission of paying pensions”.

“So we designed a charter around [ESG] issues, and decided to implement this in a no-nonsense approach,” Desfossés said.

This was through a best-in-class policy, where the bottom quartile of investments rated on ESG scores were excluded.

“It is very hard to out-guess the market, the only thing you can do is apply criteria to lead you to exclude the bottom quartile,” he said.

ERAFP also paid particular attention to measuring manager performance on ESG.

“Now we have regular meetings with managers on the way they’ve been delivering on ESG,” he explained.

Desfossés urged the members of the audience to collaborate with one another.

“Together, we can make a big difference,” he said.

ABP leads on SDGs

Since 2008, the giant Dutch pension fund ABP’s policy has evolved to integrate objectives for sustainability and corporate social responsibility completely. Josepha Meijer, vice-chair of the €385.6 billion ($604.8 billion) ABP, said that until 2008, it had a traditional policy and assessed investments on risk, return and cost. But since then, ESG criteria have been added, and then a lens of sustainability and responsibility were added.

“We promised our beneficiaries we would achieve the returns required to pay current and future pensions in a responsible, sustainable manner,” Meijer said. “We have a fiduciary duty to contribute to a more sustainable society, and believe sustainable companies will perform better in the long run.”

The implementation of this revised policy is through the concrete investment objectives of: reducing carbon dioxide by 25 per cent by 2020; increasing the allocation to investments that contribute to a better and cleaner future from €29 billion to €58 billion by 2020, including investments in renewable energy to the tune of €5 billion by 2020, and €1 billion in communication infrastructure and education. The fund is also focusing on specific themes, including child labour, cocoa, human rights, and working conditions.

ABP, which is the largest pension fund in Europe, is also a signatory to the United Nations’ sustainable development goals.

The SDGs were established in 2015 and are a list of 17 goals, measured against 169 targets, designed to guide the decisions of governments, businesses and investors to ‘transform the world’ in a positive fashion.

Meijer said the SDGs provide a widely supported frame of reference, a vision to the world that is broad and has a long timeframe.

“We think they’re a gift from the UN to the world,” she said. “As a pension fund, we have a vested interest in helping to achieve those goals, as we think they’ll shape the world the beneficiaries live in, and also shape areas of growth and provide a more stable economy. They create alignment for a common vision and avoid further fragmentation.”

CalPERS & Cbus use SDGs

Anne Simpson, investment director of sustainability at CalPERS, where the SDGs are also under consideration, says the goals are not just a moral imperative, they are an economic necessity.

“As a large investor, we have nowhere to hide from the world’s problems and risks. But we are not in a position to tackle them without a public policy framework. The SDGs provide a consensus on a shared to-do list,” Simpson said. “Until now, investors haven’t had a legitimate framework to think about allocating capital and managing risk.”

CalPERS has US$343.3 billion ($453 billion) under management, making it the largest pension fund in the US.

Alexandra West, portfolio head of strategy and innovation at local super fund Cbus Super, said there are two reasons investors should align with the SDGs.

“Investors need progress on the SDGs because they’ll assure a stable economy and drive economic growth,” West said. “And the SDGs need us; without mainstream institutional investment, the SDGs won’t be realised. As long-term value creators, we rely on a sustainable economy and economic growth. We can’t afford to
sit on the sidelines and leave it to others.”

West said developing a strategy for how to contribute to the SDGs was very difficult, and that the $41 billion fund was looking to learn from global peers, such as ABP and the Netherland’s PGGM.

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