In June, Japan’s Government Pension Investment Fund, the largest pension fund in the world, with more than $1.3 trillion in assets, said it plans to raise its allocation to environmentally and socially responsible investments to 10% of its stock holdings from 3% now. It recently chose three environmental, social and governance (ESG) indices as benchmarks, including the FTSE Blossom Japan Index and the MSCI Japan Empowering Women Index.
It is a huge show of support for ESG investing from a sector that has not uniformly embraced responsible investing. Alex Bernhardt, the US head of responsible investment at consultants Mercer, says US pension funds have been slow in comparison with European or Australian funds in adopting ESG principles for their investments.
“Large US pension funds have had aggressive ESG agendas for some time and have tended to focus on the ‘G’, but there is a huge number of smaller muni and private pensions that are doing very little,” he says. In part, that is because they lack the resources to fully assess and engage with the companies in which they invest.
Bernhardt feels the mood is shifting in the US: “Some investors seem more galvanized since the 2016 election to do more around ESG. Now there is such a wealth of academic evidence of the financial benefits of including ESG factors that it is becoming common sense to include these in investment decisions.”
Divestment seems to be the biggest movement yet. The value of assets owned by institutions and individuals committed to some sort of divestment from fossil fuel companies reached more than $5 trillion in December last year. Some 350 asset owners have also signed up to the UN’s Principles for Responsible Investing, including pension funds from all over the world – although here the US is noticeably under-represented, other than by large Democrat-controlled state funds like New York City Employees Retirement Programme and CalPERS.
Scott Sacknoff, who launched the SerenityShares Impact exchange-traded fund this year, says that in addition to a lack of resources, some of the reticence is simply confusion around what ‘good’ investing means. “What is ‘good’ is often subjective,” he says.
He points out that no one company ticks every box when it comes to ESG: “Perhaps they are engaged in carbon-reducing initiatives, but have only one woman on the board. Funds and indices with clear missions can help pension funds overcome the confusion.”
Sacknoff’s fund selects only companies that will have a positive impact on the world through their products and services, targeting 20 specific challenges to society and the environment.
Some insurance companies make the cut, for example, for their long-term care for the elderly. Apple is included because of the role of the smartphone in providing access to information. Western Union is also in the fund for its role in enabling migrants and refugees to transfer money.
“We looked at the UN’s sustainable development goals to design our methodology and invest in companies that are aligned with them,” says Sacknoff. That such companies are of greater interest than their non-sustainable peers is clear, he adds. “Ten percent of the 115 companies chosen in last September’s annual review have been bought out.”
The fund’s early investors have been family offices and individuals, but Sacknoff says it was also designed to be suitable for pension funds.
As pension funds lean on their investment managers for guidance on ESG investing, they are also becoming more demanding.
“Clients are asking their asset managers to do more,” says Mike Walsh, head of institutional distribution at Legal & General Investment Management (LGIM). “For example, several asset managers in the UK came out against executive pay, but then failed to vote at AGMs. Pension funds want to know why their asset managers are not more actively engaged, or why they aren’t monitoring their holdings.”
Exclusion or divestment alone is no longer enough for more experienced pension funds.
Jim Roth, co-founder at LeapFrog Investments, a private equity firm that has a model of ‘profit with purpose,’ says that simply doing no harm is not sufficient. He says pension holders are calling for funds to actively work towards making the world a better place, whether that is through financial inclusion, healthcare provision or green energy.
“They want to focus on positive impact rather than just divestment,” says Roth.
LGIM noticed the change early. It has always approached ESG not from a point of exclusion, but rather from a place of engagement, says Walsh. Last year, for example, LGIM worked with APG and CalPERS on the topic of diversity on boards, identifying 58 holdings in US companies that had no, or one, woman on the board.
“We approached those companies, and eight have already addressed the membership of the board,” says Walsh.
It also launched the Future World Fund in November last year, seeded with £2 billion ($2.6 billion) from HSBC’s defined-contribution pension scheme. The fund has a 90% lower exposure to carbon reserves, a 43% lower exposure to carbon emissions and 83% greater exposure to green revenues than the traditional FTSE All World global equity benchmark.
Walsh says LGIM engages with the companies held by the fund to facilitate change: “If they do not improve through direct engagement and fall below minimum standards, we will not just disinvest but also take their share values across LGIM and vote against their board chair.”
Given that LGIM holds 3% of all UK companies, that engagement is powerful.
Mercer’s Bernhardt says more disclosure would go a long away to helping pension funds as they seek to up the game in ESG: “The Taskforce for Climate Disclosure just released recommendations for disclosure of climate risk across sectors, and the adoption of those guidelines would be a huge step towards progressing a better understanding of climate risk. Ultimately, the aim is to get material sustainability information embedded in standard corporate filings.”