Socially Responsible Investment (SRI) and pension funds

Sep 2008
London, United Kingdom, September, 25 2008 - Lynn Strongin Dodds offers an update on how far European pension funds have come in the field of SRI.

Socially responsible investing (SRI) was once the preserve of a select few within fund management circles. Today, issues such as climate change and codes such as the UN Principles for Responsible Investment (UNPRI) – a voluntary initiative launched in April 2006 – have raised the profile. Larger funds endowed with resources are of course taking the lead but their smaller counterparts are expected to follow, if they aren’t already doing so.

One of the challenges with SRI is the terminology. In the not so distant past, SRI meant applying so called negative screens that prohibited investment in companies or funds involved in specific activities such as tobacco, alcohol or nuclear power. Today, it can encompass a range of strategies from actively looking at renewable energy or microfinance projects to engaging with a firm’s board of directors to change its environmental, social and governance (ESG) policies. Some are also adopting a more holistic view by incorporating ESG factors into mainstream investment decisions.

In terms of how big the market is, Christoph Butz, sustainability expert at Pictet Asset Management, says it is difficult to measure the exact amount of assets under manage-ment (AUM) under the SRI banner. “If we take a broad definition and look at funds that only use negative screening or exclusion, then the probably around 10% of all AUM of total funds are invested in SRI funds. However, if we take a stricter view and look at schemes that are incorporating positive screening based on ESG criteria or using engagement, then it is more likely to be about 1-2%. This latter view of SRI is growing fast but it is still very much a niche area.”

Leading European SRI or ESG lights include Dutch giant, ABP, Europe’s largest pension fund at €205bn for government and education workers and its fellow industry-wide schemes, PME, the €18bn metal workers fund and PGGM, the asset manager to the €86.3bn healthcare pension fund.

France, which has a long history steeped in SRI, boasts schemes such as Fonds de Réserve pour les Retraites (FRR), the €33bn French national pension reserve fund, and L'établissement de retraite additionnelle de la fonction publique (ERAFP), the €4.8bn civil service supplementary pension scheme.

In the UK, the roll call includes BT Pension Scheme (BTPS), the UK’s largest with £37bn in AUM, managed by Hermes Fund Management, the £1.5bn Environ-ment Agency pension scheme and the £30bn Universities Super-annuation Scheme (USS). Other notable mentions include the Norwegian Government Pension Fund and Sweden’s AP funds.

While behemoth funds may be following their own path, they have all taken steps to not only integrate ESG into their investment policies but also to engage actively with companies about their policies. Moreover, although SRI and ESG investment styles have been in the news more recently, many of these funds joined the movement before the topic was so high on the investment and political agenda.

Take ABP, for example. As Rob Lake, head of sustainability at APG Investments, the investment arm of the recently split off asset management company of ABP, explains: “We have been interested in ESG issues for years and the 2006 three year strategic review put flesh on the bones of our commit-ment. We decided to integrate ESG across all asset classes in our mainstream funds. One of the main objectives, though, was to use ESG to improve the fund’s risk adjusted financial returns.”

Part of ABP’s strategy includes only investing in companies that comply with the UN Global Compact, the largest corporate voluntary initiative, which was launched eight years ago. It provides a framework for bus-inesses that are committed to aligning their operations and strategies with ten universally accepted principles in the areas of human rights, labour, the environment and anti-corruption. ABP also actively seeks out companies that have a sustainability angle such as developing new technological solutions and products to improve energy efficiency.

“We will also exercise our clients’ voting rights as widely as possible across the portfolio plus enter into a dialogue with a company to promote the highest standards,” says Lake. APG Investments is also actively involved in talking to local and European Commission policy makers about ESG issues.

For small to mid-size pension funds, the SRI road is more difficult to tread, although not impossible. Some schemes are turning to their investment consultants for advice while others are looking to their fund managers for direction and are even choosing them based on their ESG credentials. Rory Sullivan of Insight Investment comments: “Consultants are doing a lot of research in this area. The next logical step would be for them to explicitly build these criteria into their manager assessment and selection processes. Pension funds could reinforce this by asking their consultants to assign 10 or 15% of the overall manager assessment score to performance on ESG analysis and engagement.”

Erik Breen, head of corporate governance and sustainability at Robeco, adds that there are several ways smaller funds can implement an SRI strategy. “The first step is to decide what the fund is going to outsource and what it is going to keep in-house. The most important thing is that they should keep the full responsibility for the investment strategy, as well as the accountability in-house. The other decision is to define a policy. There are two options – to follow external, internationally recognisable codes such as the UN PRI, Human Rights Declaration or UN Global Compact or to define their own based on their beneficiaries and common interests. I would highly recommend choosing the external codes as they are already in place and provide a framework and definitions.”

Another path may be to choose a fund of funds to gain exposure to a particular slice of the SRI story, says Chris Armitage, head of the UK at FourWinds Capital Management, a specialist in global natural resources funds. “Smaller funds cannot do what ABP does. Realistically, they may only have room for two to three mandates in a portfolio and a fund of funds will not only enable them to diversify their portfolio but also enhance returns.”

For example, FourWinds' Phaunos Timber fund is a diversified global portfolio which was launched in December 2006. It offers investors exposure to timber through tree species, age classes and geographical timberland markets. It also uses timber related instruments such as financial futures and swaps, the return on which is linked to timber related products.

Funds can also gain exposure through a stable of passive funds tracked against FTSE4Good or the Dow Jones Sustainability indices. David Harris, manager in the responsible investment unit of FTSE notes: “It is expensive for a small fund to set up a separate mandate but they can instead choose a fund manager which tracks one of our indices. The indices were set up in 2001 and select companies that meet good practices internationally on environmental and social management. We also actively engage with the companies that we select for the indices.”

The FTSE series consists of five benchmark indices covering the global and European regions, the US, Japan and the UK. An additional four tradable indices have been specially designed to cover the UK, US, European and Global regions, plus there is also a FTSE4Good Environmental Leaders Europe 40 Index and a FTSE4Good IBEX Index.

Last but not least, says Danyelle Guyatt, principal in Mercer’s responsible investment team, comes networking: “We are seeing many pension funds getting involved in collaborative activities as a low cost way to bring about improvements to the pension fund system. They include the networks on UN PRI, International Corporate Governance and Climate Change. There is enormous benefit in joining with other institutions because the pension fund is no longer a lone voice but part of a larger effort.”

Butz also points to the work of the Ethos Foundation, the Geneva-based foundation which looks after CHF2.3bn (€1.4bn) in assets on behalf of 80 mainly regional Swiss funds and invests on a socially responsible basis. It owns Ethos Services, a consultant advising on SRI, plus in 2005, it joined forced with Pictet to launch the Ethos Institutional Investment Fund. Although a relative minnow, it has punched above its weight, most recently as a shareholder of UBS, Europe’s worst casualty of the US subprime crisis.

Last year, Ethos criticised the CHF 2bn capital injection from an unnamed Middle Eastern investor and more importantly the CHF 11bn infusion from Singapore’s state investment arm GIC, which gave the group roughly a 9% stake, making it the largest single shareholder. Ethos demanded the beleaguered bank conduct an audit into how it lost $18.4bn on US subprime securities last year. While it narrowly lost the vote, it did send a message to the UBS board that dissident shareholders should not be taken for granted.


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