European asset owners shed light on ESG investment challenges, the issues they aim to address in portfolios as behemoths of capital allocation and how they are engaging with big greenhouse gas emitters.
ANNA HYRSKE, HEAD OF RESPONSIBLE INVESTMENTS, ILMARINEN MUTUAL PENSION INSURANCE COMPANY
Which ESG issues and/or UN sustainable development goals (SDGs) are you looking to address in your investment portfolios and how are you delivering them?
As a minimum requirement, we expect investees to follow international norms, such as the UN Global Compact initiative. To make sure we don’t accidentally hold any companies that would be in violation of our minimum requirements, an external service provider screens our portfolio twice a year. When a norm violation is found, we start an engagement process rather than divestment. Investment operations also use ESG indices and ratings with an emphasis on selecting ESG products on the passive side too. We do not invest in tobacco, controversial weapons or companies dependent on coal when there is no credible plan for reducing the coal exposure.
We have multiple targets related to sustainability, climate change and share of SDG solutions within our portfolio.
What are the three biggest ESG challenges that asset owners face from an investment perspective?
- Lack of comparable and consistent data. There is no generally accepted framework how companies should measure and disclose ESG related data and the data is often unaudited, which makes reliable comparing of investees difficult. Methodology used by ESG rating providers vary as well. We welcome initiatives such as Task Force on Climate-related Financial Disclosures, Sustainability Accounting Standards Board and CDP [formerly the Carbon Disclosure Project] to create comparable data sets.
- Some of the ESG issues are difficult to quantify, for example human rights, and to find relevant metrics to measure the impact. Also, for the many measurable issues, such as the carbon footprint, there are different approaches on how to measure them, which makes valuation of ESG-related risks a challenging task.
- How to prioritise the multitude of issues an investor faces within ESG is a difficult task. We should be able measure our ESG impact and what is the ESG contribution to the returns and identify the most material affecting our portfolio in order to prioritise where our ESG resources are being utilised most efficiently.
How has Ilmarinen helped develop passive ESG options and can these products also benefit retail investors?
For an institutional investor like Ilmarinen, investing in passive index funds is an important part of diversifying investments. In terms of passive investment, there had been few ESG options available that were suitable for our strategy and style. Therefore, we started looking at opportunities to develop these instruments in collaboration with various partners.
So far, we have been involved in launching ESG exchange-traded funds (ETFs) in the US and Europe with an additional launch investment in Japan.
For us, it is important that the passive products are following the underlying benchmark closely and that the fees of these instruments are competitive. The same low fees apply to other investors as well, including retail investors. This makes the passive ESG products a real alternative to more traditional ETFs.
A report by the Transition Pathway Initiative (TPI) found that 25% of 274 of the world’s highest-emitting publicly listed companies do not report their own greenhouse gas emissions at all. What choices do you face as asset owners if this continues and how do you engage with big emitters across all sectors of the economy?
As an investor, we have a choice to not invest, to invest, to divest and/or to engage. In many cases involving our portfolio companies, we have decided to engage rather than divest. Sometimes we have evaluated that engagement will not be successful and, in these cases, we will divest and refrain from further investments. Besides individual engagement activities, our active ownership strategies include, for example, the following:
- We attend the Finnish annual general meetings, meet companies on a regular basis and use proxy voting for the major foreign holdings or in cases where we feel it is important for us to be an active owner.
- We are a member of Nordic Engagement Cooperation, which is a collaborative engagement network between some of the largest asset owners in the Nordics. We have been in dialogue with several non-Nordic companies and we plan to take a more proactive approach going forward, and company reporting on greenhouse gas could be a topic for engagement.
- We are a member of the Climate Action 100+ initiative.
Are you allocating to impact investments and if so, what type?
We look at impact investments the same as any other investment. We will consider impact investing only when their risk-return ratio is at the same level as an investment product without the impact component. We refer to our impact work through the transitional investing concept, where the aim is to create measurable societal impact whilst creating market returns.
We hold some green bonds, SIFs and companies providing solutions to SDGs as an example of transitional investing.
EDWARD MASON, HEAD OF RESPONSIBLE INVESTMENT, CHURCH COMMISSIONERS FOR ENGLAND
Which ESG issues and/or SDGs are you looking to address in your investment portfolios and how are you delivering them?
As faith-based investors, we have looked at what social and environmental issues are best aligned with the church’s mission. We have distilled these down into 13 sustainable investment themes, which align to each of the SDGs, bar SDGs 16 (peace, justice and strong institutions) and 17 (partnerships for the goals), which we identify as un-investable. We are now in the process of identifying where our portfolio delivers on these goals, and where we and our managers could do more to achieve these. This process will also help us to identify where we have had the most success and where we might seek to direct capital in the future.
What are the three biggest ESG challenges that asset owners face from an investment perspective?
- Our highest priority ESG issue is climate change. We support the Paris Agreement and it is a matter of great concern that implementation is not currently on track. Ethically, we are acutely conscious that the world’s poorest and most vulnerable will be hardest hit in a world of dangerous climate change. Financially, we believe that restricting warming to well below 2˚C will produce a safer investment environment. We support the agreement through engagement with policy-makers and companies, divestment from companies unable or unwilling to support transition, and investment in low-carbon opportunities.
- We believe that poor corporate governance is a threat to both society and investment returns. We vote our directly held shares rigorously. We require independent chairs; support gender-diverse boards; challenge remuneration schemes that incorporate excessive awards or fail to take account of ethical, environmental or social issues; and expect boards to ensure that ESG issues like climate change, corporate tax and audit quality are properly overseen.
- Finally, we are concerned that companies in the extractives sector should properly manage local environmental and social risks. If the sector is to retain investor support, it simply has to stop disasters like the appalling Brumadinho tailings dam collapse happening.
A report by the TPI found that 25% of 274 of the world’s highest-emitting publicly listed companies do not report their own greenhouse gas emissions at all. What choices do you face as asset owners if this continues and how do you engage with big emitters across all sectors of the economy?
We have very clear expectations of companies on climate change and co-founded TPI to ensure that we have a robust way of assessing corporate performance and fostering progress. Our expectations are that companies in sectors associated with high emissions take their climate change responsibilities seriously and align their businesses with the well below 2˚C goal of the Paris Agreement. TPI meets our needs by assessing both companies’ management quality on climate change and their future carbon performance. We have already divested from companies deriving more than 10% of their revenues from thermal coal mining or the production of oil from oil sands, and we have committed to our stakeholders that we will start to make further divestments in 2020 and that by 2023, we do not expect to remain invested in fossil fuel companies we assess not to be prepared to align their businesses with well below 2˚C.
We actively back both CDP and Climate Action 100+. While we have made important progress with companies like BP and Glencore, we know how far we are from where we need to be. It is a fiduciary imperative for investors to ensure that policy-makers and companies act on this unprecedented risk. Firm stewardship can be required, as we have found at Exxon where we had a shareholder resolution passed in the face of management opposition in 2017. There are still too many large asset managers who are not assuming sufficient stewardship responsibility and too many asset owners who are inactive.
Are you allocating to impact investments and if so, what type?
We have made several impact investments and are looking to increase our allocation, as long as these meet our normal risk/return criteria. Our existing impact investments are across asset classes such as private equity and debt, infrastructure and public markets, and across several sustainable investment themes such as healthcare, renewable energy and energy efficiency. Going forward, this broad remit across asset classes and impact themes will likely remain, though we are in the process of reviewing our existing portfolio, which will help shape our impact investment strategy for the future. We will target investments in both developed and developing countries.
Would you like to add anything?
As faith-based investors, we believe that exclusions play an important role in responsible investment. There are parts of the market where it is simply not appropriate for us to devote capital or take profit. This includes defence, tobacco, gambling, adult entertainment, non-military firearms, high interest rate lending, thermal coal and oil sands. While we actively advocate to our managers the incorporation of ESG analysis into investment decision-making and stewardship, these are issues where, for us, integrating ESG risks and opportunities just doesn’t go far enough. We think every asset owner should reflect on whether there are parts of the market that conflict with their purposes and that asset managers should be responsive to clients who need exclusions respected.
JOHAN FLOREN, HEAD OF COMMUNICATIONS AND ESG, AP7
Which ESG issues and/or UN sustainable development goals (SDGs) are you looking to address in your investment portfolios and how are you delivering them?
Our primary ambition is to contribute to a sustainable development of society, rather than creating financial outperformance. Hence, we try to focus on the ESG-strategies that can make a difference in the real economy. In our case, that is to be active universal owners and to invest in solutions to climate-related problems. In our listed equity portfolio, we have impact mandates dedicated to SDGs 6 (clean water and sanitation) and 13 (climate action). They are expected to deliver market rate returns whilst also contributing to solving problems outside the financial sector. We also have green bonds in the fixed income fund and a cleantech mandate in our private equity (PE) portfolio.
What are the three biggest ESG challenges that asset owners face from an investment perspective?
If I were to choose a theme, it would be evaluation, and there are three examples.
- A major challenge to all asset owners is physical climate risk. The economic effects if we fail to manage climate change effectively are going to be devastating. There has been a lot of focus on transitional risk in the financial industry, but it only materialises if we are successful in dealing with the physical risk. Since the chances of success don’t look too good right now, one can almost say that transitional risk is something to wish for. The problem with physical climate risk is that it still is virtually impossible to measure on a portfolio level, and estimates are largely mere speculations, so market pricing is far from efficient.
- Another challenge is related to impact investing. These investments are supposed to generate positive, measurable social and environmental impact alongside a financial return. Measuring financial returns is not problematic, but how do you measure your social or environmental impact in a global equities portfolio? There is a lot of activity going on in this area, and AP7 is trying to contribute, but there is still a long way to go before evaluation comes anywhere near the enthusiasm as the SDGs.
- The final challenge is evaluation of engagement. In our view, this is perhaps the most valuable contribution an owner can make, yet many investors still show limited interest due to the lack of measurability.
A report by the Transition Pathway Initiative (TPI) found that 25% of 274 of the world’s highest-emitting publicly listed companies do not report their own greenhouse gas emissions at all. What choices do you face as asset owners if this continues and how do you engage with big emitters across all sectors of the economy?
Transparency around sustainability in general and around emissions specifically have been on our permanent engagement agenda for many years. We are voting all of the 3,000 companies we hold and support resolutions on this topic. AP7 has also filed resolutions with companies like Exxon, ConocoPhillips and Chevron regarding quantified emissions targets.
‘Aiming for A’ is one of the important initiatives we took part in. It was a clear indicator that even in challenging sectors such as oil, gas and mining, companies and investors could find common ground and raise transparency ambitions.
Climate Action 100+ is a very promising initiative that has created a large degree of consensus among investors unlike any other in history, and a willingness to take responsibility and contribute to the necessary transition of global business. We are active signatories and have also launched a separate project with the 55 biggest European emitters regarding the corporate climate lobbying, which is a major global obstacle to the Paris Agreement. As a result, we filed resolutions for greater transparency around climate lobbying with five of the lagging companies. Our experience is that you need to combine several engagement tools with the companies to activate the full impact potential. Sometimes investors and company share the same ambitions and work as team, sometimes it’s more of a principal-agent situation with clashing interests. You must have a toolbox to be prepared to deal with both.
Are you allocating to impact investments and if so, what type?
In all our asset classes, we have some sort of ‘impact investments’ focusing on the ‘E’ in ESG: a clean tech mandate in the PE portfolio, green bonds in the fixed income fund, and in listed equity, we have a mandate dedicated to SDGs 6 and 13. This gives us a chance to finance companies that solve climate-related problems, but it also allows us to contribute to necessary development of impact metrics, measurement methodologies and indicators. The asset management industry is far from any agreement on how this should be done, but if asset owners, asset managers and maybe academia and organisations work together, I am quite sure this process will yield valuable results in the not-too-distant future.
GÃœNTHER SCHIENDL, CHIEF INVESTMENT OFFICER, VBV PENSIONSKASSE
Which ESG issues and/or UN sustainable development goals (SDGs) are you looking to address in your investment portfolios and how are you delivering them?
Generally, we don’t exclude (except for UN Global compact issues) but integrate ESG issues into our investment processes. In other words, ESG becomes an integral part of our decision-making processes. Depending on the asset classes, we have different aspects that we are focused on or prioritise.
In equities, we implemented an active voting process (the ‘G’ aspect) for our entire equity portfolio in 2017. Since 2016, we have been working on climate-related issues, and in January 2017, we changed the benchmark for our index fund to a low carbon target benchmark. In December 2018, we joined the UN PRI collaboration to exclude controversial weapon producers also from standard equity indices. Currently 90% of our external equity managers are UN PRI signatories.
In real estate, we have been investing in social infrastructure since 2011, and improved ESG policies at our respective managers. In private debt markets and infrastructure in general, we focus on ESG issues in the external manager selection.
What are the biggest ESG challenges that asset owners face from an investment perspective?
- Becoming compliant with the new European Sustainable Finance regulation (taxonomy, low carbon benchmarks, disclosure, reporting).
- Designing long-term transition strategies – while not losing the focus on daily asset management in highly challenging times.
- ESG in public debt markets is for various reasons more challenging to implement.
- Selecting preferred business partners (ESG ratings, index providers).
- Incorporating a modified climate change and ESG value chain down to the last element of the process chain.
- Data issues (measuring/estimating scope 2 and scope 3 CO2 emissions, highly different ESG scores from various agencies).
- Avoiding higher costs all along the investment value chain.
- Understanding the essentials of meteorology, geology and related natural sciences underlying long-term climate strategies.
A report by the Transition Pathway Initiative (TPI) found that 25% of 274 of the world’s highest-emitting publicly listed companies do not report their own greenhouse gas emissions at all. What choices do you face as asset owners if this continues and how do you engage with big-emitters across all sectors of the economy?
- Engage via UN PRI collaborations.
- Design long-term transition strategies that massively reduce the weighting of these stocks and exclude them at some point.
- Select low carbon target indices and respective index funds and/or ETFs. Some index providers do excellent data and index construction work. They should try to contribute to limiting climate change by broadening the availability of various types of climate indices, also by not increasing the costs of using indices and some index data – climate change should not be seen predominantly as a business case.
- Implement carbon reduction targets in your actively managed segregated accounts, select appropriate benchmarks, design respective strategies.
- Modify incentive structures and external manager pay, align with own targets and goals.
- Stock exchanges should make greenhouse gas reporting of listed companies mandatory and implement penalties if companies do not report.
Are you allocating to impact investments and if so, what type?
It is always a question of what you call ‘impact investing’ – the new European Sustainable Finance Taxonomy should help in defining a common understanding. Since 2015, we have implemented ‘ESG Momentum Strategies’ in a handful of our equities funds (segregated accounts). The strategy is to invest in those companies that have an ESG problem at the moment, but also have the potential, the will, the need and a change in governance structure to improve.
Would you like to add anything?
The EU Sustainable Finance Initiative (as part of the EU Action Plan to finance sustainable growth) with the major taxonomy components, low carbon benchmarks, disclosure and reporting is standing out worldwide because of its depth, comprehensiveness and ruthless efforts to prevent global temperatures from warming more than 2ËšC. All investors, advisers, consultants managing or consulting assets in Europe will be forced to develop and change.
We are a private pension fund, we need to generate sufficient high investment returns for our plan members, but we strongly believe that ESG integration can contribute to even better returns, and that we all have to make an active contribution to help achieve the Paris climate-change targets.
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