Jul / Aug 2009
* Chair for the day: Emma Hunt, Principal, Mercer
* Henry Boucher, Partner, Deputy Chief Investment Officer, Sarasin & Partners
* Christopher Flensborg, Coordinator, Capital Markets, SEB
* Mairead Hancock, Head of Client Services, EIRIS
* Will Oulton, Director of RI, FTSE
* Paolo Sardi, CEO, ECPI
* Penny Shepherd, Chief Executive, UKSIF
Chairman: How has the acceptance of the concept of Socially Responsible Investment (SRI) changed among institutional investors across Europe?
Hancock: I think it has come from a fairly niche background but over the last few years it has seen incredible growth. If you just look at something like the Principles for Responsible Investment (PRI) for example, only about 20 institutional investors had signed up back in 2005 and now we have over 250, and so every year SRI is becoming more acceptable.
Flensborg: I agree that we are seeing a lot of commitment to the PRI but I slightly disagree that investors are already there when it comes to SRI. I think they want to be there, and they are going in that direction but they are not fully aware of how to best approach it yet - a lot of people are still investigating.
Boucher: I think there has been a parallel shift as a lot of investors have moved away from the conventional asset allocation models they used in the past which were geographical silos, and they are becoming more global; and with that they are becoming more thematic and more prepared to look at the issues that are - in SRI terms - easiest to invest in. So, for example, renewable energy has been a growing theme.
Chair: Have others seen asset allocation as a trigger for evolution?
Sardi: Yes, because probably the concept of risk that needs be hedged is different and therefore the instruments and asset classes are changing for that reason.
Oulton: I agree that the acceptance of the concept of responsible investment has grown but I think there is still an issue around the deployment of that belief - in how do you implement and develop a strategy or a capital allocation approach within the boundaries of RI?
What we have seen is support from trade group initiatives where people can learn from other peoples' experience. Within that I think the environment has dominated the agenda over the last two to three years, and that has led to some relatively easy asset allocation decisions which tie back to some kind of environmental or climate related issue. I believe that with the political emphasis on environmental challenges at present, there is now more of an interest and awareness from investors in this theme as compared to the broader social themes, for example.
Hancock: I do agree that the main focus has been on the environment to date, but there have actually been some quite high profile funds which have pushed the boundaries even on the social side.
If you look at, for example, some of the national pension funds, particularly where they are looking at compliance with global rules, yes the environment is part of that agenda but social aspects such as labour rights, human rights and even quite complex issues like bribery and corruption are being looked at too. This includes some of the high profile funds like The Government Pension Fund of Norway, the Swedish AP funds, and France's FRR.
Flensborg: I would agree with your comment about climate - I think that when you are looking at the different ESG approaches, you see negative screening in relation to social aspects, but a proactive more positive approach to climate.
Shepherd: The issue of negative screening is a very interesting one. One of the challenges for our industry has been trying to move people away from the idea that RI is primarily about avoiding things; but even when it seems like that is finally accepted, you still get comments which start from an assumption that this is primarily about personal values. It is fascinating how persistent that perception is when the debate among leaders in the area is very much around managing social and environmental risk, and around the practical measures needed to shift to a low carbon economy rather than about personal values.
Chair: Looking at the pension funds or the nations that are leading the charge in RI, to what extent is it a reflection of the personal values, or the organisational values or even the national values, and to what extent is it driven by a business case /investment risk/opportunity?
Boucher: It depends on the political leadership and the political climate in a particular country - in those countries that have a long established green tradition you find that sustainability tends to be strongest, for example in Germany and German speaking nations.
We are now seeing it very high on the political agenda in most countries at a governmental level; and then filtering down through the state level investors; I don't see it hugely in local government but it is getting there and then hopefully it will reach the corporate.
Sardi: If I can bring the discussion to Southern Europe, in Italy, for example there is no engagement activity at all. The pension fund system is divided up into different types of pension scheme - closed and pre-existing - and they are all experiencing different levels of discussion on ESG, but none of them are considering engagement or active ownership. That might be the next thing that will be brought to the table, but it is not there yet.
Hancock: I think the quasi-State funds are in a bit of a different situation to non-State funds. For example, if you look at the Norwegian Government case, although it comes partly from an ethical perspective, they also don't want to be at risk of being complicit in any activity which they have signed a convention against, so they actually have a legal reason behind what they are doing; whereas for other funds it is more about business risk.
Shepherd: One very interesting UK example is the BP pension fund. Their interest in the area is driven in part by the values of BP and of the people who work for BP, but those are very much business values: thinking about the long-term and about the environment in which you operate. They are saying 'how do we take those business values that we are used to working with and that we see the benefits of and translate those over into how we run the pension fund?'.
Oulton: One positive today is that we do have a much more informed debate about what RI means. It is now a debate around asset allocation, around political and investment risk, and around investment opportunities. This is the case in many parts of the world now - from Australia, to Japan, and Europe and it is emerging in the US too. So I think we have got a sensible debate about what this means to the industry and the emergence of the investment consultants engaging in this process has been part of that development. In Spain for example, we have a partnership with the Spanish stock exchange, the BME, where we produce a socially responsible index, the FTSE4Good IBEX index. This initiative came as a response to government legislation for RI allocation in public pensions. It's this sort of action from debate that we need to see spreading across countries. Ten years ago we were in a very different place. Today we are an important part of the capital markets debate.
Hancock: But I think that is partly because people do believe that values have a value ramification.
Flensborg: Well this is essential, because the mandate at the end of the day is to earn money, so the challenge for product providers is to come up with products that fulfil the RI remit, at the same as delivering the financial return that the investors need.
Sardi: It is also an issue of track record - ten years ago we didn't have any track record; now we have different cycles and so there is an opportunity for even mainstream investors to measure the added value, the performance attribution related to the ESG screening, that is now a real history and not a back test.
Chair: Talking about cycles, we are in a very interesting place in our economic cycle and the full impact on pension funds and other institutional investors is really beginning to be felt. They have had time to reflect on the financial crisis, they have had a chance to consider what it means for them and they have also had to consider how they are going to manage their way through the next ten years which nobody is expecting is going to be easy. What roles or opportunities are there for RI and particularly responsible ownership during these next ten years?
Flensborg: I think the perception of how we have to act as investors or financial experts has changed, and we need to re-position our-selves and be much more aware of products and the impact we are having.
Chair: So what specific actions do institutional investors - from the asset owner's side and the investment manager side - need to have in place?
Hancock: I suspect that the asset owners are going to have to become a lot better at governance. At the moment some are abdicating responsibility by delegating whole-heartedly to the asset manager without really much in the way of checking or doing the due diligence around what their asset manager is doing.
There are services available that actually look at the resources that managers have in place and their capability and confidence in ESG, but that also monitor what they are doing - it is a pretty difficult thing for trustees to do on their own when many of them have limited experience and knowledge of ESG issues.
Flensborg: I think another big challenge will be finding out how to outsource or get guidance on ESG without having too much impact on the performance of the arrangements.
Shepherd: Over the last few years, we have seen significantly increased capacity in the investment consultants. That is now available to be drawn on; which is effectively a mechanism for sharing costs among pension funds.
But I think it is also important not to take too narrow a view of cost - governance is about adding value not adding cost; if it doesn't add value don't do it.
Hancock: The analogy I always use is that you wouldn't not insure your house, it is a cost that you are prepared to take because at the end of the day if there is a disaster you are protected; so while there may be an upfront cost, that cost is far worth it in the longer term.
Boucher: But if you are going to demonstrate that there is a cost in taking this approach, particularly now in this economic crisis, you have really got to be able to demonstrate that there is a benefit. I think you will find the finance director's world is a little bit more black and white than the green one we live in.
Shepherd: But we are surrounded by evidence that there is a cost associated with getting the governance wrong. I think we need to look at the lessons learned about the benefits of good governance in companies and translate that to the case for good governance by pension funds.
Oulton: Phillips is a good example of a company that has taken up a public position on linking its pension fund's investment strategy to the nature of the business of the organisation - putting a significant portion of assets from their pension funds into areas such as energy efficiency and renewable energy which are core businesses for that company.
Flensborg: We are seeing quite a few taking that approach at the moment all over Europe; again it comes back to the owners - it is not the managers but the owners of the funds that are much more proactive than the managers who at the moment just have a mandate to bring in returns and nothing else.
Boucher: In the current financial crisis, going back to the government point again, if you look at the huge fiscal stimulus that the governments are putting in place to compensate for the economic activity, a huge proportion of it has a green agenda. HSBC has estimated a figure of around 15% of total fiscal stimulus.
Chair: To go back to the sorts of tools pension funds could use, we haven't talked about active ownership and the role active engagement plays - what are the views from around the table?
Hancock: I think all too often governance is restricted to voting and I don't think that should be the case. For example, this current crisis has been about a lack of understanding around what is going on within investee companies; it has not been about whether risk management systems were in place but about whether they were good enough; and about whether the culture was open enough to identify all the risks. Perhaps there were too many people not caring to identify the risks as they were making so much money. So for me it is about more than just voting; you can use your vote but to just delegate that responsibility to a voting agency - although the voting agency is probably very good - is probably not giving you an insight into the real value of that company.
Oulton: Voting is part of the ESG integration process. It is still focused on certain issues and it is used for different means depending on what market you are in. We see a huge amount of voting activity in the US because of the relatively weaker shareholder rights environment there; it is difficult to say globally how important voting is as a practice - I think it is important but degrees of how important and influential it can be might be masked by the shape of corporate governance practices in different parts of the world.
Shepherd: The challenge for pension funds is about how you assess which investment managers are good at overseeing governance of companies as opposed to being good at stockpicking, and that you find a way to incentivise and select your fund managers based on both; at the moment too often you are selecting fund managers purely on the basis of their stockpicking skills or their ability to manage technically against a benchmark and you are expecting a vanilla governance service to be provided as an additional feature on top.
Chair: Should pensions funds pay extra for advice on governance?
Flensborg: We're back to the cost issue - the first question the asset managers will ask is 'is there a cost to this?' Because the asset managers don't have a mandate to consider RI issues, it is up to advisors and product providers like ourselves to present products with clever thinking behind them, meaning that the costs are included. And this might be indices; or it might be products like the green bond to secure a transparent and absolute return.
Chair: What brings sustainability mandates into the mainstream?
Sardi: I think it is becoming mainstream but only if you are able to measure and show the added value, and this is possible not only in relation to global equities or bonds but also alternatives. For example, we started screening hedge funds and fund of hedge funds in 2005 to improve the transparency around these products.
Boucher: I think there is a problem when it comes to taking steps into a new world - because it is not a mainstream issue yet, to get to the mainstream there has to be a stepping stone, and not enough institutions have even taken a small step yet in terms of issuing a specific mandate of any sort.
I know there is a body of thinking that says what should happen is that investment managers' entire investment approach should gradually become more sus-tainable, but I think this gradualism is very hard to define, particularly for the trustees. But if they can take even a small step many more people will do too and it will become mainstream. This first step is happening on a political level but it is not happening on the ground yet.
Shepherd: I would agree that a small allocation to start with into a variety of different investment opportunities is a very positive move and I think the way we are seeing sustainable investing spreading across asset classes is encouraging; for example, the level of interest in sustainable forestry seems to be moving rather rapidly.
Hancock: I do see some innovative asset managers who are not just thinking of having small niche products for clients but are actually thinking of introducing some level of sustainability across their entire portfolio and their entire investment process.
Chair: Certainly from our experience, we are seeing a shift among many pension funds throughout Europe in their asset allocation and it is at this point that they tend to look at alternatives.
Secondly, particularly with those investors that are signatories to the PRI, we are beginning to see them building the words 'sustainability' or 'ESG' into their mandates and we expect to see that continuing.
Flensborg: I think the UKSIF and the EUROSIF are having an extremely important role in guiding people in the right direction and making them feel confident about entering step by step - of course it can't all be done in one move.
Oulton: I agree it is going to be a step-by-step approach that is taken - I think it is unrealistic to expect the core portfolios of the majority of asset owners to be significantly changed to a sustainable investment strategy; I don't think there are many that would be brave enough to do that. So I think the core and sustainable investment satellite approach is perfectly reasonable for many funds and would be a big step forward - how these satellites are defined and developed can be from a range of things across an ESG spectrum. In addition, using tools such as indices where providers have already carried out the sustainability research, make this process much simpler for the investor.
Hancock: But while I agree mostly with what you are saying it can't just be business as usual - look at the mess we have created! I think we have to do something fairly radical and I think that needs to be across the board and that may be via engagement or via stock selection but I do think pension funds and asset managers do need to do something drastic.
Shepherd: Fundamentally, what we face is the need to re-allocate capital particularly from higher carbon uses to lower carbon uses, but also from uses that damage eco-systems to uses that protect eco-systems and so on; and pension funds as a major group of asset owners have to be one of the key drivers of that process rather than seeing themselves as passive within it, because they need to provide pensions not just now but in 2030 and 2050. That is when these impacts are going to be significant.
Chair: This sounds like governance setting framework. One of the areas where Mercer is doing a considerable amount of research is looking at how climate change can impact asset allocation from a strategic perspective, so looking at how climate change can impact different countries, different regions, different asset classes, and then try and build that in very much from the top down. We are inviting pension funds to engage in that process.