Top1000 PRI edition

SEPTEMBER 2016

A SPECIAL PRINT EDITION TO CELEBRATE THE PRI’S 10th ANNIVERSARY

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We go beneath the surface to get the clearest picture Integrating sustainability isn’t something we just dip into.

Why? Because sustainability is a key value driver. By asking the right questions, we identify ESG factors that can impact future performance. This enhances our approach to identifying long-term risk and reward potential. And that leads to better informed investment decisions. Surface facts alone don’t always reveal the best opportunities. Going deeper does.

To find out more visit robeco.com/sustainability LEADER IN INTEGRATED SUSTAINABILITY

Important information This publication is intended for professional investors.

Robeco Institutional Asset Management B.V. has a license as manager of UCITS and AIFs of the Netherlands Authority for the Financial Markets in Amsterdam.

EDITORIAL AMANDA WHITE

FINANCE INDUSTRY CAN’T ‘REST ON ITS LAURELS’ After nearly 10 years of reporting on sustainability, the finance industry is finally waking up to what is required if it is to be sustainable.

Amanda White

Sustainability is defined as the capacity to endure. Sustainability is not just the consideration of environmental or even social and governance considerations. It is not a negative screen. It is so much more than climate change, so much more than corporate engagement. Sustainability is the system and the ability to continue.

Princeton University professor and sociologist, Robert Gutman, said: “Every profession bears the responsibility to understand the circumstances that enable its existence.”

THIS IS NOT ABOUT TREE-HUGGING, BUT A SENSIBLE AND ROBUST INVESTMENT STRATEGY AND A LOGICAL, THEMATIC, HOLISTIC WORLD VIEW.

AMANDA WHITE is editor of www.top1000funds.com, the online news and analysis site for the world’s largest institutional investors.

As director of institutional content at Conexus Financial she is responsible for the content across all institutional media and events. She is responsible for directing the bi-annual global Fiduciary Investors Symposium series which challenges investors on investment best practice and aims to place the responsibilities of investors in wider societal and political contexts, as well as promote the long-term stability of markets and sustainable retirement incomes. She has been an investment journalist for more than 20 years.

This should be a call to action for the finance industry, which has rested on its laurels; it’s rested on its low barriers to entry, high fees and complex language that has created enduring principal/agent problems that restrict transparency and accountability.

All participants in the finance industry should take heed. Simply, if you want to endure then you should consider your role, the industry and its purpose, through a sustainability lens.

After nearly 10 years of reporting on sustainability, the finance industry is finally waking up. www.top1000funds.com is an investment publication. It covers broad issues relating to institutional investment including investment strategy and implementation, macro-economic conditions and asset-class-specific solutions.

We have been writing about sustainability since the publication’s inception in 2008, because we

see environmental, social and governance issues as a central theme for the world in which we live, both now and, importantly, in the future – and that’s true if you’re a pension fund member, a pension fund executive, a provider of service to that industry, or a company in which the industry invests.

This is not about tree-hugging, but a sensible and robust investment strategy and a logical, thematic, holistic world view. The finance industry is inward looking, it’s time to look out.

In this regard, I consider my job will be done when there is no ESG alpha but it is priced into markets and embedded in the process of managers and asset owners.

We are very proud to be partnering with the PRI on this publication to celebrate the achievements of the past 10 years, and challenge the industry to move forward.

This magazine also looks at big-picture issues such as the purpose of finance – which is not to make money, but to serve the real economy – the achievements of the PRI and the role institutional investors can play in financing solutions to global challenges such as climate change, social injustice, poverty and inequality.

In this issue we also highlight through case studies the asset owners that are leading the way in ESG integration – and how they hold managers to account on ESG will be a key development in the next 10 years. We celebrate asset owners, and believe that building strong buy-side organisations is the key to muchneeded change in the finance industry, change that will allow investors to focus investments on the long term, and better align decisions with the needs of their members and stakeholders.

In order to do this, asset owners need to take stock of their internal organisations, pay attention to governance and decision making, hire good internal teams, invest directly, reduce the number of external providers, integrate ESG into investments and be conscious of costs. All are issues of sustainability.

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C O N T E N T S ACCOUNTABILITY TAKES CENTRE STAGE FOR PRI Fiona Reynolds, managing director of the Principles for Responsible Investment, says accountability must be the defining force of the modern investment chain.

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PRI – THE JOURNEY SO FAR The principles were launched in April 2006 at the New York Stock Exchange. Since then the number of signatories has grown from 100 to more than 1500 and the PRI has played a defining role in changing the investment landscape.

REFLECTIONS ON THE PAST, EXPECTATIONS FOR THE FUTURE An interview with Jane Ambachtsheer, partner at Mercer and consultant to the UN through the development of the PRI on what the PRI has achieved so far, and where it can go from here.

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INVESTOR PROFILE: AP7 AP7 ensures its presence at every company’s annual general meeting and last year voted at 3000 AGMs and engaged with 440 companies on issues that ranged from raps on the knuckles around poor reporting, to 50 divestments.

INVESTOR PROFILE: ABP The chair of the investment committee of the Netherlands’ ABP, one of the world’s largest pension funds, Erik van Houwelingen, says responsible investment is not just a “nice to have,” but a “must have.”

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ADDRESSING DYSFUNCTION IN THE FINANCIAL SYSTEM Co-author of the PRI, Colin Melvin, says despite the emerging responsible investment industry there is a danger that institutional funds management will continue to invest as it has done, in a manner largely unchanged for 20 years.

RESPONSIBLE OR REGULAR INVESTMENT? Else Bos, chief executive of PGGM, challenges all in the investment industry and within the PRI to think outside their current frameworks and develop new tools and ways of thinking.

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INVESTOR PROFILE: USS The USS’s commitment to responsible investment is enshrined in the fund’s statement of investment principles, along with its commitment to the UK Stewardship Code and the UN-backed PRI.

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THE PRI AT 10: LOOKING TO THE NEXT DECADE AND BEYOND From humble beginnings the PRI has come a long way. But it’s only just begun. Fiona Reynolds, managing director of PRI reflects on the past 10 years and looks to what is possible in the next 10 years.

THE STEPS OF INTEGRATION No longer an add-on, ESG is being integrated into policies and investment strategies by innovative pension funds around the world. This story outlines how some of the leading funds are integrating ESG.

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INVESTOR PROFILE: EAPF At the heart of the Environment Agency Pension Fund’s responsible investing principles is to apply long-term thinking and seek sustainable, well governed assets.

FUNDAMENTALLY REWIRING FINANCE The better aligned a society’s financial institutions are with its goals and ideals, the stronger and more successful the society will be.

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THE DECADE OF FIDUCIARY CAPITALISM Developing coherent investment beliefs is much of the battle when it comes to sustainable investing. The next decade should be a time to move from ESG green to sustainability evergreen.

ADVERTISING Business development manager Karlee Samuels Head of marketing Kathrin Alexander Subscriptions Nahrain Gabriel Advertising enquiries +61 2 9227 5719 PRINTER Special T Print

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INVESTOR PROFILE: WESPATH The fund that manages United Methodist Church’s $20 billion has been practising environmental, social and governance principles for 108 years.

INVESTOR PROFILE: VICSUPER How VicSuper’s application of the natural capital declaration is helping it manage long-term risk in agricultural investments.

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INVESTOR PROFILE: SWEDFUND Scrutinising every aspect of a portfolio company before investing is costly and time-consuming, but Swedfund’s due diligence pays off as it invests in the most risky of markets.

ESG INTEGRATION REQUIRES BOARD-LEVEL ENGAGEMENT For the success of integrating sustainability into fiduciary duty, it must go further and address the issue of fiduciary duty on the company side as well, and asset owners and managers must engage with company boards of directors.

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EDITORIAL Editor and director of institutional content Amanda White amanda.white@top1000funds.com Managing editor Keith Barrett Journalists Sarah Rundell Dan Purves Sub-editor Susi Banks Art director Kelly Patterson Graphic designer Suzanne Elworthy Chief executive Colin Tate

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www.top1000funds.com is the news and analysis site for the world’s largest institutional investors. Focusing on investment strategy and implementation, it is populated by original news stories, case studies and research that relates directly to the work of investment professionals at pension funds, endowments and sovereign wealth funds. One of its defining characteristics is truly global content that focuses on the investment strategies, portfolio construction and implementation techniques used by institutional investors. The publication has been covering issues of sustainability since its inception nine years ago.

Conexus Financial is a privately-owned global media and events business specialising in financial services. Its mantra is “A catalyst for a more informed world” and its products seek to promote best practice in order to improve retirement outcomes around the world. Globally, its Fiduciary Investors Symposium series is recognised as a leading event for asset owners to discuss investment strategy and implementation, including the latest thinking relating to asset allocation, risk management, beta management and alpha generation. It has a clear focus on issues relating to fiduciary duty and long-term investing.

REFLECTION FIONA REYNOLDS

ACCOUNTABILITY TAKES CENTRE STAGE FOR PRI FIONA REYNOLDS, MANAGING DIRECTOR, PRINCIPLES FOR RESPONSIBLE INVESTMENT (PRI) SAYS ACCOUNTABILITY MUST BE THE DEFINING FORCE OF THE MODERN INVESTMENT CHAIN. As the PRI turns 10, it’s an opportune time to take stock, and to also look ahead to what needs to be done to drive responsible investment forward over the next decade.

In terms of priorities for the coming years, one of our main focus points is on strengthening signatory accountability to the six principles. A decade on from the PRI’s launch at the New York Stock Exchange, with former United Nations Secretary General Kofi Annan, we fully appreciate that more work must be done to ensure signatories are accountable to the principles they have signed and made a public commitment to.

We also recognise that the PRI must do more to assist signatories in making progress in responsible investment and to better differentiate between signatories that are at an early stage from those who are leaders. With such a large and diverse signatory base, a one-size-fits-all approach is no longer viable.

THE ‘HEART’ OF INVESTMENT

Accountability should of course be at the very heart of investment.

Accountability must be the defining force of the modern investment chain with company management accountable to shareholders; investment managers accountable to asset owners and asset owners accountable to their beneficiaries.

Accountability is also at the heart of responsible investment. The last of the six principles is, some argue, the most important because it requires signatories to report on their activities and the progress they are making towards implementing the principles.

For a voluntary initiative such as the PRI, this disclosure is vital. The danger posed to the mission of the PRI is that signatories can hide behind their signatory status, and make little or no progress towards implementing responsible investment.

Despite public reporting requirements, there is some evidence that this is taking place.

When we were looking to develop our 2015-18 strategic plan, a significant number of asset owners questioned the commitment of some investment management signatories to responsible investment. They noted that, even after several years of membership, some had not put responsible investment policies, procedures or resources in place. Some asset owners said they no can longer select managers purely on the basis of whether they are a PRI signatory.

On the other side of the spectrum, there are some investment managers and service providers who have invested significant resources in developing responsible investment capacity, but feel they aren’t being recognised, or rewarded, by asset owners in the mandates process for their commitment and performance. This makes it difficult to defend the investments made, or to argue for increased resources.

There is strong support among signatories for the PRI to delist signatories who have no real commitment to integrating environmental, social and governance (ESG) factors into their investment processes, or behave in ways that are contrary to their publicly

stated commitments to responsible investing. This was borne out from the findings in our recent consultation on accountability and diversity, with 71 per cent of signatories saying they were in favour of delisting to remove chronically underperforming signatories from the PRI.

WITH SUCH A LARGE AND DIVERSE SIGNATORY BASE, A ONE-SIZE-FITS-ALL APPROACH IS NO LONGER VIABLE. 10-YEAR BLUEPRINT

When it comes to accountability, it is important for the PRI to continue supporting and encouraging asset owners to take the lead. Asset owners sit at the top of the investment chain. They ultimately control how investments are managed, they dictate how much emphasis is given to responsible investment practices when selecting, appointing and monitoring managers; which is why we have introduced a whole new team at the PRI dedicated to asset owners.

To mark our 10-year anniversary, the PRI will be producing a new 10-year blueprint to help shape the future of the industry, and our priorities over the next decade. A key component will be addressing accountability both within the signatory base and the broader investment system. As far as responsible investment has come in the last decade, there is still far much more to do.

FIONA REYNOLDS is managing director of Principles of Responsible Investment. She has more than 20 years’ experience in the pension sector, working in particular with the Australian government and spent seven years as chief executive at the Australian Institute of Superannuation Trustees. She has a particular interest in retirement outcomes for women. She serves on the councils of the International Integrated Reporting Council (IIRC), Tomorrow’s Company, the Global Advisory Council on Stranded Assets at Oxford University and the Business for Peace Steering Committee.

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BON ANNIVERSAIRE PRI! Matt Christensen Global Head of Responsible Investment AXA Investment Managers

AXA Investment Managers (AXA IM) was among the first to sign the PRI initiative when it was launched in 2006. Since the PRI’s launch, we have seen socially responsible investment (SRI) develop from a niche status into a true investment theme. As the journey continues, we are confident that the PRI will evolve to foster further behavioural and cultural changes in the investment community.

At AXA IM, we believe that RI can be materially relevant across the investment spectrum. We have come a long way since our first mandate to integrate specific social criteria in 1998. Today, we are progressively integrating ESG criteria into our investment process across asset classes, including; equities, bonds, property, high-yield, and alternatives.

This is because we firmly believe that incorporating ESG analysis leads to more effective investment solutions that create long-term, sustainable value for our clients.

There has been no shortage of situations highlighting the importance of RI in recent years. The Deepwater Horizon explosion, the subprime crisis, the Volkswagen emissions scandal, the rise of antibiotic resistance, and aggressive global tax avoidance schemes - these issues have palpably illustrated that we can no longer ignore non-financial criteria when investing.

Building on the strong gains already made, RI has continued to develop and expand. For example, we are now seeing the growing ascendency of impact investing. These investments focus on projects with a measurable positive impact on society. Driven by a ‘double bottom line’ of addressing societal challenges as well as financial returns, these investments might include companies committed to reducing their carbon footprint or those that improve access to healthcare.

While the importance of RI is clear, many practical questions remain for investors. Does the integration of environmental, social and governance (ESG) factors detract from equity performance? Can investors strengthen a credit portfolio with ESG integration? Is there a trade-off between financial and social returns?

These are some of the topics we have explored with the financial community.

At AXA IM, we have pioneered impact solutions with themes such as education, healthcare and financial inclusion. By harnessing the power of capital and directing it towards ‘real issues’ faced by society, we have moved beyond simply filtering ESG risks or an RI ‘labelled’ fund. Impact is about actively investing in positive stories and steering capital towards greater utility.

The last decade has been a journey worth celebrating for both the PRI and AXA IM. The continued development of ESG will bring new challenges and opportunities. We look forward to working within the financial community to address the emerging issues ahead, such as:

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expanding the scope of fiduciary duty to include ESG considerations, the avoidance of dilution or ‘greenwashing’ of SRI investments, the economic and social consequences of technology’s evolution and automation in the workforce, simultaneously considering E, S and G factors, exemplified by companies failing to pay the minimum wage somewhere along its supply chain

The investment industry has progressed from the era of ethical investing to one of ESG integration and mainstreaming. As we advance further in the age of impact investing, we are confident that adopting sustainable investment solutions will contribute to a more promising future for all, far beyond the next 10 years.

Find out more about the future of investing https://www.axa-im. com/en/responsible-investment Follow us on Twitter @AXAIM and LinkedIn about #ResponsibleInvestment, #RI, #ClimateChange, #SRI, #MattChristensen and the events we’re attending.

Not for Retail distribution: This document is intended exclusively for Institutional/Qualified Investors and Wholesale/Professional Clients only, as defined by applicable local laws and regulation. This communication is for informational purposes only and does not constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services and should not be considered as a solicitation or as investment, legal or tax advice.

Opinions, estimates and forecasts herein are subjective and subject to change without notice. This material does not contain sufficient information to support an investment decision. This communication is issued by: AXA Investment Managers UK Limited, which is authorised and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 7 Newgate Street, London EC1A 7NX. In other jurisdictions, this document is issued by AXA Investment Managers’ affiliates in those countries.© AXA Investment Managers 2016. All rights reserved.

Design & Production: AXA IM London Corporate Communications 20801 08/16

From its inception, the Principles for Responsible Investment (PRI) has been one of the integral global initiatives in establishing the concept of Responsible Investing (RI) as a key tenant in mainstream asset management.

PRI THE JOURNEY SO FAR

THE JOURNEY SO FAR IN EARLY 2005, THE THEN-UNITED NATIONS SECRETARY-GENERAL KOFI ANNAN INVITED A GROUP OF THE WORLD’S LARGEST INSTITUTIONAL INVESTORS TO JOIN A PROCESS TO DEVELOP THE PRINCIPLES FOR RESPONSIBLE INVESTMENT. A 20-PERSON INVESTOR GROUP DRAWN FROM INSTITUTIONS IN 12 COUNTRIES WAS SUPPORTED BY A 70-PERSON GROUP OF EXPERTS FROM THE INVESTMENT INDUSTRY, INTERGOVERNMENTAL ORGANISATIONS AND CIVIL SOCIETY. THE PRINCIPLES WERE LAUNCHED IN APRIL 2006 AT THE NEW YORK STOCK EXCHANGE. SINCE THEN THE NUMBER OF SIGNATORIES HAS GROWN FROM 100 TO MORE THAN 1,500 AND THE PRI HAS PLAYED A DEFINING ROLE IN CHANGING THE INVESTMENT LANDSCAPE.

APRIL 2006 The PRI initiative was launched

OCTOBER 2006 A collaborative engagement platform – the PRI Clearinghouse – was launched

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JANUARY 2007 The principles were put into practice with a dedicated implementation database

JUNE 2007 The First Report on Progress was published

APRIL 2008 The PRI Small Funds Initiative to support signatories of all sizes was created

NOVEMBER 2008 The first regional network in Brazil was established

MARCH 2009 An eight-point plan to recover from the global financial crisis was created

APRIL 2010 Bribery and corruption through collaboration was targeted

NOVEMBER 2009 The Sustainable Stock Exchange Initiative was convened

DECEMBER 2010 The largest externalities via Universal Ownership were addressed

JANUARY 2011 The principles for inclusive finance were launched

SEPTEMBER 2011 With the European Commission there was a focus on building investors’ ESG capacity

PRI THE JOURNEY SO FAR

APRIL 2012 Policy and research to overcome barriers to a sustainable financial system

DECEMBER 2012 ESG risks in private equity transactions were assessed

FEBRUARY 2013 Integrating ESG into manager selection to improve alignment for asset owners

OCTOBER 2013 A new Reporting Framework was launched

MARCH 2014 Improving fracking disclosure via a $6 trillion engagement

SEPTEMBER 2015 Fiduciary Duty in the 21st Century was launched

SEPTEMBER 2014 The PRI Academy was launched to take RI training to the world

DECEMBER 2015 The PRI attracted $4 trillion to the Montreal Carbon Pledge

OCTOBER 2015 The US Department of Labor published clarification on fiduciary duty, opening the door for more consideration of ESG

NOVEMBER 2015 The PRI launched a new guidance document on engaging with companies on corporate tax issues

JANUARY 2016 PRI board chair Martin Skancke was appointed to the Task Force on Climate-Related Financial Disclosures

APRIL 27, 2016 The PRI officially celebrated its 10-year anniversary

MARCH 2016 The PRI published a document on how asset owners can drive responsible investment

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COLUMN JANE AMBACHTSHEER

REFLECTIONS ON THE PAST AND EXPECTATIONS FOR THE FUTURE Interview with Jane Ambachtsheer, partner at Mercer and consultant to the UN through the development of the PRI.

JANE AMBACHTSHEER BIO

Jane Ambachtsheer is partner and global head of responsible investment at Mercer Investments.

She is responsible for leading Mercer’s responsible investment business, and advises investors in North America, Europe and Asia Pacific. She was consultant to the United Nations through the development of the Principles for Responsible Investment.

She acts as a North American advisor to the Carbon Disclosure Project and sits on the investment committee of the Toronto Atmospheric Fund.

She is Adjunct Professor at the University of Toronto.

Has the PRI evolved in the way you thought it would?

Looking back, the PRI has gained more traction than I would have imagined at the start. Eleven years ago, the field of sustainable investing was very niche, and the project could have gone either way. There was a lot of negotiation around the actual text of the principles, but, looking back, the painstaking work of actually getting it right seems to have paid off.

I think the beauty of the principles is that they are both simple, and transformative. It is important not to underestimate the fundamental importance of having established the principles in the first place. To me, the PRI connects the world of finance with the real economy and provides a consistent framework through which signatories can address ESG (environmental, social and governance) considerations across the investment process.

Nothing like this existed before their launch.

What was it like to coordinate the development of the principles?

The process was both chaotic and straightforward.

While there were many drafts circulated – we nailed the concept and structure of the approach during the first meeting.

Many great people were involved in the PRI’s development. The UNEP FI team – led

by James Gifford – were the key drivers, along with UN GC. Mercer played the supporting role of facilitating meetings, creating drafts, capturing feedback, helping to navigate various negotiations. Among the founding asset owner signatories, there were a number of particularly supportive and engaged senior investment professionals committed to ensuring the initiative was a success. The combination of these diverse forces enabled a great result.

Working on the PRI was the most stressful – but exhilarating and rewarding – project of my career.

What do you think have been the PRI’s more important accomplishments over the past 10 years?

We can judge the PRI’s impact through its direct impact and indirect influence.

The direct impact relates to the number of signatories, and their tangible progress over the

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years measured, through the PRI assessment reports, the output of various work streams and PRI led or supported engagements. At Mercer, we are constantly approached by asset managers that want to talk about their approach to integrating ESG into a specific investment process or asset class.

The indirect impact is just as important. The momentum behind the PRI has been a driving force in ‘normalising’ the investment industry’s focus on ESG factors. This process is still underway, but I’m confident that we would be much further behind if we didn’t have the PRI as a central framework.

What do you think that the PRI will look like in 10 years’ time?

We have seen a lot of great ESG developments recently, including more initiatives launched.

This can be overwhelming – even for those of us specialised in responsible investment, and especially for investors new to ESG issues. It is important for the PRI to drive efficiencies in navigating this complex landscape and provide a central focal point for investor ESG activity.

There are three frontiers where it can serve signatories on this front: 1 | The PRI can play a clearinghouse role for ESG-related initiatives within the investment industry. We have seen some great collaboration among the PRI and the global investor groups on climate change, for example.

2 | The PRI should build connections to mainstream investment groups and associations to strengthen their focus on ESG, such as the CFA Institute.

3 | The PRI can serve as a point of contact for relevant initiatives and developments outside the investment industry, such as the sustainable development goals and the Paris Agreement.

Achieving this will be no small feat. The ‘ask’ is complicated; the PRI’s global nature and multifaceted signatory structure is complicated; collaboration is complicated. But, where there is a will, there’s a way. The PRI has achieved a tremendous amount in a relatively short period of time. We have the masses with us, and we know our direction of travel. The question now is how far can we go? I’m optimistic.

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WHAT IS IFM INVESTORS’ RESPONSIBLE INVESTMENT STORY? We signed up to the PRI in 2008, so we were one of the early adopters in the Australian context.

We are very proud of our long heritage with regards to the UN PRI and our active involvement.

But for us the philosophies behind the PRI even predate that. We’ve had infrastructure assets for around 20 years – which is about the age of our business – and when we look back some of those early assets we purchased and the benefits we’ve been able to make with regards to the environment scale, the social scale or even the governance scale, those philosophies are part of our DNA.

IFM EARLY ADOPTER OF PRI IN AUSTRALIA Chris Newton, executive director of responsible investment at IFM Investors, talks about what the firm has achieved on this front and what its plans and hopes are for the future.

HOW HAS THIS BEEN APPLIED PRACTICALLY? We look at the Responsible Investment process in terms of due diligence, stewardship and an active ownership model. One clear example of that is the Northern Territory airports that we own.

Recently with our active management program there, we spent close to $19 million to responsibly develop the assets. $6million of that was at Alice Springs to put in new solar panels as, obviously, it’s very sunny in central Australia. But at the same time a sheltered car park was needed, so we upgraded a car park with solar panels on top – a very simple solution.

Now 90 per cent of Alice Springs Airport is powered via renewable energy. This theme extends to Darwin Airport where a $13 million investment was recently made, again for solar panels. Now about a third of the airport is powered from solar energy and the cost savings each year are around $2 million. It is a fantastic way to integrate an environmental outcome, offset carbon emissions, deliver cost savings to enhance long-term value and provide a great customer experience.

A third example, that is bit more abstract, is the refurbishment and return of the historic Water Clock Tower to Southern Cross Station in Victoria.

We invested $1.3 million to refurbish the Water Tower Clock – which is about 130 years old and had been abandoned in someone’s backyard – and brought this forgotten heritage back to the station.

Not only is it aesthetically pleasing for the tens of thousands of people who go through the train station, it also generates revenue through some unique advertising signage that is attached to it.

Those are just a few examples of our active management where we look for opportunities both to increase the value of the asset, but also to bring benefits to the community or to the environment.

WHAT ARE THE RESPONSIBLE INVESTMENT PRIORITIES FOR THE BUSINESS OVER THE NEXT SIX TO 12 MONTHS? One of the priorities is the continuation of the cultural aspects of responsible investment by integrating a strong capability development program.

Secondly, we are focused on publishing new reporting around a responsible investment charter, where we can clearly, succinctly and transparently inform the market of what our values are as a business and how we approach responsible investment.

The third, which is longer term, is around asset management and how we actively engage the executives at some of our assets to drive greater community linkages; we are particularly focusing on the ‘S’ part of ESG here.

We are long-term asset holders and therefore we are long-term partners with the community.

We look at how we can continue to invest in our assets to support local economies, local jobs, better supply chain and reduce the impact on the local environment.

ARE THERE ANY FUTURE TRENDS YOU SEE THAT IFM BELIEVES ARE CRITICAL TO ESG? Fundamentally, it comes down to a greater demand for responsible investment practices.

That’s really being driven by people who are putting their money into our pension fund, around the world. They expect fund managers to be investing in a responsible manner.

Millennials are now the greatest percentage of the US workforce and continue to grow.

All the research statistics indicate they have a much greater demand for socially responsible investments. That demand is driving the investor companies to enforce it. This will mean a greater need for transparency for what we’re doing as responsible investors and therefore how we report on it and measure it. n

COLUMN COLIN MELVIN

ADDRESSING DYSFUNCTION IN THE FINANCIAL SYSTEM COLIN MELVIN BIO

Colin Melvin is global head of stewardship at Hermes Investment Management; he is also founder and chair of Hermes EOS, the stewardship and advisory service for large institutional investors. He was co-author of the Principles for Responsible Investment and is a board director and the chair of its finance audit and risk committee. He is chair of The Social Stock Exchange and a business mentor at The Prince’s Trust.

The views and opinions contained herein are those of Colin Melvin, global head of stewardship, Hermes Investment Management, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.

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Despite the emerging responsible investment industry there is a danger that institutional fund management will continue to invest as it has done, in a manner largely unchanged for 20 years.

As an original board member, chair of its investor group and co-author of the Principles for Responsible Investment, I am pleased to reflect on its successes over the decade since its launch in 2006.

These include creating a global community of like-minded investors, with local networks to support signatories, providing forums for peers to share insights, facilitating joint corporate and regulatory engagements, developing policy and best practice advice on different asset classes, developing and monitoring standards, providing training on responsible investment, and sponsoring academic work.

However, the greatest success of the PRI is the now widespread and still growing recognition of the need for change, which is for greater responsibility and attention to sustainability by the investment industry. The significance of this achievement should not be underestimated, for if we are to change, then a realisation of this need is a fundamental first step.

However, we have much work still to do.

When I started in the investment industry some 22 years ago, I worked with intelligent and insightful people undertaking the relatively straightforward task of analysing a narrow set of historic financial information and trying to predict what was going to happen in the next short period.

Such an approach did not admit a systematic consideration of what are now known as environmental, social and governance (ESG) factors, nor did it support consistent and impactful stewardship. Despite all our efforts, and much attention to the symptoms of the dysfunction in financial markets, most of our investment management colleagues continue to behave this way.

Indeed there is an emerging danger that the nascent responsible investment industry is becoming an apologist for institutional fund management, enabling it to continue to invest in a manner largely unchanged for over 20 years.

It is as if we realise that we need to change but are forced to keep investing the way we currently do.

If this is the case, then there are two key measures we must take in order to address the dysfunctions in the financial system. These are: lengthening timeframes, and participating in policy debates as

they affect investment activity. This is to facilitate both an incorporation of a broader set of factors into investment decision-making and a change in the conditions under which we invest, to enable a greater alignment with the needs of the economy, society and the environment.

INTERACTING ENTITIES

What is required is a change in mind-set, away from a short-term transactional focus to a longer-term relational one. From supposing a finite wealth environment to one where we are creating wealth together, recognising and realising the benefits of our interdependence.

As investors in real assets, such as listed companies, we have an opportunity to promote their strong relationships with stakeholders to our common benefit. This change recognises that the entities in which we invest interact, and that costs externalised by one company may be picked up by another in our portfolios.

Asset owners have the opportunity to develop strong, trusting and lasting relationships with their investment managers; recognising their influence as clients of the industry and the opportunity with their managers to co-create a sustainable future, lengthening timeframes, measuring performance appropriately and aligning interests through welldesigned incentives.

We can also promote greater professionalism within our industry, recognising that in situations of asymmetrical information, we need to look after our beneficiaries and clients, putting their interests before our own.

In lengthening timeframes, the integration of ESG factors will occur naturally, and in those areas where it does not, we need a coordinated industry response, pushing for policy measures to address systemic concerns, such as climate change and corporate tax avoidance. We will thus consider the impact of our investments, in their selection and our behaviour as owners.

For the now 1500 signatories to the PRI, with aggregate assets under advice of over $60 trillion, we find ourselves at a historical moment, a point of inflection where our actions can either support sustainable development or undermine it.

COLUMN ELSE BOS

RESPONSIBLE OR REGULAR INVESTMENT?

In five to 10 years’ time what we currently call “responsible investment” will just be considered “regular investment”.

ELSE BOS BIO

Else Bos is chief executive of the €188 billion ($201 billion) Dutch pension fund, PGGM. She was a board member of the PRI from 2008-2014. She sits on the member supervisory board for Emory University, Sustainalytics Holdings, and Isala Klinieken, and was the deputy chair of the supervisory board of Stichting Waarborgfonds Eigen Woningen from 2010-2015. She is a board member of the Pacific Pensions Institute.

Responsible investment is here to stay.

It has seen a massive growth over the past decade and the PRI has played a pivotal role in that development. The PRI has inspired many individuals and institutions in the past 10 years to stand up and change their thinking. The PRI has brought investors together and started a movement that cannot be stopped. What we call responsible investment now will be “regular” investment in five to 10 years’ time. As such we will no longer speak about responsible investment but simply about investments; investments 2.0 that is.

As a pension investor we need to generate good financial returns for our beneficiaries. We are long-term investors and we need an economy that flourishes, is sustainable and is free from big shocks.

I believe that as investors we need to contribute to the UN Sustainable Development Goals and put them in the centre of our thinking. They provide us with a great, widely recognised, framework that can easily be communicated among professionals and pension fund beneficiaries.

I am also convinced that a circular economy will help us make good financial and sustainable returns in the long run. A circular economy, an economy in which waste is reduced to an absolute minimum, is a natural, and much needed, next step.

The dialogue between investors and corporates also needs to improve further. Over the years, the PRI clearinghouse has been instrumental in facilitating this dialogue. Going forward companies and investors should seek more systematic, forward-looking, and intensive collaboration in order to make the fundamental changes that our society, the global economy and the world as a whole require.

FIRST, DO NO HARM

Sustainability, or as the PRI calls it, environmental, social and governance (ESG), encompasses risks and opportunities to investors. Through the development of tools and by facilitating the collaboration between, and learning of, investors, the PRI has contributed tremendously to the incorporation of material ESG factors into the investment decisions by the investment industry.

However, I believe there is more than only materiality. I think that as investors, we have to prevent harm, also in situations where this is not (yet) material, and that the steering power of capital is paramount in doing so.

The steering power of capital brings along opportunities and responsibilities. Opportunities are found in what we call investing in solutions. This is about selecting investment opportunities that bring both strong financial returns and strong positive societal impact. By setting challenging targets, institutional investors take responsibility.

To this end, investors will have to develop tools to measure the impact and will be held accountable for creating a positive impact. We have collaborated with several universities (among others Erasmus University Rotterdam, Wageningen University, and Harvard University), and other investors in doing so. We are not there yet and the measurement tools need further development.

As I strongly believe that the industry as a whole will benefit by using standardised impact measurement metrics, we are inviting all PRI signatories to work together on this journey.

THINKING OUTSIDE THE ‘FRAMEWORK’

As a member of the financial industry we also have a responsibility to look at the financial sector as a whole and what our role and responsibility within the system is. The investment industry has developed a paradigm in which each and every deviation of the benchmark is considered to be (too) risky.

I think we need a new theory for investments that is: (i) more focused on long-term sustainable returns, (ii) puts more emphasis on absolute return, and (iii) develops new thinking about what real risks are.

We need a financial system that is diverse. We need a system with both short term traders and long term investors. In order to get to this system, regulators should allow for more diversity in their regulatory frameworks. I see a growing “group think” causing insufficient diversity and inability to absorb shocks.

Diversity makes the system more resilient.

There is a clear need for leadership from each and every one of us to develop a new “mental” framework, a new compass to guide us to a more resilient, diverse and sustainable financial sector.

I would like to challenge all in the investment industry and within the PRI to think outside their current frameworks and develop such new tools and ways of thinking. Through the success of the PRI over the past decade we have shown we can do it and I am certain we can do it again.

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INVESTOR PROFILE AP7

AP7 COMMUNICATES ITS ESG PASSION AP7 ensures its presence at every company’s annual general meeting and last year voted at 3,000 AGMs and engaged with 440 companies on issues that ranged from raps on the knuckles around poor reporting, to 50 divestments.

BY Sarah Rundell

The SEK261 billion ($30 billion) Swedish buffer fund AP7 has a global reputation for its proactive environmental, social and governance (ESG) strategy, defined by persistent engagement. The fund cajoles and pressures investee companies in every corner of the globe to comply with international treaties and conventions signed by the Swedish government, from climate change to child labour and corruption, using the threat of blacklisting to affect change.

AP7 comprises an equity fund and fixed income fund with beneficiaries’ allocations shifting between the two as they approach retirement. The bulk of the equity portfolio sits in a passive allocation tracking the MSCI ACWI, that provides around 95 per cent of the fund’s returns.

“Rather than try and find winners, we work with the whole market and all the problems that market contains,” explains

IN EUROPE SHAREHOLDER RESOLUTIONS ARE SEEN AS A LAST RESORT, A BIG GUN TO USE AT THE END, WHEN IN FACT THEY COULD START THE PROCESS.

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Jo h a n F l o ré n

INVESTOR PROFILE AP7

Johan Florén, head of communications and ESG at the fund which he joined in 2009 from a communications role in the private sector.

“We don’t pick companies that we think are superior and then avoid others: we do quite the opposite,” he says.

It’s a daunting task, given the index has 2,476 constituents, holds companies from 23 developed markets and 23 emerging markets, and covers around 85 per cent of the global investable equity opportunity set. Yet AP7 ensures its presence at every company’s annual general meeting (AGM), voting at 3,000 meetings in 2015.

“We vote if there is a specific topic we think we can improve,” says Florén.

Pressure for change is ratchet up via direct contact with the company through “a meeting, phone call or video conference.”

Last year AP7 engaged with 440 companies on issues on a spectrum that ranged from raps on the knuckles around poor reporting, to 50 divestments.

“We sold the shares and published all the details in our annual report,” says Florén.

“We never set out to sell stocks within the index and blacklisting is reserved only as the ultimate sanction.”

BLACKLISTED FOR CHILD LABOUR

He points to the success of the strategy, with examples like the fund’s divestment from Nordic paper manufacturer Stora Enso last year, blacklisted over using child labour in Pakistan. Since then the company’s efforts to improve have impressed.

“It won’t rid Pakistan of child labour, but Stora Enso is working very actively,” he says.

“We keep companies on our blacklist for five years, although if a corporation works proactively to deal with the problem, we will reinvest.” Yet Florén also sees the

limitations of engagement, particularly its slow progress.

“We work with issues for a long time but there is an expectation for short-term results in ESG; how you deal with this is one of the enduring challenges.” It is also a strategy that can simply hit a brick wall, leaving no option but divestment, something he ultimately sees as failure.

“Some companies have no interest in engagement at all,” he says, recalling how recent efforts to engage with Russian oil group Lukoil hit the buffers.

“They never even responded to requests for information.” Undeterred, he is busy pursuing new methods of engagement.

“We haven’t done much around shareholder resolutions to date, but this is going to change.”

It’s a strategy inspired by governance in the US, where in contrast to other regions, shareholder resolutions presented and voted upon at annual meetings and through the proxy vote are typically “the starting point” of dialogue. In Europe, shareholder resolutions are rarely brought about, not least because of the significant legal and logistical hurdles involved in getting resolutions successfully filed.

“US pension funds have told us that if they don’t have a resolution, they attract no attention from the company. In Europe shareholder resolutions are seen as a last resort, a big gun to use at the end, when in fact they could start the process.”

its business model to measures to restrict global warming to two degrees, as per last year’s Paris agreement on climate change.

Although the resolution was backed by many of the oil group’s most influential shareholders, it failed to win a majority.

“It was too low but still positive.

Remember that BP and Shell didn’t cooperate and then changed their mind.

The Paris agreement is a game changer,” he enthuses. In 2015 shareholder resolutions filed at BP and Shell have led to the companies beginning to reveal their exposure to climate risk.

In another development, AP7 is building a cleantech private equity portfolio that will ultimately account for one third of the fund’s 3 per cent private equity allocation.

“We decided to do this in private equity because we can see the potential returns, and it is also an area where financing can be a challenge: it is an area where you can get the best returns, and do most good.”

The strategy centres on investing in solutions to climate change including energy efficiency, renewables, technical challenges and storing solutions. The portfolio has had “mixed results so far” although some of the companies have done well like Tesla, the electric automobile manufacturer and Solar City in the US. “To some extent cleantech has been a bubble. Valuations have gone up and then down, so in this type of environment we keep a long term perspective,” he says.

PARIS AGREEMENT A ‘GAME CHANGER’

INTERNAL TEAM

The method was put to use earlier this year in the US when a group of investors including AP7 used a shareholders resolution to try and persuade US oil giant ExxonMobil to disclose the resilience of

AP7’s internal team manages all the ESG research and due diligence, even in the small equity portfolio invested outside the index, in active allocations with external managers.

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INVESTOR PROFILE AP7

SWEDEN’S AP FUNDS MARKET LEADERS IN ESG

SWEDISH LAW UNDERPINS AP FUNDS’ HIGH GOAL-KICKING ON RESPONSIBLE INVESTMENT WITH ENGAGEMENT OF PORTFOLIO COMPANIES A CORE STRATEGY.

“We still control the ESG element with external managers. ESG is not something we do together with our asset managers – although they are given the blacklist,” he says.

Analysis is carried out by ploughing through academic research, scanning ESG ratings, data, policies and reporting, and the fund also supports studies it thinks relevant.

He finds it challenging that most research still centres on the link between responsible investment and returns; a well-reported area which he has long-believed confirms there is “no obvious penalty for ESG.” What would “really help” is more research around the positive impact of ESG investment.

“We need a much better way to measure the impact of our investments. Then we can be more effective.” And he also wants clearer guidelines for companies on how best to report their carbon footprint in the wake of the Paris agreement.

“A large part of the puzzle is missing.

There is a lot of reporting but the quality varies. We are having to interpret the Paris agreement as asset owners, yet there are no reporting guidelines, which makes it difficult to combine this truly global agreement with any daily, realistic implementation,” he says.

Measuring water risk is just as challenging.

“The World Economic Forum tells us water is a number one risk yet there is no way to measure it in a global stock portfolio.

You can measure individual companies’ water risk and make basic assumptions, but the market needs to price this risk. We need [a] better pricing mechanism and one way to achieve this is to improve the flow of information out of companies.”

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ALL SIX OF Sweden’s AP Funds, the combined $150 billion public buffer funds set up to meet potential shortfalls within the Swedish state pension system, are market leaders in environmental, social and governance (ESG) issues and were among the first to sign up to the UN Principles for Responsible Investment. Their position on responsible investment is underpinned by Swedish law, which dictates they take environmental and ethical considerations into account in their investment activities, without deviating from the overall objective of a high rate of return.

AP Funds 1-4 engage on ESG with investee companies on governance to climate issues via an ethical council, in an effort to both share costs and wield a bigger influence through co-operation. Engagement with portfolio companies is a core strategy. When it has the desired effect, companies are removed from the council’s watch list; when it fails, companies are excluded from the AP portfolios.

During 2015 the ethical council engaged with 178 companies globally, covering a total of 254 issues, mainly concerned with business ethics, human rights, labour rights, corruption and the environment. Over the past nine years, the ethical council has recommended AP Funds exclude a total of 19 companies, of which four were reinstated in 2015 when the companies in question reformed. Last year it was involved in a number of ‘proactive initiatives’ – some industryspecific targeting of the palm oil and cocoa industries and others addressing companies on their practices in emerging markets. Focus areas have been human rights, corruption and climate issues.

comes to integrating carbon risk into their portfolios.

In 2015, all six agreed to coordinate the way they report the carbon footprints of their investment portfolios, using a common system centred around three indicators, in a move aimed at increasing transparency and improving assessment of investee companies’ work on climate issues. It’s the latest progress in a stream of initiatives.

AP2 was one of the first institutional investors to measure the carbon emissions of its portfolio by scrutinising its global equity holdings back in 2009. This year the fund plans to further reduce its exposure to financial risk from fossil fuels, by divesting from 11 coal and eight oil-and-gas production companies, with a combined value of SEK 550 million ($64 million). The fund allocates 1 per cent of its total strategic portfolio to green bonds, benchmarked against the Barclays/MSCI Green Bond Index with current investments in green bonds amounting to $485.8 million.

Recent analysis by the $35.5 billion AP3 of its carbon footprint in its listed equity, forestry and property holdings, showed they are almost carbon-neutral.

The fund has set sustainability targets for the first time, which will see it treble its green bond holdings to $1.7 billion and double its strategic sustainability investments to $2.3 billion.

“When we started in 2007, the ethical council engaged primarily in reactive dialogue with portfolio companies. Today, the council has developed to primarily focus on proactive dialogues and various industry initiatives,” says Ulrika Danielson, chair of the council.

In the most ambitious commitment to low carbon investing by any pension fund to date, in July 2015 the $35 billion AP4 Fund announced plans to invest $3.2 billion in passive investment funds designed by MSCI to track low carbon benchmarks, with plans to decarbonise its entire $14.7 billion equity portfolio by 2020. It is also one of the founders of the Portfolio Decarbonization Coalition (PDC), a coalition aiming to get investors to measure and disclose their carbon footprint, now overseeing the decarbonisation of $230 billion of assets, dramatically surpassing its target of $100 billion.

COORDINATED REPORTING OF CARBON FOOTPRINT AP Funds, including AP6, a closed fund specialising in unlisted investments, are global leaders when it

In December after a prolonged process, the Swedish government decided not to carry through proposals to axe two of the funds and set new returns targets and investment strategies.

YOU VALUE LONG-TERM PERFORMANCE. AND YOUR PRINCIPLES. SO DO WE. Northern Trust believes that your ESG partner should share your commitment to responsibility. It’s why we made Pensions & Investments’ list of the world’s leading asset managers — as well as Corporate Responsibility Magazine’s list of the 100 Best Corporate Citizens. And why we’ve been a proud signatory to the Principles for Responsible Investment since 2009. We offer you the tools, research, shared vision and holistic approach we believe you need for performance-driven responsible investing.

ACHIEVE GREATER

Call Bert Rebelo on +61 3 9947 9385 or visit northerntrust.com/holistic ASSET MANAGEMENT \ EQUITY \ FIXED \ MULTI-MANAGER

FOR ASIA-PACIFIC MARKETS, THIS MATERIAL IS DIRECTED TO EXPERT, INSTITUTIONAL, PROFESSIONAL AND WHOLESALE INVESTORS ONLY AND SHOULD NOT BE RELIED UPON BY RETAIL CLIENTS OR INVESTORS. © 2016 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. For legal and regulatory information about individual market offices, visit northerntrust.com/disclosures. Pensions & Investments rankings based on worldwide assets under management of $875 billion as of December 31, 2015 and are not indicative of future performance. Pensions & Investments 2016 Special Report on Money Managers appeared in the publication’s May 30, 2016 issue and online at www.pionline.com/specialreports/money-managers. Ranking information reprinted with permission, Pensions & Investments, copyright Crain Communications, Inc. Corporate Responsibility Magazine’s 2016 list of the 100 Best Corporate Citizens appeared in the publication’s March/April 2016 issue and online at www.thecro.com/category/ topics/100-best-corporate-citizens. Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, and personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

INVESTOR PROFILE ABP

RESPONSIBLE INVESTMENT TOP OF THE AGENDA FOR ABP The chair of the investment committee of the Netherlands’ ABP, one of the world’s largest pension funds, says responsible investment is not just a “nice-to-have,” but a “must-have.”

BY Amanda White

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As one of the largest pension funds in the world, the €373 billion ($424 billion) ABP believes it has a commitment to invest in a responsible and sustainable way.

ABP, and its asset manager, APG, have for a long time been actively engaged in responsible investing and use their influence to improve companies’ conduct and engage with regulators on setting the right kind of market standards. ABP was a drafting signatory of the PRI. While the rest of the world still ponders the responsibility, in the Netherlands it is a common belief that fiduciary responsibility takes into account environmental, social and governance (ESG) aspects in investments.

“In the Netherlands this is engrained, it’s in our culture, in investments and politics,” says Erik van Houwelingen, chair of the investment committee at ABP and a board member since 2012.

“There are different environments in which people come to terms with sustainable development – in the Dutch culture it’s more of a given you take sustainability into account. This makes a huge difference to our starting point in how we approach responsible investing.”

At the end of 2014, ABP made a decision to “step it up.”

“When we started to look again at how the world was changing, for example, with industries potentially at risk from climate change, we started to think there will be a tipping point,” he says. “The future of responsible investment (RI) will look different from the past.”

“We think there is a shift from here on out, RI is not a nice to have, but a must have, that seriously impacts our economies.”

This philosophy sits well with the longterm investment horizon of ABP, and what started to develop as a thought now has led to an updated RI policy.

ABP views responsible investing as a fundamental part of its fiduciary responsibility. After 18 months of revising the policy, including a review of academic evidence investigating the correlation between ESG and the risk profile, it arrived at the conclusion, and belief, that going forward, sustainability and governance would be a cornerstone of every investment decision made at APG and ABP. “Broadly speaking, we made a decisive shift towards the inclusion of chosen investments and allocating more capital towards solutions to sustainable development challenges,” he says.

POLICY ‘NOT SUITABLE FOR EVERYONE’

The fund has embarked on a journey of innovation to address challenges such as the sourcing of data and investing in organisation-wide knowledge management systems.

“The provision of ESG data is undergoing significant change, and maturing, but there are still issues with quality,” he says.

“To go on this journey requires a lot of hard work and dedication, it is much easier to operate based on exclusion and ESG integration. We embark on this trajectory only with full board support, you need to believe in it. Our policy is not suitable for everyone else, you need size and you need it in your DNA,” he says.

Van Houwelingen says it is an innovation project, based on the belief that the fund can meet its risk return objectives with moving towards a more responsible and sustainable portfolio.

“The jury is still out, it will be three to five years before we have evidence, but

INVESTOR PROFILE ABP

Erik van Houwelingen

we are now embedding RI fully with risk return objectives.”

More specifically inclusion means tying data to financial performance of the companies invested in.

“In ESG screening you get a score, what we’ve done is an intelligent algorithm and tried to come up with industry and company level information that shows which aspects are the most relevant to performance.

It’s about relevancy to the investment management process and usefulness for the decision making. It shows what the inclusion really is, it’s not about a set of rankings, but about portfolio performance,” he says.

Claudia Kruse, managing director of sustainability and governance at APG, and part of the management team reporting to the chief investment officer and into the board, says that approach has to be carried by the portfolio manager.

“We have and need to attract the talent with the right attitude and thinking who recognise the importance of RI,” she says.

THE WORLD IS ‘CHANGING SO QUICKLY’

Van Houwelingen describes the journey as turning an organisation already engaged and involved in RI, into an investment organisation that has RI in its DNA. “This is a big challenge and we continue to invest in development of staff and new tooling. The world is changing so quickly, you need to take the investment professionals along with you,” he says.

WE THINK THERE IS A SHIFT FROM HERE ON OUT, RESPONSIBLE INVESTMENT IS NOT A NICE TO HAVE, BUT A MUST HAVE, THAT SERIOUSLY IMPACTS OUR ECONOMIES.

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INVESTOR PROFILE ABP

AP7 COMMUNICATES ITS ESG PASSION

The fund is working hard to develop the infrastructure and human capital required for the new-look organisation and van Houwelingen believes it will take between two to three years to have it fully implemented.

Kruse says APG started voting at shareholders’ meetings in the 1990s, and currently its policy is to exercise its voting right at every shareholders’ meeting. Since 2008 ABP/APG has had its first responsible investing policy, which entails that ABP does not invest in companies involved with controversial weapons or in violation of the UN Global Compact who do not improve after engagement, or the sovereign bonds of countries that are subject to a UN arms embargo. As at July 2016, ABP had 19 companies on its exclusion list, and excluded government bonds from 12 countries because of UN security council arms embargo.

Kruse’s team has long been part of the front office, sitting with portfolio managers, so it is fully integrated into investment decision making.

“Engagement is about establishing relationships as long term owners, and ESG gives you additional insights,” she says.

Kruse says this is a policy that’s appropriate to the size of the assets and the fact that the fund has had explicit beliefs related to RI for many years.

She agrees, that in the context of active management, data is only an input, and it is about the choices the investor makes.

“In the past years we have had tools to make ESG data available to portfolio managers, now it is about integrating that into the wider systems of our organisations,” she says.

“This is an organisation-wide effort, involving inter alia performance and risk management. The effort is not carried out in a silo, but it’s the organisation doing it.”

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APG has been very collaborative for many years and Kruse says intensifying collaborative action with other like-minded institutional investors is one of the most powerful tools the industry can use.

ABP and APG are also set on showing leadership and creating market standards.

They were founders and instrumental in creating the market standards with, for example, GRESB in real estate and infrastructure.

“We want to set standards for the market on data and sustainability performance,” she says.

FAVOURING ILLIQUID INVESTMENTS

While the new policy is about inclusion and engagement, making sure RI is at the heart of what portfolio managers do and is fully integrated into investment management, it is also about accountability and transparency and has led to some very specific goals and initiatives.

The $424 billion fund has a specific policy on climate change which outlines that by 2020 the fund will strive for a 25 per cent reduction in the carbon footprint of its listed equities portfolios, which is about a $121 billion portfolio.

The fund also has a target to double investments into solutions to sustainable development challenges from $32 to $64 billion by 2020. There is also a target of $5 billion in renewable energy.

“We just published the responsible investment report and have reported $2.2 billion in renewable energy investments. It will require innovative thinking in the types of investments to get to the target. There is a much closer link to the real economy and the sustainable future,” Kruse says.

But van Houwelingen says the target of $5 billion is not just a target in itself, there needs to be balance in the risk/return profile.

“If we can’t make the $5 billion because investments are not there that meet the risk/return requirements, I’d be ok with that,” he says. “We need to invest however in how we are sourcing investments in infrastructure and renewables, and the initiatives we undertake ourselves to find

projects. For smaller organisations that would be very different.”

“The pricing of deals is a real factor as well. We made a commitment to hydro energy in Europe of $277 million and we were familiar with the parties involved, and worked hard on the bid.”

Van Houwelingen says the fund is favouring illiquid investments, and has been for some years.

“This will intensify in the coming years, and we think in the next few years there will be opportunity in the illiquid space, as demands are increasingly out there for infrastructure investments. We are also happy with our private equity capacity. These are solutions to invest more in the real economy. As a belief we think the opportunities are out there, so we are shifting efforts to that. Sourcing remains a major challenge,” he says.

But as an example of where sourcing investments can lead internally, van Houwelingen points to a project the fund invested in last year in schools in the UK to make them more energy efficient.

“This led us to say why don’t we have that initiative in the Netherlands, where there is bad air quality and energy inefficiency in schools? This led to an initiative where we work with local development banks, and jump start that initiative. You need to be active, projects won’t just come to you,” he says.

ABP, as the pension fund for civil servants and teachers, will now as part of its policy make money available for investing in education-related investments, preferably in the Netherlands. ABP’s engagement policy will be extended worldwide in the areas of human rights, security and education.

To have the right people with the expertise the fund needs, means hiring from diverse backgrounds, Kruse says.

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INVESTOR PROFILE USS

UNIVERSITIES SUPERANNUATION SCHEME SCORES HIGH ON SUSTAINABILITY The USS’s commitment to responsible investment is enshrined in the fund’s statement of investment principles, along with its commitment to the UK Stewardship Code and the UN-backed PRI.

BY Sarah Rundell

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The United Kingdom’s Universities Superannuation Scheme (USS) first introduced a responsible investment policy in 1999.

Since then the fund, which invests on behalf of 368 universities and higher education institutions that together represent some 330,000 beneficiaries, has developed environmental, social and governance (ESG) beliefs, built a specialist internal team and integrated ESG through its £49 billion ($64.6 billion) portfolio. Today ESG criteria impact investment decisions from the quantitative ranking of countries on ESG issues in the sovereign debt allocation, to carbon footprint analysis in public equity, while an internal sustainability manager oversees the real estate portfolio.

USS returned 18 per cent last year and prides itself on robust, active engagement with investee companies on climate change, corporate governance and shareholder rights, on topics ranging from supply chain management in Bangladesh to the potential stranding of coal assets and executive remuneration at banks, explains David Russell co-head of responsible investment.

ESG sits at a senior level within the fund – a USS board member attended the first UN-PRI meetings in 2006 and was subsequently elected to the organisation’s council – but also thrives at grass roots where ESG priorities from scheme beneficiaries are fed into strategy.

“Our ESG policy was first developed in response to campaigns by some USS members to divest from certain sin stocks like tobacco and alcohol,” recalls Russell. Today the trustee’s commitment to responsible investment is enshrined in the fund’s statement of investment principles, investment beliefs, its commitment to the UK Stewardship Code and the UN-backed PRI. “Our policy focuses on the integration of ESG issues into the investment

decision making process and on engaging with companies and other assets classes to ensure these issues are being appropriately managed. The aim of both these activities is to protect and enhance the value of the scheme’s assets.

We believe that companies and assets with responsible environmental and social practices and strong governance structures have the best chance of producing superior, sustainable, risk adjusted returns over the long term.”

DOGGED DUE DILIGENCE

Promoting strong governance spans engaging with companies on executive compensation and succession planning through to examination of board composition and oversight. It’s a dogged due diligence that the fund has applied, with particular energy to its own hedge fund allocation.

“Until relatively recently, the quality of hedge fund governance has been an issue of low priority for investors and generally absent from their due diligence process of potential hedge fund investments,” says Russell.

“A key part of our due diligence process focuses on the background, role, contribution, and oversight functions of the hedge fund’s independent directors, as well as the board’s overall governance structure.

Where we feel governance is substandard, we will offer proposals for improvement, but we are prepared to walk away from a potential investment, and have done so on several occasions, if the governance is deemed inappropriate and there is no commitment to make the necessary improvements.”

It’s a capacity to walk away that isn’t just confined to governance worries at hedge funds.

“We were considering whether to invest in a Japanese auto group linked with a

INVESTOR PROFILE USS

WHERE WE FEEL GOVERNANCE IS SUBSTANDARD, European auto company,” he says. “Both companies had the same chief executive and chair which raised concerns around conflicts of interest and an ability to allocate appropriate time to each company. We also had concerns around government influence and there was a lack of transparency around remuneration. The portfolio manager decided not to invest in the company and concerns around the corporate governance arrangements at the firm were a significant factor in that decision.”

Other anecdotes include the time the fund eschewed investment in an Australian small cap company where the role of the managing director wasn’t balanced by independent representation on the board or audit committee, and a European electrical group, where due diligence flagged risks around corruption in emerging markets.

But Russell stresses that the fund’s ability to really influence only comes with investment. It’s a pressure USS now applies via calculating the carbon footprint of its internally managed public equity allocation – some 44 per cent of the portfolio.

The fund compares its carbon exposure against both the MSCI ACWI and a composite index drawn from an amalgamation of the indices against which its regional public equity desks are benchmarked and created solely for the carbon foot printing exercise.

It allows the scheme to identify which companies in a particular portfolio are most exposed to carbon, a company’s “direction of travel” or the most carbon-intensive companies that aren’t reporting emissions, and Russell will engage with investee companies where he has concerns.

“The outcomes of this process are published on our website as part of our commitment to the Montreal pledge,” he says. “Every time we have undertaken carbon foot printing our public equity portfolio has been underweight both its

WE WILL OFFER PROPOSALS FOR IMPROVEMENT, BUT WE ARE PREPARED TO WALK AWAY ... IF THERE IS NO COMMITMENT TO MAKE THE NECESSARY IMPROVEMENTS. internal benchmarks and the MSCI world benchmark.”

In the last analysis in 2015 the public equity portfolio had a carbon footprint approximately 18 per cent below the MSCI ACWI and 15 per cent below the funds own composite index.

MANAGING BRIBERY AND CORRUPTION IN EMERGING MARKETS

More recently, USS has developed an equity decision support tool, (EDS), to ensure that its fund managers and analysts have the most up-to-date information regarding a company. The EDS contains a “tear sheet” which covers pertinent ESG analysis, including voting information and a summary of the latest meeting with the company.

“In this way we ensure that we are having a consistent conversation with companies irrespective of whether it is the responsible investment teams or equities research team meeting with management,” says Russell.

“A key aspect of our responsible investment activities is the provision of ESG information to our internal equity fund managers. Making such information easily available allows it to be integrated into investment decisions where the manager believes it is material, and has and does affect buy, sell and hold decisions.”

Responsible investment in private markets is more focused on identifying risks rather than opportunities, and Russell cites sea level rise impacting a port investment, to ensuring appropriate processes are in place to manage bribery and corruption in emerging markets as typical risks.

“It is about making sure that risks are being managed, or at least the decision is taken in full knowledge of the potential ESG risks.”

For private equity, due diligence focusses on the processes potential managers have in place to identify and manage ESG issues in underlying assets, and the fund has worked with other private equity investors and managers on the PRI private equity advisory committee to develop guidance for the sector which includes work on the implications of climate change for the sector.

Collaboration with industry initiatives and other funds is another pillar to ESG strategy, a process illustrated in Japan where language and culture can be barriers to engagement.

“We have long recognised that this important market would require a different approach to responsible investment than we use in our home market,” he says.

Together with other pension funds and partnership organisation Governance for Owners, USS set up the Japanese Engagement Consortium which represents investor members in engagements with Japanese companies.

“We believe this approach has delivered benefits for the scheme at a time when there is significant change in corporate governance in Japan,” he says. Similarly USS has a reputation for engaging with policy makers and regulators on all ESG issues.

“If we believe that better regulation in these areas would be in the interests of the scheme’s investments we will act here too,” he concludes.

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PRI THE NEXT DECADE

24

PRI THE NEXT DECADE

LOOKING TO THE NEXT DECADE AND BEYOND From humble beginnings the PRI has come a long way.

But it’s only just begun. Fiona Reynolds, managing director of the Principles for Responsible Investment reflects on the past 10 years and looks to what is possible in the next 10 years.

BY Fiona Reynolds It’s been a significant year for the PRI, as we have celebrated our 10th anniversary. This has given us an opportunity to both reflect on our progress to date and look ahead to the future and what is yet to be achieved. While we acknowledge that there have been many accomplishments over the past decade in terms of investors considering environmental, social and governance (ESG) factors in their investment process in the same way that they look at financial data, we know that in reality, we have just begun to scratch the surface.

The 20 pension funds, investment managers, UN representatives, foundations and other institutions that drafted the original principles in 2006 were definitely visionaries of their time – they were clear in their aims of incorporating ESG factors into the investment process and their desire to move away from the short-term thinking that was driving investment markets, to investing for longer time horizons.

We’ve learned a lot of lessons in the past 10 years; we’ve also encountered skepticism along the way. When the PRI was first launched, some investors thought of us as well-meaning amateurs, naïve in our calls for ESG integration. However, as the global financial crisis struck, investors started to realise that looking at financial data in isolation can mask a host of internal problems and that looking at environmental, social and governance considerations was actually a smarter way to approach their investments.

Another lesson we’ve learned is that the PRI’s mission of mainstreaming responsible investment cannot be realised by signatories acting in isolation. As we look to the next 10 years, the PRI will need to seek out further engagement opportunities with governments, regulators, the media and other stakeholders to ensure that we are effective.

FROM AWARENESS TO IMPACT

Earlier this year, the PRI undertook a consultation on accountability. We know all too well that a small number of signatories use the PRI as a kite mark, because they find it useful for responding to request for proposal (RFPs), for example, but there is little commitment to the PRI’s six principles behind their actions.

It has become increasingly important to us – and our signatories – to find ways of dealing with these institutions, including the possibility of delisting them if they do not make progress.

At the same time, we also know it’s important to recognise investors at the top of the food chain.

As part of our 10-year blueprint document, which will be released in the first quarter of 2017, we will look at models to best highlight leadership in responsible investment, with the aim of motivating and inspiring others.

Despite the global economic crisis, we continue to see systemic risks in financial markets, and a lack of transparency and

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PRI THE NEXT DECADE

disclosure. For these reasons, we are undertaking a project to look at how we can achieve a sustainable global financial system.

The PRI has always recognised that implementing the six principles takes place within a wider context. Our mission explicitly states our belief that “an economically efficient, sustainable global financial system is a necessity for long-term value creation”.

To address these exposures, we need to be clear about the type of financial system we want, understand how major social and technology trends will affect that system, and consider how resilient it is likely to be amid risks and sustainability challenges.

POSSIBLE MODIFICATIONS

The 2008 economic downturn raised profound questions about the role of investors in ensuring the health of the financial system.

A system that delivers short-term returns, with little regard for the accumulation of longer-term risks, is not a viable one. A sustainable financial system should seek to deliver financial returns that foster long-term economic growth and stability. How the responsible investment community might rise to this challenge will be an important topic for the PRI in the months and years ahead. Thinking through these issues has also lead us to think about whether or not 10 years on, the six principles themselves are still fit for purpose and part of our consultation is considering any modifications that are required to drive action in the decade to come.

In addition to looking at engaging stakeholders around a more sustainable financial system, we also continue the work we started last year around fiduciary duty, which continues to be used as a reason for not integrating ESG factors. Despite the US Department of Labor’s clarification last year around ESG and fiduciary duty, some legal advisors continue to say that ESG integration goes against their duty to maximise returns, which we believe of course is incorrect.

The PRI’s report, which we published in conjunction with the UN Global Compact and UNEP FI – Fiduciary Duty in the 21st Century – came to the conclusion that not looking at ESG considerations in terms of risk and opportunity is actually a breach of fiduciary duty. Following on from that report, later this year we will be releasing a

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paper which looks at fiduciary duty in Asia, covering the key markets of China (including Hong Kong), India, Singapore, South Korea and Malaysia.

We have also begun an interesting project bringing credit ratings agencies and investors together in order to get the agencies to look at ESG in a more systematic way. We thought it was important to engage the ratings agencies on ESG because they are a crucial part of the puzzle for identifying systemic ESG risks in debt capital markets.

Working with the United Nations Environment Programme (UNEP) inquiry, we have brought together six credit rating agencies (S&P, Moody’s, China’s Dagong, Liberum in Brazil, Malaysia’s RAM, and the German company Scope) and 100 investors managing $16 trillion in assets for a two-year program of “ratings forums” that builds on a statement of intent on ESG in credit ratings. This marks the first time that any organisation has brought investors and ratings agencies together to collaborate on ESG.

FINANCING SOLUTIONS TO GLOBAL CHALLENGES

ESG can affect the creditworthiness of borrowers – be they corporates or sovereigns or local governments – and thereby increase the risk of defaults and price volatility. The much-discussed shrinking liquidity in the bond markets would only seem to underscore the importance of taking a holistic view of potential risks, including those under the ESG umbrella, and how those risks can be mitigated.

Finally, following the launch of the Sustainable Development Goals (SDG’s) at the UN last year, the PRI is highlighting the role institutional investors can play in financing solutions to global challenges such as climate change, social injustice, poverty and inequality.

The SDGs were developed with representatives from 70 countries. Alongside these open working group discussions, the UN conducted a series of “global conversations”.

These included 11 thematic and 83 national consultations, and door-to-door surveys. The UN also launched an online My World survey asking people to prioritise the areas they’d like to see addressed in the goals. The results of the consultations were fed into the working group’s discussions.

The PRI (alongside the UN Global Compact, UNCTAD and UNEP FI) targeted policy makers with the report Private Sector Investment and Sustainable Development, and submitted it to the co-chairs of the Financing for Development process. The PRI also submitted a response to a consultation on Financing for Development by the UN Sustainable Development Solutions Network.

This work demonstrates the contribution investors can make towards sustainable development and climate change goals: incorporating these issues into investment and asset allocation decisions (such as allocating capital into areas such as renewable energy, energy efficiency, inclusive finance and education) and engaging with companies and policy makers.

THE NEXT 10 YEARS – FROM HERE TO THERE

The PRI’s mission calls for it to promote a sustainable global financial system that supports long-term value creation and benefits the environment and society as a whole. Working with signatories and stakeholders throughout 2016, the PRI will be developing a blueprint for responsible investment that will shape the priorities of the organisation and the responsible investment community for the next decade.

The blueprint will be published in early 2017 and will identify new projects the PRI will lead to address systemic risks and sustainability challenges facing investors in today’s markets; outline changes the PRI will be making to strengthen signatory accountability; and confirm whether the principles will be updated to better reflect the responsible investment activities of signatories today. It will include a high-level implementation plan and timeline and outline how the PRI will measure the success and impact of its work over the next 10 years.

The responsible investment community has come a long way in the 10 years since the PRI was launched. In another 10 years, I think many of the arguments we are making now about the relevance of ESG issues and responsible investment approaches to good investment practice will have been won. How we get from here to there will involve a lot of hard work, and a lot of debate and we are certainly up to the challenge.

SPONSORED ADVERTORIAL

SUBSTANCE over LABELS

ANDREW HOWARD HEAD OF SUSTAINABLE RESEARCH

A

decade of awareness building and advocacy has led over 90 of the world’s 100 largest investment managers to commit to incorporating environmental, social and governance (ESG) considerations into investment decisions, ownership and reporting by becoming signatories to the Principles of Responsible Investment (PRI). If you asked these managers to define sustainability you would find as many interpretations as there are investors trumpeting their sustainable investing credentials. One person’s “well run company” is another’s “solution provider”, “responsible corporate citizen” or “socially beneficial activity”, each with their own nuances and approaches.

In itself, the absence of a single definition or approach is not particularly important. Indeed, diversity of approaches is important in addressing different investors’ goals; at Schroders we have a variety of products, services, tools and activities under a broad ESG banner.

NOT EVERYONE FOLLOWS THE SAME RECIPE However, rolling different approaches into a generic “sustainability” bucket becomes a problem when investors form conclusions as though a common view had been agreed. Failure to recognise that sustainable investing covers a range of activities, approaches and goals lies at the heart of concerns raised in recent months over the way many in our industry argue that fund sustainability ratings ensure “funds [that claim to be looking at ESG issues] are practicing what they are preaching”. If everyone was following the same recipe, a standard taste test

could gauge their cooking skills, but criticising a cheesecake for not tasting like a brownie makes little sense, and even less if the goal was to select better ingredients rather than to bake a specific cake.

It also highlights the irrelevance of debates on whether ESG investing boosts performance, or contravenes fiduciary responsibilities. Neither question makes sense without understanding the approach being used. Of 2,000 academic studies for instance, fewer than one-in-ten of those we examined defined how they measured ESG performances any more precisely than referencing the rating agency they used. The same ratings are often used to assess ESG styles with very different goals.

SUBSTANCE IS WHAT MATTERS As interest and demand rise and the industry becomes more sophisticated, it will need to become more specific and less easily herded into generic categories. It is incumbent on managers to describe what they are doing and asset owners to articulate what they are looking for. Labels matter less than the substance of each approach.

At Schroders, we are investing in developing our own views of the issues that matter, rigorous ways to assess performance and analysis that supports decision-making across investment teams. It strikes us as obvious that building strong relationships with the stakeholders on which companies rely, and adapting to the changing pressures they exert, lies at the heart of long-term competitive advantage and sustainability. Our effort goes into building tools to identify the strongest companies rather than debating the logic.

We have close to twenty years of experience examining ESG topics and engaging companies on those issues. Our global network of sector analysts gives us a clear advantage in evaluating those trends and their impacts. Our organisation, from leadership downwards, has committed time, resources

and attention to strengthening our expertise in the area. Unsurprisingly, we are convinced we can use those advantages to help our clients, and will need to move away from generic ratings or standardised approaches to do so.

MOVING PAST RHETORIC As a result, there is no “one size fits all” answer; ESG analysis is an input into company analysis that should reflect a fund’s strategy, be incorporated into decision-making to reflect each investment process and align with ownership, engagement and voting activities.

As long-term, fundamental investors, what works for us probably won’t suit other institutions.

Measuring every institution or fund along common measures is becoming less and less viable, as is attempting to define best practice.

As the questions our industry faces change, we expect the next decade to look rather different to the last. We will no longer be able to get away with talking earnestly about the challenges posed by climate change, inequality, corruption or anything else from the menu of ESG themes.

We will have to focus much more on how ESG analysis can be improved in specific situations, rather than whether generic ratings have value.

We will need to be clear about what those tools are meant to achieve, and demonstrate whether they are doing so rather than relying on generic correlations.

Like any industry that has passed the rapid growth phase of its evolutionary S-curve, sustainable investing is shifting from reliance on a rising tide of interest to more differentiation and diversity. n

Important Information: For professional investors only. The views and opinions contained herein are those of the Environmental, Social and Governance (ESG) team, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested. The opinions included in this document include some forecasted views. We believe that we are basing our expectations and believes on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realised. UK: No responsibility can be accepted for errors of fact or opinion obtained from third parties. This does not exclude any duty or liability that Schroders has to its customers under the UK Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA, is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. Further information about Schroders can be found at www.schroders.com. USA: Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc and is a SEC registered investment adviser and registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec, and Saskatchewan providing asset management products and services to clients in Canada. 875 Third Avenue, New York, NY, 10022, (212) 641-3800. www.schroders.com/us. RI00056

ESG INTEGRATION

THE STEPS OF

I N T E G R It’s no longer an “add-on”, ESG is being integrated into policies and investment strategies by innovative pension funds around the world. This report looks at how some of the leading funds are integrating ESG into their investment process.

BY Sarah Rundell

The days when the most adventurous responsible investment strategy was negatively screening sin stocks are long gone. And investors who cite fiduciary duty as a reason for not incorporating environmental, social and governance (ESG) factors – like carbon emissions, board composition or labour issues – into the investment decision-making process, because these non-financial indicators don’t agree with maximising investment returns, seem worryingly out of touch.

Indices have sprung up weighted to ESG themes and robust stewardship and engagement is taken as read. Investors are demanding more from their managers, assets are flowing into new “solutions” portfolios, and integration, which has always been easiest in public equities because of reporting requirements, is improving in other asset classes too. Meanwhile, new climate regulation in response to the Paris accord’s goal to limit warming to below 2 degrees is pushing investors to protect their portfolios from the risk of global warming. Innovative pension funds show how ESG is no longer an add-on, but integrated in policies, investment strategies and mandates.

WHAT TO BELIEVE IN

The first step on the integration journey is articulating ESG beliefs and expectations that can then be incorporated into policies and portfolios.

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ESG INTEGRATION

A T I O N “Integration is much easier and more effective if an investor has been through the beliefs process,” explains Jillian Reid, a principal in responsible investment at Mercer. It’s a process America’s biggest pension fund, the California Public Employees’ Retirement System (CalPERS), went through after the financial crisis exposed market risks which laid havoc to the portfolio.

“The crisis challenged our assumptions, it led to some deep thinking about risk management, financial markets, diversification and new forms of risk that conventional measures don’t track. The development of investment beliefs covered much of this new thinking and led to an integration at the highest level across the total fund that moved ESG out of the ‘good cause department’ into the mainstream,” recalls Anne Simpson, investment director, global governance at the fund, who was tasked with developing a strategic plan for the whole portfolio.

A first step was mapping more than 100 separate longstanding ESG initiatives from the green wave investment plans around clean tech and energy efficiency, to a responsible contractor policy to uphold labour standards in the building industry, and an active corporate governance program. The second was reviewing the evidence around ESG and investment risk and return. The fund’s Sustainable Investment Research Initiative, which logged 700 papers in a database, set the stage for framing the ESG components of the investment beliefs.

By 2013 sustainability was ingrained at the fund with the investment belief – one of 10 – that long-term value creation requires effective management of financial, physical and human capital; another belief articulates that risk is “multifaceted,” including issues not measured by tracking error and volatility like climate change, demographics and resource scarcity. Since then first mover “experiments” with clean tech venture capital and niche ESG tilting environmental funds, as well as a habit of “naming and shaming” errant corporations rather than engagement, have been replaced for a positive, holistic approach.

UP THE INDEX

Next comes incorporating beliefs into investment policies. Passive exposure to an index aligned to beliefs is an easy first step, and large investors are increasingly choosing low cost, relatively simple low-carbon indices to reduce the carbon intensity of their portfolios in response to climate risk.

The $188.8 billion California State Teachers’ Retirement System (CalSTRS) has just revealed plans to commit up to $2.5 billion to low-carbon strategies in global equity markets run against MSCI’s Low Carbon Target Index, and in the boldest commitment to low carbon investing to date, Sweden’s $35 billion AP4 will put $3.2 billion in passive investment funds tracking low carbon

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ESG INTEGRATION

benchmarks with plans to decarbonise its entire $14.7 equity portfolio by 2020.

The $178 billion New York State Common Retirement Fund has around $2 billion of US equities passively tracked to a low-emission index created in partnership with Goldman Sachs Asset Management Others are exploring similar strategies including France’s Fonds de Réserve pour les Retraites (FRR) and the United Nations Joint Staff Pension Fund. According to index provider MSCI, $2.39 billion currently tracks its low carbon indexes in passive mandates.

And passive doesn’t rule out engagement. PGGM, the €200 billion ($224 billion) asset manager for the Dutch healthcare pension fund PFZW, has a low carbon index designed around reweighting and active engagement with 250 constituent companies. The fund is gradually shifting its passive equity allocation to the index, starting with its market cap strategy, which amounts to about half of the total passive portfolio.

“Our ambition is to halve the carbon footprint of our passive equity allocation,” says Marcel Jeucken, PGGM’s managing director of responsible investment.

“With the index we can see the most carbon intensive industries and whether they are reducing their footprint.”

Companies that engage and improve are reweighted to their full position within the index but those that stay at the bottom will be taken out of the portfolio.

“We will gradually reduce our allocation to those companies by 25 per cent a year,” he says.

An index is also a valuable tool to help measure impact, important to communicate to stakeholders but also a way of setting targets for the future.

“With an index, investors can see the results of their investment, like how much carbon they’ve taken out of their portfolio, or how much water they’ve added,” says Jeucken, in reference to indices that weight companies not only according to their carbon footprint, but also to labour relations or water management.

“At PGGM we can measure the climate impact of Polish wind energy versus Spanish solar power. We also show our impact by linking numbers to something real that our beneficiaries can relate to, like their own household carbon use.”

Integration of listed equities is pushing new themes at the United Kingdom’s £2.9 billion ($3.8 billion) Environment Agency Pension Fund (EAPF) integrating ESG across its portfolio for over a decade and which has also moved its $370 million passive equity allocation to an index tracking fund where companies are not excluded, but have a zero weighting until their carbon profile improves to allow for technical innovation and the effects of positive engagement.

Faith Ward, chief responsible investment and risk officer at the fund recently asked her quantitative

30

managers to look at how they could further integrate ESG into smart beta strategies.

“Low volatility and other smart beta stocks tend to be carbon intensive like, for example, defensive utilities.

We asked our quant managers if they could deliver the mandates but in a less carbon intensive way. They’ve come back to us with strategies that will work and we should see the results later this year. It’s challenging but there is enthusiasm from the industry,” she says.

Similarly PGGM is “currently reviewing” how to lower the carbon footprint of its smart beta, quantitative passive strategies.

PRIVATE MARKETS

Integration beyond listed equities is more challenging.

“ESG integration is commonplace in public equities.

The challenge is finding ESG managers investing in long-term illiquid assets,” says EAPF’s Ward.

In private equity investing as limited partners (LPs), rather than owners curtails investors’ ability to prioritise ESG, making manager selection all the more important.

But PGGM’s Jeucken, which contributed to the PRI’s guide on integrating ESG in private equity, believes private equity is ultimately well suited to ESG because of investors “higher stakes” in investee companies and the long-term nature of the investment.

“In private equity there is a much closer relationship with the company so that when you want better data, you get better data.” Something borne out by Mercer which gives managers in infrastructure, private equity and real estate a higher ESG rating than hedge funds and fixed income.

The EAPF has a 5 per cent allocation to private equity, concentrated on small investments in renewables, but also venture capital and sustainable property.

“The challenge is not to give away performance in fees and we have developed an approach tailored to us. Private equity delivers financially and from a sustainability point of view.”

The EAPF is now looking for managers able to integrate ESG into its private debt allocation.

“This is a final frontier in ESG, currently there isn’t a lot of manager choice, although we expect it will grow if we see more contraction in bank lending,” Ward says.

Elsewhere PGGM is looking at the carbon intensity of its credit and real estate portfolios, in the latter using big data through a partnership with data analytics company GeoPhy. At the UK’s Universities Superannuation Scheme (USS) a Global Real Estate Sustainability Index, GRESB which was formed in collaboration with a group of large institutional investors, collects data including water use and waste and emissions to measure the sustainability performance of property companies and funds.

ESG INTEGRATION

In another strand of integration, PGGM plans to quadruple its investments to positive societal impact from $5 billion to $20 billion over the next five years. These investments are drawn from existing allocations, Jeucken says.

“Although much of our investment in solutions will include direct investments in private markets, we decided we couldn’t build a whole portfolio from only private markets if we want to quadruple our total exposure, simply because of size.”

Along with investments in water, health and food security the universe includes big conglomerates chosen for their impact.

“Although big companies may only have a small percentage of their business devoted to ‘solutions’ they often have a big impact when it comes to improving the world.” Along with exposure to listed equities, the solutions allocation includes investments in green bonds from corporate issuers.

RATE THE MANAGERS

Active, top down integration comes with selecting and monitoring highly-rated ESG managers, something Mercer offers its clients via its rating of more than 5,000 investment manager strategies on ESG integration. About 12 per cent of the manager strategies it rates receive the highest ESG one or two rating out of a possible four in a service that Reid says is “increasingly valued and attracting more investor interest.”

Some investors use the rating as a screen, only hiring managers with a higher rating, others use it to monitor their managers, she says.

The EAPF doesn’t pick managers from a list. Instead, the fund does its own lengthy due diligence and trusts its instinct for picking managers which share its values. What develops is a deep partnership, defined by the fund’s high expectations and loyalty.

“We are a demanding client, but our approach to our managers and their reporting has evolved. We try not to be prescriptive and we are also very patient of underperformance, staying with managers through challenging times because we are confident in them. It’s a patience that pays off,” says Ward.

All active investments are externally managed and all engagement with corporates goes through its 14 managers in a strategy Ward favours, given the fund’s small size and limited ability to influence corporate behaviour on its own.

“We don’t directly engage with companies, but we put a lot of energy into liaising with the industry, particularly around manager selection and mandate design,” she says. Meanwhile, universities’ fund USS has put huge effort into improving governance at its hedge fund managers.

“A key part of our due diligence process focuses on the background, role, contribution, and oversight functions of the hedge fund’s independent directors, as well as the board’s overall governance structure. We are prepared to walk away from a potential investment if the governance is deemed inappropriate and there is no commitment to make the necessary improvements,” says David Russell, co-head of responsible investment at the fund.

In 2015 CalPERS began a process of requiring all its internal and external managers, in every asset class, to identify and articulate relevant ESG factors in their investment processes. Findings will factor into ongoing hiring decisions as it revamps its manager list, in a process which will see the fund axe two out of every three of its managers.

“This work is in a pilot phase so that we can identify the relevant ESG policies and practices that will inform our choice of managers, in a way that will institutionalise responsible investment,” says Simpson.

She believes that the initiative is already acting as a wake-up call to the investment management industry.

“Due to its size and our board’s vision, CalPERS is a bellwether; if we are asking for something today others will be asking for it tomorrow. Fund managers realise that if they gear up to this they will better serve other clients. The mandates are demanding data, policy, processes and tools for integration, and the asset management industry has the resources and skills to develop the data to tackle sustainability across all asset classes.”

CALL TO ARMS

It’s a call to arms that CalPERS has honed in its engagement with investee companies in that other pillar of the integration puzzle.

“We’ve found that it is much better to engage out of the headlines and follow up with actions; we follow Teddy Roosevelt’s good advice: speak softly and carry a big stick. The big stick for shareowners is the ability to exercise the vote to give practical effect to private engagement. We have used this consistently and effectively to bring about change,” Simpson says.

CalPERS took stewardship and engagement to new heights this year when it announced plans to require the boards of the companies in which it invests include climate change expertise, with boards “informed and fluent” on the issues and “competent enough to address the complex challenges.” Simpson cites BHP Billiton as an example of a company which responded to shareowner pressure to beef up board level climate competency back in 2014.

“When BHP brought in new directors and hired a climate scientist, it showed the company imagining what might happen in the future.

They didn’t wait for Paris, and it’s now an issue which other companies are being challenged on.”

And of course Simpson’s conviction doesn’t stop with introducing climate competence at only carbon intensive industries. She wants climate savvy boards on all 10,000 companies in the portfolio – illustrating not only CalPERS portfolio-wide integration but also its belief that climate change will touch all parts of the economy.

“We have mapped our carbon footprint for public companies and found that just 80 are responsible for 50 per cent of emissions. This makes them systemically important emitters, capable of bringing market risks across the whole portfolio. This is why mandatory reporting is vital and why investors need to focus their attention on those companies which need to redirect their strategy in line with the Paris targets to limit global warming.”

Integration is easier if funds collaborate. It has been successful in a stewardship context with funds working together around shareholder resolutions and “proxy access” where shareholders eject directors and influence strategy with their own nominees. And in contrast to the few investors that made it to Copenhagen’s 2009 climate summit, the big funds were out in force in Paris.

“More pension funds are embarking on ESG integration, but it is a long and thoughtful process,” says Simpson, who was speaking from New York where she was one of a group of investors lobbying for improvements in corporate reporting on climate risk.

“The hallmark of this work is partnership with other investors.

Partnership enables us to pool resources, develop consensus around best practice and leverage impact.” She pauses before considering what integration will look like in years to come.

“Responsible investment will ultimately just be called investment.

In the future the idea that investment was ever preceded with the word responsible will be puzzling. It will mean that it was once irresponsible.”

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INVESTOR PROFILE EAPF

EAPF CHIEF INVESTMENT OFFICER REFLECTS ON 10 YEARS OF ESG At the heart of the Environment Agency Pension Fund’s responsible investing principles is to apply long-term thinking and seek sustainable, well governed assets.

BY Amanda White

The £2.9 billion ($3.8 billion) Environment Agency Pension Fund (EAPF) is celebrating a decade of integrating environmental, social and governance (ESG) into portfolios, and is in a perfect position to reflect on how the industry has evolved in the past 10 years.

The fund was an early signatory of the PRI, and has responsible investing at its core. This is unsurprising given its sponsoring body is the Environment Agency, however its responsible investing principles very clearly articulate it is at its core to apply long-term thinking and seek sustainable, well-governed assets.

“A long term financial view gives you a strong platform for considering ESG,” says Mark Mansley, chief investment officer, EAPF. “We have been looking at responsible investment for more than 10 years and the process has evolved. Increasingly the market has moved forward, but we have also gained confidence. We are also fortunate to have a committee that’s supported us on ESG, and had an active interest and encouraged us to progress further. Our member representatives are keen and engaged, and that is a very important backdrop for us. It is also fair to say it’s something [we] have actively worked hard for – our committees embrace training and are knowledgeable; we set ourselves high standards for the quality of briefs we provide them to ensure we have their informed support, as without supportive governance making progress is a real challenge.”

For Mansley the biggest change in the past decade has been ESG integration by mainstream managers. However his biggest frustration remains the slower pace of integration in unlisted assets.

MORE SPECIALIST STRUCTURE

When the fund did a major strategy review 12 years ago, it introduced a more specialist structure, instead of a balanced fund. This allowed for the introduction of a specialist ESG mandate which at the time made up around 7 per cent of the fund.

“We started looking at ESG factors in manager selection in other mandates as well.

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Back then 2004/05 was challenging, and a lot of managers talked about it, but it was not a full commitment,” Mansley says.

“The biggest change we’ve seen is the extent to which managers are prepared to embrace ESG. Obviously it varies and we try to get under the skin of how they do it, but it is fully embedded in our manager selection.”

EAPF asks general ESG questions but the bulk of its ESG evaluation is embedded in standards for financial evaluation.

“There are so many different styles of managers, but what’s important is the ESG integration is consistent with the manager style and process, and embedded at the appropriate point,” he says.

“For example with quantitative managers, we expect them to use suitable external data sources. In contrast, a focused active manager might not use that data so much but will have a deep connection and understanding of the company. We look to make sure their approach is appropriate for them.”

The team at EAPF examine and understand the portfolio of their managers, and look at what they buy and why.

“We are not averse to holding a controversial company per se, but we insist the manager fully understands the risk and the investment process is factoring this in,” he says. “We also think that much of the financial performance gains from ESG may come from companies changing and improving their ESG performance, rather than simply buying companies already recognised as leaders.”

MASSIVE SEA CHANGE IN INDUSTRY

“Asking managers for case studies on where ESG made a difference, either positively or negatively, is a very good thing to do, it shows if it’s properly embedded. It’s simple and very powerful,” he says. “We have found there’s been a pretty massive sea change in the industry in the past 10 years.”

A decade ago Mansley says the number of managers who did something more than screening was very small.

INVESTOR PROFILE EAPF

EAPF SUSTAINABLE SNAPSHOT Investing in the green economy – the fund has a target of 25 per cent invested in the sustainable and green economy.

Environmental footprinting – the fund reports its active equities are 10.9 per cent more environmentally efficient per million pounds ($1.3 million) invested than the market average.

Carbon footprinting – the fund has reduced its carbon footprint of active equities by 50 per cent since 2008.

Climate goals – the fund aims to invest 15 per cent in low carbon, energy efficient and other climate “When we did a tender for sustainable equities last year, we had over 60 responses, and only a handful were poor,” he says. “The industry has come a long way in that time.”

Most recently this has been demonstrated by the way quantitative and systematic managers have embraced ESG, he says.

“The number of people prepared to have an intelligent conversation on ESG integration is really positive. What has improved is now the typical manager is including ESG. The mainstream manager now does a good job.”

But he is slightly disappointed there has not been more innovation.

“In terms of those really developing new ideas and approaches in responsible investment, it is a more mixed and complex story. We have seen some good examples but slightly fewer than I’d like. Generation Investment Management set the gold standard for global equities with proper strategic integration of sustainability, and it would have been good to see more Generations around. We are a founder investor in Ownership Capital, and I have high hopes for them – they really embody a longterm investment approach. There have been some others, but it is challenging being a real pioneer in investment management.”

As a sign of their commitment, the fund tends to favour active managers, with highly concentrated, very focused portfolios.

“In acting long term we’ve developed a strong view of the managers we like. A portfolio of fewer stocks you know well. We believe investors should be long term. We

mitigation opportunities. It also aims to decarbonise the equity portfolio, reducing its exposure to ‘future emissions’ by 90 per cent for coal and 50 per cent for oil and gas by 2020.

Responsible investment monitoring in all asset classes – work with managers across all asset classes to improve the processes behind reporting.

Acting as good owners – all active managers are required to adhere to the responsible investment policy which sets out expectations with regard to implementation of their mandate. expect a high degree of engagement with concentrated managers.”

One of Mansley’s frustrations is the low take-up of ESG integration in unlisted asset classes, where there has been less dynamism and a more compliance-driven response.

“As an example, unlisted property managers have always been a little bit reluctant to take [a] dynamic and strategy view of ESG, they’ve been more compliance driven and finding managers that go beyond that [has] been a bit of a challenge. I’ve also been rather frustrated about infrastructure, there is great sustainability potential here but also potentially high risks. We’ve found a lot of good specialists in for example renewable energy, but it has been harder to find managers we can trust with a more general infrastructure mandate. However, recently I am encouraged by signs of change and that both these markets are moving forward.”

LONG SHADOW OVER ESG INTEGRATION

Mansley says the private equity industry has made some progress, but experience here has been particularly influenced by the challenge of the cleantech sector which has been notably volatile and disappointing.

“We’re aware this has cast quite a long shadow over ESG integration. To my mind though it is still all about good investment management. The cleantech bust was not about transformation of the industry not happening, it was about the nature and implications of that transformation not being properly anticipated. The lesson is

that it is important to have a comprehensive approach to your investments and business understanding, rather than being a critique of sustainability,” he says. “Sustainability is not an excuse for sloppy decision making.”

EAPF is 100 per cent externally managed.

Internally the investment team builds its own portfolio of funds in private equity and debt.

It set a climate policy last year including targets to stranded assets exposure and investing positively in climate solutions. The target is to have 15 per cent of assets in low carbon assets.

It is also working on a long-term investing paper, which looks to move the debate on fiduciary duty forward and get people to think about what fiduciary duty really means.

But the real leadership the fund takes is in engagement, collaboration and transparency.

It is working with the Church of England on a transition pathway around climate change, where it will benchmark and map out whether companies are really changing, with the ultimate result leading to divestment if they don’t change.

EAPF was one of the first funds to do carbon footprinting, and has always been open in its reporting of what it is doing.

“We are a relatively small fund and only have limited resources and impact on company level engagement. So we have tended to focus engagement on the financial industry itself, sharing best practice and experience with other funds,” he says. “We are also well known for putting a lot of pressure on managers to raise their game and making clear our expectations of them known.”

Mansley says working with the PRI has helped the fund achieve broader strategic goals, including raising the standards across the industry, with the limited resources it has.

“We recognise our strengths so we can go into the industry, working with the PRI, and help support change. Our strengths are our governance and willingness to resource key areas such as manager selection and monitoring. Many pension organisations run on a shoe string but if you put modest resources in at a higher level you can facilitate a lot of change and make real progress on responsible investment.”

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FINANCE REALIGNED

FUNDAMENTALLY REWIRING FINANCE The better aligned a society’s financial institutions are with its goals and ideals, the stronger and more successful the society will be.

BY Amanda White

The purpose of the financial system is not to make money but to serve the real economy. Everything will change if this view is embraced.

In his book, Finance and the Good Society, Nobel Prize winner Professor Robert Shiller says at its broadest level, finance is the science of goal architecture – of the structuring of the economic arrangements necessary to achieve a set of goals and of the stewardship of the assets needed for that achievement.

“The goals served by finance originate within us. They reflect our interests in careers, hopes for our families, ambitions for our businesses, aspirations for our culture, and ideals for our society; finance in and of

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itself does not tell us what the goals should be. Finance does not embody a goal. Finance is not about “making money” per se. It is a “functional” science in that it exists to support other goals – those of the society.

The better aligned a society’s financial institutions are with its goals and ideals, the stronger and more successful the society will be. If its mechanisms fail, finance has the power to subvert such goals, as it did in the subprime mortgage market of the past decade. But if it is functioning properly it has a unique potential to promote great levels of prosperity,” he says.

Put more simply, finance is good for society. The problem is finance has been waylaid, it has become about making money, and has lost its purpose.

This is an age of financial capitalism, and that will not change, and Shiller argues finance should be embraced. But it should be expanded, corrected and realigned.

In their new book What they do with your money: How the financial system fails us and how to fix it, Stephen Davis, Jon Lukomnik and David Pitt-Watson list four main roles for the finance industry: providing safe custody for assets, a payments system, intermediation between savers and borrowers, and risk reduction (insurance).

FINANCE REALIGNED

Lukomnik, who is the executive director of the Investor Responsibility Center Institute, says the book postulates the purpose of the financial sector, which he says, like Shiller, is not to make money.

“The purpose is a service business, to serve the real economy,” he says, and its success should be judged on that.

INTERMEDIATION SAME PRICE FOR 130 YEARS

However in recent times finance has been failing the real economy. One simple point of failure is the fact the price of intermediation hasn’t changed, and in the past 130 years has hovered between 1.3 and 2.3 per cent.

Thomas Philippon from New York University measures the cost of financial intermediation and shows that the cost has been trending upwards since 1970 and is significantly higher than in the past.

“In other words, the finance industry of 1900 was just as able as the finance industry of 2010 to produce loans, bonds and stocks, and it was certainly doing it more cheaply,” he says in his paper, Finance versus Wal-Mart: Why are financial services so expensive?

One reason is that the total compensation of financial intermediaries (profits, wages, salary and bonuses) as a fraction of GDP is at an all-time high, around 9 per cent of GDP in the US.

LONG-TERM INVESTING IS A FRAME OF MIND RATHER THAN A HOLDING PERIOD, AND A CULTURE RATHER THAN A DIRECTIVE. 35

FINANCE REALIGNED

Another reason is that while some layers of intermediation may have contracted, others have been added, and money saved in one area has been offset by new charges in other areas.

What is clear is the end user is no better off.

“Despite its fast computers and credit derivatives, the current financial system does not seem better at transferring funds from savers to borrowers than the financial system of 1910,” he says.

OVERCOMING SHORT-TERMISM

So while the finance industry has increased output it has become inefficient in its production, and much of that is due to more trading, Philippon says.

“Trading activities are many times larger than at any time in previous history,” he says.

Lukomnik says it is a failing that the industry is paid by activity or assets and not outcome.

“We’ve moved to a trade-oriented investment management industry,” he says.

“The steps between agents is improving, but the A to B of touching the real economy is not becoming efficient.”

“There are 79,669 mutual funds or trusts in the world, this decreases the economies of scale and adds to the costs of investments.”

Lukomnik and his co-authors say in an ideal world, banks should hold more capital to ensure the safety of deposits; stock exchanges should be prevented from giving highfrequency traders faster access to market prices; and executives should be paid bonuses linked to the long-term growth of the business rather than the share price.

But above all, they argue, the interests of the underlying clients of the finance industry – the depositors, the workers and the pensioners – should come first.

So what needs to be done to expand, correct and realign finance? And what role do institutional investors play?

Overcoming short- termism has been touted as one of the cornerstones to recalibrating large institutions and their beneficiaries.

Focusing Capital on the Long Term (FCLT), which was started in 2013 by Mark Wiseman of CPPIB and Dominic Barton from McKinsey & Company, is focused on developing practical structures, and approaches for longer-term behaviours in the investment and business worlds.

Its stated goal is to break the short-termism cycle that rotates from a perceived need by

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investors for short-term performance, to a perceived need for continuous positive quarterly earnings guidance by corporate boards and senior management. The result is a systemic underinvestment in the kind of longer-term value creation that retirement savers need to generate adequate income streams after they have finished working.

FCLT.org says that “fundamentally rewiring the ways we invest, govern, manage and lead to better focus on the long-term outcome will require taking concrete, pragmatic steps.”

In its long term portfolio guide it says that “long-term investing is a frame of mind rather than a holding period, and a culture rather than a directive.”

Importantly it is also not driven by rankings or benchmarks, but focuses on long-term expectations and outcomes.

It outlines five core action areas for institutional investors: Investment beliefs | Clearly articulate investment beliefs, with a focus on portfolio consequences, to provide a foundation for a sustained long-term investment strategy Risk appetite statement | Develop a comprehensive statement of key risks, risk appetite, and risk measures, appropriate to the organisation and oriented to the long term Benchmarking process | Select and construct benchmarks focused on long-term value creation; distinguish between assessing the strategy itself and evaluating the asset managers’ execution of it Evaluations and incentives | Evaluate internal and external asset managers with an emphasis on process, behaviours and consistency with long-term expectations.

Formulate incentive compensation with a greater weight on long-term performance Investment mandates | Use investmentstrategy mandates not simply as a legal contract but as a mutual mechanism to align the asset managers’ behaviours with the objectives of the asset owner.

In other practical steps, the paper says that investors wanting to focus on the long

term should align stakeholders and minimise agency costs; focus on intrinsic value of assets and long-term real value creation, invest rather than speculate; develop and execute robust, sustainable investment processes and positively influence the management of investee companies.

Similarly the PRI’s mission calls for it to promote a sustainable global financial system that supports long-term value creation and benefits the environment and society as a whole.

This mission was borne from a belief that the financial system must contribute to sustainable economic development if it is to effectively serve society.

But Martin Skancke, chair of the PRI board, says: “The reality, however, is that the financial system does not function as effectively as it should. It does not exhibit the characteristics that market participants would typically associate with being sustainable, such as being fair, resilient, transparent, efficient, inclusive, well-governed and aligned with society’s needs.

“It is susceptible to risks and sustainability challenges that can manifest themselves in various ways.

“We believe that because the operation of the financial system influences the performance of institutional investors, investors should consider the operation of the financial system as a whole, including its purpose, its design, its effectiveness and its resilience to risks and sustainability challenges.

“We are already supporting signatories to respond to financial system risks, including: integrating externalities such as climate change; providing guidance to asset owners on how to embed environmental, social and governance (ESG) considerations into mandates; improving corporate sustainability disclosure via the Sustainable

FINANCE REALIGNED

Stock Exchanges initiative; and re-stating the case for action on ESG issues as part of investors’ fiduciary duty.”

This year the PRI conducted a consultation process with signatories to identify the key areas for the PRI to influence, the underlying causes of risk and sustainability challenges in the system; and the drivers that may shape these over the next decade.

According to the PRI, the issues affecting a sustainable financial system fall into four main areas of risk and opportunity: 1 | The relationship between investors and companies 2 | The relationship between managers, owners beneficiaries and advisers in the investment chain 3 | The operation of the markets 4 | Externalities.

ASSET OWNER POWER

Many commentators agree that an effective way to really enact change is to focus on building strong buy-side organisations.

Stephen Davis, associate director of the Harvard Law School Programs on Corporate Governance and Institutional Investors, says in the past two decades there has been considerable effort reforming the governance of corporates, and great improvements have been made in management and on corporate boards.

“But we have made those companies more accountable to large institutional investors, and little time has been spent on the governance of those investors,” Davis says.

“We need to shift the focus to the issues of accountability and transparency of institutional investors, then the agents will be more aligned with the grassroots – us, the people. If asset owners are more aligned to the beneficiary then there will be a knock on to asset managers.”

Building strong buy-side organisations is something Keith Ambachtsheer has been advocating for many years.

This means asset owners need to take stock of their internal organisations, pay attention to governance and decision making, hire good internal teams, invest directly, reduce the number of external providers and be conscious of costs.

“It is costing the Norwegian Sovereign Wealth Fund around 1 per cent a year not to have an arm’s length organisation with internal management, like the Canadian Pension Plan Investment Board,” he says.

“The Norway model produces 15 basis points of excess return per year but Ontario Teachers Pension Plan produces excess return of 2 per cent per year.

“Applying the Drucker principles to pension organisations – you’re effective or not, and this comes down to vision clarity,” he says.

“Removing the number of agents is key.

There are too many agents and we need more clarity so the agents truly represent the principals.”

And, he says, the most direct way to deal with that is to produce strong buy-side organisations.

Harvard’s Davis says that beneficiaries should know who’s in charge of their money, who the governing body is and how to reach them.

“And if the governing body is not performing they should be able to get rid of them,” he says. “There should be more transparency so beneficiaries know how their money is used. You can look up how a manager is investing in what companies, and the last transaction, but you can’t find out exactly what you’re paying in fees or how on a regular basis your money is voted.

Beneficiaries should know how their voice is expressed on certain issues, for example CEO pay, or climate change risk.”

“Mostly as an ordinary beneficiary you don’t know how your money is managed.

We need to refocus and look at where the beneficiaries’ interests lie.”

“If we can get the governance of the fund sorted out they can make choices to,

for example, invest directly. Are decisions made in the best long-term interest of the beneficiaries? We can’t have confidence in that if the governance is not there.”

PRI TRANSFORMATIVE

Davis, who was involved with the PRI since the beginning, says it has been transformative in influencing the capital markets, but it is still feeling its way.

“That’s right that it is still feeling its way, there’s a new adventure.”

“It’s all about stepping back, and looking at how do you make institutional investors, these large bureaucracies, into long-term owners?”

Geoff Warren, research director at the Centre for International Finance and Regulation agrees that addressing agency issues associated with multi-layered investment organisations is central to organising an investment firm to be focused on the long term.

The aim is to ensure alignment,” he says.

“All involved should remain focused on long-term outcomes; and success should be appraised in these terms. It is critical that the organisation is designed to foster this alignment, which in turn is reinforced in the processes by which outcomes are evaluated and rewarded.”

In his paper, Designing an investment organisation for long-term investing, he highlights the need to avoid making judgments based on the flow of short-term results, and how an element of trust is required to give fund managers the encouragement and confidence to be long-term investors.

Another key theme, he says, is the requirement for an investment approach that focuses on the long term. The investment philosophy, process and information used should all look beyond near-term market prospects, and address what will maximise long-term outcomes.

In sum, long-term investing is about perspective and horizon: the sights should be squarely directed towards the long run.

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INVESTOR PROFILE SWEDFUND

SMALL IS BEAUTIFUL FOR SWEDFUND, SWEDEN’S BIG ESG INVESTOR Scrutinising every aspect of a portfolio company before investing is costly and time-consuming, but Swedfund’s due diligence pays off as it invests in the most risky of markets.

BY Sarah Rundell Conflict, currency collapse and the Ebola outbreak in West Africa are the kinds of risks most investors give a wide berth.

But Swedfund, Sweden’s state-owned Development Finance Institution that invests in sustainable businesses in the most challenging – and promising – markets around the world, ploughs on in.

“Investors can be change-makers for a better world; we have so much leverage to help create better managed companies,” enthuses Anna Ryott, who brings both a passionate belief in the ability of sustainable business to tackle poverty, and experience from civil society and the business world, to the role of chief executive.

Sixty per cent of Swedfund’s SEK3456 million ($409.7 million) investment portfolio is invested in Africa, and the fund’s small size and focus allows it to apply a strategy with such razor sharp detail it nurtures environmental, social and governance (ESG) into life until it is part of an investee companies’ very DNA. “We invest in countries where there isn’t enough private capital and that are high risk.

We believe that sustainability and financial viability go hand in hand.”

In 2015 the portfolio only returned 0.33 per cent, reporting a pre-tax profit of $0.3 million, but it reversed losses from the previous year caused by several write-downs in portfolio companies. Swedfund targets a return on equity for the total portfolio above the rate of Swedish government debt and always invests on commercial terms.

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INVESTOR PROFILE SWEDFUND

INVESTORS CAN BE CHANGE-MAKERS FOR A BETTER WORLD; WE HAVE SO MUCH LEVERAGE TO HELP CREATE BETTER MANAGED COMPANIES.

IN GOOD (SWEDISH) COMPANY WITH SCANIA AND H&M

A n n a Ry o t t

Swedfund has 63 companies in its portfolio and priority sectors include manufacturing and services, financial institutions – mostly banks – and renewable energy, with a typical investment lasting nine years.

Last year it partnered with Swedish bus and truck manufacturer Scania, to fund and develop biogas production from wastewater sludge as a vehicle fuel in the Indian city of Nagpur.

Elsewhere a textile manufacturing venture with DBL Group, a Bangladeshbased manufacturer of ready-made garments in Mekelle, Ethiopia, is slated to create 4,000 jobs. The clothing retailer H&M has come in as long-term buyer, supporting with its expert knowledge in sustainable textile production in the venture which will prioritise decent working conditions, jobs for women, and environmental considerations, particularly around water use.

“We are trying to do something that sets an example and that others will follow. We get a lot of attention from other investors in these kinds of projects; this is just the beginning for these types of partnerships around sustainability.”

Swedfund joined the PRI in 2012 and it’s a membership that has enabled the fund to push investee companies harder, and benchmark against peers, explains Ryott.

“It is also about being part of a peer group that is truly interested in measuring results,

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INVESTOR PROFILE SWEDFUND

WE INVEST IN COUNTRIES WHERE THERE ISN’T ENOUGH PRIVATE CAPITAL AND THAT ARE HIGH RISK. WE BELIEVE THAT SUSTAINABILITY AND FINANCIAL VIABILITY GO HAND IN HAND.

and what gets measured, usually gets done,” she says, in reference to the PRI’s request that its members annually report their progress on integrating its principles.

Swedfund scores A+, one of just 18 signatories, in the PRIs A+ to E rating system.

COMPANIES PROVIDED WITH ‘ESG ACTION PLAN’

Swedfund invests in companies via loans, equity stakes or through funds with a good balance between sectors and geographies within its investment universe.

The decision to invest rests on what Ryott calls “three pillars”: a company’s impact on society; its sustainability and its financial viability. Swedfund’s ESG team – all three of them – scrutinise every aspect of a portfolio company before investing, analysing its capacity to create jobs, its corruption policies, environmental sustainability, employment terms, equality, human rights and tax contributions. From this, most companies are given an ESG Action Plan (ESGAP) outlining the journey it has to take to comply with the fund’s long list of policies.

“At the beginning there may be real gaps; we are not investing in perfect companies,” says Ryott.

And Swedfund takes ESG more than just skin deep. Regarding employment terms, it asks specific questions to determine the level at which a portfolio company meets the International Labour Organization’s, (ILOs), core conventions and basic terms and conditions of employment, identifying

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areas for improvement and where the team can proactively work to achieve targets; to tackle corruption it makes sure each investee company has an anti-corruption policy, an anti-corruption manager and a program to educate employees; tax is a central part of its due diligence and the ESG team delves into the transparency of each investee company’s tax reporting – quite a challenge in some African economies.

“We have to be sure upfront a company understands how to report,” she says. “We actively work with our companies to get the policies in place.”

Swedfund’s due diligence is costly and time-consuming and progress is often slow; the fund only made five investments last year.

“It takes much longer for us than ordinary investors, but we do know that if we put the time in at the start it pays off. So many companies have been hit hard and seen their value and brand destroyed by not being sustainable,” says Ryott. Finding suitable investment opportunities is also challenging.

ESG ‘BAR’ SET HIGHER EVERY YEAR

And because of the ongoing process of ESG integration, it’s not a cost that goes away once an investment has been made.

Close monitoring ensues for the life of the investment. The ESG team carries out regular audits of investee companies, sometimes digging deeper still with external consultants.

In 2015 Swedfund audited six companies and 10 the year before. In 2015 it audited an investee company’s supply chain as part of a project to improve children’s rights, leading to a list of specific actions and target dates for follow up.

And the ESG bar is set higher every year.

Ryott has just launched a whistleblower scheme whereby anyone working for Swedfund investee companies can report serious irregularities in anonymity, guided by the UN’s Guiding Principles on Business and Human Rights which asks that businesses introduce a mechanism for grievances.

In 2015, together with the European Investment Bank and the European Commission and within the framework of the UN’s Sustainable Energy for All initiative (SE4All), Swedfund established a platform for investing in sustainable energy solutions in Africa.

The results speak for themselves.

In 2015 average job growth in Swedfund’s portfolio companies grew 3.7 per cent, 96 per cent of investee companies reported a sustainability or environmental policy, 79 per cent adhered to International Labour Convention’s core conventions, and 88 per cent had an anti-corruption policy.

Portfolio companies reported a combined $59.5 million in tax.

“The numbers do get better and better and when we come to sell we get a higher value with this integrated business model,” Ryott concludes.

COLUMN ROBERT ECCLES

ABIDING BY THEIR PRINCIPLES

There is encouraging progress by asset owners and asset managers in practicing better ESG integration.

ROBERT NAME ECCLES HERE BIO

Robert Eccles is Visiting Professor of Management Practice at the Said Business School at Oxford University.

For nine years he was the Professor of Management at Harvard Business School. He has been chair of the Sustainability Accounting Standards Board since 2001 and is non-executive chair of Arabesque Asset Management.

He is a board member of Mistra Centre for Sustainable Markets. He has written extensively on integrated reporting including the first book on the subject One Report: Integrated Reporting for a Sustainable Strategy.

Encouraged by their investors, companies are increasingly focused on identifying and reporting on the material environmental, social, and governance (ESG) issues that will affect their long-term financial performance. Although these efforts are still at relatively early stages in most companies, the work of organisations like the Climate Disclosure Standards Board, Global Reporting Initiative, the International Integrated Reporting Council, and the Sustainability Accounting Standards Board is giving companies the tools they need for better ESG integration.

Also supporting this is legal memos on fiduciary duty for all G20 countries and 14 others that clarify the board’s duty is to the corporation, not shareholders as is commonly believed. This means that there are no legal barriers to companies taking material ESG issues into account in their resource allocation decisions.

The most advanced companies, such as the Swedish industrial products company Atlas Copco, recognise the important role the board has to play by issuing a “Statement of Significant Audiences and Materiality” and constructing a “Sustainable Value Matrix” as shown in their 2015 integrated report.

While also still at the early stages, asset owners and asset managers are becoming increasingly sophisticated in practicing Principle 1 (“We will incorporate ESG issues into investment analysis and decision-making processes.”) and Principle 3 (“We will seek appropriate disclosure on ESG issues by the entities in which we invest.”).

A proper understanding of fiduciary duty is as important for investors as it is for companies. The PRI has recognised this. In collaboration with the UN Global Compact, Global Reporting Initiative, and Inquiry: Design of a Sustainable Financial System, on September 7, 2015 PRI published the report “Fiduciary Duty in the 21st Century” which drew the strong conclusion that: “Failing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty.”

This dramatically reframed the debate from whether ESG integration was a violation of fiduciary duty to saying that the failure is if it isn’t. PRI has subsequently launched a three-year program to integrate sustainability into investors’ fiduciary duties that has three major components.

THREE MAJOR COMPONENTS

In order for this program to be as successful as possible, it must go further and address the issue of fiduciary duty on the company side as well. More precisely, following Principle 2 (“We will be active owners and incorporate ESG issues into our ownership policies and practices”); asset owners and asset managers must engage with company boards of directors, not simply with management, which is the common practice. Asset owners must do this themselves and insist that their asset managers do so as well.

There are three parts to this engagement. The first is to ask the company’s board to produce a simple one-page “Statement of Significant Audiences and Materiality (The Statement)” which identifies a limited number of key audiences (e.g. short-term investors only or long-term investors and a select few stakeholders) and the time frames it uses to evaluate the impact of its decisions on them. Asking for “The Statement” will enable investors to clarify which audiences are significant and, by implication, which ESG issues are material from an internal management and external reporting point of view. The legal memos described above will give them a strong platform for doing so.

This engagement then needs to extend to management to ask them to explain their materiality determination process for ESG reporting purposes (ideally through integrated reporting), the standards being used to report on ESG issues, and the level of assurance that is being given on this information.

They should also ask for management to articulate their view on the relationship between financial and ESG performance.

Third, asset owners and asset managers need to engage with the company to ensure that executive compensation, and the compensation system throughout the company, supports proper attention to ESG performance. If financial and other incentives are not tied to the material financial and ESG metrics from a sufficiently long-term view, management will understandably fall victim to short-term earnings’ pressure.

Ultimately, the extent to which Principle 1 can be put into practice depends upon the quality of ESG disclosures from Principle 2. This, in turn, requires board clarity, through Principle 3, about the company’s role in society which shapes its materiality determination process and what ESG factors it reports.

Better ESG integration by companies will enable better ESG integration by investors.

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INVESTOR PROFILE WESPATH

KEEPING THE FAITH The fund which manages United Methodist Church’s $20 billion has been practising environmental, social and governance principles for 108 years.

BY Amanda White

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Wespath Investment Management, which manages about $20 billion on behalf of the United Methodist Church, is the largest faith-based benefits plan administrator and pension investment manager in the United States.

It has been around since 1908 and with a multi-manager platform of broadly diversified funds, positive social purpose lending, and the integration of environmental, social and governance (ESG) considerations into its investment strategy, ESG has been a core of its strategy since inception.

Wespath was a drafting signatory of the PRI. Kirsty Jenkinson, managing director, sustainable investment strategies at Wespath Investment Management, says the background as a faith-based fund meant a clear alignment of values to be at the forefront of PRI. “Being part of the PRI was not just about values but creating long term value and returns. We have fundamental beliefs, from our chief investment officer and our chief executive, that you have got to be sustainable.”

“PRI has allowed us to connect and work with peers internationally and that globalisation has benefited us.”

Jenkinson says the manager’s strategy has evolved over the years, and while there has always been a focus on ethical exclusions (gambling, alcohol, tobacco, adult entertainment, weapons, and prisons), active ownership is where the team now spends most of its time, including corporate resolutions and proxy voting.

The manager tracks the extent of its exclusions across the US and international

equity funds, and about 3.7 per cent of the US equity universe (Russell 3000) is ineligible, and 5.2 per cent of the international equity universe (MSCI ACWI ex-US IMI) is ineligible.

“In terms of the impact of the exclusions on performance, on a quarterly basis we review our passive portfolios versus key benchmarks and over a 10-year period, the annualised returns of our screened passive portfolios have been in line with the returns of all the underlying indices,” she says. “This has shown that exclusion has had a normal, not negative impact on returns.”

But the strategy has evolved, and so has the mindset of responsible investors in the US. “It’s not just about what you exclude,” she says. “Active ownership is where [we] spent [a] large majority of our time.”

EVOLVING FOR A LOWER-CARBON FUTURE

Climate change is a clear priority in Wespath’s assessment of how companies are dealing with risk.

“We want to understand how well companies are positioned for a low-carbon economy. The economy is changing because of policy and taxes put in place to make it more costly for climate change, so carbon effected companies need to show how they are evolving to account for that,” she says.

Wespath was co-lead in the filing of shareholder resolutions to Occidental Petroleum in US and Chevron in the UK, that both companies provide additional disclosure to investors about scenario planning and the ways in which they are “stress-testing” their fossil fuel portfolios in anticipation of a lower-carbon future.

INVESTOR PROFILE WESPATH

WESPATH, WHICH WAS A FOUNDING SIGNATORY OF THE PRI IN 2006, HAS FOUR PILLARS TO ITS ESG APPROACH:

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ESG analysis – focusing on the factors central to measuring the sustainability and ethical impact of investing in a company or business

Advocacy and engagement – advocating for environmental stewardship, human and workers’ rights, access to health care and sound corporate governance in accord with social principles and the United Methodist Church’s Book of Resolutions

Exclusions – excluding all investments according to policies adopted by Wespath’s board of directors, consistent with the social principles of the UMC. These policies exclude investments in companies earning significant revenues from gambling or from the manufacture, sale or distribution of alcoholic beverages, tobacco-related products, adult entertainment, weapons, or the management or operation of prison facilities

Positive social purpose lending – promoting affordable housing, community development and expanded loan opportunities in poor, under-served communities. This 25-year old program has loaned approximately $1.9 billion for projects around the world.

These investments support affordable housing and community facilities for lowincome families as well as microfinance-loans to entrepreneurs in developing countries.

The management of both companies did not support the resolutions. Nearly half of shareholders at Occidental and about 40 per cent at Chevron voted in favour of Wespath’s resolution.

Meanwhile a GBPHB/Wespath co-filed resolution asking for additional reporting on the environmental risks and opportunities associated with climate change at Anglo American, was supported by company management and received 96.25 per cent support from investors, and is unprecedented for environmental resolutions.

“We used to file more esoteric filings, but now we take a more strategic look at it, if it’s a fiduciary thing, it’s a no brainer and we are being more strategic,” she says.

The manager also looks at human rights and diversity in terms of risks.

“We want to understand where companies operate and where risks are,” she says. “Board diversity is a big issue for us, and another area where US lags the rest of the world. We were involved with three resolutions this year where there was one woman on the board, we withdrew because of a promise by the companies to put another woman on the board.”

Jenkinson is quick to point out, though, that exclusions and resolutions are based

on risks to the portfolio and not moral reasons.

“There is an increasing recognition that if you’re a long-term investor then you think about global long term themes – urbanisation, demographic changes, and other major mega trends. And we think about the impact on resources and climate change of these mega changes and how they are playing out in companies we invest in. As more evidence and data is coming out about these changes it is more defining for sustainable investments.”

ONGOING MANAGER MONITORING

Wespath’s portfolios are managed by external managers, of which there are about 40.

While the mandates it searches for can be very specific – such as a recent search for a fund that’s completely focused on lowcarbon energy companies – the increasing focus is on how external managers are focused on ESG integration.

“In the past we focused on manager selection, now it’s about long-term managers and it’s more important to evaluate and monitor them. We have spent a huge amount of time setting up a template to ask questions of managers, to benchmark them and give a heat map.”

This evaluation of managers is a sticking point for Wespath.

“The big question is how long do we give them if they are in the red zone? We are assessing how we may use that to terminate managers.

“If we really want to shift the market we need to be consistent in how we monitor managers.”

Jenkinson says the easy part is putting it in an investment management agreement, but the hard part is ongoing monitoring.

“This is jointly run by the sustainable investment management and equities teams. We are taking the time not to just ask questions managers can answer easily, but to tailor questions to particular manager styles.”

Wespath believes the biggest shift in the past 10 years has been the strength in numbers, and Jenkinson credits the PRI for that.

“This shows it’s not just a small group of enlightened people, but it’s a broad market based shift, and a professionalisation of the industry. The focus is more on materiality and financial analysis now,” she says.

But some barriers remain, including the fundamental challenges of causation and correlation, and proving that active ownership and engagement adds to performance.

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INVESTOR PROFILE VICSUPER

LONG-TERM RISK IN AGRICULTURAL INVESTMENTS How is VicSuper’s application of the Natural Capital Declaration helping it manage long-term risk in agricultural investments? A case study of environmental, social and governance (ESG) integration.

BY Dan Purves

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An expression of VicSuper’s commitment to the PRI can be seen in its decision to become a signatory of the Natural Capital Declaration (NCD).

NCD’s purpose is to integrate natural capital considerations into financial products and services, and to work towards their inclusion in financial accounting, disclosure and reporting.

Industries such as farming, mining, timberland, technology and infrastructure all use natural capital as raw inputs, however, the NCD asserts the full value of natural capital has not been properly priced into the global economic system.

To address this lack of proper pricing, the NCD is developing methods to implement the four commitments (see box) in the declaration.

“This is being done through a steering committee of signatories and supporters and four working groups, supported by a secretariat formed of the UNEP Finance Initiative and the Global Canopy Programme (GCP),” NCD states on its website.

VicSuper has been given a leadership position with Kirsten Simpson, manager of corporate responsibility at VicSuper, appointed in November 2014 as the vice-chair of working group IV disclosure and reporting.

Group IV is tasked with developing a disclosure framework and guidance for financial institutions on natural capital, to contribute to understanding the significance of global trends, such as resource constraints, environmental degradation, to investment portfolios and financial sector resilience, says Liesel van Ast, programme manager at NCD. “A lot of the work is at the investment manager level, making sure they have the tools to make informed, rounded and holistic decisions on our behalf,” Simpson says.

“And for those funds that have inhouse investment managers, they will be able to use the tools too.”

Michael Dundon, chief executive of VicSuper, says comprehensive disclosure and analysis of natural capital has helped

VicSuper to make more informed investment decisions, as through it the superannuation fund has gained a better understanding of the risk profile of assets.

HISTORICAL LINK

Since 2010, VicSuper has more than doubled its assets from AU$7 billion ($5 billion) to AU$15 billion ($11.4 billion) at July 1, 2016. It manages this on behalf of more than 240,000 members (including more than 11,000 pension members) and 21,000 participating employers.

Founded in 1994, VicSuper was originally setup as a closed fund for public servants in the Australian state of Victoria, but on July 1, 1999, a restructure opened it up to most employers across the country, and a year later it became open to everyone, regardless of whether their employer used the fund or not.

This historical link to public servants in Victoria and to its interruption of “members’ best interest” to include societally and economic benefit, in addition to financial returns, means it actively searches for investment opportunities in Victoria.

CHRONIC SOIL EROSION NEEDS TO BE ADDRESSED

These parallel priorities of risk-adjusted return to members, integrating natural capital and investing in Victoria is most clearly demonstrated through its mandate with Kilter Rural, which manages VicSuper’s agriculture investments in the Future Farming Landscapes (FFL) redevelopment project.

To give some context, at July 1, 2016, VicSuper has a 17.5 per cent asset allocation to real assets in its balanced portfolio, with the investments split across property, infrastructure, timber and agriculture.

The agriculture investments were focused on land and water assets, predominantly located in northern Victoria, Australia, with the returns derived from traditional broadacre agriculture, water revenue streams and movement in asset market value.

INVESTOR PROFILE VICSUPER

The FFL business model is based on income being generated and capital value increasing via moving farming to sustainable practices, in a time when yields using traditional methods are diminishing.

By actively engaging and taking factors such as biodiversity, land health and water use into account, FFL aims to create resilient landscapes that can produce and deliver beneficial economic and environmental outcomes across a variable climate.

“It is a really proactive way of thinking about the farm and its future years and how to adapt to the changing climate.

They fully offset all of their emissions and are essentially carbon neutral, which is fantastic,” says Simpson.

The VicSuper team on a farm tour

ENGAGEMENT THROUGHOUT THE PORTFOLIO

THE NCD’S FOUR COMMITMENTS ARE:

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“Creating systematic methods for financial institutions to assess their impacts and dependencies on natural capital through portfolios.

Developing and testing (quantitative, analytical) methods to link natural capital to financial risks and opportunities.

Working towards an accounting framework that includes natural capital.

Working towards disclosure and reporting that enables financial institutions to understand how they are positioned for natural resource risks and opportunities.”

This is juxtaposed against Australia experiencing soil erosion by at least several hundred – and in some regions several thousand – times the rate at which it can be replaced, according to the Food and Agriculture Organisation (FAO) of the UN. While there are large uncertainties around when this will have a critical impact on agricultural productivity, environmental impacts are already evident in inland waters, estuaries and coasts.

“It is clear that a concerted program of soil conservation is essential to control this chronic form of land degradation across large areas of Australia,” the FAO states in its 2015 report.

With this as a backdrop, Kilter was awarded a mandate from VicSuper to manage and redevelop 11,000 hectares across a variety of farmland including maize, sorghum, tomatoes and barley as well as sheep farming.

VicSuper’s long-term risk management through engagement feeds through into how the superannuation fund views divestment.

To date, the only sector it has divested from is tobacco. In all other sectors, VicSuper is pursuing a strategy of advocacy and engagement to influence change, as it sees this as the most effective way of creating value over the long term, particularly if it is done across the supply chain.

In the energy sector, for example, VicSuper can be invested in exploration companies such as Woodside Petroleum, mining companies such as BHP Billiton, distribution companies such as AGL Energy and usage companies such as Origin Energy.

“We firmly believe that as an active owner of assets on behalf of our members, engagement should be used as a tool to influence changes in corporate behaviour, especially when it comes to the management of ESG risks and opportunities,” says Kevin Wan Lum, head of equities and alternative investments at VicSuper.

To this end, VicSuper has appointed Regnan Governance Research and Engagement Pty Ltd and the Australian Council of Superannuation Investors (ACSI) to engage with listed Australian companies on ESG risks and opportunities. And for international listed companies, as well as regulatory bodies and other intermediaries, VicSuper is using Hermes Equity Ownership Services.

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COLUMN ROGER URWIN

THE DECADE OF FIDUCIARY CAPITALISM ROGER URWIN BIO

Roger Urwin is strategic director of the CFA Institute’s Future of Finance, global head of investment content at Willis Towers Watson and advisory director of MSCI Inc. At Willis Towers Watson he leads the firm’s work on transformational change and has conducted major strategic reviews at a number of global leading asset owners.

He is also involved with the Willis Towers Watson thought leadership group, the Thinking Ahead Group.

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Developing coherent investment beliefs is much of the battle when it comes to sustainable investing. The next decade should be a time to move from ESG green to sustainability evergreen.

The past 10 years have been momentous for the world of investment.

The three things that for me have defined it are: the upskilling of asset owners, the integration of environmental, social and governance (ESG) into their investment processes and living through the global financial crisis.

Not surprisingly, the global financial crisis has been the most far-reaching of these because its after-shocks are still with us. At the centre of the crisis were the failures of our investment models to cope with a morass of global linkages. As an example, the unsustainability of banking practices was crying out for investors with clear heads and enlightened stewardship. But investors were the dog that didn’t bark.

Too many investors in this past decade indulged in unimaginative investment approaches that privileged recent trends and downplayed more pervasive factors.

Our unconnected dots contributed to large-scale evaporation of wealth worldwide.

The upskilling of asset owners is an encouraging sign that we may do better in the next crisis. We have lived through an era of “asset rich - time poor”. The asset owner has been chronically under-powered where it should have been strongest in its in-house intellectual property. Now we have a more effective picture with much more skilled asset owner chief investment officers.

This gap in a globally connected orientation is also being filled by the improved understanding of externalities – ESG being the pragmatic way we characterise this. Some funds have travelled far in the ESG framework in the past decade. We can cite CalPERS as a fund in which the belief that “ESG factors impact risk and return over the long term” did not even get majority board support five years back.

But in 2013 its ground-breaking beliefs work connected “long-term value creation to effective management of financial, physical and human capital”; and cited “advanced governance as the primary tool to align interests between CalPERS and managers of its capital, and to manage risks successfully in investee companies”. Much of the battle in sustainable investing has always been in developing coherent investment beliefs.

What is different going forward? Where the decade just past was really about financial capitalism, the next decade certainly should be about fiduciary capitalism.

This is positioning investment not as an end in itself, but as a means to an end “to the ultimate benefit of society” as the CFA Institute promotes in its mission.

A KIND OF KARMA

This is moving from the inherently divisive and selfinterested financial capitalism model to an enlightened self-interest model, where prosocial and financial motivations work well together in a form of “karma”.

This is a big ask. First, how can our investment institutions mobilise the social capital to create this karma? Second, how can we engineer these prosocial impacts working with suitable analysis and models in an industry dominated by financial measures?

We must shift gears and look at our portfolios in a fundamentally different way to gauge impacts on the sustainable development challenges of our generation – jobs, inequality, wellbeing, resources, climate and ecosystems.

We must make this happen in the enlightened self-interest model in which our financial goals are preserved. There is no appetite for our institutional funds to pay a price for any prosocial motivations.

Corporate disclosure and analysis must step up. Disclosure will not cure poor governance. But better analysis, measurement and narrative will help investors to identify quality of practice and target their decision making accordingly. There are many winwins possible here.

This should be a time of greater purpose in finance. It’s a time when investors can do more for sustainable development goals. It’s a time for technical innovation to measure the unmeasurable. It’s a time for leadership when chief investment officers take sustainability seriously. It should be a time for going beyond the evolving ESG paradigm to a step-up in which asset owners reduce their externalities, increase their societal dividends and critically produce better financial outcomes.

We have previously seen sustainability as a “green” movement but maybe the word “evergreen” captures the increased resilience and relevance needed. The next decade should be a time to move from ESG green to sustainability evergreen.

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s climate change, resource depletion and environmental erosion become more pressing and ubiquitous risks, their impact on portfolios will increasingly shape investor decisions.

Kevin Bourne, Managing Director of Database Services at global index and data provider FTSE Russell, says, as a result of these risks, legislative change by governments and unilateral action by groups of investors are on the increase.

LIMITED LEGISLATIVE IMPACT Bourne says, “To date, there has not been a huge amount of direct regulation that impacts the investment community in respect of sustainable investment.”

This, he believes, could be about to increase as concerns grow with policy makers about the pace of change within global markets. Two notable exceptions are France’s Article 173 and California’s SB 185, the state’s so-called coal divestment law, introduced in late 2015. It called for the state’s two leading pension schemes to remove certain carbon-related assets from their portfolios, and according to Bourne, “What has been implemented certainly got people’s attention, not just in France and California but around the world.”

MANAGING CARBON RISK, A DATA QUALITY CHALLENGE? Strong government positions on carbon may be a plus for the sustainable investment movement but it remains challenging for investors to manage their portfolio’s carbon

risk. According to Bourne the options available span a range of different techniques but these require close scrutiny if subsequent asset allocation decisions are made.

“Some investors are choosing to do nothing” says Bourne. “Others are removing carbon from their portfolios either because they don’t believe in fossil fuels from a values perspective or because legislation, such as SB 185 in California, is forcing them to divest.”

“Another tack” says Bourne, “is to footprint portfolios to understand their CO2 exposure and then possibly tilt the portfolio towards a lower overall CO2 level.”

Assessing the carbon footprint of a portfolio could certainly lend itself to more informed decision-making. But it is not always easy as it involves analysing companies in a broad investable universe and calculating how much CO2 they produce through commercial activities. This presents a data quality challenge because of variable reporting levels against the GHG protocol.

Bourne believes poor and missing data issues should be more transparent for investors to assist them in the decision making process

BEYOND ESG AND CO2 – ‘THE MISSING MODEL’ Bourne explains, “When looking at sustainable investment data broadly, there are three high level questions that need to be answered. Firstly, how does the company operate? The measurement of this is achieved with an ESG model that calculates a transparent rating. Secondly, does the company pollute in respect of climate change gases? This is captured through a CO2 e footprint of emissions and reserves.

Finally, does the company provide green goods, products and services as part of the industrial transition to a green economy?

This last question is what we call ‘the missing model’ and our work in this area

is the most recent addition to our sustainable investment metrics.”

The recent launch of FTSE Russell’s groundbreaking Green Revenues (LCE) data model and Green Revenues Index Series is revolutionising investors’ ability to measure and understand their portfolio’s exposure to the green industrial transition.

MEASURING GREEN EXPOSURE The Green Revenues (LCE) data model and Index Series allows users access to consistently measure and model revenues from goods, products and services that help the world to adapt to, mitigate or remediate the impact of climate change, resource depletion or environmental erosion.

By incorporating this measure of green revenue exposure, FTSE Russell’s new model provides the first complete picture of the scale and velocity of the structural shift to a green economy across public companies.

SUPPORTING A GROUNDSWELL ECONOMIC SHIFT FTSE Russell’s Green Revenues model is the culmination of five years of work and covers more than 14,000 public companies, representing 98.5% of the world’s market capitalisation. Bourne notes, “Until the publication of our model, it has been extremely difficult for investors to quantify, with any certainty, the impact of this industrial transition on portfolios.

What we now understand, is that companies are producing more green solutions in line with rapidly evolving demands from society and policy signals from governments. The notion of ‘Stranded Assets’ is not just a structural challenge for the hydrocarbon industry” says Bourne as the new model already identifies more than 2,600 companies with green revenues from one or more of 60 new green industrial sub sectors.

In addition, a new series of ten Green Revenues Indexes is based on the model and cover key FTSE and Russell benchmarks. For investors, this means disciplined and transparent tools to track transition exposure and a new standard in company level data for investors looking to measure, model and participate in the global green economy.

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© 2016 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes FTSE International Limited and its subsidiaries and Frank Russell Company. All rights reserved. The Low Carbon Economy Industrial Classification System™ & Low Carbon Economy Industrial Engagement Matrix™ (US Pat.Pend) are unregistered trademarks of LCE Risk Ltd. All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no member of the LSE Group nor their respective directors, officers, employees, partners or licensors (a) accepts any responsibility or liability for any errors or for any loss from use of this publication or any of the information or data contained herein, nor (b) makes any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of or the suitability for any particular purpose of the Green Revenues (LCE) data model or the Green Revenues Index Series.