Work in Europe If You Want Your Pension to Grow While Doing Good

(Bloomberg Markets) -- These days, European asset managers’ websites all seem to have a section devoted to ESG, providing their take on a range of environmental, social, and governance topics including green energy and women on boards. Every mutual fund company has an ESG product, and every investment bank is rolling out ESG research.

Europe is the place to be if you want to do good while becoming richer.

So what’s driving Europe’s responsible investing revolution? One group at the heart of it is the region’s pension industry. Funds aren’t only shunning tobacco or weapon stocks; they’re also integrating ESG standards into the investment processes. Indeed, the most progressive funds seek to invest in companies that do good—a practice that some critics say edges dangerously close to philanthropy.

Europe had a $12 trillion of assets committed to sustainable and responsible strategies in 2016, the most among any region, according to the Global Sustainable Investment Alliance. What’s more, its 2016 total represented a 40 percent jump from 2012. And the region’s pension funds—with their massive assets, long-term horizons, and government backing—have been a major driver, Bloomberg Intelligence says.

It’s unsurprising that pension funds have such sway: The top 1,000 hold a total of €7.2 trillion ($8.2 trillion) in assets, IPE Research data show. “They have billions under management. As soon as they say something, all the asset managers listen,” says Cedric Durant des Aulnois, chief executive officer at Montanaro Asset Management Ltd. in London, who reckons his company’s ESG capabilities have helped it amass about €1 billion in mandates from pensions. “This is not a fad. It’s a structural change.”

There are a number of reasons for pension funds’ growing focus on ESG. One is regulatory. Starting in January, changes in the European Union’s so-called IORP II—the Institutions for Occupational Retirement Provision directive—compel plans to cover ESG in risk management. New U.K. laws will require pension trustees starting in October to show how they account for ESG in their financially material considerations. There’s also the sense that pension beneficiaries increasingly expect their trustees to help combat climate change or recycle waste.

The worry that adopting ESG will compromise returns has also dissipated somewhat. That is to say, many asset managers see it as risk mitigation. Investing in clean energy contributes—however marginally—to reducing the risks of climate change. For that matter, a company with better governance might be less prone to a management scandal. One with better labor practices might have lower staff turnover.

“These are not nonfinancial factors; they are not-yet financial factors,” says Piet Klop, senior adviser for responsible investment at PGGM, which manages Europe’s third-largest pension fund from Zeist, the Netherlands. “Especially for long-term investors, taking externalities into account actually makes a whole lot of financial sense.”

There is some evidence supporting that. A 2015 meta-study found that 90 percent of studies saw a non-negative relationship between ESG and corporate financial performance, with a large majority reporting positive results. The MSCI World ESG Leaders Index outperformed the MSCI World in 2018, though it slightly trails over the five- and 10-year periods.

To be clear, the ESG revolution in Europe isn’t complete. The Scandinavian countries and the Netherlands are more progressive than the rest of the continent. And while the giant funds are already proselytizing about impact investing—which has the express purpose of achieving a social good—the smaller ones are still scrambling to assess their portfolios’ ESG risks.

Pension funds beyond Europe have started to prioritize ESG. Japan’s 165.6 trillion yen ($1.5 trillion) Government Pension Investment Fund, the world’s largest, has allocated billions of dollars to ESG through stock investments. The California Public Employees’ Retirement System, the biggest U.S. public pension fund, has pressured companies on executive pay, harassment, gun control, and climate change through voting and engagement.

It’s no wonder asset managers are rushing to promote their ESG credentials. But how do you win over a particularly conscientious pension when anyone can download an ESG rating set from MSCI?

Here’s some advice from investors:

■ Integration is the baseline. Instead of having an ESG analyst stashed in a corner of the office, consider ESG in every step of your investment process. Engaging corporates to improve their practices is important. That means, at bare minimum, voting at shareholder meetings. But beyond that, Montanaro Asset, for example, has mediated conflicts between unions and management. ATP Group, Europe’s fourth-largest pension fund, conducts what it calls thematic engagement: It asks companies it invests in about big themes such as climate change, says Ole Buhl, ATP’s head of ESG.

Work in Europe If You Want Your Pension to Grow While Doing Good

■ Pensions seek asset managers that can help analyze ESG issues. They want “a partner for know-how,” says Lisa Beauvilain, head of sustainability and ESG at Impax Asset Management Group Plc in London. Masja Zandbergen, head of ESG integration at Robeco, says the Dutch asset manager tailors investment solutions around themes its clients focus on. It’s created benchmarks—based on a factor, such as value, as well as an ESG theme—for pension funds to passively follow.

■ Reporting on the impact of investments matters. Some funds, such as Montanaro’s Better World Fund or Impax’s Specialists or Leaders funds, tell you how many tons of waste your investment has collected and the emissions avoided.

■ Doing good can carry complications. Under U.K. rules, trustees can take nonfinancial factors into account when investing, provided that no financial detriment results and members generally agree with these priorities—a condition that’s hard to prove. That’s why it’s usually easier just to build a financial case for ESG considerations, says Stuart O’Brien, a partner at Sackers & Partners LLP, a law firm in London specializing in advising pensions. Trustees need to be careful mixing ethical considerations with financial ones, he adds.

■ Defining ESG and its investment implications isn’t a black-and-white exercise. ABP, Europe’s second-largest pension, for instance, doesn’t divest from companies in the coal business. The reason: Those companies may be able to contribute to the transition toward renewable energy, says ABP chair Corien Wortmann-Kool. ESG investors say they’re not interested in the best companies; they like the improving ones.

■ Currently there is no one way to legally classify a fund as “sustainable,” which creates opportunities for greenwashing—the disparaging term for misleading sustainability claims. The EU is trying to fix this and in May 2018 proposed a bloc-wide classification system for sustainable economic activities, which it plans to begin rolling out this year. For now, pension trustees need to do their homework.

“Everyone’s falling over themselves to extol their own ESG credentials, which is why trustees need to be very careful to actually understand the issues in more detail,” O’Brien says. “They need to get into the weeds with their managers: You say ESG is important to you—give me some concrete examples of how you actually do this.”

Lee covers European equities at Bloomberg News in London.

©2019 Bloomberg L.P.