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Practical steps for investing in a sustainable tomorrow

Published October, 2017 |

Society and sustainability Print

Pension funds’ long term horizons mean they are ideally placed to benefit from ESG investing, and a number of large European funds already find value in the use of ESG factors. However, studies suggest that many funds have so far been slower to adopt ESG investing than other institutional investors.

This apparent reluctance may reflect some misunderstandings about ESG. Many pension fund trustees seem to believe that ESG investing limits diversification, leads to underperformance or conflicts with their objectives. That might explain why many pension funds are yet to fully realize the potential benefits of ESG.

A new EY report, Investing in a sustainable tomorrow, considers the arguments for European pension funds to adopt ESG investing. These include a number of industry developments and regulatory requirements. Arguably, it is the potential long term investment benefits that carry the greatest weight — both in terms of risk reduction and, potentially, of outperformance. However, the report also examines the practical barriers that make it difficult for many pension funds to explore the growing business case for ESG investing.

A combination of external/regulatory requirements, industry developments and fiduciary evolution are pushing ESG investing up the European pensions funds’ agendas. Furthermore, a small but growing body of academic evidence indicates a link between corporate sustainability — a company integrating ESG goals into its strategy — and company financial performance. With this in mind, we offer some practical steps for exploring the potential benefits of ESG investing.

How to explore the potential benefits of ESG investing

Governance and control

  • Consider whether your legal or fiduciary responsibilities might require you to consider ESG factors when investing.
  • Ensure you are aware of all national and European legal and regulatory requirements relating to ESG, and the indirect effect of any requirements in other jurisdictions.

Leadership and strategy

  • Identify your current level of ESG adoption, decide what you believe would be your best approach, and consider how to address any gaps.
  • Review the quality and level of corporate sustainability practices by investee companies.
  • Assess the potential benefits — and practical requirements — of pursuing ESG integration across the fund’s full range of activities.

Understanding and capabilities

  • Review your existing ESG knowledge and resources and consider how to ensure that trustees and investment committee members are informed and updated about ESG terminology, techniques and areas of debate.
  • Keep up to date with the latest academic and commercial research on ESG investing. This not only applies to the potential benefits, as attention should also be paid to the risks that can arise from ESG factors such as climate change-related “asset stranding”.
  • Monitor the ESG experience of institutional investors at large, particularly those that are seen as leading adopters, or as having achieved particular benefits from ESG investing.

DB vs. DC 

  • DB funds should work closely with sponsors and investment consultants to consider whether ESG investing can complement their short, medium and long term investment goals. They should then assess whether, and how, they should integrate ESG factors into their overall investment strategy.
  • DC funds should consider the potential for increasing demand for ESG investing options from current and future members. They should then take steps, in consultation with sponsors, to reflect this in the design of their default strategies and the range of self-selected funds they offer.

External partnerships and support

  • Consider signing up to the Principles for Responsible Investment (PRI) or ESG-focused groups of institutional investors.
  • Review and analyze the experience of close peers or affiliated funds that already make use of ESG investing.
  • Assess the ESG expertise and experience of your fund’s advisors and consultants, and consider whether you are making best use of these external relationships.

Investment management

  • Be aware of the full range of possible techniques for implementing ESG investing. This includes both active and passive strategies and a full range of asset classes.
  • Engage closely with investment managers to understand the range of ESG-themed products and services they offer. This could include ratings and research, segregated mandates, passive funds or ETFs and active stewardship.
  • Challenge prospective investment managers about their ESG capabilities as part of manager selection procedures.

Co-operation and collaboration

  • Set out a strategy to ensure clear and effective co-ordination between sponsor, fund, consultants, managers and other partners.
  • Explore the possibility of co-operation with other pension funds, industry bodies or sponsors, taking full advantage of any shared experience and knowledge.
  • Contribute to industry or government led initiatives aimed at improving the quantity and quality of ESG disclosure by investee companies.

There are of course barriers and obstacles to ESG investing – these are explored in depth in the main paper. In light of these, pension funds should be aware not only of the potential opportunities, but also of the risks of inaction in this arena. Despite the complexities of the topic, there is much that European funds can do to engage with ESG investing and to benefit as a result.