CalPERS steps up ESG drive

After an extensive review and high-level workshop earlier this month the CalPERS’ investment team will seek board  approval in December for a total-fund plan to more fully integrate environmental, social and corporate governance principles into all the investment decisions it makes in each of its asset class.

Anne Simpson (pictured), CalPERS’ corporate governance chief, says these new ESG policies and practices will include looking at how to build in tilts to strong ESG performers in its passive equity investments, an extensive ESG procurement policy for external managers, and setting new ESG standards for its infrastructure and forestry investments.

“I think this is a natural phase of this (ESG) being a relatively new area,” Simpson says.

“CalPERS has been a real innovator in the field but now it is time to harvest what has been learned, to distil the lessons and see how we can be more effective.”

Each of the asset classes has identified priority areas for ESG as part of a review the $226 billion fund undertook last year and which resulted in a high-level workshop in mid-August.

Simpson said the fund is also looking to collaborate with 11 other funds that have been part of a wide ranging ESG review conducted with Mercer LLC in 2010.

The funds from around the world include Government Employees Pension Fund of South Africa, PGGM in the Netherlands, Universities Superannuation Scheme in the United Kingdom and Previ in Brazil.

The funds have collectively more than $1.5 trillion in assets under management and Simpson says they share a common aim.

“Any of the things we do we want to be talking to our peers about their approach because we have many of the same objectives,” Simpson says.

“Over the long-term we are virtually a universal, almost permanent owner. The group that we have been talking to, the 12 of us, between us we have $1.5 trillion in assets but there is core common interest underlying that in these sustainable risk adjusted returns.”

The collaboration has significant ramifications for external managers, with these funds likely to demand significant transparency, monitoring and reporting of ESG performance from service providers.

“There is a good case for the customers to clarify what it is they are looking for, what sort of capacity, what sort of monitoring and what sort of reporting back to the funds,” Simpson says.

“But – without losing sight of the fact that having your heart in the right place doesn’t mean that your head is screwed on – it doesn’t mean that you can make money and invest successfully just because you care about these ESG issues. We have to find a way for those managers with talent to be integrating this stuff as a matter of course.”

The CalPERS board will consider a report outlining how each of the asset classes will implement these ESG integration priorities in December.

Simpson says reforms include a total fund approach that involves CalPERS providing a sustainability report in 2012 that will be the focus for comprehensive ESG performance reporting across all of its asset classes.

Through its review process conducted by Mercer, the consultants did a “sustainability inventory” of the fund and identified 111 separate initiatives CalPERS had undertaken.

Simpson said its ESG integration plan aims to bring all these different initiatives into one unified ESG approach that provide clear best-practice principles across the whole fund.

The review and subsequent workshop identified three unifying themes and subsequent areas of concern that all its ESG policies and practices would aim to consider.

These were:

  • Environmental: climate change – carbon, energy efficiency, clean technology, renewable energy and water stress.
  • Social: human capital – exploitative labour practices, health and safety, responsible contracting and diversity.
  • Governance: alignment of interest – executive compensation, fund manager terms and conditions.

Simpson says the aim was to provide uniform and consistent practices that would add to both the overall ESG performance of the fund and also improve sustainable risk-adjusted returns.

Each asset class was asked to look at their ESG priorities, how they would measure performance and what ESG practices they would build into their procurement processes to develop better monitoring and disclosure from external managers.

“The procurement theme will be consistent, the performance theme will be consistent. By ensuring that each of the asset classes has identified their priorities that are consistent with each of the ESG themes, we have identified what will give coherence and synergy between these many different initiatives that have been kicked off over the years,” she says.

In terms of asset allocation Simpson says the fund is looking to evaluate and build in some of the scenario testing that was done as part of the Mercer study “Climate Change Scenarios Analysis – Implications for Strategic Asset Allocation”.

The study, which CalPERS participated in, looked at four different base scenarios that involved different levels of action by the global community to climate change.

These scenarios were used to generate estimated prices for carbon, and a number of other potential risks to a portfolio of assets were extrapolated from them.

Simpson says CaLPERS will also look to assess the fund’s exposure to climate change risk across the whole of its portfolio.

In its two predominately internally managed asset classes, public equities and fixed income, the fund is looking at various  ESG implementation initiatives.

The fund will take the corporate governance engagement work it had done as part of its so-called “focus list” and extend it to its global equities portfolio.

The focus list involves CalPERS reviewing the performance of the top 500 US-based public companies with a market value ranging from $15 million to $1 billion, including stocks and corporate bonds.

It then confidentially engages with companies it deems to be underperforming in a number of areas from profitability to corporate governance issues such as board composition, shareholder rights and executive compensation.

“There is a plan to globalise and monetise the focus list,” Simpson says.

“The idea behind monetising the focus list is to capture more of the gains that are generated if we are able to have the same positive impact on companies’ financial performance outside the US.”

In fixed income, the fund would examine its due diligence processes and look to better articulate its ESG evaluation framework to the market so as to have sustainability risk become part of pricing considerations, says Simpson.

“By articulating how we approach due diligence in terms of fixed income, if this is relevant, timely and material information, it will affect price, as the market comes to understand both risk and opportunities,” she says.

Simpson said one of the concerns of the fund was the lack of quantitative analysis around certain areas of ESG integration and it would be commissioning a number of research projects, including fixed income.

The research into fixed income would look at quantifying ESG factors and their contribution to risk adjusted return.

CalPERS has more than $50 billion in its Alternative Investment Management (AIM) asset class, making it one of the biggest private equity investors in the world.

In AIM the fund will look to bolster its monitoring of clean technology and emerging manager exposures. It will implement new manager due diligence processes that include ESG factors.

“AIM is largely an externally managed asset class, so they are focusing on this question of procurement,” Simpson said.

“What they are going to do is really focus on their emerging manager program, where we have about $7.5 billion with emerging managers. They are usually new firms and these typically have a more diverse leadership and management than traditional firms. We think there are opportunities for us placing money with these new firms and also for a broader section of the financial community to tap into the CalPERS capital.”

In its real asset portfolio CaLPERS will be undertaking research to identify appropriate reporting standards and alignment of interests.

Across all of its real asset class it will also commission research on how best to include ESG factors in its due diligence and manager selection.

For its real estate assets CalPERS will also join the Greenprint Foundation, which tracks the carbon footprint of various properties in an effort to reduce carbon emissions from the built environment.