Sustainable investing is not about philanthropy or giving up returns.
The Office of Investment Management (OIM) at the United Nations Joint Staff Pension Fund believes portfolios that integrate material ESG metrics into their investment decision-making process, supported by active engagement, have the potential to provide returns that are superior to those of conventional portfolios while exhibiting lower risk over the long term. This view is supported by several published academic studies and our own research.
Journey on the path of sustainable investing
The United Nations Joint Staff Pension Fund is a defined-benefit fund established by the General Assembly of the United Nations in 1948, entrusted to provide retirement and related benefits to more than 205,000 staff and retirees of the United Nations and 23 other member organisations. The Office of Investment Management manages a US$63 billion multi-asset class, global investment portfolio, 85 per cent of which is actively managed in-house. The fund invests globally in more than 100 countries and 27 currencies, and in multiple asset classes: global equities, global fixed income, private equity, real estate, infrastructure, timber, and commodities.
OIM began the journey towards sustainable investing decades ago by restricting investments in tobacco and armaments, reflecting the values of the United Nations. The office became a signatory to the Principles for Responsible Investment (PRI) in 2006. This was followed in 2008 by investing in the first green bonds, issued by the World Bank, and being the catalyst investor in low carbon exchange-traded funds in 2014.
In recent years, OIM has been transitioning from a program of ESG-related activities to integrating ESG considerations across all asset classes.
OIM began introducing ESG metrics into the investment process by giving portfolio managers a broader set of tools to consider in their decisions. For internal actively managed public equity portfolios, we are piloting a four-stage process, tailored around PRI’s recommendations. In 2018, OIM implemented a new custom global equity index that can serve as a benchmark for other global equity investors. This index takes into account investment restrictions on companies that exceed a defined threshold of revenue generated from tobacco or weapons. Within fixed income, we have been increasing our portfolio of green bonds in line with net outstanding issuance in this market segment. For private markets, OIM integrates a comprehensive analysis of ESG issues into the due diligence process. We are exploring GRESB as an ESG benchmark for core real estate.
Technology and the availability of alternative data sets enables greater integration of ESG considerations in investment decisions
Asset managers require new technology and alternative data to make better-informed investment decisions and to better evaluate the risk-return characteristics of actively managed portfolios.
Integration of ESG considerations requires new tools and alternative datasets that are not conventionally used to support investment decision-making. OIM is leveraging its partnerships with key data providers to construct an internal proprietary ESG database, which will help distill material ESG data by separating the noise from the signal and also provide the investment teams with more robust screening capabilities. We believe combining financial and alternative metrics may increase the odds of improving the risk-return profile of our portfolio over the long run, compared with the conventional investment approach.
Our Sustainable Investing approach is beginning to incorporate forward looking methodologies in evaluating the impact of climate change on our investment portfolio
Likewise, investors need new tools that integrate energy economics, alternative climate scenarios and traditional financial data to evaluate return and risk exposures related to climate change and new sources of energy. These tools could help investors evaluate the climate change transition risk and achieve greater climate sustainability in their investment portfolios. OIM recently signed a strategic partnership with a leading provider of predictive climate analytics. Our efforts to signal our commitment to a low-carbon strategy through passive investment in low-carbon ETFs in 2014 was just the first step in addressing the impact of climate change. With the strategic partnership, we are now planning to move to an active strategy by using a highly sophisticated climate and energy simulation model to assess companies’ ability to adapt to various carbon emission scenarios. This ‘E score’ will be used as an input factor in developing our proprietary ESG investment-decision supporting technology, risk management and reporting.
UN Sustainable Development Goals
OIM is also conducting research on developing quantifiable SDG scores using artificial intelligence (AI) to leverage big data and systematically measure companies’ impact on the SDGs. This research will aim to provide empirical evidence that will address the widespread perception that there is a trade-off between incorporating ESG or SDG considerations into investment decisions and generating strong financial returns. It will strengthen our understanding of the interdependencies between a firm’s long-term economic value and its societal impact. OIM looks forward to publishing a more detailed white paper on this topic in the next year, which will be designed to serve as a catalyst for a broader discussion among long-term institutional investors.
Engagement through encouragement
The last pillar of our sustainable investing approach is engagement. An active sustainable voting policy, combined with engagement, can result in more effective and durable change consistent with the UN’s values. OIM believes in a collaborative and constructive dialogue with company management to achieve mutually beneficial outcomes. The fund is a signatory of the Climate Action 100+ initiative and is building up its engagement activities in collaboration with other long-term institutional investors.
We see evidence that ESG considerations are beginning to enter the mainstream investment world. ESG factors could affect the credit rating of corporate issuers. Fitch stated recently that these factors influence 22 per cent of its current non-financial corporate issuers. ISS reports an increasing number of ESG-related items on the proxy voting agendas of corporations.
As investors, we strive to avoid risks that may compromise long-term economic value. We need to rethink how externalities affect systemic risks and their long-term financial implications. The value of investments is influenced by many global drivers, including technology, natural resources and the environment, geopolitics, the inter-dependencies of globalisation, and demographics.
A world in transition is not particularly stable and the fact that systematically integrating ESG considerations into active portfolio management is not yet mainstream presents an opportunity.
Capitalising on it requires leadership, a culture of innovation and, perhaps most importantly, effective engagement with all stakeholders.
Herman Bril is director in the Office of Investment Management at the United Nations Joint Staff Pension Fund.