Pioneering Dutch fund builds SDG index

From the outside, investment strategy at Detailhandel, the €21 billion Dutch fund for retail workers, looks relatively simple. Ninety per cent of the portfolio is passive and the fund invests the bulk of its assets in three markets. Fixed income (58 per cent), equity (32 per cent) and real estate (4 per cent) plus a 4 per cent allocation to Dutch residential mortgages and a 2 per cent allocation to alternatives. But scratch beneath the surface and the fund is one of the most innovative amongst Dutch and global peers.

Detailhandel has just created a new index for its €5.8 billion global equity portfolio linked to four SDGs (8,12,13 and 16) that reflect its key ESG priorities around labour rights, economic growth and mitigating climate change. Not only is the pension fund one of the first to integrate SDGs in this way. The strategy is also trail blazing for its specific integration of beneficiary wishes around the SDGs following the results of a survey of their investment priorities. See Dutch fund commits to member preferences.

“This model is new. We think we are the first pension fund to incorporate SDGs to a simple developed market index,” said CIO Henk Groot in an interview from the fund’s Utrecht headquarters where a number of asset owners including a prominent US fund and numerous Dutch peers, keen to better tie their sustainability and ESG themes with their belief in low cost passive investment, have journeyed to find out more.

Working with BlackRock, which manages all 90 per cent of Detailhandel’s passive assets under management and now assists with all the analysis and monitoring, and index provider FTSE Russell the new index applies to the entire 26.4 per cent developed market equity allocation. FTSE Russell tilts company weights within the index based on a wide range of ESG scores based on hundreds of different criteria spanning environmental policy and governance. The result is improved ESG scores, a reduction in the fund’s carbon footprint and a continued passive mandate.

The fund’s exposure to CO2 emissions and fossil fuel reserves is forecast to decrease by approximately 50 per cent, while exposure to green revenue will increase by around 10 per cent. It is also low cost. Although the strategy has involved a one-off transition cost, management costs are on the same level as what the fund pays now. According to Detailhandel’s latest 2017 annual report management fees are 9.1 basis points, rising to 17.3 with transaction costs.

“Developing and integrating the index did involve a one-off transition cost but we managed to keep the overall management costs on the same level as what we used to pay,” Groot says.

How to integrate SDGs

The first step to integrating SDGs, or any more active sustainability policy, in a passive portfolio is to invest in segregated mandates rather than funds which apply their own ESG values, advised Groot. “It was important to move from fund investments to segregated mandates to allow us to apply our own bespoke ESG policy.”

He also advises investors to spend time working out which SDGs fit their ESG policy. The SDGs have broad descriptions, and some have a crossover of themes and goals; index providers also have their own methodologies that they apply to the SDGs.

“You need to be very clear and transparent that the SDGs you focus on, fit your own ESG themes,” he said. Detailhandel’s adopted SDGs include decent work and economic growth (SDG 8), responsible consumption and production (SDG 12) climate action (SDG 13) and peace, justice and strong institutions (SDG 16)

The customised benchmark has dropped 500 companies from Detailhandel’s original 1,600 stock portfolio. However, Groot explains this fallout is more subtle than any sweeping exclusion.

It is a consequence of FTSE Russell adjusting the company weights within the index according to its ESG analysis on the key SDG themes, not active exclusion.

“The overweighting and underweighting methodology we have used meant that the allocation to some companies became so small it wasn’t worth keeping them in,” he explains.

Now the fund has begun the process of building the same SDG index for its 5.8 per cent emerging market equity allocation, after which it hopes to apply it to its corporate bond portfolio too.

“We are in the early stages of seeing if we can do the same in emerging market equity. Then we’ll see if we can introduce an SDG index for our corporate bond allocation.” Setting up segregated accounts in emerging market equity where the fund has always invested in funds is one of the most challenging aspects.

“Opening segregated accounts in emerging markets is a long and difficult job. For example, opening a segregated account in India can take 6 months because of local market requirements,” he says.

The fund is no stranger to innovation. Three years ago, in what Groot describes as another “major change” Detailhandel allocated 4 per cent its AUM to Dutch mortgages to sharpen its lagging fixed income allocation with steady cashflows, funded from its European government bond portfolio. “Dutch mortgages have a high correlation to highly rated fixed income. The allocation fits in our matching portfolio and analysis showed that adding this asset category led to an increase of access return and a decrease of risk,” he says.