Theresa Whitmarsh, former executive director of the Washington State Investment Board and Hiro Mizuno, former CIO of the Japan Government Pension Investment Fund, the world’s largest pension fund, are behind the latest investor tool to support ESG integration and prevent greenwashing.

The Pension Fund Coalition for Inclusive Capitalism, part of the Coalition for Inclusive Capitalism and co-chaired by Theresa Whitmarsh and Hiro Mizuno, has released an open resource template to help pension funds’ structure contract language in their investment agreements with asset managers around ESG integration in public and private equity. The resource is intended to protect against superficial implementation of ESG and enable asset owners to better direct their asset managers to invest in line with their priorities.

The model contract language establishes minimum ESG guidelines for use in investment agreements with asset managers as well as private equity side letters and LP agreements. Whitmarsh and Mizuno collaborated with pension fund managers and legal advisors to draw up the template which includes a prototype for integrating asset owner reporting requirements and voting rights and is another building block in the crucial market infrastructure supporting sustainability and impact investment.

The templates can also be tailored to asset owners’ ESG and long-term investment priorities. “Our aim is to give asset owners better tools to evaluate asset managers in terms of their alignment of beliefs and how they get expressed,” says Whitmarsh.

She adds that the initiative has its roots in an initial asset owner survey exploring how investors expressed their views on ESG in their contracts with asset managers. “We found nothing,” she recalls. “Although asset owners had discussions with their managers and expressed views via proxy voting and exclusion criteria for example, no single asset owner had contract language: although the whole ESG approach has evolved, contracts haven’t.”

Whitmarsh adds that Mizuno also led on the initiative when he was at the GPIF, working with Japan’s asset management community to try and get contract language into GPIF’s mandates to enable the pension fund to better control how its assets were invested in line with its ESG wishes. “GPIF is such a large asset owner and his requests were responded to but still, even with his clout, he struggled to get language into contracts.”

It led them to talk to the legal profession to draw up a playbook to support asset owners. She notes how the template avoids being too prescriptive given ESG is still an expression of judgements and viewpoints. “We recognised there are a wide range of approaches to ESG. There is no one way to express ESG beliefs so we have created a workbook and template approach with many options.”

Asset owners have been quick to welcome the initiative. “It’s important that large asset owners, including pension funds, treasurers, and endowments, know how to structure an optimal relationship with their investment managers,” says Illinois State Treasurer Michael Frerichs. “Asset owners have a vested interest ensuring that their managers are using best-in-class practices that add value and serve their needs. This includes the integration of ESG factors into investment decisions, the adoption of strong proxy voting practices, and the provision of robust reporting on investment management and stewardship activities. The model language will help investors structure strong relationships with their managers and it will help create uniform standards across the market.”

“Pension investors and asset managers must create long-term value for clients and beneficiaries by considering social and environmental outcomes,” said Gordon J. Fyfe, Chief Executive Officer  and CIO at British Columbia Investment Management Corporation (BCI). “Standard tools like model mandates can support the approach portfolio managers take to consistently apply ESG principles.”

Whitmarsh also believes asset managers will welcome the template, particularly given the legal language in the contracts has been heavily vetted. She notes how managers are reluctant to enshrine strategies around for example proxy voting into contract language despite clear guidelines from asset owners lest it trigger compliance issues.

“This language has gone through a lot of legal review,” she concludes.

 

 

 

“A forecast is a prediction; we’re saying what we think will happen. A scenario is different . . . it generally looks much further out and is trying to build a picture of the future in extreme uncertainty.” — Seb Henbest

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British Columbia Investment Management Corporation, BCI, the $200 billion asset manager for around 30 Canadian pension funds and insurers, is planning to double its private debt allocation. Sarah Rundell spoke to Daniel Garant about the shifts in the portfolio and the focus on active management.

BCI began building the allocation to private credit after the GFC when new regulatory burdens on banks requiring they hold more capital opened a gap for investors to lend more to private companies. Today, one reason opportunities in the asset class have spiked is because of its competitive advantage over the syndicated loan market, explains Daniel Garant, executive vice president and global head of public markets at BCI where he oversees a $137.8 billion allocation to fixed income and public equity, the bulk of which (79.5 per cent) is managed internally.

“Private debt competes with syndicated loans in the upper-mid market, but syndicated loans are more subject to market volatility. For instance, private debt transactions saw a higher certainty of execution than syndicated loans when Russia invaded Ukraine – private debt brings certainty of execution.”

According to BCI’s 2021 annual report, private debt accounted for 9.1 per cent of the $71.2 billion fixed income portfolio.

Another reason he favours the asset class is because private debt is tied to a floating rate, meaning returns will adjust to inflation.

“There will be a lag, but a floating rate will adjust with rising rates and this is a good protection against inflation.”

In a third seam, the allocation also supports BCI’s clients’ liability profiles. “In this sense, private debt fits with assets like infrastructure and real estate,” he says.

BCI invests in private debt via partnership with external managers either in separately managed accounts or co-investments. In a hybrid approach, the internal team carry out the screening and research on each individual credit.

“It is not a passive model where we allocate to external managers; we get to select the credits we like and the pricing we are comfortable with,” says Garant.

Bias for Active

It’s an active approach that is reflected across the portfolio. In another strategy born from today’s investment landscape (where Garant says volatility will bring plenty of opportunities despite the challenges) he is increasingly prioritising active equity over owning the entire market to strike when opportunities are mispriced, add value, and better manage risk as lockdowns in China and war in Ukraine cause a prolonged supply chain crisis for many corporations.

Active allocations in the public equities program include two active funds with a strong ESG focus (global thematic and global quant ESG where ESG scores drive the stock selection). The global thematic fund’s investment process focuses on long term trends based on internal research.

“Allocations are really based on our expectations of where trends are going in the next three to five years,” he says.

The Global Quantitative ESG Equity Fund has outperformed its benchmark since its inception in 2019.

“In addition to risk management, our ESG screens are a source of value creation.”

Emerging markets

BCI’s belief in active management over indexing is also apparent in emerging market equities. BCI has started to integrate ESG analysis into emerging market equities (23.1 per cent of the $66.6 billion public equity allocation) for some client funds.

“The effort on the ESG side in emerging markets is significant,” he says, describing how emerging market assets have a wide dispersion that requires a bottom-up and top-down analysis. “We can’t just do stock selection; country selection also matters,” he says.

BCI decided to shift more from indexing to active in emerging markets over a year ago, a prescient decision given today’s darkening economic picture of rising rates and slower economic growth in emerging economies.

“We are now seeing clear signs that geopolitical developments in emerging economies are going to be a factor in the future in a way we haven’t seen for the last 15 years,” he says.

Leverage

He is also mindful of the impact of rising rates on other investment seams in the portfolio. Like leverage, where ensuring financing costs are adequately compensated with expected returns is a growing theme for investors.

For example, he believes private equity will increasingly feel the pinch given its dependency on the availability of cheap leverage, particularly if the selloff in public equity proves a warning shot of tougher times in private equity too.

“Things are getting pricey,” he says.

BCI increasingly filters opportunities in the portfolio, steering clear of investments where bidders are getting on top of each other; happy to be outbid and only allocating to the best transactions.

In an approach that differs from Canadian peers, BCI’s member funds decide their own level of leverage in line with their own liabilities and funding ratios. They make the decision when they select their asset allocation in an approach that Garant argues offers more transparency than other approaches where investors struggle to gauge how much leverage they have because it is already embedded in products.

“Instead of embedding leverage in asset classes at the corporate level, we have structured an application of leverage at a client level. Some clients will want to increase leverage because of where they are in their asset mix, others won’t, and we don’t make a decision on their behalf – it is client specific.”

Economic landscape

Looking out on the macro landscape, Garant is most concerned about wage increases, already starting to come through, fuelling inflation further. “Wage inflation worries us most because it is more persistent,” he says.

Moreover, investors are in the hands of central bank policymakers who have been slow off the mark in anticipating and taming inflation: rates will continue to rise more than what is already priced in, he predicts.

Although he is confident central bankers have the tools they need to fight inflation, he is worried about whether they will chart a soft or hard landing for the global economy.

“The Fed will be able to tame inflation, this is not the issue. The question is whether they do it in a way that will cause a short-term recession. There is a risk of an economic slowdown.”

He concludes, however: “Nothing lasts forever; I don’t believe in strong inflation for the next 10 years. Central banks have the tools to bring it under control.”

 

 

 

 

In a recent stewardship update, BlackRock, the world’s largest asset manager, warned that it will support fewer shareholder resolutions on climate change this year because they have become too extreme and prescriptive.

The asset manager’s stewardship arm, BlackRock Investment Stewardship, BIS, stated how the US Securities and Exchange Commission’s revised guidance on shareholder proposals has broadened the scope of permissible proposals resulting in a marked increase in environmental and social shareholder proposals of varying quality coming to a vote.

“Our early assessment is that many of the proposals coming to a vote are more prescriptive and constraining on management than those on which we voted in the past year,” said BIS.

Elsewhere the note, which suggests a shift in stance since BlackRock pledged to up its use of its voting powers to influence sustainability in the thousands of listed companies in which it invests, stated how companies face challenges in the near term given under-investment in both traditional and renewable energy. It has resulted in an energy shortage that is now exacerbated by current geo-political tensions.

With this in mind, BIS said it is particularly wary of shareholder proposals to thwart financing traditional energy companies. Similarly it is unlikely to support resolutions which force companies to decommission assets or set absolute Scope 3 emission reduction targets. Moreover, BIS noted that other investors and global proxy advisors ISS and Glass Lewis have been recommending that shareholders not support overly prescriptive or constraining proposals either.

Looking out on today’s landscape, the note states that BlackRock is not likely to support resolutions that it deems to micromanage companies. This includes those that are unduly prescriptive and constraining on the decision-making of the board or management; call for changes to a company’s strategy or business model, or address matters that are not material to how a company delivers long-term shareholder value.

In 2021, BIS supported 47 per cent of environmental and social shareholder proposals in a strategy it says is designed to be both consistent with long-term value creation but not unduly constraining on management in pursuing their strategies to create shareholder value.

Push back

Elsewhere, evidence is growing that the energy crisis is leading other investors to back off pushing for climate resolutions at the big oil groups. Follow This, a small activist investor and campaign group based in the Netherlands with stakes in several oil groups, saw support for its climate resolution at BP’s recent AGM drop to 15 per cent from 21 per cent last year.

“BP may have convinced investors that addressing the current energy shortage overrides addressing climate change,” said Mark van Baal, founder of Follow This in a response. “Neither our climate resolution nor BP’s strategy have changed; their current strategy still does not lead to emission reductions by 2030. However, investor sentiment apparently has changed, likely as a result of the energy crisis and windfall profits brought on by the war in Ukraine.”

Elsewhere, shareholders in US oil and gas producer ConocoPhillips didn’t support a proposal to include Scope 3 greenhouse gas emissions in its emissions reduction targets, with only 39 per cent of shareholders voting in favour of the motion.

This contrasts with last year when companies faced an upsurge of shareholder support for resolutions and votes on environmental and social issues. Like ExxonMobil, forced to take on three new directors on its board, marking a landmark win for activist investor Engine No. 1.

 

Tailings dams, the vast toxic lakes used to store the by-products of mining operations encapsulate the sustainability challenge in the mining industry. Often built cheaply, more dams are collapsing in an increasing trend impacting communities and families in a sector where waste is treated as an externality rather than as part of the business.

Three years ago, the Church of England Pensions Board, CEPB, looked again at how it engaged with companies on the subject. The problem lay with the pension fund engaging with mining groups, seeking assurances and disclosure on their tailings operations, rather than engaging with the problem itself.

“You’ve got to engage the issue and address the problem,” said Adam Matthews, chief responsible officer, CEPB, speaking at Sustainability in Practice at Cambridge University.

That meant getting up to speed on tailings dams; finding out how many companies have them and the universal standards (there were none) under which they operate. “We understood what we needed to start to push for,” recalls Matthews. Three years down the line, CEPB was armed with data on which listed mining groups have tailings dams and where they are located. It found some dams pose huge risks sited next to communities – while others are well run and in remote areas.

In 2020 the industry adopted a universal standard, the Global Industry Standard on Tailings Management, reached as a consequence of investor pressure alongside the support of the UN and PRI, and industry buy-in. “Investors were at the table, driving the process,” said Matthews. “We need to get to the point where we can be assured all dams are operating to the Standard, practices are changing and boards know this is a major priority for their investors. “In a next step, CEPB has started to vote against companies not committing to the Standard.

Water and accesss to minerals next

The pension fund is also isolating other issues in the mining sector similarly critical to the transition and which pose uncomfortable questions for companies. These include sustainable water use and access to minerals. For example, most car companies’ electric vehicle production targets are not connected to the reality of their existing supply chains. Elon Musk recently tweeted Tesla may get into the lithium mining and refining business directly and at scale because the cost of the metal, a key component in manufacturing batteries, have gotten so high.

“We are looking at issues to ensure how this sector addresses systemic challenges,” says Matthews.  “If we are going to meet demand, we need more mines and expansion, yet new mines can take many years to come on online.”

Matthews noted how investors need to get tougher when they engage; engaging with an attitude and interventions that reflects the size of the challenge. CEPB is invested in a number of mining groups, but Matthews said any change has to be sector-wide. One company may do well like Anglo American where he named outgoing CEO Mark Cutifani as crucial to helping drive forward climate and environmental plans – but when others pollute or neglect workers’ rights, the whole sector loses its social licence. “You get external pressure on you, asking how you can invest in a sector that kills people.”

Universal owners

Matthews stressed the importance of working with others. Rather than trying to drive change alone he stressed the importance of building partnerships with other like-minded asset owners to drive systemic change. “There are strategies you are able to deploy once you understand your position,” he said.

Matthews said that pension funds do have legitimacy to push for change. They are acting on behalf of their members to shape issues on a global scale. Still, he noted investors do have a careful path to navigate because some action points are areas for governments – although he noted areas where governments should act, but don’t. The mining industry is crucial to society, yet one of the worst industries at managing systemic change, he said.

Delegates heard how for universal owners, externalities created in one part of the portfolio will be paid for in other parts yet universal owners can’t stock pick their way out.

Universal owners can have an impact via their asset allocation, and the threat of divestment does scare companies. “Tactics are available to universal owners to get companies to change their behaviour,” said Ellen Quigley, sustainability advisor to the CIO, University of Cambridge, who is also a senior research associate at the Centre for the Study of Existential Risk.

She said oil companies will see their cost of capital rise if fewer banks lend to them. She urged investors to engage with banks given most new capital flowing into fossil fuels comes via bank loans and bond issues. She added investors can also steer clear of fossil fuel infrastructure because it is visible and not data dependent.

 

 

There are eight million different species on the planet, of which one million are threatened with extinction. “We have seen a catastrophic loss of species in the last 50 years” said Mike Maunder, executive director, Cambridge Conservation Initiative representing ten organizations including global NGOs and specialist conservation groups working to explore the role of society, business and investors in securing a biodiverse future.

Much of the planet’s biodiversity (the sum of all living things on the planet and their interactions) is still unknown – scientists are still exploring fungal and bacterial realms of life.

Speaking at Sustainability in Practice at Cambridge University, Maunder said it is possible to halt biodiversity loss in our response to climate change, restoring landscapes and seascapes. “We know how to rebuild nature,” he said. He also noted how biodiversity literacy in the finance and business world is poor: the fog comes down and the conversation gets stuck.

Smell the coffee

He noted how domestication of biodiversity needs to carry on. But he warned that the crops that serve us today won’t be the crops of the future; food chains are going to change. Coffee’s path from the wilds of Ethiopia to domestication via the Middle East and Europe is a powerful story of crop domestication. “Modern coffee can be traced to five plants. There is a tiny genetic base for one of world’s greatest crops,” he said.

Yet today, coffee faces risks from diseases, climate change and soil quality. Pollination of coffee crops is also threatened by increased night temperatures. “It is a fragile environment,” he warned. He said the decline in soil health, the loss of pollinators and invertebrates and the wider loss of genetic diversity removes our response to climate change via breeding alternatives. “We need to go back to those wild relatives,” he said.

The impact of biodiversity loss in developed countries is different to poorer nations. Here it impacts where farmers can craze their cattle, or if people can catch fish to feed their family. He noted how 70 per cent of world food production comes from vulnerable small farmers warning that if they struggle to produce food, it will threaten global security. Biodiversity loss causes migration away from degraded land, leading to migration and all the accompanying misery.

Soil

Maunder said that one third of agricultural land is losing its topsoil and degrading, prevalent in Europe and North America’s wheat producing lands. “We need to look at the future of soil when we are thinking of food,” he said. He blamed carbon-rich fertilizers and said once soil health is restored, and organic matter builds back, the need for inputs declines. He stressed the importance of stopping agricultural advancement into new pristine landscapes and urged for the end of the incentives that make food production harmful for biodiversity.

Maunder said that tools do exist to halt the loss. A red list reveals where business activity imposes most losses on nature; he said businesses already know how to build sustainable supply chains. He said biodiversity can be rebuilt in the circular economy, with investment targeting natural regeneration and future proofing business.

Investors should look at a company’s entire activity and identify the risk and dependencies linked to nature. Once investors begin this mapping exercise, they can turn the relationship around.

Pandemic

He also noted that the risk of another pandemic is high because human health is closely intertwined with our environment. “We are very vulnerable to animal disease,” he said. “Covid was not a one off, there are a swarm of potential infections.” He said the risk of disease was another argument for halting forest loss and noted the growign number of diseases in domesticated crops like oranges and bananas.

He noted how biodiversity loss and the climate crisis increasingly overlap. “Climate doesn’t exist on its own,” he said. When natural capital is lost, we measure it in flooding and agricultural collapse in a cost to society that finally begins to resonate. “When business suffers it [biodiversity loss] rises up the agenda,” he concluded