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A recent survey conducted by the International Forum of Sovereign Wealth Funds (IFSWF) and One Planet Sovereign Wealth Funds (OPSWF) finds that SWFs have become more systematic in their approach to addressing climate change but need to do much more regarding disclosure and reporting of climate risk.

In a 2020 survey, only 24 per cent of SWF respondents said they incorporated ESG considerations into their investment processes and only 18 per cent had a dedicated ESG team; 48 per cent said they did not take a systematic approach to climate change. Twelve months later, 71 per cent of respondents have adopted an ESG approach and less than 10 per cent said they didn’t consider climate change in their investment approach at all. Only 20 per cent of respondents considered climate change in an unsystematic manner.

The latest survey was distributed to 46 SWFs with total assets under management of more than $5.75 trillion – over 90 per cent of total assets under management, according to the IFSWF’s database. The survey elicited a 74 per cent response.

Over the past year, SWFs have rapidly expanded their use of different methods of assessing climate-related risks and opportunities to better understand their portfolio exposure and reduce their climate impact. For example, 34 per cent of respondents have now carbon footprinted their portfolios, up from 23 per cent last year. Similarly, 31 per cent now use climate-scenario analysis versus 17 per cent in 2020. Similar progress can be seen in climate stress-testing, green- and low carbon portfolio analysis and stranded value/assets at risk analysis.

The survey also revealed that while only 9 per cent of respondents reported that they were mandated to address climate change, almost two-thirds of respondents are proactively adopting such an investment approach. Rather than waiting for it to be included in their mandate – many of which were written years or even decades ago and could be bureaucratic or politically challenging to update – SWFs are pressing on. The survey found SWFs are doing this because they believe that it is “the right thing to do” (50 per cent) with 23 per cent saying they thought it would boost returns and 27 per cent saying it would reduce risks to their portfolio.

In 2020, nearly a fifth of respondents reported that a substantial obstacle to adopting an ESG or climate change investment approach was that stakeholders did not believe these issues to be important. This year this proportion had dropped to only 3 per cent. As a SWF’s board is most frequently the body responsible for approving the adoption of these strategies, this transformation of opinion has removed a substantial obstacle to sovereign funds adopting and implementing ESG approaches.

Tooling Up

41 per cent of respondents said they were planning on upskilling their investment teams with ESG expertise, 38 per cent said they were either expanding or establishing a dedicated ESG team. The most pressing issues for the survey respondents were technical challenges such as investment-analysis-like scenarios, as well as carbon foot printing and target setting.

Not only are SWF managing risks. They are also seeking out new opportunities to finance the energy transition and fund technologies that will help the world adapt to climate change. The report found that overall, SWFs continue to favour more established opportunities in these spaces. For example, renewable energy remains the most popular investment sector, with 70 per cent of respondents saying it was the most attractive climate-related sector, broadly in line with our findings last year. However, SWFs are beginning to look at a wider range of climate-related investment opportunities.

The report found that as sovereign funds develop greater knowledge and more understanding of climate-change-related investments, they are engaging more with the issue. Only 14 per cent of SWFs currently divest from companies on environmental grounds (the same proportion as last year), but the survey found a small rise in the proportion that engage with portfolio companies on climate-related issues from 54 per cent to 58 per cent, the share of which has come from the funds that previously did neither.

KPIs and Metrics

SWFs struggle with defining key performance indicators and metrics on which to assess their strategy. Over half of the respondents do not use metrics to assess their climate impact and most SWFs are yet to fully report on their climate approach: 83 per cent of respondents that use a climate change or ESG approach don’t publish their climate change strategy.

Although there has been an improvement in reporting – 35 per cent of respondents still do not report anywhere on how they are tackling climate change, down from two-thirds last year – most sovereign funds are not yet disclosing much information on this topic. Twenty per cent of respondents only report on climate change directly to their stakeholders, a further fifth describes their climate change approach in their annual reports, but less than 20 per cent of respondents have a separate climate change report or use one of the accepted sustainability reporting standards for their publicly available annual report.

Sovereign funds should do more to develop and use metrics and targets for their climate exposure, writes the report. For observers, SWFs disclosure on climate strategies is important as a measure of progress. But for the funds themselves, defining their carbon reduction targets and their exposure to climate change-related investment sectors is essential. “The development of these metrics will depend on SWFs ongoing efforts to develop bespoke methodologies, deepen expertise and engage with their stakeholders to ensure they are comfortable with public targets and metrics that might not be achieved due to circumstances outside of their control,” said the report.

That said, the challenging nature of identifying appropriate data and metrics, developing and implementing methodologies to measure and manage climate exposure and understanding the plethora of different reporting standards and frameworks, should not be underestimated, particularly for the large funds with complex portfolios. The survey concludes that SWFs are not only working on this internally but also engaging with international climate change associations and their peers to engage and make an impact on reducing carbon emissions globally.

“It was a painful process,” says Yoo Kyung Park, head of responsible investment and governance for APAC at APG Asset Management, recalling the largest pension provider in the Netherland’s bruising engagement and ultimate decision to divest from South Korea’s state-owned utility Korea Electricity Power Company (KEPCO).

“Our hope was that if we could change KEPCO even slightly, we would have an impact on South Korea’s scope 2 emissions. But engagement wasn’t going anywhere, and we could no longer call ourselves a responsible investor by continuing to hold shares in the company.”

Unable to make any progress engaging the monopoly owner of the majority of South Korea’s 50-odd coal-fired power plants to limit and exit overseas coal and fossil fuel exposure; disclose its own emissions, or put in place emission reduction targets, APG sold its last remaining share in the company earlier this year, already whittled down from an original $138 million stake. The final trigger was KEPCO’s decision to go ahead with the construction of new coal-fired power plants in Indonesia and Vietnam, says Park in an interview from APG’s Hong Kong office.

Her experience offers an illuminating window into the challenges and frustration of engaging with companies unwilling to change in an attitude she links to KEPCO’s state-ownership and the absence of what she calls any “commercial sense” of the climate emergency.

KEPCO’s senior management is constantly replaced resulting in short CEO tenures that prevent any accountability or governance structure for investors to grip.

She found board members at the utility and its subsidiaries unclear of their role, while investor relations teams never passed on APG’s calls for engagement. Requests to meet KEPCO’s CEO, board members and the audit committee (important because APG wanted to see how the company was factoring in risks including carbon pricing and stranded assets into its financials) all fell on deaf ears. Four letters to the CEO and chairman went unanswered, as did any number of emails.

The only long-standing and enduring figurehead at the company was the government, yet Park says it was never wholly clear which government department was responsible for the company. Calls for engagement with 20 different government ministries were all ignored.

“We just hoped that someone would pick up” she says, describing a lack of response that runs counter to President Moon Jae-in’s public espousing of South Korea’s commitment to reduce carbon emissions and show climate leadership.

“We found the part of the government linked to KEPCO ownership doing something very different to the public face; there were different signals depending on which part of government you spoke to.”

APG wasn’t working alone. In a two-pronged approach Park worked on her own and with other investors including Sumitomo Mitsui Trust Asset Management, Church Commissioners for England and Legal and General Investment Management under the Climate Action 100+ umbrella.

Here engagement priorities included putting pressure on KEPCO to limit and exit overseas coal and fossil fuel exposure and disclose its emissions reduction targets with a detailed breakdown of emissions at parent level and from its independent power producers. Other requests included aligning KEPCO’s corporate disclosure with TCFD recommendations and raising emissions reduction targets beyond South Korea’s Nationally Determined Contribution (NDC)

South Korea’s own institutional investors were notably absent from the fight, says Park. South Korea’s $783 billion National Pension Service, which has an estimated 7 per cent stake in KEPCO, is governed by laws that make engagement hard, she says. Additionally, the so-called 5 per cent rule which stops asset owners which collectively own more than 5 per cent of a company’s shares from acting in concert, stalls collective action.

Elsewhere, she observes a cultural resistance to engage.

“In the Netherlands, asset owners that are not active on responsible investment issues will be criticised by society at large. In Asian culture, asset owners don’t want to be seen as too active.”

Moreover, exposure to KEPCO provides sought-after exposure to one of the South Korea’s few, sizeable, defensive companies.

However, she is encouraged by the work Korea’s National Pension Service is doing with local asset managers.

“They are working behind the curtain, tightening their brief with local asset managers around ESG, and whatever they do, will have a big impact on the whole market.” In its latest (2020) annual report, NPS writes that its FMC (Fund Management Committee) had decided to “exit from coal finance to reduce carbon emissions.”

Continuing, “NPS will stop investing in the construction of new coal power plants at home and abroad and plans to establish phased implementation measures as a preparation stage to apply negative screening.” The pension plan has commissioned a study to gather stakeholder opinion to guide implementation.

APG’s KEPCO saga is in marked contrast with her experience engaging with South Korea’s chaebol, the large business conglomerates controlled by founding families like Samsung.

“At least chaebol have one person responsible, and they will be there for ever,” she says. For example, APG’s engagement with SK Innovation, a sprawling holding company with a refining and petrochemicals arm, began from a low base four years ago at the same time as its engagement with KEPCO.

“SK Innovation pushed back, saying they understood what we were saying, but that it was difficult for them to incorporate a carbon strategy because it would affect their main business of refining,” she recalls.

Today the company has a climate strategy, emission reduction targets and management buy-in. “We were able to engage with the long-standing owner of the business. He cared about his reputation, and because the owner of the company moved on climate all the other executives had to buy in. It’s really a governance issue.”

Danish pension fund, the DKK 925 billion ($140 billion) ATP, is protecting against greenwashing in its growing allocation to green bonds with a variety of in-house screening processes.

Its latest investment to green bonds via an internally managed DKK 7 billion ($1 billion) allocation to euro-denominated investment grade green sovereign and corporate bonds encapsulates a due diligence process that is shaping the fund’s green bond push where it seeks low-cost, resilient, risk-adjusted returns.

From having no green bond investments in 2017 when it first began dipping a toe in the new asset class, ATP had DKK 30 billion ($4.5 billion) invested in green bonds by the end of 2020, making it one of the leading investors in the asset class in Europe. Today the allocation sits within an ambitious target for DKK 200 billion ($30 billion) in green investments by 2030.

“We have not set a target of how much of this will be fixed income, but presumably the majority will come from green bonds,” says Christian Kjaer, head of liquid markets at ATP.

Protecting against greenwashing is a central tenet to success. The absence of standard measurements and reporting metrics means ATP has formulated its own precise screening criteria based on ICMA’s green bond principles which assess the quality of the issuer and the level of transparency about the use of proceeds and the green impact.

That said, Kjaer says the development of the EU’s green taxonomy which creates green standards and definitions will help define more clearly what is green and create standardisation across issuers. Elsewhere, trends in impact reporting are improving the market.
In the corporate bond segment, ATP has added an additional layer of due diligence to assess the issuers “commitment” to sustainability.

“We believe this is a good indicator of the issuers’ credibility,” says Kjaer.

It involves screening the issuers for involvement in ESG controversies; examining if the corporate reports all three scopes of emissions, and if they have set any environmental targets, or have an overall sustainability strategy, in an approach designed to ascertain if green bond issuance is part of the company’s wider transition across the entire business.

“Transparency is key to limit the risk of green washing,” he says.

By managing the entire green bond allocation in-house, ATP hopes to not only reduce greenwashing risk but lower costs and have better control of the investment process that must navigate often limited liquidity and the operational logistics of trading many different bonds and issuers.

The allocation to green corporate bonds sits in ATP’s investment portfolio, but green supranational and government bonds are in the hedging portfolio. Green government bonds are as good a hedge as traditional bonds as long as they have the right credit rating, says Kjaer.

ATP’s hedging portfolio (around 80 per cent of assets) is intended to fully protect the pensions guaranteed to plan participants by law, while the 20 per cent allocation to riskier assets in the investment portfolio seeks to provide additional return. ATP doesn’t use any derivatives in the green bond allocation.
In the current market, ATP expects to get “about the same” return from green bonds as it gets in traditional bonds.

However, a key difference is resilience with Kjaer citing “some indications” that green bonds could be slightly more resilient in a crisis.

Due diligence

ATP’s in-house screening is the fruit of several of years analysis of the new asset class. In 2017 the fund decided green bonds were a “good fit” with ATP both in terms of creating returns and as a contribution to the green transition.

Green due diligence on bonds issued by development banks involves exploring if the issuer details its green strategy, and how the projects it is seeking to fund fit into that strategy. ATP likes issuers to describes their process for selecting projects. The pension fund also requires insight on when the proceeds are expected to be fully allocated to projects and favours issuers reporting at the project level.

Regarding government bonds, ATP seeks to understand how green bonds will contribute to country-level targets outlined in the Paris Agreement.

The pension fund also checks proceeds are not going to green projects that have been double counted like, for example, projects in state-owned companies that issue their own green bonds.

ATP also asks government issuers to describe what budget periods are financed by the bond issue.

The Responsible Asset Allocator Initiative at New America, in partnership with the Fletcher School at Tufts University, has released its 2021 rankings of the 30 world-leading responsible, sustainable long-term investors. Scott Kalb, director at RAAI and former CIO at KIC explains the process which looked at 251 asset allocators from 63 countries, and what distinguishes the leaders globally.

It has become fashionable of late to bash ESG investing.

“Investors pursuing virtuousness, may at best be deluding themselves and at worst, doing more harm than good,” warned the Economist in an article on September 4, 2021, stating that responsible investing practices may promote “poor returns and a flabby corporate sector,” even suggesting they could “derail the capitalist model.”

This bashing is as nonsensical as it is sensational. Sure there are problems with ESG implementation, especially when it comes to protecting retail investors. For example, greenwashing by corporations and asset managers has become a problem and regulators need to step in and set proper reporting standards. But such challenges should not be used as an excuse to deter ESG investing, particularly by large asset allocators such as pension funds and sovereign funds, who have the scale, resources, and expertise to make a difference. We should instead encourage them to take greater action.

It is in this context that the Responsible Asset Allocator Initiative (RAAI) at New America, an organization dedicated to mobilizing capital toward sustainable and responsible investing and toward achieving the Sustainable Development Goals, has just released The 2021 Leaders List: The 30 Most Responsible Asset Allocators, a ranking of the world’s top sovereign wealth funds and government pension funds on their responsible investing practices. The study, developed in partnership with the Fletcher School at Tufts University, rates and ranks 251 asset allocators from 63 countries with assets of $26 trillion, to identify the 30 leaders and 22 finalists (the top quintile) that together set a global standard for leadership in responsible, sustainable investing. This year’s ranking builds on the groundbreaking RAAI reports released in 2017 and 2019.

RAAI researchers have found that top asset allocators are implementing ESG not out of “virtuousness” but rather out of practicality. These institutions see responsible investing as a vital tool to manage systemic risks and generate long-term, risk-adjusted returns for savers. Traditional financial metrics are useful in managing short-term idiosyncratic risks in portfolios, but they fall short in pricing and managing long-term systemic risks such as climate change or income inequality. Modern portfolio theory focuses on diversification as a key method to protect portfolios, but systemic risks cannot be easily diversified. Accordingly, leading asset owners are adapting their investment decision-making process and using ESG to identify and price long-term risks, engage with portfolio companies, and manage risk-adjusted returns more effectively.

The RAAI leaders and finalists provide a window into the future of investing, a world where the planet’s largest investors are addressing the world’s greatest challenges. These top performers are unleashing hundreds of billions of dollars to invest in renewable energy, clean technology, and sustainable infrastructure, while improving access to clean water, affordable housing, healthcare, and education.

For the 2021 RAAI Leaders List Report, researchers expanded the scope of coverage, evaluating 634 asset allocators and rating 251 institutions, up from 471 and 197 institutions, respectively, in 2019. The number of rating criteria increased from 20 to 30, raising the bar to a minimum score of 96 per cent for the 30 asset allocators that were selected for inclusion on the prestigious leaders list. The 22 asset allocators selected as finalists, were not far behind the leaders, needing a minimum score of 92 per cent to be included in the top quintile.

Key findings from the 2021 RAAI study:

The UK has the greatest number of asset allocators on the leaders list with five, followed by four from the US and three each from Australia and Canada.
Overall, Europe is the best performing region. The 62 rated asset allocators in Europe have an average score of 78 per cent. Europe accounted for half of the top quintile asset allocators.

Responsible investing is advancing across the world but slowly and from a low base. There is scope for substantial improvement. The average score for all world asset allocators increased from 44 per cent in 2017 to just 52 per cent in 2021.
The leaders and finalists continue to set the bar for responsible investing, widening the gap with the rest of the world. The top quintile shows an average score of 96 per cent. The other 200 rated asset allocators showed an average score of just 40 per cent.
The world’s two biggest economies, the United States and China – comprising 40 percent of global GDP – are lagging dangerously behind on responsible investing. The average score for the 82 USA asset allocators rated by RAAI is just 34 per cent.

The RAAI leaders list is a unique group, representing 15 countries and five geographic regions, including Africa, Asia, Australasia, Europe, and North America. With $7.9 trillion in AUM, the leaders exert enormous influence in global capital markets and can serve as a powerful force for change.

THE 2021 RAAI LEADERS LIST (in alphabetical order)

Alberta Investment Management Corp. (AIMCo) (Canada)
AP Funds (Sweden)
APG Groep (Netherlands)
ATP Group* (Denmark)
AustralianSuper (Australia)
Aware Super* (Australia)
BCI (Canada)
Brunel Pension Partnership* (UK)
Caisse des Dépôts et Consignations (France)
CalPERS (USA)
CalSTRS (USA)
CDP Group, SpA* (Italy)
CDPQ (Canada)
COFIDES* (Spain)
ERAFP (France)
Government Pension Fund – Global (Norway)
GPIF (Japan)
Ireland Strategic Investment Fund* (Ireland)
LGPS Central* (UK)
London CIV* (UK)
New York State Common Fund* (USA)
New Zealand Superannuation Fund (New Zealand)
PensionDanmark (Denmark)
PGGM (Netherlands)
Public Investment Corp. (South Africa)
Railpen (UK)
UC Regents Investment Funds (USA)
Unisuper* (Australia)
United Nations Joint Staff Pension Fund (Global)
USS* (UK)

* New addition to the leaders list in 2021

Click here for further information on 250 asset allocators rated by the RAAI

Click here for a PDF of the 2021 RAAI Leaders and Finalists

Scott Kalb is director, The Responsible Asset Allocator Initiative at New America.

The Responsible Asset Allocator Initiative is focused on mobilizing capital from the world’s largest institutions toward responsible investing and the achievement of the Sustainable Development Goals of the United Nations. It is a window into the future of investing, a world where global savings institutions deploy funds not only to achieve financial returns but also to address the broader social and environmental challenges we face today. The RAAI was founded at New America, an organization dedicated to renewing America by continuing the quest to realize the nation’s highest ideals, honestly confronting the challenges caused by rapid technological and social change and seizing the opportunities those changes create.

Amanda White, director of institutional content at Conexus Financial, dives into the past, present and future of responsible investment with PRI’s founding executive director, James Gifford, and current outgoing CEO, Fiona Reynolds.

In this candid conversation, they reflect on the genesis of the PRI mission, where we are today and trends and challenges going forward for the responsible investment industry from both an integration and impact lens.

What is the Fiduciary Investors series?

The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.

The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption, and asks investors to think differently about how they make decisions and allocate capital.

Based on empirical evidence alone, funds that insource or internalise end up with better outcomes, both on a net and gross value-added basis, according to CEM Benchmarking data which draws from the evidence of some 300 funds in 17 major pension markets around the world representing $11 trillion of assets.

Performance numbers support the move for funds to bring investment management inhouse, however funds considering a move towards internalisation will need to come to terms with governance changes and challenges to be successful, Mike Heale, principal at CEM Benchmarking has highlighted.

“Very clearly, you have to be ready for the challenges of having a lot bigger and more complex organisation to manage,” Heale says.

“Governance, independence and quality… culture, talent, compensation. You have to think through all the challenges of how internal and external management will coexist and be managed within your organisation,” he says.

Funds can add the most value by bringing active management in house, CEM data reveals. The degree of internalisation and to a lesser extent scale of a fund can also add value for funds pushing further down the internalisation path.

The CEM data reveals that funds tend to pull the trigger on movements towards internalisation at around the $40 billion-dollar mark, even though Heale suggested that funds smaller than $40 billion could benefit from taking investment management inhouse.

The larger funds get, the more they’re likely to internalise a greater portion of their funds, the CEM data shows.

Despite the empirical evidence supporting the move to internalisation for funds of a certain size, Heale left the door open for funds to consider preserving the outsourcing model however. Some notable examples of funds not insourcing include Australia’s HostPlus and US based Washington State Investment Board, both of which have continued to achieve strong outcomes by engaging external managers.

“There are some large funds that could internalise that, for a variety of reasons, have primarily external models that have been extremely successful. And, you know, they’re generating very good results, and they’ve got good expertise in picking managers,” Heale pointed out.

“Some of that is related to the governance constraints… because if you can’t align and you don’t believe that you can get success and it’s not going to be possible to pay your people what’s required to do it then you’re probably better off to stick with what you know and what has proven to be successful with you in the past,” he said.

“Not every fund that embraces internal management have outperformed… But again, the weight of empirical evidence is on your side that you should expect some outperformance if you implement well,” he said.