Investment in the 17 SDGs is growing, but SDG 16, and its call to promote peaceful and inclusive societies for sustainable development, gets the least investor attention. Yet the idea that investors can mobilise their capital to nurture peace is wholly possible, argued Scott Weber, president, Interpeace, the Swiss-based UN-backed organisation set up in 1994 that strives to build peace in conflict-riven countries. Speaking at the Fiduciary Investors’ Symposium at Harvard University, he outlined ambitions for investors to rally behind a fledgling project to invest in SDG peace bonds to foster home-grown solutions to conflict.

An inaugural bond could allow investors to finance mental health in Rwanda, where generations remain plagued by the aftermath of the genocide. Other bonds could finance infrastructure and energy in former conflict zones in a new area of finance that he compared to green bonds 25 years ago.

“Governments will pay out bonds at the end of the term with a coupon that is better than a treasury bond,” he said.

At its core investors will buy into the belief that people in conflict zones need ownership of their own peace process. During the height of the piracy crisis off the coast of Somalia, the world spent $6.1 billion on re-routing and arming ships, insurance and other strategies to counter the risk, said Weber. Yet all the time the root of the problem was onshore in Somali villages where people had turned to piracy following the loss of their fishing industry to foreign trawlers.

“Governments spend on the symptoms and not the core issues,” he said, explaining that Interpeace’s ensuing initiative in Somali villages has profoundly reduced piracy. “If people don’t own the solutions to problems, they don’t stick,” he said. “90 per cent of countries in conflict today have previously experienced conflict. It is about getting people to build peace themselves.”

Moreover, investing in peace is the most important SDG of all. How can any of the other development goals ever be achieved if war shatters their benefit, he asked delegates.

“Lots of people live in conflict, and most have no access to the type of capital you are raising. All SDGs in a conflict country depend on peace.” He added that few conflict-riven countries achieved the UN’s Millennium Development Goals.

For investors, the novel idea raised questions of where the revenue would come to pay for the bonds. Others commented that under existing SDG investment, investors already invest in emerging market infrastructure.

For some it sounded far-fetched.

Kate Murtagh, managing director for sustainable investing and chief compliance officer at $37.1 billion Harvard Management Company noted that that SDGs offered an “additional prism” through which to monitor ESG integration adding that the SDGs were crafted as “development goals for countries to strive for” rather than “an investable framework.”

She said, however, that such conversations are important to take investors out of their comfort zone and that a “willingness to have these conversations” is how novel ideas take root.

Signposts
Sustainable investment comes with hundreds of different definitions and ratings, but the SDGs offer signposts and classification. For example, ratings from MSCI and Sustainalytics differ from each other.

“The SDGs bring a framework that is uniform and more tangible,” says Erik van Leeunwen, co-head of fixed income, Robeco. He explained that one of the challenges integrating SDGs is applying them to public markets – important because this will take them mainstream. van Leeunwen listed public food companies need to ensure healthy food (SDG 3) and the car industry to go electric to combat climate change (SDG 13) as examples of the types of public companies that need to change.

“We need these public companies to make the transition and realise the SDGs,” he said.

In 2016 Robeco began shaping a framework to gage which of its holdings contribute to the SDGs via a range of KPIs. These include looking at the products investee companies make, to whether they are active in emerging markets or the extent to which they have integrated diversity.

“If you want to build a diversified portfolio it is possible,” he said. “You can target high impact companies. Our framework is a good way to link investment to the SDGs and engage with clients to build more positively impactful portfolios.”

At €473 billion ($575 billion) APG, Europe’s largest investor managing the pension fund of one in five Dutch citizens, SDGs are increasingly integrated alongside the manager’s primary goal of ensuring returns.

“Our client funds are very clear that they want us to invest for returns, manage costs and contribute to sustainable development,” said Anna Pot, manager, responsible investments, APG. Most recently this has involved developing an inclusion policy. The strategy demands that portfolio managers should defend the rationale for investing in a company from a risk, return, cost and ESG perspective. “We can invest in a laggard, but if we do, we know it involves a risk,” she says.

Much of APG’s SDG strategy is driven by its beneficiaries.

“Our clients have set specific targets to invest more in companies that contribute to the SDGs,” she said.

This has led the manager to develop sustainable development investments that meet the SDGs. It recently created an SDI (sustainable development investment) Asset Owner Platform together with sister fund PGGM.

The AI-driven technology sifts through reams of structured and unstructured data to gauge the extent to which companies’ products and activities meet the UN’s Sustainable Development Goals. Collaboration has been a key element of developing the platform to try and ensure shared definitions, she explains.

“SDIs are companies that contribute to the SDGs,” she says. “If it is only us who applies this definition there is a risk of all having different definitions. We invite others to join us on our journey.”

Robeco’s van Leeunwen noted that because the SDGs have only been around since 2015, it is still too early to assess their impact.

“We don’t know if it is definitely a better way of investing, but if you look at the results the risk is higher in companies that don’t contribute to SDGs.” Those companies that contribute negatively have a higher default rate, he concluded.

Last month, three members of the investment team at Norway’s largest pension fund travelled to Saudi Arabia to meet fast-growing companies on the ground. Kommunal Landspensjonskasse (KLP), the fund for local government employees and healthcare workers, has just under a quarter of its NOK 745 billion ($77 billion) assets in passive equity, and the trio wanted to see for themselves if the 30 Saudi companies graduating to the MSCI Emerging Markets Index contravened KLP’s strict ESG principles.

Back in Oslo, KLP still excludes Saudi companies from its emerging market investment universe, partly because of concerns about the fund’s ability to monitor new entrants given Saudi Arabia’s poor record on free speech. But the team, who’d gone to talk not about financials but workers’ rights, particularly companies’ efforts to draw more women into the workforce, were quietly impressed.

“We had some good meetings in Saudi Arabia and there are positive changes happening in the country,” enthuses Jeanett Bergan, head of responsible investment at KLP who says the fund’s strategy in Saudi Arabia is based on a “precautionary approach,” in development since the spring.

“The companies we met view these changes positively and were, for example, working hard to increase the share of women in the work force.”

Positive change also lies at the heart of KLP’s strategy, where active ownership via stewardship, engagement and ultimately exclusion allows the large passive allocator to integrate ESG.

With a responsible investment team of just four, plus the support of multiple data service providers, the pension fund monitors and cajoles 7000 companies across 50 countries tracking MSCI and Barclays’ equity and bond indices, of which it currently excludes 200.

Strategy is based on openness and transparency, designed to build global attention around “high risk industries” and the “worst offenders,” as well as put new issues centre stage. An attention, she argues, that is only achieved with the threat – and reality – of divestment.

“If we exclude big brands it creates a lot of attention, it builds knowledge in society and people learn about the ethical dilemmas of corporate activity and investment. When we publicly exclude a company, that transparency forces us to defend the reasons why and be very thorough and consistent.”

For example, the fund’s recent decision to exclude firms deriving more than 5 per cent of their revenue from oil sands has earned an invitation to speak at a Canadian pension fund forum next April. Elsewhere, policy to exclude companies producing cannabis for recreational use hit the headlines again when the fund had to divest cannabis groups coming into the index on a run of strong returns.

Meanwhile, fires in the Amazon have prompted headline-grabbing lobbying of global agri-businesses such as Cargill, Bunge and Archer Daniels Midland, in which KLP invests a combined $14 million, to do more to protect the rainforest.

“We are invested in all the problems of the world and there are always challenges in our portfolio. By drawing a line, and saying this is unacceptable we are doing a tiny bit to raise the bar,” explains Bergan, back at her desk after talking about responsible investment to a group of Norwegian students.

One reason for the pension fund’s sizeable punch is its close association with Norway’s giant $1 trillion sovereign wealth fund, Government Pension Fund Global (GPFG) which holds on average 1.4 per cent of all the world’s listed companies.

“We piggy-back on them,” she says. “For us, it is a real benefit to link to GPFG, giving us an even greater impact than what we would probably have.”

Yet in some ways KLP, which was founded in 1949 and introduced ethical guidance and transparency across the portfolio at the turn of the century, has led the way. Back then, GPFG had only just begun investing in equities yet KLP was already building a media awareness and public focus on ESG that has now become the benchmark for all Norwegian public funds.

Today, the two share ESG analysis so that if KLP sounds the alarm, GPFG will listen and vice-versa. For example, in 2017 KLP showed its ground-breaking report on the environmental and human rights fallout from India and Bangladesh’s beach shipbreaking yards to Norway’s Council of Ethics, the body in charge of evaluating if investee companies are consistent with the GPFG’s ethical guidelines.

“GPFG also found it unacceptable, partly based on the conclusions of our report,” says Bergan, about to hit the road again to assess progress and change in the contentious industry.

Manager relationships

Rather than outsource engagement, KLP only has a handful of manager relationships, primarily in its 2 per cent private equity allocation.

“I’ve learnt that you can’t outsource this work because you have to be able to talk about it, answer difficult questions and understand the situation for yourself. We need to be involved and on top of engagement for our self.”

Experience has also shown that relationships grow testy when managers don’t exclude the same companies as the pension fund. Something Bergan attributes not to a desire by managers to put returns first (although she notes that exclusion of whole sectors like tobacco and weaponry can dent returns over time) but more to a cultural reluctance to be “instructed,” and accept KLP’s way of thinking.

“Mostly it is fine, and much easier than 10 years ago. However, we want them to exclude the same companies we have, and some managers don’t like to – or simply can’t be instructed in this way.” Although KLP acknowledges their challenge, the fund takes a tough stance.

“If over time we see that they are in conflict with the guidelines, we with withdraw,” she says.

As for new approaches, although Bergan observes that 70 per cent of Morningstar’s ESG indices are now performing better than their benchmark equivalents, she has no plans to introduce tailored indices. The fund’s strict guidelines, plus recent innovations like the raft of five new eco-labelled investment funds, give KLP the tools it needs to sufficiently align beneficiary demands around fossil free climate targets and better ESG scores, without adopting indices that tilt to green revenue or exclude heavy polluters.

“We are in the nitty gritty, and our portfolio managers work hard at delivering returns using the traditional benchmark and still having tough constraints.”

She also notes the challenge inherent in changing to a system of ESG benchmarks that would still require exclusions. It could also threaten KLP’s advanced criteria, thorough and transparent analysis and systematic process, she concludes.

The argument in this piece is simple, but relatively aggressive: past returns are too high because they were based on false profits.

The Thinking Ahead Institute’s work on value creation led us to propose the concept of a value creation boundary. Value is created inside the boundary and is destroyed outside it. There is discretion as to where to draw the boundary. Drawing a tight boundary concentrates the value created for the fortunate insiders, and means the value destruction for any particular bystander will typically be very dilute. So dilute, perhaps, that they do not even realise they are suffering any value destruction. However, collectively – and over time – the value destruction accumulates and becomes highly visible.

Taking this from the abstract to reality, our lived experience has been within an environment of shareholder primacy, which is nothing other than the drawing of a very tight boundary. Shareholders were the insiders and everyone and everything else fell outside. Now the value destruction has accumulated and is staring us in the face. It is the carbon in the atmosphere, the plastics in the oceans, the phosphorus and nitrogen in our rivers and lakes; it is also visible in the fight for living wages. In fact, if you are willing to allow me some slack I would argue that the UN’s sustainable development goals are a manifestation that the economic machine has caused multiple problems for the masses lying outside the boundary.

So far, so clear. But what has this got to do with past returns?

The value destruction outside the boundary is simply different language for the term economists use – ‘externalities’ (Properly viewed through a wide frame and over a long horizon, there is no such thing as an externality in a closed system). Both versions refer to the dumping of waste into environmental sinks, rather than paying to dispose of it cleanly. In other words, the true cost of production in our economic activity was understated, and hence profits were overstated. It is therefore my contention that past returns were inflated relative to what they should have been, based on these false profits. The only way for past returns not to have been inflated would be if market prices already incorporated the knowledge that profits were overstated, and had done the adjustment for us. In effect we have run down our natural resources and converted them into financial returns, as if that was normal behaviour.

All this would be of no more than academic interest if nothing was likely to change. If we can continue to avoid accounting for the true full cost of production, who gets to declare that the profits are false? So, can we continue to costlessly dump our waste into environmental sinks? It is my belief that the sinks are now full or, with a global population of 8 billion people, will be full in short order. And by ‘full’ I mean in a practical, rather than literal, sense – it will be perfectly possible for greenhouse gases to further accumulate in the atmosphere long after most biological life, including us, has become extinct.

If the sinks are full, then the cost of waste disposal will need to be internalised and profits will fall. And what if society demands that the sinks be cleaned? Hold that thought…

Does the overstatement of past returns matter, and should we care? To answer this question I will simply quote from the FT’s Moral Money email of October 2, 2019: “The influential Wall Street lawyer Marty Lipton argued that business was underestimating the potential litigation risks associated with ESG issues. ‘When significant costs to society from climate change and the depletion of resources are tallied, as they will be, an armada of regulators and plaintiffs’ lawyers will appear,’ he warned… risks were far from abstract, Lipton warned: directors may be held personally accountable if their oversight was deemed in hindsight to have been insufficient.” So, even if we leave aside the moral aspects, and look at this question purely in financial terms, it looks like shareholders should care as returns could be clawed back. And directors should care a lot.

In summary, it is my belief that past returns were over-stated. The implication is that future returns will be lower. More accurately, total value created will need to increase for shareholders to retain the same amount of value as previously. It might be possible, as with the global financial crisis, to get taxpayers to pick up the internalised costs. But taxpayers are also employees and customers, so it is hard to see how corporations dodge the bullet completely. It turns out that drawing the value creation boundary tightly, and acting as if the earth can absorb limitless amounts of waste, is not a game we can keep playing forever.

 

Tim Hodgson is head of the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute (TAI).

 

 

The Future Fund is adding risk to its portfolio, and focusing on liquidity, as part of a part of an ongoing strategy to free up more capital in the portfolio in the event of a drawdown. It is in the midst of selling off a “large slice” of private equity assets on the secondary market and has bought listed equities in emerging markets in the past year.

David Neal, chief executive officer of the A$167 billion Future Fund, said his team had struggled to make a dent in the portfolio despite “quite aggressively” selling off other private assets like the UK’s Gatwick Airport, because prices kept going up. He said the net cash flow from the private holdings was A$6 billion over the last 12 months and would be the same again in the next year.

“If anyone wants a large slice of really high-quality private equity let me know because we are looking,” Neal told delegates at Investment Magazine’s Fiduciary Investors Symposium in the Yarra Valley.  “We have a process underway at the moment of doing a secondary sale of private equity, it is essentially a rebalancing trade.”

Over the last 12 months the fund has added risk to the portfolio and bought emerging market equities, while at the same time sold off some of its illiquid assets to take advantage of the higher prices that were chased up by competitors.

About 15.8 per cent is currently allocated to private equity, 6.7 per cent to property, 7.1 per cent to infrastructure and timberland and about 36 per cent to public market equities, according to their latest quarterly update. That compares to 14.8 per cent allocated to private equity in 2018, 7 per cent invested in property, 8.2 per cent in infrastructure and 32 per cent invested in stocks.

“We are not selling down (private equity) to reduce risk,” Neal said on the side lines of the conference. “We are just selling down to increase liquidity in our portfolio. If you are not sure about what the future environment looks like you need to have the ability to change your portfolio. It’s more opportunistic.”

A Willis Towers Watson report earlier this year found that many institutional investors were shrugging off signs of overheating in private equity to allocate more capital. Researcher Preqin Ltd. estimated that the amount of so-called dry powder waiting to be invested in private equity hit $2 trillion last year.

“As assets realise their potential then we are looking to sell down where it makes sense,” he said. “Everyone is increasing their real asset portfolios, everybody is increasing their private equity portfolios and they are all chasing the prices up.”

Neal said the fund, which saw its assets grow by A$3.1 billion in the last quarter, would continue to buy more public market equities to increase liquidity, despite the potential risk of a selloff. 

The fund, he added, still has a large chunk invested in “growth equity” where it provides capital for companies to stay private for longer particularly in technology and heath care services.

Losing money “happens when you are in a growth asset that is striving for higher returns,” the CEO said. “The important thing is to be able to take advantage of that so if there is that market drawdown, we would expect there would be assets which are a good buy. Perhaps we could even go back into the private markets again.”

Neal said the sovereign wealth fund needed to add risk in the portfolio because it could not rely on its beta return alone, which over 10 years is around 3 per cent real and is short of their target return of CPI plus 4 or 5 per cent.

He also said the prospects of modern monetary theory to stimulate growth, which was becoming increasingly accepted, could also potentially put a floor under the market.

“Perhaps the government doesn’t need a major correction to start to think about that kind of policy response,” he said. “Maybe the chances of a really bad outcome are a lot less than we might otherwise have thought.”

 

I chat with Alexander, CEO at Rebellion Research, on stock selection, portfolio construction and his passion for teaching.

Nothing on this podcast is to be considered investment advice or a recommendation. No investment decision or activity should be undertaken without first seeking qualified and professional advice.

The investment arm of one of Australia’s state governments, TCorp, has issued a A$1.8 billion sustainability bond reflecting the appetite of investors which are increasingly hungry for bonds that are issued to fund social and environmental projects.

The TCorp issuance follows in the footsteps of other large institutional investors around the globe that have issued green and sustainability bonds including the Canadian Pension Plan Investment Board and Caisse de Depots, with Japan’s GPIF also focusing on green and social bonds.

TCorp last week launched the bond whose proceeds will be used to invest in green and social projects across New South Wales, including water infrastructure and access to essential transport and education services. The borrowing agency for the NSW public sector said the bond issue will have a coupon of 1.25 per cent and a maturity date of 20 March 2025.

It’s the second bond to be issued under the NSW Sustainability Bond Programme amid surging demand for fixed income products that incorporate ESG. “It recognises where the market is heading and will satisfy investor demand,” said David Deverall, chief executive officer at TCorp, which has more than A$107 billion of funds under management. “Investors have embraced the social assets introduced to complement the green assets in the pool,” he said. “We see this as a path forward to intergenerational equity and a key opportunity to invest in the sustainable development of assets in NSW.”

The issue was oversubscribed by A$740 million. Asset managers accounted for 62 per cent of investors and the bulk of investors were from Australia.

The bond issue follows TCorp’s $1.8 billion 10-year green bond launched a year ago and which was oversubscribed by A$767 million. Another government borrowing agency, Queensland Treasury Corporation, sold A$1.25 billion of green bonds this year. All up, Australian borrowers issued US$15.6 billion of green bonds, placing Australia third in the Asia-Pacific region for issuance, on data from the Climate Bonds Initiative for the year to June 30, 2019.

While sustainability bonds are relatively new, the issuance of green bonds have grown in popularity and has now hit the US$1 trillion mark.

The growing demand for these bonds from fixed income investors jibes with the findings of a green bond investor survey of 48 top Europe-based fixed income managers with combined assets under management of €13.7 trillion.

Specifically, the survey carried out by the Climate Bonds Initiative, highlighted the unmet demand for green bonds and flagged a lack of adequate supply, especially from corporate issuers. Respondents called for improved transparency, standardisation, clear linkages of proceeds to green outcomes, supportive policy frameworks and the inclusion of a wider issuer universe.
“This will require a concerted effort from issuers, underwriters, ratings agencies, regulators and policy makers,” the report’s authors said. “It also reinforces the critical role the capital markets can play in helping the world allocate capital towards addressing climate change”
TCorp’s new issue comes as Japan’s Government Pension Investment Fund, the world’s largest pension fund, at US$1.4 trillion, and the European Bank for Reconstruction and Development, plan to develop sustainable capital markets through a focus on green bonds and social bonds. GPIF has forged a similar initiative with Nordic Investment Bank.

GPIF requires its asset managers to integrate environmental, social and governance aspects into their investment analysis and decision-making.

Hiro Mizuno, GPIF’s executive managing director and chief investment officer, said the pension fund regards the purchase of green, social and sustainability bonds as one of the direct methods of ESG integration in fixed income investment.

“GPIF wanted to make such bonds mainstream investment products, in order to ensure sustainable performance of the pension reserve fund for all generations,” he said earlier this month.

For its part, NIB has an explicit mandate from its Nordic and Baltic owner countries to finance projects that improve productivity and benefit the environment. NIB established its environmental bond NEB framework in 2011, and has since issued a total of €3.7 billion in environmental bonds.

In January, the Canadian Pension Plan Investment Board issued its first Euro denominated green bond. The sale of €1 billion in 10-year fixed-rate notes will enable CPPIB to invest further in eligible assets such as renewables, water and real estate projects, as well as diversify the Fund’s investor base. This issuance follows CPPIB’s inaugural green bond in June 2018, the first such market offering from any pension fund. Investors bought $1.5 billion of the Canadian dollar-denominated 10-year bond.

Social responsibility

Fiona Trigona, TCorp’s head of funding and balance sheet, said there had been a huge change in appetite for environmental and social-friendly bonds since they issued their green bond a year ago, as boards and investors increase their focus on social responsibility.

“While green bonds have existed for a number of years, investor appetite is rapidly evolving. Demand is now increasing for bonds underpinned by not only green, but also social assets.”

Speaking of the two transactions, Trigona said it was important to see the banks’ attitudes change in terms of providing more fixed income products in this area,” she said. “The dealers bringing transactions to market now know this is an area they need to get more involved in.”

Joint lead managers are ANZ, Bank of America Merrill Lynch and National Australia Bank.

TCorp said it was working closely with the NSW government to ensure the assets financed are aligned with the International Capital Market Association’s sustainability bond guidelines and the United Nations’ sustainable development goals.

The asset manager has access to a A$3.5 billion pool of green and social assets thanks to the state government’s investment in infrastructure and social projects.

Five new sustainable water and wastewater management projects have been identified for the sustainability bond, as well as two new social projects relating to education and transport. TCorp said it’s committed to reporting on the outcomes of these assets on an annual basis.