PGGM is one of the global leaders in implementing a framework that aligns its investments to the UN Sustainable Development Goals.

For one, it has developed taxonomies, together with fellow Dutch giant APG, that identify the so-called SDIs (sustainable development investments), which contribute to the SDGs.

It has also helped other Dutch investors and the country’s central bank develop a guide of SDG impact indicators.

And since 2015, it has had a policy of investing €20 billion ($24 billion) using these indicators, specifically in solutions for food security, water scarcity, healthcare and climate change.

As part of that policy, the impact of those investments has to be measurable, and the €220 billion ($268 billion) fund recently embarked on an exercise to see the impact its portfolio was having on people and the planet.

It partnered with the Impact Management Project (IMP), a collaboration of more than 700 organisations, to map its portfolio, showing where it avoids harm, benefits stakeholders and contributes to solutions.

One key finding of this process was the revelation that there is a difference between intended impact and real impact, says PGGM adviser, responsible investment, Cedric Scholl.

“This needs to be really measurable, not just [based on intentions],” Scholl says.

IMP’s process involves collecting data and measuring the impact of companies across five dimensions. Investors can then determine whether their impact goals have been met, and work with investee companies to improve their positive impact or reduce their negative impact.

The five dimensions are:

What: What outcomes does the effect relate to, and how important are they to people experiencing them?

How much: How much of the effect occurs in the time period?

Who: Who experiences the effect and how underserved are they in relation to the outcome?

Contribution: How does the effect compare and contribute to what is likely to occur anyway?

Risk: What risk factors are material, and how likely is the effect different from expectation?

The mapping is designed to encourage a business to reduce its negative impact and increase its positive impact. It categorises investee companies in three ways: those that avoid harm; those that avoid harm and also want to generate benefits for stakeholders; and those that aim to avoid harm, generate benefits and to contribute to specific solutions.

The process provides a lens for an investor to understand the impacts different businesses want to make and the extent to which investment in those businesses aligns with the investor’s own intentions.

PGGM’s results

The results of PGGM’s mapping were intriguing.

It found that 4.5 per cent of its portfolio is allocated to investments that are “benefiting people and the planet” and 2.5 per cent is allocated to investments contributing to positive outcomes.

These seem like small numbers considering that PGGM is one of the leaders in sustainable investment.

But the numbers do not show a clear picture. It was difficult for PGGM to classify its investments because of a lack of data, particularly in criteria like how under-served people are who are experiencing the outcomes.

Scholl says one of the biggest surprises to the team at PGGM carrying out the mapping was how difficult it was.

“We put things in the ‘avoid harm’ column, and while a lot of those also contribute to benefiting people, we don’t have any data on [to what extent] so we couldn’t categorise them as such,” he explains. “Lack of data is the biggest problem.”

Olivia Prentice, from advisory firm Bridges, which is the facilitating organisation of the IMP, says PGGM’s experience underscores the need for more data.

“PGGM is far ahead of other investors, for example, by delivering against the SDGs,” Prentice says. “But when they scrutinised their data, they realised they didn’t set impact goals, so they couldn’t measure that. This demonstrates the risk behind [just having intentions]. You have to collect the data.”

While it is not the investor’s job to determine the best data for the underlying company to collect, she says because investors are not asking for it, they are contributing to the problem.

The issue of what data to collect is an enduring problem in impact investing. For example, collecting information on job creation doesn’t measure how a person’s life has changed because they found work. Prentice suggests that more information is needed from the people benefiting from impact investment.

“At the moment, impact investing is…driven by the intentions of an investor, rather than by the people close to the impact,” Prentice says. “We need to give more power to the people close to…where the capital is allocated, including frontline enterprises like charities.”

Scholl says it would be helpful if companies were more active in data collection.

“This is part of our call to action. It is necessary to have more focus on how companies contribute to solutions,” he says. “We hope someday we will favour companies [based on] those indicators, and we hope we can grasp the more positive contributions investments can make. At the moment, we can’t, but we have a desire to make decisions based on this type of information.”

The holy grail in the £8 billion ($11.1 billion) Church Commissioners for England’s successful investment strategy is preparation for challenges during times of peace and calm. Making big decisions on asset allocation in the heat of market dislocations is not only painful, it’s also one of the main reasons investors fail to be contrarian. Pre-committing to strategies that kick in when markets hit specified levels is the answer.

It means completing all the discussions and governance steps with investment committees, consultants or advisers in advance, and mandating to managers well ahead of time.

This lies at the heart of Church Commissioners – the endowment that supports the work of the Church of England, including funding dioceses in low-income areas, maintaining crumbling cathedrals and paying clergy pensions. It has helped the fund exceed its targeted return of inflation + 5 per cent over five-, 10-, 20- and 30-year periods, despite excluding on ethical grounds sectors such as weaponry, thermal coal and human embryonic cloning. Commissioners returned 17.1 per cent during 2016. As for the latest year’s results, all chief investment officer Tom Joy would divulge ahead of the fund’s annual report, due out in mid-May, was that “2017 was a strong environment for risk assets, as was 2016”.

Joy has endeavoured to institutionalise the ability to both think ahead and diverge from the norm at the fund, despite the fact investors, like most people, are more comfortable acting in a group.

“It’s about looking at the behavioural hurdles that stop people being contrarian, and putting in place processes that circumvent them,” he says.

Joy has already prepared for any dislocation in credit and fixed income markets, as investors are now particularly prone to illiquidity during market volatility since regulatory changes led banks to scale back their participation as middlemen.

“Should there be a dislocation in the market, we are pre-committed to strategies that will draw our capital into high-yield bonds, emerging-market debt and other structured credit spaces,” Joy says. “We currently have very little allocated to this area, but we have a high degree of money that is pre-committed, and all of the necessary operational infrastructure is in place with managers.”

Although this is the only strategy to which he is currently pre-committed, he is considering doing the same in UK commercial real estate, where the fund also has a low weighting.

 

Cash stashed   

It’s a cautious strategy, mindful of a market correction, and it manifests in many ways throughout the diversified portfolio, which spans equity, multi-asset, credit, property, land and timber allocations. For example, Joy is increasingly incorporating hedging strategies, just not through traditional fixed income. Instead, the fund has a deliberately high 10 per cent allocation to cash.

“Myriad factors have led us to run a high cash position – valuations are high, investor complacency is high,” he lists, although he does think investors received a “useful and meaningful” reminder from the recent fall in markets that investment involves risk.

A high allocation to cash means the fund can easily meet distributions and won’t be forced to sell assets at depressed prices, Joy says. It also means he has dry powder in the event an opportunity emerges.

He adds: “When there is a recession or set back in markets, a traditional fixed income hedge normally means fixed income appreciates in price. It means investors can take profits and continue to meet distributions. But as we have just seen, there was a big wobble and bonds and equities went down when, obviously, cash didn’t.”

He has also allocated 8 per cent of the fund to defensive equities. This sits within the fund’s 40 per cent of assets under management (AUM) in equity, which Joy doesn’t plan to reduce at the moment, despite acknowledging that equity “isn’t cheap” and that in the US it is “overvalued”. The defensive allocation comprises long, short, and active long-only strategies invested with managers that have a global, demonstrative track record of outperforming in weak markets. The strategy is less volatile than the market.

“The aggregate of this portfolio has a beta of about 0.3, so that is materially lower than the market.”

‘Someone who eats their own cooking’

Joy continues to favour active management, despite the investment industry’s structural shift into passive.

“For many people, passive is the right answer. Identifying, selecting and implementing an active equity strategy is not simple,” he acknowledges. Doing it successfully depends on picking managers with specific characteristics in a process that weeds out 90 per cent of the market, he explains. The key consideration is alignment.

“You need someone who eats their own cooking,” he says. A focused product range is also important, so multiproduct firms don’t feature in Commissioners’ manager roster. In most cases, the only strategy the chosen asset manager tends to run is the one Commissioners has bought.

Joy also likes managers to have a “clear philosophy around capacity”, particularly in private markets. In short, he wants managers to be prepared to turn people away despite the ensuing loss of fees.

“Success leads to managers attracting more assets under management but the bigger the fund, the less chance a manager has of hitting the same level of returns in the future as they have in the past,” he says.

Another factor Joy considers crucial when choosing managers is the other investors in the fund. Active managers have long, protracted periods when they underperform, and he wants to know they will continue to manage the money in downturns, rather than hurtle around trying to save the business if investors start bailing out.

“You need to know that the other people you are investing with understand what they are buying, and this is commonly overlooked,” he explains. “We spend a lot of time looking at who the other [limited partners] are and let’s just say there are types of investors we are more comfortable being aligned with than others.”

The fund has manager relationships in its portfolio that stretch back over 10 years. Many are boutique firms, rather than household names, but Joy declines to name key managers or the number in the portfolio.

“It’s always the same pattern,” he says, reflecting on what Commissioners’ long-term approach tries to ensure against. “A manager will have a good track record, say, three years of material outperformance of the benchmark, and they get hired. At that moment, the chances of that continuing in the near term are quite low. So, what you find then is a long and protracted period of underperformance of the benchmark. The manager gets sacked and the merry-go-round starts again. If you look at those managers’ track records over the long term it could be great, but that doesn’t always benefit clients who may not be with them long enough.”

The investment division is run by an internal team of 35, eight of whom, plus Joy, are responsible for manager selection and monitoring. The property portfolio, which accounts for nearly a quarter of AUM spread across commercial, residential and agricultural property, is also run internally, as is the responsible investment division, which now houses a beefed-up engagement team, led by Adam Mathews. The Church of England Pensions Board set up the team in 2016. It lobbies investee companies, particularly on executive remuneration, climate change and board diversity.

The fund’s 4 per cent allocation to private equity is concentrated in the mid-market buyout space, where competition for the best managers isn’t as fierce. The strategy is focused on pushing more into venture capital. At the end of 2016, Joy hired a new head of venture to increase Commissioners’ ability to invest in tech in the US. That market is characterised by strong manager relationships and a bias amongst managers towards US clients, he says.

To overcome that, Commissioners must play to its strengths.

“Our name, pedigree and clear focus on the long-term help,” he says.

Esteemed behavioural economist Richard Thaler has turned his attention to pension funds, specifically looking at the persistence of ‘nudging’ in defined-contribution schemes.

Thaler is a 2017 Nobel Prize winner and co-author of Nudge with Cass Sunstein. Now, he has teamed up with Henrik Cronqvist from the University of Miami Business School, and Frank Yu from China Europe International Business School, to examine the persistence of the choices DC members make once they have been nudged.

When nudges are forever – inertia in the Swedish pension system, looks at the choice architecture of the Swedish Premium Pension Plan and the persistence of the effects of its nudges.

The authors examine the initial choices and subsequent rebalancing activities of the 7,315,209 savers in Sweden during the period 2000-16.

“It seems a good bet that nudges will have the longest life when people are on autopilot,” the paper states. “In outer space, an object that has been nudged will keep going in that direction until it is nudged again. Retirement savers appear to resemble such objects.”

The nudges

When the pension plan was formed, in 2000, members of the fund had a choice; they could go into a default option or make their own portfolio selections.

At the launch, most funds in Europe were allowed to enter the system, which led to 456 mutual fund options for investors, who could select up to five to form a portfolio.

The default fund, for those who didn’t make a choice, was globally diversified, low-fee, and largely indexed. AP7 managed it.

Having a default is classified as a nudge, the paper states. However, the government encouraged investors to decline the default and choose their own portfolio. It did this through public announcements and a well-funded advertising campaign – this was a separate nudge.

The authors examined both nudges and found that two-thirds (66 per cent) of retirement savers chose to form their own portfolio when the pension system launched. About 4.4 million people were in the workforce at that time.

After the launch, however, the ad campaign was cut significantly. Also, the cohorts the plan has added since it began have comprised mostly younger people and immigrants.

By 2016, the percentage of people who choose their own portfolios had dropped dramatically, from 66.6 per cent in 2000 to 0.9 per cent.

The authors point out that most participants have a set-and-forget mindset, they make a choice and then don’t revisit it. This implies that their enduring portfolio choices will depend on the year in which they joined the system.

“The decision to encourage do-it-yourself portfolio management has strongly influenced 3.2 million Swedish citizens. Similarly, the decision of the default fund has had a major impact on the 4.2 million investors in that fund.”

The researchers found that initial selections were persistent. For example, they found that changes in the default fund, AP7, caused little movement from members. Over the years, AP7 evolved from a diversified portfolio of equities, hedge funds and private equity, into a global index fund tracking the MSCI-ACWI index. Also, in 2010, the government allowed up to 50 per cent leverage in the fund. Only 300 people out of every 1 million made a move out of the fund, even after these changes.

The researchers also concluded that selections remained persistent among members in choice options. In one example, this was true even after journalists reported allegations of fraud by one of the fund companies, Allra.

Before the allegations, in January 2017, Allra had four funds in the pension system, and 123,217 investors with a total of $2 billion had picked these funds. During the week after the fraud allegations, only 1.4 per cent of the Allra investors sold their shares.

“One lesson from this experience is that choice architecture mattered even more than its advocates might have thought,” the paper states.

What’s next?

The Swedish Government is considering reforms to the system, and the authors have some suggestions on how to improve it, based on their research.

First, the paper states, the choice architecture should be revised to offer a third level beyond the current options of selecting a default fund or choosing from a menu of funds. The researchers also suggest some changes to the default fund.

“We suggest that the default fund return to its strategy of being a simple global index fund with no leverage,” the authors state. “If the goal is to guess what informed citizens would choose for themselves, we think it is unlikely to be a fund with 50 per cent leverage. If investors want such an aggressive fund, they should be required to choose it actively.

“To accommodate such preferences as well as [those] of more cautious investors, we suggest offering a small number of ‘alternative defaults’, perhaps just two. One might be an aggressive version that includes some leverage, perhaps capped at 25 per cent. The other might be a more conservative alternative, say with just 75 per cent equities.”

Second, the authors say the number of funds offered to those who want to form their own portfolio should be substantially trimmed. It now numbers nearly 900, which the authors say is “obviously too high”.

“We do not have a specific number to suggest, but one way to think about it is to choose a number of funds that is small enough that some kind of regulator can monitor their activities, to prevent future scandals.”

Third, whatever changes are adopted, the authors state, they should be introduced in conjunction with some kind of “restart”, because the system is nearly two decades old and many participants (perhaps most) have not paid any attention during that time to what they own.

 

The paper can be accessed below

When-nudges-are-forever-inertia-in-the-Swedish-pension-system

 

 

The €8.7 billion ($10.7 billion) Ireland Strategic Investment Fund is carving out a role as a catalyst for investment in the Irish economy. Since it was established at the end of 2014 from the remnants of the National Pensions Reserve Fund, the sovereign development fund has invested €3.4 billion in sectors such as housing, infrastructure and agriculture, amounting to about two transactions a month and about €600 million to €700 million each year.

But outside ISIF’s growing portfolio lies a much larger pool of capital the fund has drawn to the Irish economy with its ability to enthusiastically lead and comfort other investors.

“The total commitment to the economy arising from our €3.4 billion is €9.1 billion,” says ISIF director Eugene O’Callaghan, whose leadership of the fund has built ISIF into one of Europe’s most renowned impact investors.

ISIF’s recent investment in venture-capitalist Business Growth Fund’s new €250 million vehicle targeting equity stakes in Irish small and medium-sized enterprises is a typical example of this catalytic role in action. ISIF’s investment helped draw BGF to Ireland and encouraged Irish lenders Allied Irish Banks and Bank of Ireland to put capital into the fund, too.

“BGF has a business model that works well in the UK and were looking to expand into Ireland,” O’Callaghan says. “At the same time, we were looking to see how we could find a platform or conduit to invest €2 million-€10 million in small-ish businesses. BGF was more comfortable investing in Ireland with us as a substantial investor. Overseas investors who don’t know their way around private-market transactions are reluctant to invest alone, and local investors like pension funds have limited resource capabilities and take comfort in investing alongside our well-resourced teams.”

Long-term and flexible

O’Callaghan leads a team of 45 that oversees a diverse private equity and credit portfolio where every investment must deliver both commercial returns and an economic impact. Last year, the fund returned 3.4 per cent on its Irish investments, which have added €655 million of value since inception in 2014.

Investments are bracketed into three strategic areas: enabling, which includes connectivity, infrastructure or housing assets; growth, which supports the engines of the Irish economy; and leading edge, which comprises stakes in companies involved in life sciences or technology. Investment is split 65:35, between fund and direct investment, respectively.

ISIF considers every investment’s ability to promote “economic additionality”, namely benefits to GDP, while avoiding “dead weight”, meaning investments that don’t affect the economy, and “displacement”, where the investment would simply substitute existing economic activity. For example, avoiding dead weight means ISIF won’t invest in sectors that are already served by private-sector investors or lenders to such an extent that ISIF’s involvement won’t make a difference. Instead, it looks to target important gaps that other investors and lenders aren’t filling.

Seeking out this niche has shaped a strategy that is both long-term and flexible. Demand for long-term capital isn’t always met by banks, which have capital adequacy restrictions, or by private equity, which typically has a three- to five-year time horizon, O’Callaghan says.

“When any risk stretches out to 10 years, there is very little capital available, and we are finding opportunities here,” he explains.

A recent investment in this space included €10 million to finance an upgrade at Shannon Airport.

Opportunities also arise from ISIF’s ability to be flexible. O’Callaghan is equally comfortable investing in low-risk or high-risk areas. ISIF can invest anywhere on the capital structure, from safe and secure senior debt all the way through to junior and mezzanine debt, and can take equity stakes in established or early-stage businesses.

“We can be flexible where typical investors are not flexible, and we offer an alternative to banks that are low risk, and private equity funds, which need double-digit returns,” O’Callaghan says.

He notes this leads to opportunities with medium-risk in the middle of the capital structure.

“There is usually a small amount of high-risk money a sponsor or promoter might have, and senior debt that might be available from banks,” he says. “The piece in the middle, between sponsor equity and low-risk debt, is missing, and we can plug that gap.”

O’Callaghan also believes Brexit will offer some real opportunities for the fund. ISIF isn’t cashing in on the migration of financial services from London to other European capitals, including Dublin, but it does see real opportunity in fintech.

“London has a great fintech sector, and if there is a hard Brexit, I think some of these businesses may relocate to Dublin.”

He is also preparing to invest the fund in Ireland’s food sector as it seeks to diversify away from the UK.

“They need capital to diversify,” he says. “We will invest in the food and agricultural sector to provide long-term, patient capital.”

Ensuring diversification

But ISIF still has about €5 billion to deploy, and O’Callaghan acknowledges that finding investment opportunities in Ireland’s small economy that don’t compete with private capital is challenging; for instance, the fund has dipped out on the lucrative returns in Dublin’s vibrant commercial real estate sector.

“There are some very attractive opportunities in commercial real estate, but there is also a great deal of capital and activity and our investment won’t make any difference,” he explains.

O’Callaghan uses a structured matrix framework to help ensure diversification; investment sectors are juxtaposed against risk categories graded one through five. It means ISIF can easily identify which sectors are not filled and focus activity in those areas, while limiting investments where the matrix is filled. Areas where the fund has almost reached its limits are technology and Irish venture capital, partly because ISIF inherited assets from the Pensions Reserve Fund.

Undeployed capital lies in an externally managed global portfolio targeting a five-year return in excess of the cost of Irish debt, at about 4 per cent. The portfolio is split between cash, bonds and equity based on the liquidity needs of the fund as Irish assets are identified and investment readied.

“There is no such thing as liquidity of investment for the community as a whole,” John Maynard Keynes wrote.

Let’s examine how this applies to tobacco and carbon divestment. I’ll address this macro-position at the end of this article. First, I want to lay out the groundwork.

Arguably, the movement to divest tobacco holdings from institutional portfolios can be traced to an individual. (That makes for a better story; multiple influences within a complex system make for a poor narrative.)

Dr Bronwyn King is an Australian radiation oncologist who was once treating lung cancer sufferers and is now chief executive of Tobacco Free Portfolios.

“It was only during a meeting with a representative of her superannuation fund in 2010 that Bronwyn learnt some of her money was flowing to tobacco companies through the default option of her superannuation fund,” the Tobacco Free Portfolios website states. (Source: http://www.tobaccofreeportfolios.org/who-we-are-2).

This is a flaw in the narrative, but a perfectly forgivable one. No money was flowing to the tobacco companies. Existing ownership rights were being shuffled between willing buyers and sellers, that’s all.

Nevertheless, King saw a problem.

“In recognition of the profound death and disease caused by tobacco, there are 181 parties to the UN Tobacco Treaty, vowing to implement robust tobacco control regulations,” she wrote. “In contrast, the global finance industry still invests in, and profits from tobacco. But this is changing…”

The tobacco industry causes harm, therefore there is an ethical case against it. But most of the global finance industry operates under a fiduciary duty, which comes from a history of ethics-free, finance-only decisions. So what does the financial case for divestment from tobacco look like?

History shows that tobacco companies have been extraordinarily successful investments; if customers are compelled to buy a product (because of a physiological addiction), it shouldn’t be too hard to make super-normal profits. To build a financial case against holding such assets, one must argue that future returns will be different.

To me, there are two relatively clear aspects to the industry’s future returns: an attractive stream of cash flows from an existing business model supported by tied-in customers; and a very unattractive set of ‘externalities’ (essentially litigation or regulation) that could take most, if not all of those cash flows away.

It would take a brighter mind than mine to combine those two elements into an expected value. My thinking is more simplistic.

If I know that a tobacco asset has a positive probability of going to zero over my investment horizon (and the cumulative likelihood grows ever larger as the horizon lengthens) why hold it? Part of compounding wealth is about avoiding drawdown, and there are many other assets I could hold instead, so why take the risk?

Given that, I believe I can construct a valid, financial-sounding (but in reality, ethics-infused) case for divestment.

That brings us back to Keynes. Applying the idea there is no such thing as liquidity of investment for the community as a whole, I can remove tobacco from my portfolio but society can’t.

If I sell my securities, I can do so only if there is a willing buyer on the other side, and so the tobacco business model continues largely unimpeded. It’s just that the returns and the risks now affect someone else’s portfolio.

As a bit of an aside, King’s super fund contributions were not funding this industry. But a previous generation of financial industry participants did fund it. Back then, there were credible claims that smoking could even be good for you. This history shows the importance of genuine long-term thinking. It is better not to fund an industry that causes harm than to try to shut it down after it exists (and can lobby). But this would represent incredible foresight.

So there’s a shuffling of ownership but tobacco company operations continue. I presume that is not the result that King desires.

It can be argued that if enough people decide to divest, there is an impact on the cost of capital to tobacco companies. But will that affect them? They are no longer allowed to give money to advertising agencies, and there is no point in capital expenditure to expand production. In short, they don’t need capital and are unlikely to be bothered by a higher cost of capital.

The truth is, tobacco is a dead business, and everyone knows it.

You can, in fact, make a case that tobacco’s returns went from merely excellent to extraordinary at the time it became generally recognised that it was a dead business. This is because the industry had no other use for the cash thrown off by continuing operations than to return it to shareholders.

So, for me, divestment doesn’t achieve what it aims for – the ending of tobacco-influenced human suffering. The answer is to shut down the business model, which would entail a deliberate choice by brave shareholders to strand financially attractive short-term assets.

That is, unless we could persuade governments to nationalise the tobacco companies.

This would give society the liquidity, the out that is otherwise achievable only by stranding. It would also allow a government to manage the asset-liability problem as it saw fit, over the time horizon it deemed practical.

Apply this to fossil fuels. Tobacco is a $517 billion problem (the global market cap of tobacco companies). To me, fossil fuels are the same type of problem but at an order of magnitude much bigger ($5 trillion).

If fossil fuels equally cause human suffering (or are about to), then they pose exactly the same private divestment versus public externality problem.

Therefore, we should probably start thinking about engaging with governments to nationalise fossil fuels under a mandate to wind them down as well. The private capital windfall could then be applied to funding new industries – hopefully with greater knowledge of potential future externalities.

 

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

 

South Africa’s 1.6 trillion rand ($131 billion) Government Employees Pension Fund (GEPF) has just bailed out struggling state-owned electricity monopoly Eskom with an emergency 5 billion rand ($0.4 billion) bridging loan, at the government’s behest. This has confirmed fears among South Africa’s vocal trade unions, which have worried for a while that Africa’s largest pension fund might be used to prop up ailing state-owned companies beset by poor management and performance.

Unions are also enraged that their representatives on the GEPF’s board weren’t consulted on the decision, which was executed by GEPF’s asset manager, the Public Investment Corporation (PIC).

“The government did it without any consultation,” says Zwelinzima Vavi, head of the South African Federation of Trade Unions (SAFTU), whose 700,000 members include many of GEPF’s 1.7 million active members and beneficiaries. The GEPF board comprises 16 members, seven of whom are employee representatives, appointed by their respective labour unions.

Vavi says the Eskom loan is indicative of a conflict of interest within the PIC. New South African Deputy Finance Minister Sfiso Buthelezi was appointed last year to the role, which carries with it the position of PIC board chair. Vavi says Buthelezi lacks the governance track record and rigour that PIC leadership requires. Unions are now calling for an independent chair, to stop politics from keeping a grip on decision-making at the PIC.

Loan breaks GEPF’s mandate

South Africa’s biggest banks had refused to lend any more to Eskom, following allegations of corruption and poor corporate governance. The bridging loan, which ensured the company could pay February’s salaries and supplier fees, adds to the GEPF’s already large exposure to the company via a 90 billion rand ($7.5 billion) allocation to Eskom debt. The additional lending broke the GEPF’s mandate, which bars it from investing in non-investment grade assets. Eskom’s credit rating is junk status.

“We are not averse to the pension fund investing in state-owned enterprises as a matter of principle,” Vavi says. “What we are opposed to is the fact that the government has burnt all its bridges with banks and has turned around and used the PIC as a cash cow to bail out Eskom. Borrowing money from workers’ pensions in this way is a hell of a risk.”

The Eskom loan calls into question the strength of GEPF’s own governance structures at a time when the pension fund is increasingly using its influence to improve governance in investee companies.

Eskom recently put in place a new board to try to turn its fortunes around but it was the financing banks, rather than the GEPF, that pushed effectively for better governance at the utility, says Peter Draper, managing director of Tutwa Consulting.

“It is the banks that drew a line in the sand by not financing anything until governance improves,” Draper says.

GEPF principal executive officer Abel Sithole insists that “ESG is a very important consideration for the fund and is encapsulated in our investment beliefs and policies”. Sithole stresses the crucial role ESG plays in promoting the long-term value of the fund’s investments. ESG considerations are now applied across the portfolio and the fund has embarked on a process to better understand the critical ESG risks to which its holdings are exposed, and how best to mitigate them.

The price of poor governance

Beefing up corporate governance among investee companies, in which the PIC is frequently the largest single shareholder, is essential if the GEPF is to safeguard its 50 per cent of assets under management allocated to South African equity, a weighting that accounts for 13 per cent of the capitalisation of the Johannesburg Stock Exchange.

The pension fund’s vulnerability to poor governance was revealed at the end of last year. When furniture company Steinhoff International Holdings’ share price collapsed after it revealed accounting irregularities, the GEPF lost 0.6 per cent of the value of its entire portfolio.

GEPF owned 10 per cent of the company, a holding that made up about 1 per cent of the fund. At the time, GEPF said that, as a defined benefit fund, its members were not affected by movements in the value of individual investments.

GEPF and the PIC have now asked for board representation at Steinhoff, and are insisting on the appointment of at least two independent non-executive directors, expressing “discomfort” with the lack of board independence and a conflict of interest.

Scrutiny of GEPF’s private portfolio presents an even bigger challenge for Sithole’s ESG team and GEPF’s trustees. Unlisted equity investments total about 46 billion rand ($3 billion), the GEPF’s most recent annual report states.

Tied to corporate South Africa

The GEPF’s fortunes are intrinsically tied to corporate South Africa because its ability to diversify outside the country is limited. The pension fund’s foreign investment is capped at 4 per cent in bonds, and 5 per cent in equity, in allocations currently divided between wider African investment and developed markets. That leaves 90 per cent of the portfolio invested in South Africa, including the 50 per cent allocation to stocks, a 31 per cent allocation to domestic bonds and a 5 per cent allocation to domestic property.

“This has served the GEPF very well so far; we regularly assess our asset allocation and it is not being changed,” Sithole says.

The GEPF returned 4.3 per cent for the year ending March 2017, outperforming its strategic benchmark of 3.7 per cent. GEPF completed an asset liability study during its last actuarial valuation at the beginning of 2017.

The PIC manages all of the fund’s fixed income assets in-house and it has a socially responsible fund, Isibaya, for developmental and infrastructure investment. About three-quarters of its allocation to South African listed equities is run in-house, on a low tracking error basis. The remainder is allocated to South African private-sector managers with a range of different styles.