The $1.3 trillion Government Pension Investment Fund of Japan is actively promoting environmental, social and governance integration at all levels of its investment chain.

Hiro Mizuno, chief investment officer of GPIF, said that because the fund outsources investments, ESG integration can be done only through the investment chain.

“We work hard internally to consider ESG in our asset manager evaluation,” Mizuno told delegates at the PRI in Person conference in Berlin. “We are encouraging our passive managers to set up as active stewards. They hold a lot of our voting shares and they need to consider ESG in their business activities. We are one of only a few asset owners to change our mandates to passive managers according to the quality of their ESG activities. We also try to hear more from corporations [about] what they want to hear from us and are promoting ESG at the company level.”

ESG factors should be a part of all asset classes, he said.

“We will integrate ESG into every single investment we make, regardless of asset class or geography,” he said. “We are now starting infrastructure and real-estate investing; they are new asset classes for us, so it’s easy to integrate ESG.

“We have a 25-year investment horizon, we spent a lot of time on finding managers to generate good alpha but at the end of the day that doesn’t matter for our performance. The financial system has to be sustainable,” he said. “It’s important for us to make sure we affect the whole investment chain and it becomes more sustainable by taking ESG into consideration.”

Mizuno said the fund was looking at engagement with index vendors, whose indices also play an important role in making sure the investment chain is more sustainable.

“Performance is measured by traditional benchmarks, but we need to change that to enforce alignment with ESG priorities,” he said.

Expectations for managers

GPIF has three explicit expectations of managers, outlined in its stewardship principle guidelines.

It asks managers to become signatories to the Principles for Responsible Investment or explain why they don’t need to do so; it expects managers to integrate ESG into their investment decisions; and it asks managers to engage with companies on serious ESG issues.

The fund also has recommendations for other asset owners, to help forge a sustainable financial system.

“Short-termism is not just a problem at corporate or asset manager level, but also at asset owner level,” Mizuno said. “I encourage all asset owners to stop producing quarterly reports. It’s hard to step back from that because it seems like going backwards in transparency.”

Speaking alongside Mizuno, on a panel titled Systematically Integrating ESG Across Asset Classes for Long-term, Sustainable Returns, Eva Halvarsson, chief executive of AP2, said integration means having a sustainability lens throughout the organisation.

“To be successful, you have to have commitment from the top,” Halvarsson said. “We are very lucky to have that. Every board meeting, management meeting and meeting with our staff we talk about sustainability. It’s commitment and culture. This is part of our DNA at AP2; everyone is engaged with these issues. I’m a strong believer that this should come from within. These are not issues for the ESG department.”

Halvarsson said the motivation for ESG integration comes from an investment imperative.

“The investor with the best and most information can make the best investment decision. You need a new kind of information,” she explained. “One of our most important values at AP2 is constant improvement. If we are to achieve that, we need to learn a lot of new things…You can apply that in working with ESG.”

Corporate engagement creates value for the target company, and for the investor, that goes way beyond financial benefits, research commissioned by the PRI has found.

The PRI commissioned two pieces of research about corporate engagements. One piece, conducted by the London School of Economics, found that the return on equity of a target firm increased by 1 per cent three to four years after a successful engagement.

Further, it showed that the lead investor increased its shareholdings after a successful engagement.

Xi Li, associate professor of accounting at the London School of Economics, looked at the best practices for impactful co-ordinated engagements. The research used a quantitative methodology to examine 31 unique projects from 2007-17, which included 1671 dialogues with 964 target companies from 63 countries. It involved 225 investors, including asset owners and managers, from 24 countries with $23 trillion.

The research found that successful engagement had a couple of common characteristics and Li recommended that investors try to include in their own engagement activities. These include finding a lead investor with high assets under management and a big holding in the target, from the same geographic location as the target company. This should be supported by other investors with broad influence across foreign countries, preferably with high AUM and a big holding in the target. It also recommended that investors engage with corporations with high institutional investor holdings.

While the increase in the return on equity of a corporation is a key gain, another study found that financial value creation is not the only benefit of investor engagement.

In the second piece of research, Jean-Pascal Gond, professor of corporate social responsibility at Cass Business School, conducted interviews with 52 actors in charge of handling environmental, social and governance requests from 36 corporations.

It found that engagement creates value for corporations through multiple mechanisms – communicative dynamics, learning dynamics and political dynamics.

“Engagement helps corporations clarify expectations and accountability, and helps manage impressions. It also helps corporations develop a knowledge of ESG issues,” Gond said. “A lot of corporations said they loved engagement because it was free consulting. There are a lot of political dynamics going on in this process, and engagement helped to enhance the loyalty of long-term investors.

“Interesting for us to find out that the corporations were quite proactive and could understand the benefits of this engagement with investors. These investors will speak to other investors and enhance loyalty.”

These value creation mechanisms also apply on the investor side, he said.

Gond encouraged investors to broaden the definition of success beyond just financial value creation. He also said investors shouldn’t delegate all engagement, and that they would get more from engaging strategically.

“Investors should understand what corporations could get from engagement and communicate with them about what [they] expect from the engagement,” he said.

Christiana Figueres, the convenor of Mission 2020, challenged PRI signatories to invest 1 per cent of their assets in clean technologies and renewable energy by 2020.

“We have run out of time for anything that is gradual or marginal, we need to step up exponentially if we are to protect the global economy,” she said. “We don’t want to be caught unawares or in a systemically uninsurable economy.”

PRI signatories have a total of about $70 trillion under management.

Figueres, who was the executive secretary of the UN Framework Convention on Climate Change and was instrumental in COP21, further challenged delegates to announce their 1 per cent commitment to renewables within one year, when a Climate Action Summit will be held in California, hosted by Governor Jerry Brown.

“We are at a very important transition stage in the global economy,” she explained. “We now have $320 billion per year invested in renewable energy and technologies. A growing number of shareholder resolutions are asking for disclosure of the carbon risk and the risk to the value of the company in the future. And the amount of money in green bonds will move to about $100 billion this year, up from $8 billion only a few years ago. All of those data points show we are moving in the right direction in decarbonising the global economy and shifting capital from carbon intensive investments to lower or no-carbon investments.”

She said, however, that this transition can’t be elastic or drawn out infinitely. In particular, she said there are two firm boundaries keep in mind.

First, earth’s atmosphere can take only another 600 gigatonnes of carbon emissions before crossing a dangerous threshold.

“[We’ve] already put up 1200 gigatonnes, If we go beyond another 600, then there will be huge implications. We are putting 40 gigatonnes up each year now.”

But there is also a boundary for the rate of decarbonisation.

“The global economy can’t decarbonise by much more than 6 to 7 per cent per year,” she said. “[This means] we can take that 40 to net zero by 2050. If the economy had infinite adaptability, we could move to zero immediately, but it doesn’t. These are very tight boundaries.

“Putting together all of those numbers, you come to the conclusion that we need to take advantage of the fact we’ve had three years of flat emissions, and actually begin to bend the curve of emissions down. It is out of the question to stay at 40 gigatonnes per year. The point at which we need to bend the curve down is 2020, only three years from now. We need to [cut] 50 per cent of emissions every decade [to get] to net zero by 2050 – that is the prudent rate of dissent to protect the economy.”

Investors, she said, can play a further role in the prudent decarbonisation of the economy,

She congratulated the PRI, and its signatories to the Montreal Pledge which she said was instrumental in giving governments confidence they needed in negotiating the Paris Agreement.

How workers are treated is a key indicator of the quality of a company, and investors should use this information to help assess a company’s investability, California Public Employees’ Retirement System trustee Priya Mathur said at the PRI in Person conference in Berlin.

“As an asset owner, the relationships between a company and its people are indicators of broader issues,” Mathur said. It’s the canary in the coal mine.”

Paul Lee, head of corporate governance at Aberdeen Asset Management said many companies say their people are their greatest asset but don’t give substance to that.

“It’s a shame that a lot of companies don’t get beyond the facile statements,” Lee said. “We see in a lot of modern corporations that the relationship between companies and their employees is breaking down.”

Lee said his favourite question to ask corporate management is, “How are your people?” followed by, “How as an outsider do you get an understanding of your relationship with your employees?”

“The nature of the answer gives you as much as the substance of the answer,” he said.

Lee and Mathur were joined on a panel by Branton Phillips, who is part of the organising committee for the Fair Future at Tesla and a Tesla production worker.

Phillips said that, while he and his co-workers were proud to work at Tesla, there were “some major problems in the safety and health of the workplace”.

“We have an excellent production culture but the safety culture is lacking,” he said. “There are certain trade secrets I can’t talk about, and won’t. But a lot of the workers can’t speak up about some key issues and much of it is around safety.”

Phillips earns $18 an hour and lives in the San Francisco Bay Area to be close to work.

“A lot of people are travelling an hour-and-a-half because they don’t want to live in the Bay Area because the rents are so high. So they’re working 12 hours a day and then travelling for another three hours,” he said.

Tesla production staff recently wrote an open letter to the board’s independent directors outlining the need for a better health and safety environment.

Lee said for a manufacturer such as Tesla, if it has a good health and safety record it will necessarily mean it will be a better company.

He said that the ‘gig economy’ has led to many companies choosing to distance themselves from their employees. He pointed to a “hypothetical Irish airline” that has freelance pilots, and Uber, which claims not to employ its drivers, as two examples.

“With that airline, this company has deliberately chosen a distant relationship, making its business model unsustainable,” he said. “The gig economy has a strange dependent relationship with staff but it’s not employment or freedom. It’s hard to see how the individual workers are not being taken advantage of; they don’t have scope and the rights to organise and come together to fight for a better environment.”

“Uber says it doesn’t employ any of its drivers, but the moment it is barred from London it says 40,000 people will be out of work. It’s a private company and we’re not invested in it, but when it does come to market these issues will need to be addressed.”

An open and collaborative interaction between the board and internal environmental, social and governance staff is essential for asset owners to implement responsible investment policies, a panel of trustees told the PRI in Person delegates in Berlin.

Renosi Mokate, chair of the giant South African fund GEPF, said the board must demonstrate it has an interest in ESG and be open to learning.

“For ESG specialists, they have to have a level of competence that inspires confidence in the board,” Mokate said. “This is an evolving area and needs interaction between staff and the board; nothing can be out of bounds.”

Staff of GEPF recently looked at the fund’s responsible investment policy and framework, and reworked its materials to introduce greater clarity.

“This has given us clarity, for example with engagements, we have never had an explicit approach, but we now do. This allowed the board to reflect on that and agree on the way forward.”

GEPF also included the sustainable development goals in its framework.

ABP trustee Xander den Uyl said the establishment of the taxonomies around what makes a sustainable development investment, by APG and PGGM, was a great example of the board and the staff working well together.

“We have been working very hard on getting the SDGs investable,” den Uyl said. We have a very clear responsible investment policy, and very good co-operation between the responsible investment staff at APG and the board of ABP.”

Mokate said GEPF also spends much time on board education, and the trustees make decisions about what areas they want to do a deep dive into.

“This allows the committees to work more efficiently and ensures the information is well developed and efficient,” she said.

Cbus Super trustee Rita Mallia said the Australian fund has a good internal team that prioritises getting the board timely and relevant information.

“We have 100 pages to get through in our board papers, so making it efficient is really important,” Mallia said. “We are all time poor so being able to get timely information is important. Embedding ESG is an important consideration, so it doesn’t just become another layer and another thing we need to do.”

Service Employees International Union Master Trust director Vonda Brunsting said her board recently had a difficult conversation around race and how it played out at the fund and in its investments.

“We recently responded to a black man being shot and killed by police, and we brought this conversation into the pension board room,” Brunsting said. “Race is a really hard topic, but we thought we needed to address the issue.

“We were in a consultant search at the time, and brought the issue of race into that search. We then worked with our consultants to examine the portfolio and policies in relation to this.”

The US-based fund made a number of changes, including to the makeup of its own board, and when vacancies came up, it added four new directors; all were people of colour and two were women.

The fund also took up the issue of diversity in corporate governance.

The sustainable development goals (SDGs) are a shared to-do list for the global economy, say large asset owners that have adopted them in their investment strategies.

The largest fund in Europe, ABP, and a large and fast-growing Australian fund, Cbus Super, have both adopted the SDGs.

Anne Simpson, investment director of sustainability at the largest fund in the US, the California Public Employees’ Retirement System, where the SDGs are also under consideration, says the SDGs are not just a moral imperative, they are an economic necessity.

“As a large investor, we have nowhere to hide from the world’s problems and risks. But we are not in a position to tackle them without a public policy framework. The SDGs provide a consensus on a shared to-do list,” Simpson said. “Until now, investors haven’t had a legitimate framework to think about allocating capital and managing risk.”

Similarly, Josepha Meijer, vice-chair of ABP, said the SDGs provide a widely supported frame of reference, a vision to the world that is broad and has a long timeframe.

“We think they’re a gift from the UN to the world,” she said. “As a pension fund, we have a vested interest in helping to achieve those goals as we think they’ll shape the world the beneficiaries live in, and also shape areas of growth and provide a more stable economy. They create alignment for a common vision and avoid further fragmentation.”

Alexandra West, portfolio head of strategy and innovation at Cbus Super, said there are two reasons investors should align with the SDGs.

“Investors need progress on the SDGs because they’ll assure a stable economy and drive economic growth,” West said. “And the SDGs need us; without mainstream institutional investment, the SDGs won’t be realised. As long-term value creators, we rely on a sustainable economy and economic growth. We can’t afford to sit on the sidelines and leave it to others.”

West pointed out that only 10 per cent of investment required for the SDGs will come from government.

“We need the SDGs to be realised but unless there is collective action they won’t be achieved,” she said.

ABP has helped developed taxonomies to provide clear guidance on what types of investments qualify as sustainable development investments.

West said developing a strategy for how to contribute to the SDGs was very difficult.

“There’s no how-to guide,” she said. “The work of ABP and PGGM is very useful for investors in how to invest in the SDGs.”

Simpson said until now there has never been a framework that bundles up the world’s problems and opportunities.

“The SDGs are very helpful for investors, they give us a navigation route. We now have milestones that will be helpful for investors.”