Big pension funds have been slow to embrace ethical investment – but the explosive growth in climate change funds is starting to wake them up to the opportunities

If money talks, then pension funds shout. In the UK, pension funds own around one-fifth of stock market-traded companies, representing some £2,310 billion worth of assets under management. As such, their potential influence in terms of asset ownership is considerable.

Yet, with a few exceptions, when it comes to throwing their weight behind environmental, social and corporate governance (ESG) issues, the track record of many big pension funds is less than impressive.

A key issue is the lack of transparency surrounding fund management. Rory Sullivan, head of SRI research at Insight Investment, says that while many fund managers claim to engage in socially responsible investment (SRI), there is little evidence to suggest that they actually do. “Many claim to be responsible investors, but there’s no real way of telling who does what,” he says.

A survey by NGO Fair Pensions last year to rank the level of transparency and engagement among the top 20 fund managers revealed widespread conflict between parent company statements on corporate responsibility and the investment strategies pursued by their investment management arms. Three-quarters of the firms surveyed – including UBS, JP Morgan and Barclays Global Investors – failed to provide publicly available information on how they deal with environmental and social issues. Half of the companies surveyed had no policy on these issues.

The survey also revealed a big gap between what fund managers say they do and what they achieve. Only a few fund mangers – including F&C, Insight Investment, Hermes, Schroders and Morley Fund Management – could demonstrate any tangible impact of their engagement with the companies in their portfolios.

A role for SRI?

According to Matt Christensen, executive director of the European Social Investment Forum (Eurosif), many pension funds are “taking a toe dip” on SRI by including only one screen – often weapons – and leaving it at that. “Right now there is a lot of breadth, but no real depth to SRI commitments from pension funds,” he says.

Rather than addressing ESG issues via asset allocation, larger institutional pension funds prefer to engage with their existing assets, influencing corporate behaviour via their major shareholder status. This approach is favored by pension funds such as the California Public Employees Retirement System (Calpers), the Dutch ABP fund, and Norway’s government pension fund.

Pension funds have traditionally shied away from SRI funds on the grounds that negative screening conflicts with their fiduciary duty to act in investors’ best interest. By excluding investment into arms, pornography, gambling or tobacco, which is what many SRI funds do, the investment pool is reduced, risking inferior returns. “For some pension fund trustees, introducing negative criteria is like investing with one arm tied behind their back,” says Seb Beloe, head of SRI research at Henderson Global Investors.

This perception is slowly changing. A report in 2005 by international law firm Freshfields Bruckhaus Deringer LLP concluded that fiduciary duty requires ESG factors to be considered where there is the potential for material, financial impact from those factors.

While this has yet to stand up in court, Rory Sullivan points out: “Fund managers have demonstrated that they can include responsible investments in their portfolios that deliver good returns. They have also proven that engagement can deliver, so there really is no conflict with fiduciary duties.”

Even so, last year in the UK only 12 large pension funds of 285 companies listed on the FTSE4Good UK Index had a responsible investment policy, according to a survey carried out by the UK Social Investment Forum (UKSIF). As Fair Pensions points out, the lack of performance measurement and reporting makes it “difficult to shake off the impression that RI policies are merely PR exercises”.

The introduction of legislation, such as the UK SRI Pension Disclosure Regulation, and initiatives like the United Nation’s Principals of Responsible Investment (UN PRI) are increasing awareness of SRI.

But awareness is about where it ends for many pension funds. While the UK regulation obliges fund trustees to disclose their ethical policy within their Statement of Investment Principals (SIP), it does not force them to engage on ESG issues through their fund manager. Similarly, the UN PRI has yet to deliver any measurable improvement in activism on ESG issues.

Climate-change funds – hot, but not always ethical

One style of “green fund” that has benefited from an influx of investment across the board – including from pension funds – are those that focus on investments into climate change-related companies.

These funds include producers of low-carbon energy such as renewables, gas and nuclear; firms with energy-efficient products, such as fuel cells and insulation; and companies dealing with water, waste and pollution control. The carbon market alone is estimated to become a $1 trillion commodity market in the next ten years – an asset class unlikely to be ignored by pension funds.

Beloe says climate-change funds have attracted a lot of money because there is a greater understanding of the issue. “Because carbon has a price it can be more easily integrated into the investment decision-making process, and in this sense it presents no conflict in terms of fiduciary duties.”

Adam Ognall, deputy chief executive of the UK Social Investment Forum (UKSIF), says the huge number of high-performing climate-change funds over the past three years has garnered interest from pension funds. Growth in the renewables market is being driven by government targets such as the EU’s renewable energy directive, and Ognall says “pension funds have been looking to invest in these kinds of things over the last 18 months”.

However, the inclusion of nuclear, biofuels and biotechnology within climate-fund portfolios means the term “climate-change fund” does not always mean it is ethical. Beloe says the number of pension funds engaging in climate-change funds paints too rosy a picture. “When you look at the broader picture of ethical and sustainable development issues, the role of pension funds is pretty limited.”

In the longer term, Christensen says while the performance of climate-change funds doesn’t suggest SRI will become mainstream, more SRI funds are likely to be included by pension funds as their track record becomes proven.

As Tom Mcphail, head of pensions research at fund manager Hargreaves Lansdown observes: “Where investment is needed, there are returns to be had – there are government targets to be met and there is money to be made.”

Facts 1: Climate-change funds

F&C’s Global Climate Opportunities Fund, launched last year, focuses on alternative energy, forestry and carbon trading.

Schroder’s Global Climate Change Fund targets firms that help companies to mitigate and adapt to climate change – such as silicon wafer supplier MEMC, power and automation technologies company ABB Group, oil and gas services firm Nabors, ethanol producer Cosan, and Chinese forestry operator Sino-Forest Group.

Deutsche Bank’s DWS climate-change fund invests in companies such as wind turbine makers Vestas Wind Systems, sustainable energy technology supplier Gamesa Coporacion Tecnologica and solar energy provider Solar World AG.

Scotia Bank’s Global Climate Change Fund invests in companies developing strategies to adapt to or mitigate the effects of climate change.

Virgin Money’s Virgin Climate Change Fund invests in high-performing, environmentally focused companies with lower carbon footprints.

Facts 2: Pension Funds with SRI strategies

ABP (Netherlands)
AP2 (Sweden)
ARIA (Australia)
Caisse de dépôt et placement du Québec (Canada)
CalPERS (US)
CIA (Switzerland)
The Environment Agency Pension Fund (UK)
ERAFP (France)
Fonds de Réserve pour les Retraites (France)
Government Pension Fund (Thailand)
Metallrente (Germany)
Norges Bank (for Government Pension Fund)
(Norway)
PGGM (Netherlands)
PREVI (Brazil)
TIAA-CREF (US)
(Source: Insight Investment)

Facts 3: Government backing for SRI

Belgium: in addition to a law against the financing of weapons by pension funds, savings in SRI products can now lead to a higher tax break.

Holland: The Green Funds Scheme encourages ethical investing by granting tax exemptions to savers.

UK: The Community Investment Tax relief (CITR) initiative encourages private investment in businesses fostering wealth creation and employment in developing countries.

Facts 4: Strong ethical funds

Tom McPhail of Hargreaves Lansdown singles out Jupiter Ecology Fund and the F&C Stewardship Fund (formerly the Friends Providence Fund). US funds to catch the eye of investors include the Winslow Green Growth Fund and the New Alternatives Fund. The former, however, took a hammering in the first quarter of 2008 dropping 26.6% – further than any other SRI fund tracked by Lipper or Morningstar.