European Pensions Go Green for Social, and Bottom-Line, Benefits

Funds increasingly are using environmental, social and governance criteria in their investment decisions, believing they are vital for long-term success.


In 2012, Mats Andersson, CEO at Fjärde AP-fonden, or the Fourth Swedish National Pension Fund, began a massive purge of the fund’s public equity portfolio. The mandate: Strip out every known environmental polluter in the S&P 500 index (defined as companies with large carbon dioxide emissions and/or fossil fuel reserves) from the portfolio, which makes up 60 percent of the fund’s total holdings. When the triage was completed, only 350 companies remained. Money freed up by the sales was reinvested among the remaining companies.

Welcome to socially responsible investing, Swedish style. AP4, as the fund is commonly known, has been a leader in the SRI world for years, along with its three fellow Swedish state pension funds. But in 2011, not content with the status quo, the fund’s board of trustees decided the time had come to accelerate its commitment to SRI, not just to save the environment but to juice performance.

“We did it because we want to get better returns,” explains Andersson, who has headed the 39 billion kronor ($40 billion) fund since 2006. “There’s a misconception that there’s a conflict between sustainability and long-term investing. We believe it’s a return enhancer.”

European pension funds pioneered socially responsible investing, which emphasizes the use of environmental, social responsibility and corporate governance (ESG) criteria, back in the 1990s. The movement is spreading fast today across the full spectrum of pension funds, asset managers, sovereign wealth funds and charitable organizations such as endowments and foundations. The Global Sustainable Investment Alliance, an umbrella group of SRI organizations, reported in its “2012 Sustainable Investment Review” that owners of $13.6 trillion of professionally managed assets made reference to ESG concerns in their investment selection and management. Europe had the lion’s share, with $8.7 trillion, followed by the U.S., with $3.7 trillion, and Canada, with $589 billion.

Today, European pension funds are looking to stay at the forefront of the movement by deepening their commitment to responsible investing. For players like ATP, Denmark’s national pension fund, that means stepping up engagement with portfolio companies to persuade them to better align themselves with the fund’s ESG goals. Others, like PGGM, a Dutch manager of €189 billion ($215 billion) in pension assets, mostly for health care workers, are working to extend their socially responsible approach to the investing mandates they award to external asset managers.

The four Swedish national funds, created in 2000, began their ESG programs the following year under a mandate from the government, but none has embraced it as enthusiastically as AP4 has. The fund was underperforming its peers when Andersson was recruited as CEO, and he would eventually see SRI as a key way to differentiate AP4 and improve its returns.


At the same time it was weeding out the environmental bad boys from its U.S. stock holdings, the Stockholm-based pension fund created a new strategic mandate for 25 percent of its overall portfolio. Under this mandate investments such as equities and real estate are evaluated with a much longer time horizon of up to 15 years rather than the traditional one-year assessments at most pension funds. Drawing on the action it took in the U.S., AP4 shed its ESG-deficient European and emerging-markets holdings in 2013.

Although it’s difficult to pinpoint ESG factors as the main reason, the fund’s performance has improved. AP4 generated net returns of 16.4 percent in 2013 and 7.2 percent in the first half of 2014, easily the best of the four AP funds. (AP3 came closest, with 14.1 percent and 6.5 percent, respectively.)

Few European pension funds are willing to divest stocks on the large scale that AP4 did. Most funds prefer to engage in dialogues with companies in an effort to persuade them to align themselves with the funds’ ESG goals.

That was the raison d’être behind the 2007 creation of the Swedish AP funds’ Ethical Council, established to coordinate corporate dialogues and investor initiatives for all four AP funds. The council contends that divesting rarely solves problems and should be regarded as a last recourse. But as many asset owners admit, talk can be slow and drain precious staff time and financial resources. So in 2014 the council imposed a four-year time limit on dialogues that concern violations of international conventions. If the council hasn’t achieved its objective by that time, it will recommend that the AP funds divest their holdings in the company involved.

“In the absence of global legislation on climate change and human rights, what investors do and don’t do has become very important to a lot of people,” says John Howchin, the Ethical Council’s secretary general and a former head of environmental research, corporate dialogue and strategic development at Norges Bank Investment Management, manager of Norway’s giant sovereign wealth fund. “Setting a framework and system that are long-term, that reflect norms and conventions signed by the Swedish state, is quite complicated and continues to need adjustment.”

Ole Buhl, head of ESG at Danish pension fund ATP, also prefers dialogue to exclusion. “It’s not us telling a company they should change their behavior, but a discussion and dialogue on how they could do things differently,” he explains. “Dialogue, not conflict.” Still, ATP has excluded 50 companies that didn’t meet its policy requirements, mostly between 2005 and 2009. “It’s not a successful dialogue that ends up in divestment,” Buhl notes.

Partly because of its size — 700 billion Danish kroner ($106 billion) — ATP, like several large Dutch pension funds, doesn’t hire third-party consultants to screen its investments. “My team and our internal portfolio managers are doing all the engagement — one-to-one meetings, a reactive and activist approach,” says Buhl. But whereas the Dutch funds must travel the world to engage with companies, ATP managers so far have had an easier job: The fund’s largest equity investments are in Danish companies.

In 2011 the fund began talks with Danish pharmaceuticals company Lundbeck after discovering that its epilepsy drug, pentobarbital, was being used as a sedative in lethal-injection executions in several U.S. states. ATP held meetings with Lundbeck, requesting that the company try to prevent that use of its medication. Although the pension fund found that Lundbeck had not violated ATP’s social responsibility policy, it concluded that the drug company had not been forthright in its corporate communications. Partly as a result of its dialogue with ATP, Lundbeck has stopped selling the drug to U.S. prison authorities.

Getting a company like Lundbeck to police the use of its drugs is one thing; proving that such actions improve portfolio returns is another. SRI initiatives are often aimed at the future long-term performance of equity, real estate, infrastructure and other investments. Most pension funds measure their success one engagement at a time, with an eye toward the long-term benefits of investing in a good global citizen, not higher returns in the next quarter or year.

Buhl explains that ATP excludes stocks based on noncompliance with fund guidelines, without assessing whether exclusion will reduce or increase short-term performance, while believing it might increase long-term performance. “We have never tried to calculate the performance effect of our exclusions so far — mostly, given the way we invest in both equities and corporate bonds, we would not expect the effect to be significant, if even measurable,” Buhl says.

Marcel Jeucken, who heads a 15-person responsible-investment team at PGGM, thinks SRI initiatives are good for society and for the fund, even if there is a lack of hard data demonstrating an impact on returns. “You have to start from conviction,” he asserts. “You can wait another ten, 20 or 50 years to see if climate change exists. Or you can say, ‘We believe it exists and we have to adapt our portfolio.’”

APG, the Dutch firm that manages €396 billion of assets on behalf of giant pension fund ABP and several smaller funds, distinguishes between the macro and micro impacts of its SRI efforts. “Our equity portfolio is very large — we invest in over 4,000 equities — so changes at an individual company could not be measured at the portfolio level,” says Claudia Kruse, head of sustainability and governance. But she says APG has been effective in pushing for concrete changes at individual companies.

In 2012, APG began a dialogue with Apache Corp., a Houston-based gas and oil exploration and production company, in an effort to persuade it to reduce the environmental impact of hydraulic fracturing, or fracking — by reducing the use of toxic chemicals and freshwater, for example. In 2013 the company cut its use of freshwater in fracking by substituting 10 million barrels of brackish water and 3.1 million barrels of produced water, a by-product of oil and gas extraction. In addition, Apache is on track to reduce methane emissions and has started to use gasoline for its trucks instead of dirtier diesel fuel.

In another engagement APG worked with its fellow shareholders to pressure South Korean giant Samsung Electronics Co. to tackle long-standing health issues related to semiconductor production. The pension manager sent its first letter to the company, cosigned by seven other investors, after a former Samsung semiconductor worker died from leukemia in 2010 — the ninth such fatality. By mid-2011 the company had been persuaded to expand health care coverage and sick leave for seriously ill employees and to conduct research into potential connections between those illnesses and chemicals used in the company’s production processes. Last year Samsung vice chairman Oh Hyun Kwon made a public apology about the health issues. A case study APG’s Kruse sent to Institutional Investor concludes, “From an investor’s perspective, one of the biggest positive changes we think we have driven is that Samsung management now takes matters like environment, health and safety seriously since it has realized that these are long-term value drivers.”

Not every pension fund has €396 billion worth of muscle behind its requests for cleaner, fairer, more sustainable behavior. That’s the impetus behind the growing collaborations among European and U.K. pension funds.

Principles for Responsible Investment, a London-based organization, was established in 2006 after a call from then–United Nations secretary general Kofi Annan. In September 2014, AP4 announced it was joining the Portfolio Decarbonization Coalition, created by the U.N. Environment Program Finance Initiative, a group of some 200 institutional investors that promotes the inclusion of environmental and social factors in investing. The coalition has set two goals to achieve by the start of a major U.N. climate change convention in Paris in December: Get commitments from institutional investors to disclose the carbon footprints of companies representing at least $500 billion of their assets under management, and obtain commitments to reduce the carbon intensity of at least $100 billion of equity investments.

It’s not just corporations that are feeling the heat from pension asset owners. Pension funds are making demands on their asset managers too. In its report “Institutional Markets 2014: Opportunities in a Crowded Market,” released in February, Boston-based analytics firm Cerulli Associates found that more than 50 percent of asset managers received client requests for SRI and ESG mandates last year.

In January a group of 16 public and private British pension funds with combined assets of £200 billion ($306 billion) — including Universities Superannuation Scheme (USS) Investment Management, BT Pension Scheme, West Midlands Pension Fund and the National Employment Savings Trust, a recently created multiemployer pension — published “A Guide to Responsible Investment Reporting in Public Equity,” aimed at establishing reporting standards for individual asset manager mandates. The guide joins the National Association of Pension Funds Stewardship Disclosure Framework, published in October 2013, which sets standards for reporting transparency at the firm level. As of late January, 65 asset managers representing £14 trillion in assets — a group that includes BlackRock, Goldman Sachs Asset Management, T. Rowe Price and Russell Investments — had signed on to the NAPF framework.

USS sends ESG rating data, provided by MSCI and its GMI Ratings subsidiary, to its own portfolio managers to alert them to potential ESG issues at portfolio companies. “We literally red-flag them,” says David Russell, co-head of responsible investment at USS in London.

Kathleen Hughes, global head of liquidity sales and European head of institutional sales for GSAM in London, says investors used to ask asset managers if they offered ESG products. “Today investors are demanding that it be woven into their investment process,” she says. •

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Follow Frances Denmark on Twitter at @francesdenmark.