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Large Public Pension Plans ‘Move Aggressively’ Toward ESG Integration, Even as Smaller Plans Fall Short

Smaller defined benefit plans fall victim to budgetary constraints, personnel shortages, and a “murky” regulatory environment, according to a Cerulli Associates survey.

Environmental, social, and corporate governance investing might dominate the public conversation around institutional portfolios, but only the largest public pension funds in the U.S. have made significant headway in adopting impact investments. For smaller- and mid-sized defined benefit plans, a fully-integrated ESG portfolio remains a distant dream. 

According to a survey from Cerulli Associates, 20 U.S. public pension plans are listed as members of Climate Action 100+, an initiative to fight climate change through corporate governance. Ninety percent of respondents believed public pensions will have a moderate-to-high demand for ESG strategies in the next two to three years. When compared to other allocators, public defined benefit plans’ demand for impact investment strategies fell in the middle of the pack. The survey showed that family offices, high net-worth individuals, and foundations had even higher demand for ESG strategies in 2020.

Large public pension plans, including New York State Common Retirement Fund, the New Jersey Division of Investments, the Washington State Investment Board, the California State Teachers’ Retirement System, the Seattle City Employees’ Retirement System Board of Administration, and the San Francisco City & County Employees’ Retirement System, are among the institutions making notable allocations to impact investing, the report said. 

“For those really large plans, they are moving pretty aggressively with ESG. They are right at the forefront of integration,” Robert Nelson, Cerulli’s institutional director, told Institutional Investor. “But my sense is that the smaller and medium-sized plans are not nearly as far along.” 

Nelson attributed the gap between small and mid-sized pension plans and large pension plans to factors like struggles with ESG benchmarks and third-party scoring systems, budgetary constraints, and personnel shortages. 

“Midsized plans are challenged enough to just uphold their fiduciary duty to pensioners,” Nelson said. 

At smaller plans, Nelson said there also may be a bit of “conservatism” at play due to the volatile ESG regulatory environment in the U.S. The survey places some responsibility for the lag on the “murky” regulatory environment, noting that the back-and-forth may have had a disproportionate impact on ERISA-regulated corporate pension plans. 

Still, public pension plans are ahead of the demand curve when compared to corporate pension plans. Twenty-nine percent of respondents said public DB plans had “low demand” for impact investing; 53 percent of respondents said corporate pensions had “low demand” for these investments.

In general, U.S. investors are more reluctant to incorporate ESG than investors in other parts of the world, but the U.S. is beginning to catch up. For instance, a Bloomberg Intelligence report released Wednesday said the U.S. saw 40 percent growth in ESG assets under management in the past two years, accounting for almost half of global ESG assets. According to the report, U.S. investors, who were once largely reluctant to adopt ESG, are jumping aboard the ESG train and sparking a mass “rebranding” of companies to ESG-centric investment entities. 

“There’s more pressure on companies to respond to shareholder engagement to ramp up ESG engagements, and we’re seeing more company actions on things like reduction goals,” Shaheen Contractor, Bloomberg Intelligence analyst, told II

But this trend could result in increased greenwashing. According to the report, anti-greenwashing regulations inflicted over the past two years in Europe have resulted in a $2 trillion reduction in the region’s ESG assets. 

“The rebranding trend may be a double-edged sword,” the report said. “Regulation will play an important role as scrutiny and requirements increasingly seek to tackle the risk of greenwashing.” 

Looking ahead at the next two to three years, Cerulli survey respondents expect the greatest opportunities to lie in foundations, endowments, and public DB plans. Corporate DB plans fall short of expectations. What's more, as larger public pension plans increasingly incorporate ESG into their portfolios, smaller- and mid-sized plans will follow suit. 

“The environment that we have today is one that reflects the long-term trend toward greater interest and greater implementation of ESG throughout institutional channels,” Nelson said. “And I think that will affect defined benefit plans.” 

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