Pension funds that develop environmental, social, and governance frameworks without government interference tend to have an easier time incorporating those programs into their investment process.
This is just one of the conclusions of a recently published paper entitled “The Origins of ESG in Pensions: Strategies and Outcomes,” which included an analysis of how Canada’s Public Sector Pension Investment Board has been incorporating ESG into its portfolio since 2001.
The C$204.5 billion ($162.6 billion) fund served as a case study for researchers Judith Stroehle, the research and program lead for the Oxford Said Initiative on Rethinking Performance at the University of Oxford’s business school, and Stéphanie Lachance, a managing director for PSP’s responsible investments team.
“We find that the regulatory environment of pensions is not always a supporting factor for the integration of ESG, and that pensions confront strict and narrow mandates, which often make it difficult for them to incorporate factors other than those of a financial nature,” the paper said.
PSP was created in 1999 and began operating a year later. Just one year after that, the fund adopted its first social and environmental investment policy, making it an early adopter of ESG investing.
The policy said that the environmental and social impact of the companies PSP invested with “may be one of a number of relevant factors that our investment professionals would wish to take into account in making investment decisions.”
According to the case study, the decision to implement this policy came not from the government, but from internal discussions with the fund’s board and its senior management. This, according to paper, enabled ESG investments.
“As opposed to a responsible investment approach being imposed by a regulator, it allowed for the development of an approach aligned with PSP’s mandate, its investment strategy, and its total fund perspective,” the authors wrote. “This enabler helped in building a strong level of conviction about ESG risks and opportunities within the organization.”
Since then, however, PSP’s approach to ESG has changed. In 2018, the fund adopted a policy that requires it to share how ESG is incorporated into investment practices.
Before investing, PSP identifies any material ESG risks and opportunities of potential portfolio companies. Likewise, when the fund invests with external managers, it asks regularly about ESG. To ensure that its managers’ decisions are aligned with its responsible investment policy, PSP created an in-house assessment framework to evaluate and rank asset managers’ ESG practices. These managers are broken up by quartile and are prioritized for engagement and progress measurement based on that ranking.
PSP also exercises its proxy voting rights, collaborates with other funds, and actively engages with boards, the paper said.
Stroehle and Lachance noted that PSP engages in ESG investing through three lenses: institutional, which covers historical and regulatory mandates that affect pension systems; organizational, which looks at investment policies, governance structures, and collaborations; and portfolio, which tackles investment strategies and asset allocation.
They noted that while pension funds are all different — and thus cannot implement ESG exactly the same as PSP Investments has — they do better when they have the same level of freedom that PSP did to create its own ESG policy.
“The freedom of pension boards and leaders to do this, however, can be restricted through lack of clear guidance on ESG expectations from plan sponsors or regulators,” the paper said. “Additionally, regulators can inhibit the integration of ESG by placing large reporting burdens on pension funds, therefore making ESG an expensive use of resources.”