Defining your portfolio’s values

Pressure from members and media reporting is encouraging funds to review their ESG policies. But the choices are not clear cut. Nina Röhrbein reports

While socially responsible investment (SRI) policies have traditionally excluded investments in armaments and tobacco, more recent SRI codes appear to have broadened their exclusion criteria to other areas.

In January, Pensioenfonds Zorg en Welzijn, formerly PGGM, the €88bn Dutch health care pension fund, withdrew its €37m investment in oil company PetroChina because of the company’s alleged involvement in human rights violations in Sudan after pressure on PetroChina failed to produce results.

And the €2.8bn Dutch industry-wide media pension fund PNO decided in February to exclude nine companies that make or sell products containing fur, in addition to the eleven companies that are involved in the production of armaments.

Jane Goodland, (pictured right) investment consultant at Watson Wyatt, points out that SRI pension fund guidelines have been paying particular attention to investments in armaments such as cluster bombs and landmines. She says: “These types of exclusions have tended to be used by public sector funds although some corporate pension funds are also looking at their policies. This is probably due to the higher profile of public schemes and the greater reputational risk associated with them.”

“Media attention such as the Dutch current affairs programme Zembla - which highlighted pension fund investments in armament companies - can motivate members to raise the issue with their pension fund manager,” she adds.

“We have had an SRI code since 2004,” explains Leo Witkamp, (pictured left) chief executive at PNO. “But we noticed that it had not been managed properly because it was very short which left a lot of room for interpretation. And so when the Dutch pension fund industry was hit with Zembla in 2007 it was a reason to review our code.”

“With the help of Prof Harry Hummels, associated with the European Centre for Corporate Engagement of Maastricht University, and Henrik Syse, former head of corporate governance at Norges Bank Investment Management, the manager of the Government Petroleum Fund, our advisory board came up with its own environmental, social and governance (ESG) values,” Witkamp explains. “We do not want to invest in the weapons industry which is why we excluded these stocks. The exclusions on fur were the result of a democratic process, as the majority of the combined board and advisory board, as representatives of the pension fund members, wanted to exclude companies involved in that business.”

Indeed public pressure and the opinions of members often appear to play a role in determining a pension fund’s SRI policy.

“As our members work in the media, they tend to be very critical and have outspoken ideas about various topics,” says Witkamp. “As a pension fund, we have to listen carefully to what they want although they are aware that not every individual idea can be enforced.”

“Where there is a high level of consensus among members, pension fund managers are likely to listen to these concerns,” says Goodland. “But consensus may be hard to reach over trickier issues such as alcohol, animal testing or tobacco, which makes developing a policy difficult.”

And communication with members is the key.

“Where we differ from other pension funds is that we will very shortly have direct communication with our members via a website,” says Witkamp.

SRI criteria and exclusions, says Goodland, depend on the individual pension fund. “The overall objective of the organisation - whether it is a charity, an academic institution or a public fund - often guides the SRI policy for the pension fund,” she explains. “However this seems to be less the case for corporate pension funds.”

“Common exclusion criteria are alcohol, tobacco, arms and gambling,” she adds. “Beyond that, criteria may relate to environmental practices, human rights or labour practices. Criteria tend to be fund-specific and influenced by a multitude of factors such as the cultural influences or views of members.”

“Our new SRI code will be under constant evaluation,” says Witkamp. “But we expect the number of exclusions to remain between the current level and perhaps another 10, as exclusions are not our main objective. The heart of our new system is engagement, for which we hired UK-based advisory Hermes Equity Ownership Services (EOS). Hermes EOS will update their results and the progress of their engagement with companies on the new website.

On topics such as child labour, for example, engagement helps more to improve the situation in a country than the withdrawal of investment. However, when engagement fails to produce results, we will exclude that stock, as we are convinced exclusions below a certain number do not affect fund performance.”

Goodland agrees that engagement and best-in-class are more recent approaches. “Engagement is something which some institutional investors feel comfortable with because they can exert shareholder influence even with passive investment strategies,” she says.

But how do you decide what stocks to exclude?

“Criteria may not be straightforward, armaments screen, for example, may exclude companies that sell weapons or all those involved in weapons manufacture,” explains Goodland. “Some fund managers make a distinction between items specifically made for the end-purpose and those more generic items used in many different applications.”

“Some have concerns about the impact screens have on the available investment universe, but the tobacco-free S&P500 index, for example, only excludes four stocks,” she adds. “Obviously the more onerous and far-reaching the screens, the greater the impact they will have on the available universe. But performance is also down to the fund managers.”

Although exclusions seem to feature in plenty of pension funds that have an SRI policy, Goodland does not think they are an absolute requirement for all pension funds.

“From Watson Wyatt’s perspective we think of sustainable investment as any investment strategy which to some degree incorporates ESG factors in the investment decision-making process,” she says. “There is a range of manifestations under the sustainable investment umbrella, all of which have their place and may be more or less appropriate for different institutional investors. SRI is pretty much in the eye of the beholder, the individual fund.”

For Rebecca Dixon, (pictured right) associate in Mercer’s responsible investment unit, it is important to distinguish between SRI and responsible investing. “At Mercer we think of SRI as being more values-based, incorporating ESG issues in the
investment management process primarily because of the belief that it is the right thing to do, while it may or may not bring benefits in terms of returns,” she says.

“The products tend to be a specialist niche offering with SRI at the core. Generally, SRI-marketed funds do have some element of exclusion, while some argue that even best-in-class is an exclusionary practice.

“Responsible investing is more value driven, integrating ESG considerations into investment management processes and ownership practices in the belief that these factors can have an impact on financial performance,” she notes. “Responsible investing tends to be more of an integrated approach but also includes engagement, elements of exclusion and other responsible investing practices. It is the approach that more mainstream pension funds are taking.”

“The joy of sustainable investment is that there are lots of different views,” Goodland adds. “And while actively managed sustainable investment funds might not have an explicit exclusion on tobacco in their fund literature, they will, by their very nature, be unlikely to invest in tobacco companies.”

According to Goodland, pension funds are becoming increasingly interested in SRI policies. And Witkamp agrees. “SRI is a significant issue, particularly in the Netherlands,” he says.

“The country’s largest union the FNV has a 10-point plan for SRI and with our new code we meet that criteria. And because unions play an important role on the boards of pension funds - at least in the Netherlands - I expect more schemes to implement an SRI policy. SRI ideas may differ, but showing your participants that you are aware of the topic is the key issue.”

And the universe has not only become tighter for institutional investors.

Earlier this year, Standard Life Investments announced that its ethical retail funds would no longer invest in airline stocks. The new policy was adopted as a direct result of the investment house’s 2007 annual ethical investor survey, in which 30% of respondents stated that they would prefer a complete exclusion of airline stocks from the funds.