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Benefits and Pensions Monitor
The Case For At Least Some SRI
By: Dr. Matthew J. Kiernan
 In late October this year, the Canada Pension Plan Investment Board (CPPIB) made what I believe will prove to be a watershed announcement. It adopted its first formal Policy on Responsible Investing. With assets of more than $90 billion, CPPIB is a leader in the world of Canadian institutional investment – by virtue of both its size and its vision. Its new policy is ambitious, yet appropriately measured. By any standard, it is the most comprehensive and thoughtful to appear in Canada to date. It is hoped that CPPIB’s counterparts at other pension funds will take serious notice.
Absolute Forefront
In one sense, the CPPIB policy is really only an acknowledgement of the blatantly obvious – environmental, social, and strategic governance (ESG) factors can, in fact, materially affect the financial risk and prospects of their portfolio companies. Sad to say, however, this recognition places CPPIB at the absolute forefront of pension fund thinking in North America. Only the two giant California funds (CalPERS and CalSTRS) have moved further and faster.
With this move, CPPIB has, ironically, leapfrogged ahead of the US$28 billion pension fund of the United Nations itself, based in New York City. The UN fund, despite its promotion of a new set of ‘Responsible Investment Principles,’ has yet to actually use ESG research itself. It might be instructive to reflect on the reasons why the UN and so many other North American pension funds have been so passive.
I believe there are at least five major reasons for this state of affairs:
- The deep-seated (but erroneous) belief that a company’s social and environmental performance are, at best, irrelevant and, at worst, actually injurious to their competitiveness and financial returns.
- The equally baseless view that, since financial returns are ‘inevitably’ compromised, the imperatives of fiduciary responsibility demand that social and environmental factors be set to one side when investment decisions are made.
- The distressing tendency of most investment professionals to treat all ESG investment strategies as one homogeneous, undifferentiated – and unhelpful – mass.
- The ‘silent conspiracy of passive resistance’ by most pension fund consultants, key gatekeepers who are virtually unanimous in their ignorance of and, therefore, indifference or even hostility to ESG factors. Unfortunately, few if any of the critics have taken the trouble to test the veracity of their assertions, either through their own original research or by consulting the growing financial literature in this area.1
- The extraordinary deference of pension fund trustees themselves, who tend to be intimidated by their professional advisors and sometimes forget that the advisors and money managers work for them and not the other way round. It is perhaps this last impediment which is the most distressing of all. Consider just a few of the broader, socio-economic ‘megatrends’ which are already affecting the security and earning power of longterm retirement savings:
- The globalization and intensification of both industrial competition and institutional investment, particularly in emerging markets. This exponentially increases the level of risk from ESG factors for both major corporations and their investors.
- Tightening national, regional, and global regulatory requirements for stronger company performance and disclosure of ‘non-traditional’ business and investment risks.
- Higher expectations from both consumers and individual investors, substantially increasing the saliency and financial stakes of ESG performance of companies.
- Growing pressure from international nongovernmental organizations (NGOs), armed with unprecedented resources, credibility, access to company data, and global communications capabilities.
- The emergence of ‘fiduciary capitalism,’ the growing inclination and capability among major institutional investors for shareholder activism in the governance of their portfolio companies on ESG issues. Climate change, for example, has now become the fastestgrowing category of shareholder resolutions in the United States. Sadly, it still remains something of a neglected intellectual orphan here in Canada.
The combined impact of these five macro-level factors is already demonstrably clear – the competitive and financial significance of companies’ ESG performance is increasing markedly. Few knowledgeable observers would dispute this. Yet despite this, resistance from the mainstream institutional investor community persists.
Nothing Will Change
Our own firm has recently completed some research into this phenomenon, interviewing dozens of portfolio managers, financial analysts, and investment consultants in Canada and elsewhere. Our conclusions were unequivocal. Unless, and until, the owners of capital (read: pension fund trustees) actively and insistently direct their staffs, investment advisors, and money managers to address ESG factors in a comprehensive and sophisticated manner, nothing will change. The inertia throughout the entire investment management food chain is simply too powerful and pervasive. I have yet to hear a single persuasive argument as to how studiously ignoring major issues such as climate change adds value to the stock selection process or to the level of fiduciary prudence.
Despite this, however, it is currently a universal practice in North America. No pension fund of which I am aware currently assesses its portfolios systematically for climate risk, nor does any incorporate climate risk research into portfolio construction.
Fortunately, though, there is something of a salutary ‘perfect storm’ brewing – a confluence of developments which seems certain to give ESG factors greater prominence in the world of pension fund investment. The three most powerful of these conflicting occurrences are:
- The release of a comprehensive and high-profile report from Mercer Investment Consultants.2 That report, delivered by one of the most influential consultants in the world, essentially debunks the myth that fiduciary responsibility precludes integrating ESG issues such as climate change into investment strategy.
- The release in October 2005 of a similar report from Freshfields, the third largest law firm in the world.3 After reviewing fiduciary legislation in 10 OECD countries, Freshfields essentially concluded that it is not only permissible for fiduciaries to address these issues, it is arguably mandatory in many cases.
- Concrete actions taken by major pension funds in California, the Netherlands, France, Scandinavia, and Australia. Those actions include specific asset allocations to ‘ESGenhanced’ strategies, explicit new requirements for ‘ESG literacy’ for both internal and external asset managers, shareholder advocacy and research, and new allocations to ‘clean tech’ private equity and ‘green’ real estate.
In Canada, it can only be hoped that as the CPPIB moves forward to execute its new policy, other pensions funds will rapidly follow suit. Canadian beneficiaries deserve nothing less.
 Dr. Matthew J. Kiernan is chief executive at Innovest Strategic Value Advisors.
1. See for example, Bauer et al (2005) ‘The Eco-Efficiency Premium Puzzle in the U.S. Equity Market,’ Financial Analysts Journal, Volume 61, Issue
2, 2005; K. Gluck and Y. Becker (2005) ‘The Impact of Eco-Efficiency Alphas,’ Journal of Asset Management, Volume 5, 4, 2005.
2. Mercer Investment Consulting (2005), ‘AClimate for Change.’
3. Freshfields Bruckhaus Deringer ‘A Legal Framework for the Integration of Environment, Social, and Governance Issues into Institutional Investment.’
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