Calls for accelerating the transition to a low-carbon economy are prompting investors to evolve their approaches to equity investing, investors said.
European retirement plans have increased sustainable investments considerably in recent years in the wake of European governments launching investment programs and regulations aimed at reducing carbon emissions to zero by 2050.
But advancements in climate-related investment due diligence and ESG research by the industry are showing significant progress is needed as early as in 2030. In turn, retirement plan executives are stepping up efforts to revise targets and embrace more actively run portfolios.
- The £12 billion (£15.9 billion) National Employment Savings Trust, London, said it will move an additional £5.5 billion of its default fund's passive developed market equity investments with a climate tilt into an actively run climate-aware segregated account with UBS Asset Management.
- Edinburgh-based Scottish Widows, which has £160 billion in assets, selected the BlackRock Climate Transition World Equity fund for a new £2 billion allocation to active equity.
- The 470 billion Swedish kronor ($53.7 billion) AP7, Stockholm, shifted an additional 500 million Swedish kronor into an active green equity strategy, increasing its exposure to a strategy run by Impax Asset Management Group PLC to 1.4 billion Swedish kronor.
- The €45 billion ($53.5 billion) Varma Mutual Pension Insurance Co., Helsinki, slated up to €1 billion to invest over the long term in shares of companies whose operations support the United Nations' sustainable development goals.
The European Union's interest in promoting investment in ESG strategies provides a marked contrast with the U.S., with the Department of Labor in June proposing that ERISA plan fiduciaries be barred from making ESG investments that sacrifice returns or take on additional risk.
European ESG strategies, however, are proving they can measure up to non-ESG counterparts. A study of 4,900 passive and active funds domiciled in Europe conducted by Morningstar Inc. and published on June 16 showed that through Dec. 31, 2019, a majority of sustainable funds have outperformed their non-ESG peers over multiple time horizons.
Over the 10 years through 2019, nearly 59% of the surviving 745 sustainable funds topped the returns of their average surviving non-ESG peers.
Sources said active management in the context of ESG investing is a necessity and is worth the extra cost. As the breadth of ESG research expands, active management offers flexibility to react to new data becoming available, they added.
"In a passive tracker fund, you are limited to the benchmark," said Katharina Lindmeier, responsible investment manager at NEST, the multiemployer defined contribution plan in London. "The benefit of active is you can react much more quickly from information that comes out. You can adjust methodology and remove companies.
"In passive (funds) you can't address ESG risk in a way that you would do in active," she added.
Jonathan Parker, head of defined contribution and financial well-being at Redington Ltd. in London, added that plan executives' interest in active funds isn't the result of disappointment with passive ESG strategies.
"If trustees want to incorporate ESG at all into an investment strategy they have to take a more active approach than they have in the past because changes in (the U.K.) regulation are much more prescriptive in what they require trustees to do," he said.
In 2019, trustees were required by law to begin incorporating ESG factors and present financially material ESG considerations over the life span of their plans' investments.
Starting Oct. 1, trustees additionally will be required to report on how they acted on the principles set out in their policy, including financially material considerations, social and environmental impact of investments, and how trustees exercised voting rights and engaged with their portfolio companies.
"We are only really scratching the surface in terms of trustees understanding what (ESG) means for them and how strong their beliefs are and how deeply they want to implement (ESG) into an investment strategy," Mr. Parker said.
Mr. Parker added that trustees are still limited by a shortage of data. "Getting data out of companies is getting better," he said, adding that investors too often end up with the manager's or the index provider's interpretation of the data.
Luba Nikulina, global head of research at Willis Towers Watson PLC in London, added that definitions were even more vague three years ago in regard to what contributed to the sustainability of a business. She noted that asset owners should investigate how active managers are engaged with the companies in which they invest rather than just consider past performance of a particular fund.
Stephen Budge, principal and DC investment consultant at Lane Clark & Peacock LLP in London, said an active approach requires an additional layer of governance. "We would favor active approach if it is additive," he said. Mr. Budge added that investors could consider including an active impact investment strategy sleeve into default options. Tackling issues that plan participants care about could improve the level of engagement with plan participants, he added.