Features, May 2000 Pension sector shows green tinge In the run-up to the July deadline for socially responsible disclosure looms, there were few outward signs of a radical shift in pension fund's behaviour. But beneath the surface, Mark Nicholls detects changing attitudes The UK's new rules on pension funds' socially responsible investment (SRI) policies may not, as some activists might have hoped, converted the investment management industry into ethical investors overnight. Pension funds and their advisors and fund managers are, by and large, taking a cautious approach to the new regulations. But as the deadline approaches, SRI issues have risen up the City's agenda in ways that would have been unthinkable two years ago, observers say. In response to the new rules, investment management companies are advising clients how to address SRI issues, developing policies to engage with companies on social and environmental issues, and in some cases, appointing dedicated environmental researchers to ensure that these issues are explicitly addressed in the investment decision-making process. "There's a willingness to listen to SRI issues [among the investment management community] that wasn't there two years ago,"says Penny Shepherd, executive director of the UK Social Investment Forum (UKSIF). "We always expected that pension funds would take a 'toe-in-the-water' approach. July 3 is not a watershed date - it's part of a process, and it's going to be a long haul." "Most trustees are quite sensibly addressing this quite slowly - given the complexity of the subject, this is a pretty responsible approach," says Geoff Singleton, a consultant with Hyman Robertson, a consulting actuary. From July 3, pension funds must include in their statement of investment principles their policies on how social, environmental and ethical considerations are taken into account in their investment decisions, and their policies on how they exercise rights - such as voting rights - attached to their investments. Those pension funds that have already stepped forward with explicit SRI policies are very much in the minority. However, two of the largest funds, the BT pension fund and the University Superannuation Scheme, which manages the pension assets of university staff, are ahead of the pack. But both funds' policies on SRI (see Environmental Finance, February 2000, page 7) are couched in fairly conservative terms and acknowledge the primacy of maximising financial returns for their beneficiaries over such non-financial issues as environmental performance. Food retailer Sainsbury's has had an SRI policy for more than three years, which was recently amended to include the exercise of voting rights, and some local government pension funds have been committed to some degree of SRI before the announcement, last summer, of the July change. But the majority of pension funds are still considering the implications of the new rules, according to consultants. Sarah Willis, associate director of Environmental Governance, a London-based consultancy, says that trustees first need to understand what is meant by socially responsible investing. "They have to decide what their beneficiaries' concerns are with regard to SRI, how these relate to the financial performance of their investments, and what tools there are to address these issues with their investment strategies." Pension fund trustees are faced with four options: do nothing, which is likely to incur the wrath of some beneficiaries and attract negative press coverage; invest part or all of the pension fund in socially responsible investment vehicles; ensure that social and environmental issues are taken into consideration in the investment process; or set out an engagement policy, whereby funds use their equity holdings to encourage companies to improve social and environmental performance. The last two options are proving most popular - and in both cases, it is falling to the investment managers to implement SRI policies. "It's beyond the scope of most trustees to set out in detail what they mean by 'socially responsible'", says Nick Fitzpatrick, a partner at actuaries Bacon & Woodrow. "They have to rely on their investment managers to help them with voting policies, building portfolios and setting out general SRI principles." As far as asset allocation goes, fund management companies are dividing into those that say their fund managers take - and have always taken - environmental and social issues into account, and those that are appointing individuals or teams dedicated to research on these issues, and ensure they are formally addressed in investment decisions. The majority of investment managers are taking a business-as-usual approach to incorporating SRI principles into investment decisions. In a recent briefing note to clients, for example, Deutsche Asset Management says that ethical and environmental issues make up part of a range of non-financial criteria which can impact company performance "which we already take into account in our analysis where relevant." It goes on to say that "for socially responsible issues to play a more central part in our research, we need to be convinced that we can add value to our investment process by devoting further research to them." It isn't difficult for investment managers to argue that they have always addressed environmental concerns. At the extreme, poor environmental performance can destroy shareholder value - a fund manager would have to display little environmental awareness to refuse to invest in a company in a high-risk sector (such as oil and gas) whose management team failed to prioritise strong environmental controls. This satisfies most trustees, says Crispin Lace, of consultants Watson Wyatt. "They are coming to the conclusion that it's too difficult to agree on policies that exclude certain companies [the traditional ethical investing approach], and are instead taking comfort in the fact that investment managers are telling them that they're taking these issues into account in their investment decisions." Others, however, are attempting to add value by explicitly incorporating environmental and social considerations into the research and investment process. Schroders Asset Management and SG Asset Management, for example, have both appointed individuals with responsibility for SRI issues. At Schroders, with £89 billion under management in the UK, associate director Charles Price has been recently charged with socially responsible investment issues, and is building a team to both ensure that fund managers are fully appraised of SRI issues when selecting stocks, and to identify underperforming companies to 'engage with' on SRI questions. He currently has two staff working with him, and expects to add to the team over the next six months. And in March, SG Asset Management - which was set up in 1998, and now has £5 billion under management - appointed Carole Arumainayagam to add an SRI element to its existing research capability. The appointment followed a £200 million mandate awarded by Norfolk County Council at the start of the year. The council wanted an SRI component in the management of its money, and SG turned to Arumainayagam, who, after 12 years in the City, had recently completed a masters degree in environmental economics. Her role is clear: by examining companies with a dedicated eye for environmental risks (and, to a lesser extent, longer-term environmental opportunities), Arumainayagam is charged with generating higher returns for SG's clients. "This is complementary to the [traditional] stock selection process - we're trying to identify issues that are relevant to various companies. SRI should take an integrated view of a company's performance: taking social, environment and economic factors into account,"Arumainayagam says. SG's policy, in this regard, is putting SRI exactly where its advocates recommend: firmly at the heart of the investment process. But few investment managers have so explicitly embraced SRI in portfolio allocation. Instead, they are stressing dialogue with companies they already invest in, through their existing company contacts and their corporate governance services. Given that fund managers, as a rule, still insist that their first duty is to maximise financial returns, in the final investment decisions most will only be dictated by environmental imperatives if all other things are equal - which is rarely the case. Investment managers are therefore spelling out engagement policies that seek to address environmental and social issues, either on an in-house basis, or by recruiting third parties to carry out corporate governance functions. Philips and Drew Fund Management, for example, has stated "we suggest that focused engagement is the best strategy for our clients" and "where a company has not met expected SRI standards, we should use our influence to seek an improvement". This will be done through its regular meetings with management, and by exercising voting rights. Again, the level of engagement varies between investment managers. Invesco, part of the Amvescap Group which has $392 billion under management globally, for example, says that it is considering how to turn an "implicit" assessment of environmental issues into an "explicit" process, according to Hugh Ferrand, business development director of its UK institutional division. This could include sending companies questionnaires, or routinely asking SRI questions in company visits. The firm is also in the process of employing a proxy voting service. Independent voting services, such as the Pensions and Investments Research Council (PIRC) and Manifest, anticipate increased interest in their services. Manifest has launched a new Green Card service, that combines environmental analysis of companies with its voting service (see page X). Perhaps surprisingly, one option for pension funds - investing in SRI products - has not proved popular on the institutional level. Despite the growing popularity of 'best-in-class' funds, which aim to hold representative portfolios of the best environmental performers, many trustees still associate SRI with negative screening. Excluding companies or whole sectors on environmental, or, more usually, ethical grounds brings the risk of pension funds underperforming their benchmarks, and failing to maximise financial returns to their beneficiaries. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE