Author: LIU Yujun,GUO Peiyuan Origin: Investment & Pension China
In China, large amounts of pension assets are diverted to pay for current benefits. When the remaining assets are actually invested, an overwhelming majority of them are invested in bank deposits and Chinese government bonds with very low returns. This is one of the reasons why China faces a huge pension gap today. Deciding how to change Chinese pension fund investment rules, and whether to invest them in China’s capital markets has been a hot topic in recent years. In October 2013, several Chinese ministries, including the Ministry of Human Resources and Social Security, the Ministry of Finance, and the Ministry of Civil Affairs, reached a consensus to accelerate the pace of China’s pension funds investing in capital markets. They agreed to encourage local social security funds and corporate pension funds to enter capital markets, and to broaden the range of allowable assets that pension funds can invest in to increase returns.
During the same month of October, the world’s second largest pension fund, the Norwegian Government Pension Fund - Global (GPFG), was instructed by its Ethics Council to sell holdings in Zijin Mining Group due to Zijin’s activities posing a “risk of severe environmental damage”. Swedish state pension funds, known as AP funds, also announced that they would divest their holdings in Walmart for its “systematic abuses of workers’ rights”.
Other large European pension funds, including the Norwegian pension fund GPFG, the Netherlands civil servant pension fund ABP, the Netherlands healthcare and social work sector pension fund PGGM, and one of the Netherlands largest pension administrators and asset managers MN Services, have also excluded Walmart from their investment universe in recent years. The funds sold Walmart shares mainly because of the company’s involvement in labor and human rights violations, corruption allegations and environmental pollutions. These funds were following an investing strategy of socially responsible investment (SRI), which has been quite popular among pension funds in the US and Europe in the past decades.
SRI
SRI, also known as Sustainable and Responsible Investment, focuses on corporate social responsibility in addition to financial performance. SRI considers factors with environmental, social and governance (ESG) dimensions, believing that such non-financial factor analysis can give an early warning of financial risks. SRI practitioners hold the view that the future profitability and stock price of a company are affected by how a company thinks of, and treats, the relationship between ESG factors and its corporate strategy.
Application of SRI among global pension funds
Pension funds were early participants in the field of SRI. The first SRI fund in the UK is the Friends Provident Stewardship Fund established in 1984. Currently, pension funds have become one of the most important institutional investors in the SRI market. In 2006, 20 largest pension funds in 12 countries proposed the United Nations-supported Principles for Responsible Investment (UN PRI) Initiative to “encourage investors to integrate ESG factors into investment and become active shareholders”. In 2011, pension funds accounted for 1/5 of the total SRI assets in France and Germany, and the proportion reached 58% in Austria. In Asia, most of the asset owners that adopt SRI are pension funds, including the Fuji Pension Fund, the Kikkoman Corporation Pension Scheme, the Secom Pension Fund, the Korea National Pension Service, the Korea Teachers Pension Fund, and the Government Pension Fund of Thailand.
SRI strategies are implemented in state pension funds, sector pension funds and corporate pension funds, covering both defined benefit (DB) and defined cost (DC) schemes. SRI is applied to many asset classes, including publicly listed equities, bonds, hedge funds, real estate, private equity, deposits, and commodities, among which equities and bonds are the most popular ones. SRI strategies differ with varying goals and objectives, with major strategies including negative screening, positive screening and stakeholder engagement.
What traits do pension funds and SRI share?
SRI pension fund assets have enjoyed continuous high growth rates, not only because several European countries and international organizations designed the SRI policy guidelines, but also because of the special characteristics of pension funds.
Many European countries have enacted laws and regulations, or adopted economic instruments to ask or stimulate financial institutes to fulfill their social responsibilities by integrating SRI into their businesses. Quite a few countries require pension funds to incorporate ESG considerations into their investment decision making, requiring them to disclose how, and to what extent, they consider ESG information of target companies. Belgium has specifically published a law against financing weapons, and the UK and Netherlands governments grant tax reductions to encourage community and green investment. In addition, in 2005, Eurosif launched a Pension Programme SRI Toolkit to help interested pension fund trustees understand how to integrate SRI strategies into their portfolios.
Pension funds are long-term investors because they do not face short-term payment pressures and can make investment decisions with a long-term orientation. Long-term investors can take decades-long approaches: they can track long-term economic restructuring and invest in low-carbon, environmental protection and other sustainability topics with large mid- to long-term returns.
Furthermore, pension funds manage large asset portfolios, usually in trillions of dollars. Their investments are quite diverse, crossing asset classes, sectors, and geographies. As shareholders of numerous companies in various sectors, pension funds can be viewed as universal owners, and their investment performance depends on the aggregate market and overall economy, rather than single companies. If a company in a portfolio obtains profits via polluting the environment or by violating human rights, its negative externalities will, either in the short-term or long term, inevitably impose costs on the company itself, on other companies in the portfolio, or even on the broader public in the form of taxes, insurance premiums, physical cost of disasters, and so on. Thus the overall return of the portfolio will experience a reduction.
Laws, regulations, and some protocols will raise the costs of such negative externalities. Also the increasing social and environmental concerns among civil society will negatively affect the reputation and brand image of companies if they breach laws and regulations, have a negative financial impact, and finally lead to a loss in investor returns and reputation. Such public concerns will also have an influence on job seekers’ and consumers’ choices, prompting them to choose companies with better ESG performance. In return, these companies will get prosperous and become more popular. As a result, a positive reinforcing loop is formed.
With today’s greater globalization, companies are building broader supply chains around the world. Environmental and human rights policies, as well as product standards, vary from country to country. Having different regulations and standards makes it inevitable for companies to face higher legal violation risks and greater potential criticism. Correspondingly, pension funds have increased reputational risks due to their long-term nature. This then requires pension funds to pay more attention to target companies’ ESG policies and performance, and to highlight the most relevant risks to include in investment decision-making, in order to achieve stable long-run returns.
From another perspective, pension funds act in the interests of their ultimate beneficiaries, and thereby should not be willing to hold shares of companies that benefit from polluting the environment or violating human rights, damaging the environment and society where their ultimate beneficiaries live.
Appendix: Cases of SRI Pension Funds
Case 1: Norwegian Government Pension Fund - Global (GPFG)
Case 2: The Netherlands healthcare and social work sector pension fund - PGGM
Case 3: Corporate pension fund of Zürich Cantonal Bank (Pensionskasse der Zürcher Kantonalbank, PKZKB)
For more details about the short history of SRI, SRI strategies, and the SRI pension fund cases, please see the full text of the article on Investment & Pensions China Vol. 6 (p19-22) (available in Chinese only).
Written by Liu Yujun & Guo Peiyuan
This article was originally published in Investment & Pensions China Vol. 6 and condensed and reprinted in China ESG Monitor (December 2013) -- a monthly newsletter highlighting ESG trends and research relevant to sustainable investment in China.
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