Part of what they believe in

What's in a name? Quite a lot, it seems, when it comes to letting social, ethical and environmental considerations enter the head-over-heart world of institutional investment.

Ethical investment, socially responsible investment, sustainable investment, and responsible investment - these are just some of the terms that have been used in the investment community over the last few years as participants struggle to factor matters of conscience into the dry investment equation.

Some of Europe's largest pension funds have now signed up for the United Nations' six Principles for Responsible Investment, which were launched in April. The UN chose the less specific term ‘Responsible Investment', when it sought to link the practice quite directly to increased wealth in financial markets.

In his speech at the launch, Kofi Annan UN secretary-general, said it was now increasingly clear that the UN objectives of peace, security and development went hand-in-hand with prosperity and growing markets. "If societies fail, so will markets," he said.

Dutch pensions giant PGGM, like many other institutions, now uses the term responsible investing rather than SRI or socially responsible investment, says head of responsible investment Marcel Jeucken.

"As a large institutional investor, we consider responsible investment as a necessity; it is one of our investment beliefs; it is a logical part of our fiduciary duty and our identity," he says. Crucially, the term responsible investment takes in the issues of the environment and corporate governance as well as ethical and social factors - the so-called ESG (Environmental, Social and Governance) issues.

Although the whole idea of institutional investors making ethical judgements can be problematic, PGGM's responsible investment policy does have an ethical element to it. Certain types of investment are excluded, for example with regard to weapons and human rights, says Jeucken.

"There are some bottom-line elements through the exclusions, but they are only one part of our policy," he says. "An important part is engagement," he adds.

As part of its portfolio strategy, PGGM has set up a long-term equity portfolio that includes investments it thinks will add value in the long-term.

"We've furthermore identified a growth area for thematic investments in which we will also search for ESG themes, for example climate change emission trading investments," he says. Once it has pinpointed such themes, the fund then intends to invest quite considerably in them, he says.

PGGM's new responsible investment policy was set up last year in conjunction with an external consultant. It includes a whole range of activities: exclusionary screening, long-term investment, thematic investments, voting, and engagement - talking to companies about concerns.

"How do we stimulate our external managers to include these ESG issues?" asks Jeucken. "That's another line we're following."

Some in the pensions industry do not like the way that governance and sustainability - what they see as two separate issues - are being brought together under one heading.

There is a concern that while good corporate governance is essential in protecting the interests of investors, and therefore consistent with a pension fund's fiduciary duty, this is not necessarily the case with sustainable investment - which takes environmental and social factors into account.

The Enviroment Agency in the UK takes its guidance from a recent study. "We think that the UN report by Freshfields give the most up-to-date legal view that it is the duty of fiduciaries to take account of ESG factors that affect financial returns," says Howard Pearce, head of environmental finance and pension fund management at the Environment Agency.

The study was completed in October 2005 by the Law Firm Freshfields Bruckhaus Deringer on behalf of the United Nations Environment Programme's Finance Initiative.

The Environment Agency has an environmental overlay strategy that covers all of its assets and mandates. "We incorporate our environmental overlay strategy into all our 10 mandates," says Pearce.

Pearce says that there is absolutely no conflict between SRI and the fiduciary duty to get the best returns. "Our fund return last year was 0.8% above its benchmark," he points out.

Best-in-class is the chosen method to select stocks, he says. "We support best in class portfolio construction and management. Negative screening is for those funds taking specific moral and ethical stances," he says.

Engaging with companies is just one of the tools investors can use, he says. "Voting your shares and collective activism on some issues also works, for example, the Carbon Disclosure Project," he says.

The Dutch Association of Industry-Wide Pension Funds (VB) says some Dutch pension funds do have small SRI-portfolios.

"Dutch pension funds are still hesitant about the question whether SRI will guarantee the best returns," a spokeswoman says. They use both negative screening techniques and ‘best-in-class' to select stocks, she says.

Austrian multi-employer pension fund APK Pensionskasse has a process that combines the issue of SRI with that of governance. The SRI process, says Günther Schiendl, head of investments at APK, is implemented by Katharina Leeb, the fund's SRI/Governance expert, who controls and monitors the process, in conjunction with an external partner who carries out the screening according to criteria that are approved by APK.

"This screening is currently carried out for our equity portfolio twice a year," he says. "With the non-compliant corporations we start an active communication process to show our concern and our desire for change," he says.

"In general we believe that just selling the respective shares means less power to change than holding your investments and pressuring for change," he says.

Because the pension fund's equity portfolio is 99.7% compliant anyway, SRI does not conflict with its fiduciary duty, says Schiendl. "In addition, our active governance process produces additional returns through the pursuit of class action suits and corresponding settlement payments," he says.

"We feel that the governance process is at least as important as the SRI process, and financially it might be even more important. We inform our corporate clients as well."

Developing your own process is the best way for pension funds to implement SRI, he says. Using specialised SRI funds might distort a pension fund's asset allocation, he says, and decrease the control it has over its own investment process.

"We believe strongly that a pension fund has to define the SRI and governance process as an integral part of the overall investment process," he says.

In Sweden, the Telia corporate pension fund uses negative criteria to weed out stocks that fall short of its SRI criteria. "We screen all our portfolios from an ethical view and exclude companies violating human rights, labour standards, pollution and corruption," says Peter Antonsson, president of the Telia fund.

"I believe that negative screening is the best method, otherwise you more or less hand over to the SRI consultant to manage the portfolio and that is not something we want to do," he says. This policy was first implemented in 2002. Now, the fund has two SRI mandates, which are run by State Street and First State, he says.

"SRI does not conflict with a good return," he says.

Peter Damgaard Jensen, CEO of PKA , is equally sure about this. The fund believes social responsibility will add to a company's long-term performance, he says. "Such considerations must be part of the investment analysis," he says. "Thus there should be no contradiction between good pensions and good conscience."

Pension funds should look at the issue of SRI as one of several investment considerations, he says.

It is also important for them to set up guidelines that work naturally in the environment of a given company, ensuring, for example, that they will have broad acceptance among stakeholders, will fit into daily operations and be easy to follow up.

Thirdly, a pension fund should not get involved with SRI at all if the only reason for doing it is one of show. "Otherwise you will have to face too much criticism from everywhere - not least the media," he says.

Although PKA says it has been discussing SRI matters since the 1980s, increasing levels of assets and internationalisation in its investment strategies made it necessary to redefine the guidelines, says Damgaard Jensen.

This redefinition process took place in 2004 and 2005. One of the aims was to create widely acceptable ethical guidelines that were easy to handle in the daily operations and easy to follow up, he says.

The PKA Pension Funds have total assets of €14bn, of which more than €4bn are invested in stocks - this equates to stakes in around 1,200 companies worldwide.

As professional pension schemes, which are owned by the members and have no external shareholders, members have traditionally taken a strong interest in the way the pension fund earns its money, says PKA.

"The boards in the eight pension funds wanted to ensure that their decisions regarding ethical investment guidelines had a wide support and acceptance amongst members," says Damgaard Jensen.

Among the four points of PKA's ethical guidelines are a pledge not to invest in companies that violate the UN's conventions on human rights and labour rights, the environment and corruption. It uses the principles in the UN's Global Compact as a benchmark.

It will also not invest in companies that make weapons, though subcontractors are not included in this. It is the companies' core activities that are the centre of focus, PKA says.

The external managers have agreed to adapt the guidelines to the portfolio; EIRiS conducts a permanent screening procedure, and reports any ‘irregularities' to the pension fund boards, which then discuss this with the portfolio managers or with the company itself, says PKA.

Others in the industry are more sceptical that there is a coherent argument for taking social, environmental and ethical issues into account when investing on behalf of a large group.

"Some SRI supporters try to bypass the problem by claiming that SRI maximises returns," says William MacDougall, pension investment consultant in the UK.

"If so, fine, but don't call it SRI, just call it maximising returns. The real issue is - is it ever justifiable to have lower returns in exchange for social goals?"

He says he accepts in theory that there are some minimal social duties beyond the requirements of the law. "It would be wrong to invest in a firm exporting shackles or cattle prods to Zimbabwe or China for example," he says.

"But beyond that you get into very dangerous territory; you are likely to fail the primary fiduciary duty to get the best financial returns for pensioners, while engaging in political activities of very dubious merit."

Belgian industry-wide pension fund Amonis does not invest in tobacco producing companies, nor does it invest in companies that produce or stockpile anti-person mines, says chief financial officer Tom Mergaerts.

A pension fund can easily invest along certain SRI lines without there being any conflict with its fiduciary duty, as long as the fiduciary has the duty - agreed by the beneficiaries, the board or general assembly - to get the best returns provided they are obtained by SRI. "This is then a conditional duty," he says.

It is important for pension funds to define SRI in a practically manageable manner, he says. "I would prefer to use the concept of sustainable investments, and then define that concept, for example, respect for human rights and labour conditions, respect for nature and preservation of the environment," he says.

In order to stay logical throughout, a fund should put all their (future) investments through a compliance check with regard to the own definition of sustainability to safeguard consistency in the principle of SRI, says Mergaerts.

This would make it thus impossible to invest in companies that respond to eg, a 50% score on the sustainability scale, and retain only those that are 100% sustainable, he says.