Investment strategy: how one Dutch pension fund democratised its ESG process

On an overcast day in February this year, 44 people filed into a conference room in Utrecht to share their thoughts about sustainable finance.

But this was not the usual crowd of suited-and-booted execs from asset management and data companies ready to swap virtual business cards over networking drinks.

Instead, the attendees had all worked in the Dutch retail sector at some point in their careers, and had gathered to discuss how they wanted their pension fund, Pensioenfonds Detailhandel, to invest their retirement savings. Detailhandel is the sector-wide pension fund for Dutch retail businesses.

“We know how to manage financial risk on behalf of our members,” says Louise Kranenburg, Detailhandel’s head of responsible investment. “But deciding on other people’s norms as a fiduciary is a much harder thing to do.”

Ethical steer

To get a clearer steer from its million-plus members, the board asked 20,000 of them if they wanted to participate in a project to help identify the most important ethical issues it should consider as it reviewed the fund’s investment policy.  

Eventually, it whittled the number of members down to closer to 50, selected to reflect the make-up of the scheme in terms of age, gender and location. They were then invited to Utrecht for the February gathering, and twice more in March.

The investors and academics, including from the UK’s Cranfield University and Maastricht University School of Business and Economics in the Netherlands, who oversaw the project, hosted talks and answered questions on everything from how pension funds work, to climate change and the effectiveness of collaboration.

The discussions culminated in the scheme members drafting 49 recommendations for Pensioenfonds Detailhandel’s board.

This was not the €30bn fund’s first attempt to make its responsible investment process more democratic. It started working with academics to survey its members in 2018, when it wanted to know if they agreed with the Sustainable Development Goals its board had chosen to prioritise – decent work, climate action, and peace, justice and strong institutions.

They repeated the survey a couple of years later, and consequently added a fourth SDG – responsible production and consumption – to the list.  

But Kranenburg says the board wanted a more in-depth sense of its members’ sustainability preferences, which it could not get from quantitative surveys and studies.

“We needed to understand why members felt the way they felt, and to talk to them more about the nuances involved in the decisions that pension funds make,” she explains. 

“If you just ask members if they want to invest in businesses that abuse human rights, they’d all say ‘no’. You need to put the question into context and explain how a pension fund invests, what’s actually possible, and what it would mean for them if we made a decision differently.”

Three of the event’s sessions were devoted to talking about trade-offs, including how diversification is reduced when a pension fund excludes sectors and companies from its investment universe.

Other topics discussed included human rights, social housing and the cost of living, which Kranenburg notes were all more highly emphasised by fund members than by most investment professionals, who tend to focus their sustainability efforts on climate change.    

The resulting recommendations, currently being evaluated by Detailhandel’s board, did not contain any major surprises, she adds.

“But it was a big gamble; we didn’t have any control over those recommendations. They could have told us they didn’t want us to do responsible investment at all, or they could have gone to the other extreme.”

The board has not committed to adopting the recommendations, but Kranenburg points out that “they’d have some serious explaining to do” if they ignored all of them. The board is expected to publish its response to the document in the coming weeks.

IORP II changes

Other pension funds across Europe may find themselves needing to think more carefully about integrating member values into their investment policies too, if a current proposal from EIOPA makes it into law.

The EU pensions supervisor has suggested, as part of a wider update to the Institutions for Occupational Retirement Provision directive, better known as IORP II, that pension funds should be required to consider beneficiaries’ sustainability preferences (see panel).

Given recent pressure from EU member states, particularly Germany, to get the European Commission to curb its interventions on ESG, the proposal is not guaranteed to survive the legislative process under the new European Parliament.

And even if it is not vetoed or diluted, the language is likely to be vague enough to allow pension funds a lot of wiggle room.

“There is a principle-based obligation to incorporate member preferences, but it doesn’t define how that should be done,” explains Matthies Verstegen, Brussels head for the Federation of Dutch Pension Funds. “So it shouldn’t be understood as a blanket requirement to conduct surveys or canvass beneficiaries.”

Verstegen thinks it is right for the EU to be loose with its wording, given that pension funds are structured differently across member states.

“In somewhere like the Netherlands, the vast majority of beneficiaries are part of a single investment collective without investment choice, so it’s necessary to translate a broad spectrum of ideas and beliefs into a single investment policy,” he says. 

Kranenburg insists that Pensioenfonds Detailhandel’s process is an effective way to establish the necessary compromises to achieve this, and could be copied by other pension funds.  

“If you approach sustainability in a very quantitative way, like a survey, you’ll often elicit very polarised views; members are either for or against, or they don’t care,” she says.

“But when people actually talk to each other and ask questions to experts, they will eventually work out a common ground. And that’s what’s useful about the 49 recommendations we received.”

Legal limitations

In places like Belgium and the UK, it is widely perceived to be against the law for pension trustees to integrate the values of their members into investment decisions.

“In the Belgian context, the investment risk for occupational schemes is always with the employer,” explains Joris Beernaert, head of pensions and insured benefits at the Brussels office of law firm Loyens & Loeff.

Even in a DC scheme, the sponsor is required to guarantee a level of return on contributions when a member retires.

“The sponsor’s sustainability preferences should therefore always prevail,” he adds, including when deciding which products to offer scheme members.

It is an approach that flies in the face of the growing belief that pension savers should have their views respected when institutions are running money on their behalf.

“Technically, it’s not actually their money,” points out Stuart O’Brien, a partner at UK pension law firm Sackers.

“Under a DB scheme, they’re entitled to a promised level of benefit at the end, and it’s the trustees’ role to make sure returns are sufficient to ensure that. If they aren’t, it’s the sponsor that has to top it up.”

For that reason, UK law is seen as very restrictive about how trustees can consider “non-financial factors” in their investment policies.

In 2014, the Law Commission issued guidance, still used by many trustees, that stated: “In general, non-financial factors may be taken into account if two tests are met: (1) trustees should have good reason to think that scheme members would share the concern; and (2) the decision should not involve a risk of significant financial detriment to the fund.”

O’Brien describes it as “a pretty narrow test, and almost impossible to achieve in practice”.  

Integrating values-based considerations may be more relevant for DC schemes in the UK, because there the pension saver bears the financial risk, and can make some investment choice. 

“The law in terms of the role of trustees is the same. They can’t set up a default DC scheme which has lower performance because they are accounting for members’ sustainability preferences,” says O’Brien.

Alternative approaches to democratising pensions

Trustees can ensure that members are offered suitable alternatives, however.

“That’s what these surveys can be good for,” O’Brien claims. “They can help gauge members’ appetite for sustainability and social impact, so you can decide which products you ought to be giving them the choice to opt into, if they want to move away from the default fund.”

There have also been efforts to canvass pension savers on how they want their shares voted at AGMs. Aviva and Legal & General are among those to use apps like Tumelo to give beneficiaries a say on topics such as climate and executive pay.

This sidesteps the legal restrictions – voting decisions should not demonstrably result in ‘financial detriment’ – while still taking into consideration beneficiaries’ sustainability preferences.

‘Red herring’

Beernaert also points out that many pension funds covered by IORP II appoint half their board of directors from among employees or union representatives.  

“It’s up to that board to decide the ESG considerations that are taken into account, so in some way the scheme members are already involved,” he suggests.

But O’Brien believes the push to democratise sustainability decisions is, at best, a red herring.

“You shouldn’t need a mandate from members on most of these issues,” he says. “Trustees seeking that kind of cover from their members are abrogating their responsibility.”

Instead, he says, they should be looking at environmental and social issues through a financial lens, which legislation in the UK and Europe is increasingly being updated to encourage.

“There is plenty of space to address sustainability in investment decisions that way. Trustees should not be waiting to see if they can get their members to give them the green light.”