The Dutch TV programme Zembla caused quite a stir earlier this year when it accused the country's largest pension funds of unethical investment practices. Specifically, it alleged that they had invested in companies that used child labour, caused serious environmental damage and, above of all, invested in companies that produce cluster bombs and anti-personnel landmines.

And the findings of Zembla were not easily put to rest. In a reflection of the continuing sensitivity of the issue, Holland's top two pension funds, ABP and PGGM, would provide IPE only with written responses. ABP gave written answers to the questions put forward to it, while PGGM issued a statement.

"The programme caused a public debate about what pension funds should and should not invest in," said Rob Lake, senior portfolio manager for environmental, social and governance (ESG) issues at ABP Investments, the asset management division of the Netherlands' largest pension fund with assets under management of around €215bn. "Although this is an important question to be answered, the programme itself and the discussion afterwards were characterised by a lack of nuance. The irony was that the programme targeted the larger pension funds, while they were and are the ones that were putting a lot of effort into developing a sustainable investing policy."

The programme "did not discuss the challenges that sustainable investing poses for pension funds," Lake's response added. "For example, everyone who works for the Dutch government - such as teachers, firemen and military personnel - is a member of ABP. Considering that ABP's goal is to serve the interests of its members that leads to very interesting questions in the area of ethics. Dutch as well as European law, for example, demands that these interests be primarily considered in financial terms. ABP thinks of ethics as the ethical values that its most important stakeholders hold, namely the 2.5m participants. But these include pilots that can be asked to drop cluster bombs, the minister of defence who is responsible for contracts to buy weapons on behalf of the Dutch government, all members of the government and all members of the opposition. It also includes smokers and non-smokers, people who drink and do not drink alcohol. That is why it is difficult to define what is ethical and what is not and to exclude a company or industry from the investment portfolio whilst trying to represent the interests of all participants."

ABP bases its investment decisions primarily on Dutch, European and international law and most countries, including the Netherlands and the rest of the EU, have banned the production and the use of land mines, Lake noted. "In consideration of the spirit and the scope of the international law on landmines and the ethical values of the majority of its members, ABP has decided not to invest in either landmines or cluster bombs - which are not prohibited by international law yet, but meet similar opposition - even though the act of investing in the producing companies is technically not illegal," he added.

So has the programme led to a shake-up of ESG policies by Dutch and other European pension funds?

Jane Goodland, investment consultant at Watson Wyatt, believes that the impact has been to stimulate pension funds to revisit some policies and to clarify what they mean in practice.

But PGGM, the pension fund for Dutch healthcare and social work sector employees, which has €88bn of assets under management, claimed there was no correlation between the TV programme and the refining of its responsible investment (RI) policy.

"The TV programme was broadcast in March, when we had our exclusions policy, which we announced in November 2006, in progress, but it had not yet been approved by our board," said PGGM spokesperson David Uitdenbogaard.

PGGM published a refinement of its RI policy at the end of June, three months after the Zembla programme. In this, it stated that it intended actively to influence the behaviour of companies whose performance it considers inadequate with respect to the environment, social conditions or corporate governance. To achieve that, it said it would vote actively as an informed shareholder at the shareholders' meetings of all the approximately 4,000 companies in its worldwide investment portfolio and strengthen its 2001-implemented engagement programme with companies, both via third parties and by actively exerting pressure on the companies to change their practices.

It added that if engagement was unsuccessful it aimed to use exclusion as a last resort.

Under its revised exclusion policy, PGGM would assess all investments with reference to certain themes and criteria, focusing on weapons and human rights. Companies that engaged in the trading or manufacture of weapons of mass destruction and weapons that continue to cause death and injury in the aftermath of military conflict would be excluded out of hand, it stated.

PGGM said that before the end of the year it planned to appoint three external ethical consultants to its investment committee. They would advise on the future development of its RI policy and dilemmas encountered in its application.

But Lake conceded that the Zembla programme did have an influence on ABP's responsible investment policy. "ABP's ESG policy did not start with the Zembla programme," he said. "But it has definitely sped up and intensified the further development and implementation of our ESG-policy."

He added: "Since Zembla, companies that produce anti-personnel landmines or cluster bombs have been divested. We are in the process of reviewing our policy on exclusion and engagement and are expecting to make further announcements about it in due course. Where possible, we will also be looking to expand our investments with a sustainable angle."

Lake stated that ABP Investments considered that it has an obligation to achieve the highest possible return for participants. "In doing so, it believes that companies with strategies which, in addition to financial return, place a high value on the environment, social factors and good corporate governance will perform better in the long term and add value."

In addition, ABP said it is aware of the far-reaching influence of its investments and the social responsibility that this implies, which led to its decision to implement an ESG policy.

"With respect to promoting good corporate governance standards we have already been active for years," said Lake. "The development of our policy with regard to environmental and social started in 2006, meaning that for equities worth €22bn we already take ESG criteria - which are integrated into our investment decision process - into account. On top of that, we have a number of specialised investments with an ESG angle, such as in the newly-launched Ampere-fund, Climate Change Capital's Carbon II fund, clean technology joint venture AlpInvest and investments in microcredit."


"The impact of Zembla was obviously greatest in the Netherlands and its effects have been mainly contained within continental Europe," says Goodland.

But some large pension funds did take notice. For example, the UK's Universities Superannuation Scheme (USS), which has assets under management of around £30bn (€43.1bn), was not only aware of the programme but watched it to assess whether it had any implications for its own operations. But as it does not operate a screening policy it has not taken the same actions as some other large European pension funds.

David Russell, co-head of responsible investment at USS, says that while UK campaign groups FairPensions and the Campaign against the Arms Trade had raised Zembla among a number of other issues, it has not been contacted by any of its own members.

"Following the Zembla programme, our four-strong in-house RI team assessed our holdings to identify which companies are involved in the production of landmines or cluster bombs," says Russell. "Bearing in mind that under the Ottawa convention, landmines are banned in most countries, this sharply reduces the number of possible UK or other Europe-based landmine manufacturers. We tried to identify from the information available which companies could be involved in this sector. USS also assessed how other pension funds around the world were addressing this issue. What we discovered is that it is actually very difficult to identify which companies are exposed to this issue without directly speaking to them. Following our initial investigations, we engaged with two companies in our portfolio that were identified as being potentially involved in this sector. However, both indicated that they were no longer manufacturing the components for such products."

USS developed its engagement and integration-based RI policy - as opposed to a screening-based approach - in 1999. Russell says that legal advice suggests USS can take extra-financial issues into account where they are material in an investment decision, but it cannot screen companies out based on ethical or moral points alone.

It has invested or committed around $200m (€140.6m) to clean or renewable technologies, mainly through private equity-type vehicles, a process it started in 2000/01, says Russell.

"As with any new area, there are risks so you have to make sure you invest in the right funds because in the end not all of them will perform," he says. "Investment in this area also brings with it some policy risks as the performance in this sector is often driven by national or European government policies. These risks should be taken into account in the investment process and hopefully be rewarded with higher returns."

But could an affair of the scale of Zembla been avoided?


The Norwegian government's Pension Fund - Global, with assets under management of Nkr2,000bn (€259.6bn), started its ESG policy soon after the first allocation to the fund in 1996. Its ESG guidelines were adopted in 2004.

Since then, it has devoted a lot of resources to an ethics council, which advises the finance ministry on investments and the exclusion mechanism, while its manager, the central bank, is responsible for exercising ownership rights, says Martin Skancke, director general and head of asset management at the Norwegian finance ministry, which formally owns the fund and oversees its operations.

"Our exclusion policy is based on two different approaches," he adds. "Under our automatic exclusion mechanism, companies producing weapons that in their normal use are in breach of what we regard as fundamental humanitarian principles - such as nuclear and biological weapons, cluster bombs and landmines - are excluded, but companies producing, for example, handguns or fighter aircraft are not. Our ad-hoc mechanism excludes companies based on their behaviour rather than their production, such as the worst forms of child labour. We use the exclusion mechanism where there is a risk of being complicit in unethical activities or conduct and we cannot mitigate that risk through engagement with the company. But it is only a measure of last resort. Our goal is to work with companies, influence and change their behaviour so as not to exclude them. However, it does not make sense to go to a nuclear weapons manufacturer and ask them to produce something else."

Skancke adds: "We hope that our screening mechanisms combined with the work of the ethical council will prevent a Zembla affair here. But of course no system is perfect and despite feeling that we have a good and reliable system we cannot give a 100% guarantee that we are able to exclude everything from the start. However, we can guarantee that once we find a company producing weapons we consider to be in breach of humanitarian principles or behaving badly, we will exclude it."

This approach carries its own problems, Skancke concedes. "In principle if you exclude many companies you will take away some diversification gains in your portfolio. However, we have excluded just over 20 companies in a portfolio of around 7,000. And such a small level of exclusions does not really affect the risk and return profile of our portfolio. But if you have investments that do not meet public scrutiny they can be a reputational risk factor for the fund. For us, it is important to be transparent about our investments and exclusions for the public to have confidence in the management of the fund."

The Pension Fund - Global's ethical guidelines are due to be reviewed by the government in early 2009. Next year it plans a broad consultation with NGOs and other external sources to enable them to give their opinion on the guidelines and their performance so far in comparison with best international practices.

And the fund is not alone in its efforts. Goodland says ESG has become increasingly important in the pensions industry and demand has risen sharply over the past year, although most ESG activity remains in the public pension fund market, local government funds, charities and religious groups.

"In the last 12 months more of our clients - the vast majority of whom are corporate pension schemes - have been showing more interest in this area," she says. "Some have started to review their investment policies and look at providing sustainable investment options in a DC platform. Others are at the ‘thinking-it-through' stage while working out the best approach, and a minority have gone beyond this to full implementation."

Goodland adds: "A growing body of academic research supports the argument that pursuing a sustainable investment approach does not necessarily mean lower returns. What is important is getting this research out of the academic world to fund trustees. Generally the majority of UK corporate pension schemes are at an early stage but they are coming under increasing pressure from various sources to develop a policy and be transparent about how they tackle these issues within their investments."


Karina Litvack, head of governance and sustainable investment at F&C Asset Management, puts this year's sharply increasing popularity of the firm's responsible engagement overlay approach down to the Zembla programme as well as the UN's Principles of Responsible Investment and the extensive media coverage on climate change. "In the wake of Zembla, a number of potential clients have approached us about an engagement strategy with divestment options," Litvack says. Interest in the product comes mainly from the Netherlands, Scandinavia, Switzerland, Germany and the UK.

Skancke thinks that the easier access to company information via the internet has also helped ESG development.

And Netherlands-based Robeco Asset Management views Zembla as a reflection of the trend of increased demand for ESG products, not as a starting point, says spokesman Ronald Florisson. "Over the past few years, we have seen the rise of Dutch corporate governance forum Eumedion, the ongoing attention on climate change and the plea for ethical behaviour in investments from society and in particular, pension participants," he says.

"Since we implemented our RI policy, the materiality of ESG issues in investment decisions has gone up sharply and they are now being recognised across the market," says Russell. "For example, since the launch of the enhanced analytics initiative in 2004, of which USS was a founder member, a lot more sell-side research has been made available enabling portfolio managers to integrate extra-financial issues into their valuations of companies, which helps them make better long-term investment decisions. Companies are also more aware of how they can communicate these issues to shareholders."

He adds: "One of the most important changes is that as a result of the EU emissions trading scheme, carbon now has a value. This has been a significant driver of awareness about how these issues can impact value. The market downturn at the beginning of this decade was linked to poor corporate governance, and there has long been an awareness that good governance is good for investment. But it was the cost of carbon that illustrated to investors how these issues can impact value."

USS is increasingly focusing internally on how to better integrate extra-financial information into its investment decisions, says Russell. It is also investing significantly in the alternative investment sector.

"The renewable and clean tech area is a sector that we are always watching for opportunities," Russell says. "We believe that the implementation of the fund's RI strategy adds value, not only in investment decisions where it is becoming increasingly material, but also over the longer term in engagement with both companies and the market where we make sure extra-financial issues are recognised as value-creators and potentially value-destructors if they are not managed appropriately. Value of these activities cannot always be quantified but that does not mean we should not undertake them."

"ESG was very much grounded in ethics and morals 10 years ago so investments in armaments and tobacco companies were regarded as wrong because they kill people," says Litvack. "The view was that you could deliver a perfectly competitive return but at the end of the day if selling a stock meant losing money that was unfortunately necessary to fulfil the ethical commitment. Therefore, the onus was on the fund manager to fulfil the ethical commitment and deliver a good performance, but there was no question that ethics were in some way a contributor to a good performance. Then seven or eight years ago the idea took hold that sustainability and ethics could actually be a value driver insofar as companies that behaved more sustainably were positioned to outperform over time. And that is what really attracted the pension fund industry to the idea that institutional investors could play a role in promoting more responsible corporate practices."