Scandinavian investors have for a long time had a sustainably orientated ethical approach. But Nina Rohrbein finds that this is not playing to the positive

The widespread assumption is that the greenest and most socially responsible people live in the Nordic countries of Europe. And this assumption still appears to hold true.
According to the Nordic Investor Survey 2010 by Danish Consultancy Kirstein, year-on-year interest in socially responsible investment has increased again with Iceland as the only exception.

"Scandinavian investors have for a long time had a sustainably orientated ethical approach but Norwegians and particularly the Swedes are far ahead with regard to the implementation of ethical standards," says Joachim Böttcher, director global sales at the Copenhagen based asset manager BankInvest. "The Danes are lagging a bit behind, while the Finns appear non-transparent in the context of ESG." Böttcher also notes that Norway's approach to environmental, social and corporate governance (ESG) was driven by its Government Pension Fund Global, which derives its money from Norway's oil industry. When it was recognised that the oil money was only intended for Norwegians and almost exclusively invested for the benefit of the next generation, he points out, an inter-generationally fair framework of the fund was developed with integrated ESG principles. "In Sweden, ESG was driven through the work of Ulrika Hasselgreen from Ethix SRI Advisors and the work of the churches, particularly the Church of Sweden," Böttcher adds.

Christine Tørklep Meisingset, SRI manager at life insurance and pension provider Storebrand, which operates in Norway and Sweden, believes that Swedish individual investors are more mature and more concerned with ESG issues overall than Norwegian owners. "Swedish individuals have a much longer history in savings through mutual funds and pension investment decisions are - to a large extent - made by the individual," she says. "In Norway there is a strong tradition for real estate investments but we lack awareness in relation to mutual funds and asset management. However, Norwegians are now facing an increasing individualisation of pension products."

The Swedish government AP funds were legally required to take ethical and environmental issues into consideration, thereby setting an example to private pension funds in Sweden, which followed in their footsteps. The increasing number of signatories to the UN Principles for Responsible Investment (UNPRI) has also raised interest among Nordic asset owners, managers and service providers.

The focus has traditionally been on the environmental and social aspects in the Nordics, whereas the ‘G' - governance - has been handled separately and perhaps more informally, directly with the boards.

"This is still the case but leading investors will increasingly start integrating all three aspects," says Kjell Norling, head of global fund distribution at SEB Asset Management. "The main catalyst for this will be when PRI implementation becomes more advanced in the region. A credible PRI implementation implies that you must integrate E, S and G in all your portfolios, which will bridge the current gap that many Nordic investors have between ‘E' and ‘S' on the one hand, and ‘G' on the other."

Kirstein's Nordic Investor Survey 2010 reports that negative screening is still the most common way of handling SRI in the Nordics, with pension funds making use of well-known agencies to follow this methodology. But the interest for integrated processes - such as the activist approach - is increasing and more investors are following that route.

"Scandinavia's SRI industry is mainly driven by negative screening approaches, which represent 90% of the strategies," says Böttcher. "The other roughly 10% are dominated by engagement and positive screening."

Screening and other services are generally provided by external providers.
"It is fairly common to have a policy of blacklisting in the Nordics," says Meisingset. "The Norwegian Government Pension Fund in particular set the standard for excluding
companies based on its ethical guidelines, which were adopted in 2004-05. Several of our competitors concentrate on compliance with this list. Some also buy in analysis from external rating bureaux in order to establish such a blacklist."

The Seventh Swedish National Pension Fund AP7, for example, which was required by the regulator to take ESG issues into account in its investments at its creation in 2000 but was not issued with guidelines, has a blacklist of 50-plus companies it screens out.

"We do not have a sector tilt in our negative screening process," says Richard Gröttheim, executive vice-president and head of asset management of AP7. "To determine the exclusions we look at the UN and International Labour Organisation (ILO) conventions that Sweden has signed and which the companies appear to be in breach of."

AP7's screening process is outsourced to two Swedish companies, Ethix and GES Investment Services. Both produce a list every six months, upon which the AP7 board decides what to do. AP7 also undertakes engagement following the exclusion of a company or during the analysis phase of the company.

"We send a letter to them, explaining why we have excluded them, adding if they take the appropriate measures they could be included again," says Gröttheim.
While AP7 does not use positive screening it has since 2007 had a specific 1% allocation to cleantech within its private equity portfolio.

The tide has started to turn
Storebrand has had a group-wide ESG policy since 2005 although most portfolios started to implement one as early as 2001. It uses a combination of negative and positive screening, with all ESG analysis undertaken by its eight-strong in-house team topped up with some external help on information and data provision. It operates a zero tolerance policy on controversial weapons, which means that it will exclude such investments right from the start. But on environmental issues, on human rights violations and corruption, Storebrand always attempts to get the company on the right track before a decision is made to disinvest.

It follows up its exclusions through questioning of the companies and eventually - as in the corruption cases involving Volkswagen and Siemens - if the issues have been resolved and it has proof of, for example, good anti-corruption systems in place and the risk of re-occurrence has diminished, it might resume investments.

"We also use best-in-class analysis as a basis for identifying some of the companies that we exclude on a group-wide level," says Meisingset. "Our ESG policy covers all geographic regions and asset classes. We believe that the highest impact can be achieved through engagement and dialogue and pressuring companies into systematic improvement. Our experience is that a combination of different ESG methodologies - namely engagement, exclusions and best-in-class - gives us a stronger result than if we only had one or the other. Sometimes, we need to exclude the company in order to
achieve an improvement, while at other times we need to lift the ones that are the best performers in order to motivate the others to follow suit."

Danish experience
PKA, which manages eight Danish pension funds with a total of DKK124bn (€16.6bn) in invested assets and a UN PRI signatory, has also been involved in ESG for a number of years.

"In co-operation with ESG research provider EIRIS, we have been undertaking negative screening since 2003 but have recently also become more active in our engagement process as it has become more acceptable to have a dialogue with companies to try to make changes instead of just selling the share," says Peter Lykke Thomsen, head of secretariat at PKA. "For this active approach we use Hermes Equity Ownership Services because it is easier to apply pressure to companies through common ownership services."

PKA engages with companies before and after exclusion. While it does not undertake positive screening as a methodology, the pension fund manager actively chooses attractive-looking investments within the ESG segment, such as microfinance, forestry and climate investments. Currently PKA is considering moving into investments in farmland, and continues to focus on sustainable, less CO2-emitting real estate.

Finland too

Responsible investing has also always been a key element in the investment process for another UNPRI signatory, Finland-based Tapiola Mutual Pension Insurance Company. The first guidelines taking ESG perspectives into account were set in the 1990s.
"Every year we evaluate how we can further improve the ESG integration into our investment policy and also report the development to the board," says Hanna Hiidenpalo, chief investment officer at Tapiola. "Climate change has been a big issue for us during the last few years. We try to avoid companies whose approach is in conflict with our values but our assessment methods do not involve active negative screening. We try to seek best-in-class companies for our portfolio."

Tapiola's screening process is undertaken solely by its own analysts and portfolio managers according to various criteria. However, for governance issues the insurance company gets external help.

Fellow Finnish investor Varma Mutual Pension Insurance Company has had general corporate governance principles in place for a number of years, which include ESG issues, but gives no specific instructions with regard to screening or engagement. The policy was reviewed and updated in 2009.

"By, for example, having a direct representative on the board of some of our portfolio companies we tend to be closer to them than pension funds usually are," says Risto Murto, deputy CEO and CIO at Varma Mutual Pension Insurance Company. "If you have direct membership on the board you are in the sense already engaged with the company at the maximum level."

Sweden says ‘yes'
The Church of Sweden pension and buffer funds have always felt a strong responsibility, which resulted in an ESG policy early on. "We also have the strong belief that sustainable investments in responsible companies generate a better performance in the long run compared to traditional, non-ESG investments," says Anders Thorendal, treasurer and chief investment officer at the Church of Sweden pension and buffer fund.
The Church of Sweden funds have been considered some of the leaders in ESG in the Nordics. And while negative screening still plays a role - when it comes to weapons, gambling, alcohol and similar - since 2006 the focus has shifted away from negative screening to a focus on positive criteria, for instance, a best-in-class approach.

The funds run a best-in-class approach with some of their managers but generally try to integrate the financial and sustainability processes instead of treating them separately via an overlay.

"We concentrate on finding asset managers that focus on the opportunities rather than the risks in terms of sustainability," says Thorendal. "The Church of Sweden, for example, perceives climate change as a serious threat and has therefore a restrictive view with regard to investing in companies that are active in the extraction of fossil energy sources. Managers of the Church of Sweden's capital are expected to invest in companies that contribute to solving the climate issue instead."

In other words, the funds do not see a need to be involved in the oil sector but rather invest in renewables and cleantech listed holdings and private equity.

The integrated approach is currently being applied to equities and since 2009 also to corporate bonds although there are fundamental differences in this approach, as in equities the funds try to find winners whereas in corporate bonds they aim to avoid defaults.

The Church of Sweden funds only work with external asset managers, most of whom have their own in-house ESG resources. But the funds also make use of external screening companies, such as GES Investment Services and MSCI RiskMetrics. They occasionally engage with companies - for instance with the government AP funds on Statoil's involvement in tar sands - but plan to raise their involvement in the future.

SEB Asset Management's approach to ESG - whose screening process is undertaken by GES Investment Services - is to use active ownership to influence selected companies to improve their work on relevant ESG issues. "The intention is to be supportive and constructive in our engagement efforts," says Norling. "We believe that active ownership is more responsible and effective behaviour than exclusion. If companies do not respond in an adequate manner, we might consider excluding companies from the investment portfolios. The debate is moving more and more away from the concept of ethical funds, in other words exclusion of industries or companies, to ESG or sustainability as a value driver. The next step is for investors to start translating ESG disclosure into ESG value drivers."

But is the trouble of going through ESG policies being rewarded?

"We believe that responsibility is a real and a potential source of competitive advantage to firms in different sectors," says Hiidenpalo. "We have developed strict ESG criteria and tools which are used in the analysis process. A responsible company is most likely to be a leader in its category and has developed numerous processes to secure competitive edge and benefit from them as well as generate excess returns in the long run."

"Companies can contribute to reduced risks and costs as well as finding business opportunities by actively managing environmental and social matters, achieving long-term value creation and future financial return in the process," adds Norling.

Corporates comply
Nordic investor attitude is reflected in the region's companies, 90% of which have key policies in at least one of the sustainability areas according to a survey by the Sustainable Value Creation Initiative (SVCI). A majority have policies for all of the areas although the surveyed companies differ in the scope of their rules and priorities for each of the sustainability areas, which is a natural result of different sectors and industries having to deal with different aspects of sustainability.

Meisingset believes that most Nordic companies will be exposed to ESG risks mainly through their supply chain, depending on the industry, geographical areas and type of production. Storebrand puts those different risk aspects in three main categories, namely environment, human and labour rights and corruption.

On the best-in-class side, it divides the output into environmental, social and governance. "Many of the companies that operate in high risk industries where there is a lot of potential for conflict, such as human rights, corruption and environmentally sensitive areas, are quite mature in reporting and in addressing ESG issues systematically due to scandals in the past," says Meisingset. "But they need to know that someone - investors, customers and NGOs - will be asking for progress because otherwise it would be very easy for them to sit back."

Worries about ESG policies damaging performance are often to blame for a lack of interest in ESG in other countries. However, this does not appear to be the case in the Nordics.

Storebrand and AP7 have run financial tests and analysed the impact of ESG on returns and concluded that it has not hurt them in any significant way.

"In the short term, you may well be able to profit from investing in unethical companies," says Meisingset. "But if you have a long-term view you have to take non-economic factors into account too. Corruption is one example: there is nothing as detrimental to economic growth. If we invested in companies with a corrupt culture we would undermine the transparency and functioning of the markets that we depend on to make profits over the long term."

Due to the growth in emerging markets, Nordic companies are likely to find themselves exposed to an increased risk of environmental damage, corruption and human rights violations. However, there will also be numerous business opportunities for the companies that manage those risks in a sustainable way, believes Meisingset.

"We strongly believe that responsible business behaviour as an important criterion in the company selection adds to investment returns as it reduces risk in the portfolio," says Hiidenpalo. "Over the last 10 years the average return of our equity portfolio has been considerably higher than the overall market returns and the risks, especially volatility, have been lower."

Thorendal adds: "With a fully integrated process we do not know if the performance comes from ESG or from elsewhere - it is not always possible to make that distinction. But our benchmark, the Dow Jones Sustainability index (DJSI), has had more or less the same return as the MSCI World index during the last decade and is even slightly ahead so ESG - with our focus on positive screening - has not hurt us."