In April, the Fond de Réserve pour les Retraites (FRR) awarded its first SRI mandates following an RFP issued last year.
Nada Villermain-Lécolier, head of manager selection and SRI policy at FRR is keen to stress that the law that created FRR states only that it has to disclose how we take into account social and environmental issues, not that it has to invest in this way. “The main real impulse came from the supervisory board of the FRR which said that it is important not only to maximise profit but also to ensure the long term sustainability of the portfolio and of the companies we are investing in,” she points out.
The FRR’s supervisory board states: “The FRR acts for the benefit of the community and for this reason must adhere to investment policies that are consistent with communal values that promote balanced economic social and environmental development.”
Villermain-Lécolier notes that there is no precise content in this provision because it didn’t say what quality values to follow precisely. “But at least there is a political line,” she says. “The supervisory board goes further because it asks the executive board to actively promote best practices aimed at encouraging asset managers to respect these values in their financial analysis and in the transparency of corporate governance.”
FRR board member Antoine de Salins explains that, because of its fast growing size, its mission and the nature of its beneficiaries - all the future pensioners of the social security retirement system - the FRR could be seen as a universal owner which invests in the economy as a whole. “Returns are also affected by structural factors such as education and R&D and more generally the sustainability of the economic developement.”
He adds: “We do not consider SRI to be an asset class as such; we do not attach to it financial characteristics different from non SRI portfolios. It is a different way of managing, with added costs because of its sophistication. So we need to find the right balance between innovation and the will to go further on the one hand and a pragmatic progressive clear long term strategy on the other.”
The winners of the tender were AGF AM, Dexia AM, Morley Fund Management, Pictet AM and Sarasin Expertise AM.
The long list contained 40 candidates; after the first round 20 dropped out. “We were pleasantly surprised, although overall the quality was not as consistent as traditional mandates,” says Villermain-Lécolier. “For SRI tenders, managers have to provide more detail and explanation. You can’t understand a management process without understanding the philosophy – that is the starting point.”
The first question concerned the reason for pursuing an SRI strategy. De Salins groups the responses of the applicants into three categories: “The desire to make more money than the competition; a wish to change the world – which is perfectly legitimate but on its own insufficient for us; the third category was commercial development in response to the growing demand from clients. Some of the applicants were not very clear on this point which is surprising because SRI is a pioneer industry.”
A number of the proposals contained a further fundamental flaw. “We made it very clear at the beginning of the tender that we were following a best in class approach,” says De Salins. “But we received some offers based only on engagement without anything else such as processes – and of course we didn’t accept them. This doesn’t mean that we are not ready to engage; the issue of engagement is more global for us – do we want in the long term to follow the path of engagement for the entire portfolio.”
He adds: “When you concentrate your strategy on engagement only you miss something and for the supervisory board it was clear that the priority should be given to best in class. We want to be sure that there is the opportunity to integrate extra financial elements into the basic investment processes in the long term.”
The FRR defines best in class both as those who have best practices and those who do not have best practices are improving which gives the manager margin for stock selection. “The point is also to finance companies which are improving, says Villermain-Lécolier.”
At the beginning of the process FRR had an open mind about what management processes it favoured and did not favour in terms of external impact or quality of research. “In the five we selected there is one who doesn’t have a big SRI research team,” Villermain-Lécolier notes. “We didn’t want to exclude those who don’t have a big internal team providing the external one is good enough.”
The process of selection was challenging indeed. “The philosophy was much less explicit than in non-SRI selections,” she continues. “Furthermore management costs are often higher – in some cases double that of traditional management. In terms of the operation and middle office we found that the SRI managers were as good as traditional managers; the main differences was that the track record was shorter. We analysed with the help of our consultant - B Finance - a common period of three years, whereas in the case of the first call for tender we looked at a period of more than three years.”
How far are asset managers able to satisfy demand for SRI? “I think we are constrained by the supply side of the economy and the ability to attract investors but things are moving and developing well,” says Villermain-Lécolier. “Our experience shows that there are lots of good players out there which we didn’t choose for many reasons and there is capacity in the market which is growing.”
“But not enough today to manage €30bn or €40bn,” De Salins adds.
He notes: “Though this tender we wanted to give critical mass to the market, and the €600m could grow. We want to create with the managers a sort of partnership where we will try to join our forces in the analytical research in the years to come.”
In April the FRR signed the UN principles for responsible investments. “This is an important initiative,” De Salins notes. “The main political issue was the question of fiduciary duty and there are still two ways to think about this issue. The classical one is that fiduciary duty only relates to the financial return and you can’t have an SRI strategy if you have no clear evidence that it is compatible with this absolute goal.
“Some other investors were closer to this line of thinking. We found a compromise thanks to a very good study of the original UN document carried out by a partner of the law firm Freshfields. The study’s technical and legal interpretation was that fiduciary duty should, in the interest of the beneficiary, take some interest in the global economy.”
Some interest. How much interest? Villermain-Lécolier cites critics who say that the FRR is observing SRI principles only in connection with this €600m mandate which is a tiny percentage of overall assets under management of €30bn. “When we launched RFPs for the management of European mandates we already put lots of SRI elements in the mandates,” she says. “We wanted to choose mainstream managers and yet we wanted them to be keen to accept universally accepted SRI principles in managing the portfolio. We did not want to have excessive reputational risk or excessive financial risk and so we asked them to take into account principles such as the UN global compact or the principles of research agencies.” She adds: “So the result is that in our European equities portfolio - about €6bn - we are working with those managers to know more about the way they are implementing their engagement. The rest of the portfolio is either invested in index equity or in small caps or bonds where we are not yet ready to take into account SRI considerations. We want to learn much more about what is going on in the European large and mid-cap universe before struggling with the rest of the portfolio. In SRI lots of things still represent challenges. First of all we do not know how SRI performs. Second we don’t have any metrics for measuring or limiting the impacts so it there are still a lot of unanswered questions. That is why we are doing things gradually.”
Villermain-Lécolier explains the need to know if the principles which the FRR has drawn up, based on respect of human rights, development of employment, assuming responsibility for the environment and respecting the consumer and free trade processes did make a difference and that they are a good way to reduce future impact. “Many things have to be evaluated before we can apply the approach universally,” she says. “But if the SRI mandate is successful it would be logical to gradually apply the SRI principles to the rest of the portfolio.”
However, if the SRI mandate is not successful, what then? “By the law the maximum duration of the mandate is five years,” says De Salins. “At the end of that time, if it has performed badly, we will report to the board and return to the market. It could be either that we have made mistakes in the choice of the asset manager having used the wrong investment processes. On the other hand it could be that our investment positions are good and principled but it is the SRI concept that was failing.”
Looking beyond to the broader SRI market in France – how does the FRR view the current state the debate? A growing number of institutional investors are interested in the SRI approach and it is part of the FRR’s role to show the way but for some of them, which have the paritarian board structure, the decision to move forward could be more difficult because ESG issues could involve sensitive political issues since ultimately it implies dealing with the definition of the collective values that the institution is committed to,” says De Salins.
But it’s time to look ahead: with the considerable tender process complete, and as the FRR takes a lead position in the SRI debate, minds are open and the mood is upbeat.