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Cool heads for emotive issues

Many of the issues of ethical investment are highly emotive. For years the business activities of many companies around the world – ranging from the manufacture of weapons to stategies which result in the destruction of rain forests – have aroused public anger.
But Europe’s pension fund managers know it is up to them to keep a cool head. Personal concerns about the treatment of staff in third-world factories should not distract them from their primary task – to get good returns for their members.
Increasingly, however, legislation requires the funds at least to state their position regarding socially responsible investment (SRI). As awareness of SRI grows, how are European funds tackling the issue?
As a state pension fund, Sweden’s E13.9bn AP3 fund is now obliged to invest according to socially responsible guidelines. New investment rules were implemented in 2001, which require state pension funds in Sweden to take social and environmental considerations into account in their investments, without neglecting the overriding goal of maximising returns.
But, says Pernilla Klein who works on SRI and corporate governance issues at AP3, it is up to the funds themselves exactly how they take account of SRI principles.
“Their boards are free to determine how. We have decided to implement our SRI strategy through engagement,” she says. As part of the decision to introduce a socially responsible engagement overlay to its investment policies, AP3 awarded consultancy firm CoreRatings with a mandate to provide SRI research on AP3’s equity holdings.
“It (engagement) is the best way. If we sell off our holdings, then we relinquish all influence,” she says.
Engagement means talking to the company about its policies and using one’s voice as an investor – for example, by voting at the annual general meetings of the companies. Engaging with the companies themselves – rather than simply excluding companies from the investment universe if they participate in problematic activities – also means that there is no conflict between ethical investment and maximising returns.
“By excluding large parts of the portfolio, we would have a high risk,” says Klein. In the UK, where pension funds are obliged by law to state their position in regard to socially-responsible investment principles, many funds have opted to take an ethical stance. In many of these cases, says Klein, those UK funds have decided to go down the engagement rather than the exclusion road. While engagement may be a positive way of taking an ethical stance, there are drawbacks. It is potentially costly, says Klein.
“So we have to limit the task,” she says. “As a first step we say we’re only going to engage with Swedish companies because that’s where we have most of our investments.” Altogether, AP3 invests in more than 2,000 companies. Naturally, many of these are foreign. Voting at the AGM of a company headquartered halfway around the world is not a simple task. But Klein points out that there are ways of doing this – via a voting agency, for example.
What in the US is seen as ethical investment – with a stream of investment products to match – is seen in a wider perspective in Europe, says one European pension fund. “In Europe, we see it all as sustainable/green/ecological investment. We see it as responsible, socially and with regard to resources,” says Guenther Schiendl, head of investments at Austrian pension fund APK – an E1.6bn multi-employer fund.
“For us, this is within a broader context. We see ourselves as a responsible investor in relation to people and nature. We see that there is a holistic approach – it is the process we use, the relationship we have with our customers and suppliers,” he says. “We do not believe that by adding one SRI fund to our portfolio we are making much difference,” he says. Since the early 1990s, APK has had certain rules of responsible investment inscribed in its investment principles.
Schiendl agrees it can be hard to ascertain exactly how a company it may invest in does conduct its business. “We are concerned. If a company doesn’t supply you with the necessary data, it is very difficult to form an opinion on whether such a company is responsible or not.”
“We have spoken to several consultants and have gained an understanding of how they work. It is clear that it is not an exact science.”
Taking an exclusionary approach to ethical investment can be problematic, pension funds say. Fabian de Bilderling, senior investment official at Belgacom in Belgium, says his fund has several concerns about SRI. If you look at the SRI universe, the stronger the ethical criteria, the less diversification in your SRI portfolio,” he says. Limiting stock selection to these securities would impair diversification.
“The current SRI benchmarks are not stable over time because the universe analysed is still growing and the turnover which results from this implies higher costs in the portfolio,” he says. “Also, there is no homogeneous criteria on the definition of SRI.
“We want to create a positive engagement by encouraging companies to be more socially responsible rather than avoiding investing in them,” he says. To this end, the Belgacom fund has prepared a memorandum, which it has sent to all its managers, called ‘Memorandum on best practices on socially responsible investment’.
The memorandum requests that managers screen the companies they may invest in and encourage them to pursue sustainable business practices. They should challenge the companies on their SRI efforts and take SRI consideration as an integrated part of their investment decisions.
The Belgacom Pension Fund is convinced that if other investors follows this ‘positive engagement’, this will raise awareness at the companies of ethical and environmental issues, and make them see that doing business responsibly is in their best interests. SRI becomes then a sell-fulfilling prophecy.
The pension fund has also written a code of ethics to be signed by the pension fund employees to encourage them to comply with the principles of good conduct specific to the financial sector and ‘conduct themselves in an exemplary manner – with integrity’, says de Bilderling.
Similarly, Belgian fund VKG has moved to contact all of its 10 investment managers. As a first step VKG has asked each manager to provide the fund with details of their SRI principles.
“Following that, we will decide what to do,” says chief investment officer Karl Haeck. Once the fund has collected all the information it needs on how its investments currently stand in relation to the principles of SRI, it intends to contact the pension scheme members themselves for feedback on the issue. It could be that there are certain principles come to the fore.
Haeck says the most likely outcome of the whole exercise is that the fund will decide to create an SRI overlay.
In Denmark, JOEP, the pension fund for lawyers and economists, already has principles which the companies it invests in must live up to. It does not invest in companies whose main activity involves arms manufacturing. And corporate behaviour must comply with national requirements or requirements adopted by international organisations which Denmark has acceded to.
Although the first step in assessing potential equity investments is economic and financial, JOEP says it also puts great emphasis on companies which show good corporate governance and openness regarding their strategies on working conditions, environment and ethics.
But some pension funds see the issue of SRI differently. Swiss state social security fund AVS views SRI as just another style of investment – and one that might just produce the alpha it needs.
Among its actively managed portfolios, the Swiss fund has various different styles. “One of these is SRI,” says Dominique Salamin, the fund’s manager. “We do it because it is an active management method; we do it to get alpha,” he says.
The fund has no obligation, legal or otherwise, to invest according to ethical or environmental principles, he says. Salamin believes that in an ideal world, investors should engage with the companies they invest in, at least by exercising their voting rights. But this unrealistic, he says, as there are too many holdings in a global portfolio.

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