Seeing for ourselves
As early as 1996 ABP stated that sustainable corporate behaviour was in the interest of long term investors. In the same year we established a code of Prudent Investment Policy. This code contains what we consider to be best-practice investment principles based on Anglo-Saxon trust law.
A key principle in trust law is the duty of loyalty. The opening statement of the ABP code is derived from it: investments are made exclusively in the interest of the participants in the pension fund, aiming to achieve a maximum financial return (within certain risk parameters of course). The code adds that ABP will resist investment compulsion and investment restrictions. Socially initiated investments should always meet ABP’s return requirements. We expressed the connection between the long-term interest of a pension fund, socially responsible behaviour and superior corporate governance.
In this period, the idea was to focus on a negative SRI approach, but no actual investments based on this approach were implemented.
In 2000 the code was revised. The revised code stipulated that ABP wanted to encourage sustainable investment behaviour and the incorporation of best-practice corporate-governance principles. It explicitly stated that ABP would promote the integration of social, ethical and environmental criteria in its investment process.
So, while there was a lot of belief at the time, there was little real proof of how such a policy would work.
At ABP, the question we had to address was how we could implement an SRI policy whilst ensuring that it remained in the best interest of our clients and lead to the highest possible return within strict risk control parameters (risk is OK but it should be manageable). These are the golden rules for all of the fund’s investments as mentioned earlier.
We started in 2001 with two experimental portfolios. Based on a ‘best in class’ approach, meaning no elimination of specific sectors or countries, we started two portfolios – one of for the US and one for Europe.
Since then our approach has changed significantly, as has in our view the potential of SRI investment.
One reason for this change of sentiment was the proliferation of research publications that indicated that portfolios based on sustainability screening could not only be managed without a ‘cost’ (negative excess return) but also offer the possibility of delivering positive excess returns.
Not only that, but we could see the results in front of our eyes.
The returns in the first one and a half years of our internally managed experimental regional SRI portfolios were very good, albeit over a too short time period to draw conclusions.
In mid 2002, ABP organised a seminar on this issue in order to share our views and experiences and hear those of other pension funds and professionals in the SRI community.
The idea was to create a series of networks and exchanges of ideas to get both pension funds and academics thinking about whether SRI would really accelerate as an approach and lead to the long term goal of enhancing returns or not.
At around the same time ABP started to change its general equity investment approach from a regional to a global basis, which was something we also wanted to do with the SRI portfolio.
By the end of 2002 in order to achieve this geographic/strategic shift we decided to transfer our SRI investments to the Loyalis Global Sustainability Fund (LGSF).
Loyalis is a wholly-owned subsidiary of ABP and the reasons for the transfer were fourfold:
1) The risk/return profile of LGSF and the characteristics of the fund
perfectly match the goal of ABP.
2) LGSF offers an opportunity for other pension funds to participate and thereby enhance any potential network of pension funds working in the SRI area.
3) To concentrate SRI asset management at one entity within the ABP-organisation
4) Critical Mass: the management is relatively costly, so we wanted to offer the product to third parties.
The Loyalis Global Sustainability Fund has for its philosophy a well-diversified global portfolio and sustainability screening based on a ‘best-in class’ approach. The fund also incorporates state-of-the-art portfolio and risk management. The aim is to outperform the MSCI World Index by 75 basis points on a three to five year rolling basis with a target tracking error of 3% (ex post).
To date, the performance indicators have been pleasing. For the period June 2001 until September 2002 the two regional funds had a cumulative excess return of 2% with a tracking error of 1.9%.
On a back-tested basis over the period February 2000 until May 2002, the new global fund recorded an excess return of 2% per annum (gross of transaction costs) with a tracking error of 3.1%.
Innovest Strategic Value Advisors acts as sub-adviser to the fund. Innovest is an internationally recognised investment research and advisory firm specialising in analysing companies’ environmental and social performance and their impact on competitiveness, profitability, and share price performance. Innovest has been recognised recently by several independent commentators as the leading firm in the world in this area.
Our participation in LGSF, we believe, satisfies both the sustainable and investment objectives ABP seeks. From a sustainable perspective, the fund acts as a way of stimulating companies to act in a sustainable way to develop economic growth. It also provides us with a tool to implement a sustainable investment strategy as part of our long-term investment policy.
On the investment side, it offers a way of achieving profitable returns with diversification in investment style. It also provides a well-diversified global equity portfolio.
Above and beyond that, the fund offers to outside investors the chance to participate in a network of long-term investors who all have a vested interest in solid and sustainable business practices in the long run.
Having looked back then at the implementation of ABP’s SRI approach, what can we say about the future?
How will the world of SRI look in, say, three years time? Several scenarios are possible in our view.
One is that over the long term there is no added value in return terms for SRI, meaning, of course, that there is no place anymore in our portfolio.
The second scenario could be that SRI continues as a satellite portfolio in the total portfolio with a risk/return profile in line with all our other active strategies (one of the eggs in our investment basket, so to speak).
A third possibility is that sustainability criteria prove to be ‘the’ factor for selecting companies in active management and will be used for the whole ABP equity portfolio and in the end also for our other asset classes. A conclusion will be drawn within three years.
At this stage, a satellite approach with an active measurable product is the most suitable, given the current information we all have. It can also be an interesting and quantifiable complementary strategy for organisations that believe in engagement.
Ton Leukel is manager of account management and product development at ABP Investment in the Netherlands