Susanne Jacobson and Linda Stany assess the role smaller investors are playing in the responsible investment area
Large asset owners have for some time ruled the responsible investment (RI) landscape using their resources to influence individual companies and investors. However, as the links between RI and financial performance become increasingly apparent, many smaller and medium-size schemes are waking up to their fiduciary duty to manage long-term ESG risks and opportunities. In Norway, Sweden and Denmark, assets managed by investors considering these issues have nearly doubled in the last two years. With regulators' interest in this area expected to increase in a number of European countries, schemes of all sizes should act now to stay ahead of the curve.
This year, the proportion of total global capital markets represented under the UN Principles for Responsible Investment (UNPRI) reached 10%, a significant landmark in support of ESG issues and their link to performance. The principles are based on the premise that ESG issues "can affect investment performance" and are therefore "firmly within the bounds of investors' fiduciary duties". The initiative is now attracting a wide range of investors, including smaller schemes that may not have the same resources as their larger counterparts but aim to invest in line with their fiduciary duty.
Nordic investors have been early adopters of RI practices and represent around 10% of global total assets under management in the UNPRI. In the Nordic countries, more than 70 funds or organisations have signed up, committing to manage ESG issues. Eurosif reports that in Sweden, Norway and Denmark, sustainable and responsible investment assets have grown from around €500bn to more than €950bn over the last two years, according to its recent SRI study.
The Nordic RI market is dominated by large asset owners that have dedicated considerable time and resources to develop a comprehensive approach, based on strict guidelines, portfolio screening, ESG integration and stewardship (ie, engagement and voting). These investors have also demonstrated a high level of transparency with regards to their RI activities. The most common approach in the Nordic market is norms based screening which involves excluding companies that violate certain principles (such as international conventions) from the investment universe. Investors may also engage in a dialogue to improve performance in companies where potential violations have been identified.
Alongside the Norwegian Government Pension Fund, the Swedish AP funds have been influential in shaping the RI market in the region. In 2007, the four buffer funds in the national Swedish pension system, AP1, AP2, AP3 and AP4 established a joint Ethical Council to collaborate in the effort to improve ESG standards in companies outside Sweden. The Council has enabled more effective engagement with companies around infringements of international conventions. The Nordic Engagement Co-operation (NEC) is a similar initiative which was initiated by three Nordic institutional investors to coordinate their engagement activities with companies on ESG issues.
Four of the Nordic countries have now also established domestic Social Investment Forums (SIFs) which bring together investors to promote sustainable investment. Most recently, Finland launched FinSIF which has attracted considerable attention in the region.
In some cases smaller schemes in the Nordic region may have hesitated to adopt RI, fearing a drain on their limited resources. However, in our experience, size doesn't matter and there are many steps that smaller schemes can take to manage ESG issues and fulfill their responsibilities as owners.
First, fiduciaries need to agree on their own approach, understand the expectations of their beneficiaries and align themselves with best practice. There are a number of options to consider, including screening, stewardship, ESG integration and/or joining a collaborative initiative. The chosen approach must then be reflected in their policy statement. It is also advisable to inform the members of the approach to that is being adopted. At a simple level this could involve posting the RI policy on the website.
If schemes have limited resources to hand they could ask for more from their managers. With guidance, both stewardship and ESG integration can successfully be carried out directly by the manager (and in some cases with the support of a specialist ESG research organisation). The policy will serve as a term of reference when discussing these issues with existing and new managers.
To encourage their managers, asset owners can include requirements on ESG issues in requests for proposals (RFPs), ask ESG-related questions in meetings with managers and review the extent to which existing managers currently consider ESG issues in their investment processes and fulfill their stewardship responsibilities. To maintain momentum, managers should be required to report their progress regularly. At a very basic level, members and other stakeholders can be informed of progress by providing links to existing managers' ESG and stewardship policies on their website.
In the aftermath of the financial crisis and the BP disaster, ESG issues have risen up the agenda, and acceptance of the link between ESG and fiduciary duty is growing. In the Nordic countries, investors have stepped up early to adopt RI practices which position them well to meet these challenges. However, as the trends in this area continue to gather pace the pressure will grow on asset owners of all sizes to ensure that they are keeping up with new challenges ahead.
Susanna Jacobson is senior responsible investment analyst and Linda Stany is investment consulting associate, both at Mercer