Why ESG Matters for Pension Fund Strategies and Outcomes

Stéphanie Lachance is Head of Sustainable Investment at Fiera Comox in Canada, where she leads the sustainability strategy. Judith Stroehle is a Senior Researcher at the Saïd Business School in Oxford where she leads the Oxford Rethinking Performance Initiative and co-established the Oxford Impact Roundtable for sustainability reporting and accounting.

As intergenerational stewards of capital, some pension funds have embraced environmental, social and governance (ESG) considerations in their investment practices, but many others have not. Indeed, there remain many obstacles to be overcome due to a range of structural, regulatory and legal hurdles. Nevertheless, we argue that pension funds have a clear set of advantages that outweigh the challenges of integrating ESG, deriving from pension plans’ logic and history. Here we summarize some of these themes in our recent study entitled The Origins of ESG in Pensions.

Sustainable growth pledges rising

In 2020, the CEOs of the eight largest Canadian pension funds – the so-called ‘Maple 8’ – made a public pledge committing to create ‘more sustainable and inclusive growth by integrating environmental, social and governance (ESG) factors into our strategies and investment decisions.’ Stating that this was ‘not only the right thing to do” but also “an integral part of our duty to contributors and beneficiaries,” the group predicted that their new policy would “unlock opportunities […and] deliver long-term risk-adjusted returns.”  Three of the largest global pension funds (CalSTRS, GPIF, and USS) posted a similar open letter the same year.

These statements are striking and show just how much pension managers are beginning to recognize that ESG is embedded in the very fabric of their long-term investments. In addition, many asset owners have led and focused initiatives in recent years.

The most prominent examples of these initiatives are focused on climate change as well as diversity, equity and inclusion (DEI). When the UN initiated Race to Net Zero, it moved many pensions funds to declare their intent to have net-zero portfolios by 2050 or sooner. Several initiatives were launched thereafter, the most recent being the Glasgow Financial Alliance for Net Zero (GFANZ), chaired by Mark Carney, which was launched in April 2021, bringing together leading net-zero initiatives from across the financial system to accelerate the transition.

Asset owners and asset managers are well placed to drive and support collaboration towards net zero objectives, as private finance can help fund private sector initiatives. But unlocking systemic change will require collaborative, ambitious commitments and near-term action across the entire financial system.

Recent initiatives

A recent report from the Principles for Responsible Investment entitled ‘Diversity, Equity & Inclusion: Key Action Areas for Investors’ pointed out that DEI factors are correlated with business performance and have a basis in human rights. Two notable initiatives for pension funds seeking to move in this direction include:

  • The 30% Club is a group of business chairpersons and CEOs seeking to increase gender diversity on boards and senior management teams, and
  • The Investor Leadership Network facilitates collaboration by leading global investors on key issues related to sustainability and long-term growth, as well as DEI.

Compared to conventional investors, pension managers’ intergenerational focus requires them to consider ESG, so that they can secure long-term financial returns for their beneficiaries. Global warming is especially a concern since, at least in some jurisdictions, pension funds worry about their fiduciary responsibility if climate change is not properly considered.

Regulatory developments

Overall, a mix of new pension regulation, changes in the legal interpretation of fiduciary duty, and organizational characteristics are likely to influence pension funds willingness and ability to integrate ESG.

Globally, regulatory developments may help produce the much-needed data to help fund mangers make better ESG decisions. The IFRS Foundation announced recently that it would establish an International Sustainability Standards Board, a new standard-setting board to provide a comprehensive global baseline of sustainability-related disclosure standards. Around the same time, the European Commission proposed a revamped Corporate Sustainability Reporting Directive along with industry initiatives towards data standardization, such as the ESG Data Convergence Project for the private equity industry. Greater transparency and better information will enable pension fund investors to more actively engage with ESG as a strategic theme driving future investment choices.

Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.