The trend toward implementing ESG — environment, social and governance — has hit critical mass, and most investment organizations are at various stages of either installing or preparing these policies. But could the hype get in the way of an organization’s mission?
That is a question that is on the minds of many people with a fiduciary duty to constituents.
Institutional investors such as pensions, endowments and sovereign wealth funds serve the financial needs of particular interests — pensioners, college students, a country’s citizens, for example. And the investment staff are duty-bound to make investments that further that mission.
But investment staff can get caught between differing views on how ESG should be used.
As featured on Fox & Hounds Daily website, an article by Christopher Burnham, a former Connecticut pension fiduciary and founder and president of the Institute for Pension Fund Integrity, noted that California Public Employees’ Retirement System board member Priya Mathur was recently voted out due to ESG issues.
Mathur was replaced by police officer Jason Perez, who stated during his campaign for the CalPERS board that ESG considerations are costing the pension returns. “This example [of certain investments] clearly shows how CalPERS is being used as a political action committee as opposed to a retirement fund.”
Burnham continues that ESG is, of course, important, and good governance is a critical part of investing, “However, a fiduciary has one mission and one mission only, and that is to manage the funds to which they have been entrusted with the highest return at a reasonable risk.”
Balancing fiduciary needs with ESG goals is the challenge for institutional investors, and there are reports that find the two are actually compatible — that ESG policy can lead to higher returns. But not in all cases.
In its September report, ESG investing for public pensions: Does it add financial value, the Institute for Pension Fund Integrity reports that while the research on whether ESG policy can add financial value to portfolios is not fully developed, there are studies that have found they can.
“The research into ESG in the private sector has yielded some very promising results,” notes the report. “For example, one study published in the Journal of Applied Corporate Finance found that companies that have integrated ESG metrics into their investment strategies have, on average, seen higher returns and lower risks. Another study from The Quarterly Review of Economics and Finance suggests that for firms located in the United States and the Asia-Pacific region, investing in firms with high ESG scores yields returns at the same level as investing in firms with low scores.”
Despite the promising results in unlisted private market investments, IPF finds that ESG policy affect on listed public market investment is considerably more mixed.
What’s at stake for pension holders is their future retirement security, and that creates tension between pension members, trustees and investment staff as well as the investment managers investing pension capital.
Kevin O’Connor, a firefighter and former chair of the Baltimore County Employees’ Retirement System, summarizes in Firehouse, a publication covering firefighting in the United States, the sentiment of a lot of pension holders, trustees and investment staff:
“In essence, the ‘Prudent Man Rule’ that binds all fiduciaries demands that pension investments must be predicated on what is best for the system and its participants, not someone’s political or outside agenda. When firefighters anywhere hear that a politico is preaching divestment and the promotion of a social agenda over investment return, we need to call foul and fight to protect our money.”