(Forbes) There is a curious anomaly in the corporate world in the United States that is putting the beneficiaries of U.S. corporate pension funds at risk. Stated very simply, while more and more companies are proclaiming their commitment to “sustainability,” their pension funds are virtually ignoring the topic. Before I elaborate and give evidence on this, let me first provide some context.
In the corporate sector in America and the rest of the world, companies which focus on material environmental, social, and governance (ESG) issues that are important for their industry and strategy will generate superior financial performance over the long term. There is a growing body of academic research which supports this, such as “Corporate Sustainability: First Evidence of Materiality” by Mozaffar Khan, George Serafeim, and Aaron Yoon of the Harvard Business School. Leading companies, such as participants of the UN Global Compact, and institutional investors including signatories to the Principles for Responsible Investment (PRI), are recognizing this and incorporating ESG factors into their resource allocation decisions.
This focus on material ESG issues is matched by a growing desire from these companies, and investors, to take a longer-term perspective rather than simply focusing on short-term financial results. CECP’s “Strategic Investor Initiative,” Focusing Capital on the Long Term, and the Coalition for Inclusive Capitalism are all examples of initiatives working to create this change in behavior. Integrating material ESG issues into the core of a company’s strategy and resource allocation process and long-termism are two sides of the same coin. A common complaint of companies today is that the short-term focus of most of their investors is making it hard for them to make ESG payoff over the long-term. The investor retort is that companies are doing a poor job of explaining how ESG creates financial results, and provide very little data on their ESG performance.
So here’s the curious part. While an increasing number of American companies are trying to take sustainability seriously, their pension funds are acting just like the investors they are complaining about! While US SIF: The Forum for Sustainable and Responsible Investment has been able to identify 10 corporations whose pension funds are practicing some degree of integration, the $1.5 trillion in socially responsible investing assets in corporate America is largely in the portfolios of insurance companies, not corporate pension plans. Yet sophisticated investors such as The California Public Employees’ Pension Fund (CalPERS), with over $300 billion on assets, has recognized that its ability to meet the retirement needs of its 1.8 million members will depend on formal ESG integration across all of its asset classes. Last August, CalPERS’ Board adopted the Environmental, Social, and Governance (ESG) 5-Year Strategic Plan, a six -point plan that is the next evolution of CalPERS’ work on sustainable investing and the Global Governance program. Other large state pension funds in the U.S. and globally are pursuing a similar path.
Indeed, “sustainable investing” as a whole is growing. US SIF recently published its “Report On US Sustainable, Responsible and Impact Investing Trends 2016”, which stated that total US-domiciled assets under management using SRI strategies grew from $6.57 trillion at the start of 2014 to $8.72 trillion at the start of 2016, an increase of 33 percent. The PRI now have almost 300 U.S. signatories, and gained more U.S. signatories in 2016 than in any previous year, although not a single corporate pension plan. Globally, PRI’s 1500 signatories from 50 countries represent around $60 trillion in assets under management. Yet very little of this growth in sustainable investing has come from corporate pension plans with only about 50 of PRI’s signatories being corporate pension plans.
Of course, corporate pension plans are regulated under ERISA and have been subjected to substantial litigation, making them understandably cautious about adopting new practices. But refinements to ERISA are reducing this risk to ESG integration. As I wrote in October last year (“Protecting American Pension Plan Benefits”) the U.S. Department of Labor, which regulates corporate plans under ERISA issued Interpretive Bulletin 2015-01. That bulletin provided guidance on the investment duties of pension plan fiduciaries and clarified that “environmental, social, and governance factors may have a direct relationship to the economic and financial value of an investment.” According to US SIF CEO Lisa Woll, “With the change in Erisa guidance a year ago, we know that some corporate pension plans are now assessing whether and how to incorporate ESG criteria. By the time of the 2018 report, we do anticipate that we will see the effects of the new guidance and some uptick in ESG strategies by corporate pension plans.” A more recent Interpretive Bulletin 2016-1, published last year, lends further support to ESG integration by pointing out it is appropriate for plan fiduciaries to take account of “financial and non-financial measures of corporate performance.”
Of course, for any organization, ESG integration is a journey — one that CalPERS started on over a decade ago. There are however organizational steps that corporate plans can take to make ESG integration an operational reality. A series of practical recommendations are set out in Fiduciary Duty in the 21st Century: US Roadmap published by PRI, UNEP-Finance Initiative, and the Generation Foundation. These involve incorporating ESG into the core competencies of fiduciary training, explicitly addressing ESG approaches in Investment Policy Statements and in the selection of asset managers and investment consultants. According to Brian Tomlinson, Associate Director at PRI/UNEP-FI, “Analysis of material ESG factors is part of fiduciary responsibility and may help plan fiduciaries avoid mispricing of risk and poor asset allocation decisions. We expect more U.S. corporate plans to take practical steps to make ESG integration an operational reality in the coming years, reflecting broad investment market trends”.
In 2015, corporate pension plans worth $3.2 trillion in defined benefit [DB] and $6 trillion in defined contribution [DC]) represented nearly 40% of the total $24 trillion of U.S. retirement assets. That figure includes IRAs, corporate, state and federal DC and DB. State and local DB held approximately $3.6 trillion, and Federal DB held approximately $1.5 trillion.
Corporate pension plans have the same investment universe as CalPERS and have equally long-tailed pension liabilities for their beneficiaries. And yet, no good case can be made for why ESG integration is good for CalPERS but isn’t good for corporate pension plans. When are U.S. CEOs going to demand from their pension plans the same thing they want from their own investors: ESG integration based on a long-term perspective? Ultimately, it is in their own interest to do so.
I will leave the final words on this to Gavin Power, Deputy Director of the UN Global Compact, who said, “Over the past two decades, we have seen a dramatic transformation in how companies integrate sustainability into their policies and practices. We believe corporate pension plans remain an untapped area. Considering sustainable development issues in pension fund investment decisions is a natural extension of a company’s holistic commitment to sustainability. It is also in the interest of beneficiaries—both through returns and in creating a better world for their retirement years.”