It can be a difficult prospect to focus on the long term, even when it’s part of your job as an institutional investor to do so.
Often, the return possibilities offered by burgeoning assets look highly tempting, even if they expose the institution to higher levels of risk than they would like. For state-linked asset owners, balancing risk and return can be especially hard. Concepts of diversification and risk-adjusted returns often matter little when attention-seeking politicians are demanding answers about why your fund’s returns were well below that of the local equity market.
The needs of environmental, social and governance (ESG) requirements are even more nebulous.
ESG commitments require investors to consider the positive or negative impact of their investments on pollution, exploitation or indifference to local society, or a willingness to be transparent and accountable. These are principled objectives. But they require time, effort and money to monitor. And, from a returns perspective, the benefits are not always easy to discern.
This is particularly the case when applying exclusionary strategies, a basic ESG strategy that strips out companies deemed to be unacceptable investments (such as tobacco companies or arms manufacturers). Unfortunately, ‘sin’ companies often enjoy reliable revenues and profits. And often the governance of fast-growing entrepreneurial companies is relatively poor, yet many have been great investments.
This has led many asset owners to argue against ESG principles, stating that their fiduciary responsibility is to maximise returns for their stakeholders (be it pensioners or governments), not apply feel-good restrictions that hurt investment performance.
This is wrong-headed for many reasons. One of the simplest is its focus on the short term, at the expense of the long.
At this point it is hard for most (non-US-Republican) people living on the planet to deny the overwhelming data supporting climate change. The impact will be huge, even under the most optimistic scenarios.
Rising temperatures, and associated increases in storms, sea levels and reduced snowfall will cause property damage, deaths, disease, decreased agricultural yields and lower economic growth, to name a few outcomes. Unless there is a broad effort to ratchet back on the usage of fossil fuels, the consequences will be exacerbated. That is very bad for investments (as well as life in general).
The trouble is it will get worse over the long term, not tomorrow.
Many of the world’s biggest asset owners understand this. This is why Norway’s Norges Bank Investment Management, the world’s largest sovereign wealth fund, (whose riches come from oil exploitation), proposed cutting its oil and gas stock investments in November. This followed New Zealand Super slashing carbon emissions in its passive equity portfolio by 40%; it’s looking to apply the same to its active equity investments too.
Actions taken by the world’s biggest investors have real influence on companies and their peers. But more Asian asset owners should do so too.
Some deserve credit. The Government Pension Investment Fund of Japan initiated ¥1 trillion ($9 billion) of passive equity investing via ESG indexes in July (netting it our annual institutional excellence ESG award).Taiwan’s Bureau of Labor Funds has made efforts too, as has Malaysia’s Employees’ Provident Fund.
But there are many conspicuous absentees. Korea’s National Pension Service is only now reportedly looking at its first ESG mandate. No other major Japanese investor besides GPIF has committed to ESG. And no major Chinese institution has installed ESG criteria, despite Chinese President Xi Jinping touting the country’s commitment to green financing at the 19th Party Congress in October.
The Asset Owners Disclosure Project’s 2017 report noted that 67% of China’s asset owners with investments of over $2.6 trillion (80% of the country’s assets under management) were ‘laggards’ over climate risk.
This needs to change. Climate change will hit Asia, with its vast populations and stretched resources, hard. And poor governance only entrenches corruption, illegality and pollution. When considering their fiduciary responsibility, Asia’s leading asset owners should look to the long term. Let’s hope more do so in 2018.