“Engagement is a big part of sustainable investing”, says Anna Varpula, VER’s Responsible investment adviser. A common misconception around adopting environmental, social and governance (ESG), or socially responsible, investing practices is that it may hurt the portfolio’s performance. However recent studies have found that investments that integrate ESG factors alongside traditional financial analysis tend to lower risk and outperform conventional portfolios over medium to long term.
The State Pension Fund of Finland, VER, is an example. In 2011, it became a signatory of the UN-supported Principles for Responsible Investment (PRI) global investor network. For seven years now the governmental pension fund has adopted ESG investing. It is a long-term fund and returned an average 5.6% annually over five years and 5.4% over ten years.
We interviewed the fund’s Responsible Investment Adviser, Anna Varpula, to know more about its ESG principles, the challenges the fund faces in staying socially responsible and what the future looks like.
The ESG Investing Code
“In the long term, there is evidence that sustainable businesses give sustainable returns,” says Varpula. VER is therefore committed to also monitoring their portfolio companies’ compliance with the UN’s Global Compact sustainability principles.
The fund primarily invests in equity investments (up to 55%) and fixed income investments (at least 35%), with separate equity and fixed-income portfolios. For listed investments in equities and corporate bonds, VER expects the companies to have in place an ESG policy and comply with the international standards based on the Global Compact.
Most asset managers do have ESG policies and reporting in place. VER has questionnaires for managers to assess sustainability and social responsibility standing prior investment decision and after that annually.
“The ESG procedure has to vary depending on the asset class as well,” says Varpula. This means, for example, that the opportunities for engagement for corporate bonds differ from those offered by listed equities.
Since the fund invests globally, comparing different industries is challenging. VER also has other investments - up to 12% - such as real estate, infrastructure and hedge funds. So, while portfolio managers consider ESG a part of the overall analysis for all prospective investment, it follows an adaptive strategy. However, the pension fund still prefers investments where the asset manager has signed the PRI, or at least provides strong evidence that it will act responsibly. It also often analyses companies by website, annual reports and other such sources to assess their ESG status.
Although VER’s responsible investment policy is regularly updated, environment, climate change and water are the big three constant themes the fund will have focus on.
When investing as a shareholder or as a major investor, it tries to have a positive impact on company policies as well. “Engagement is a big part of sustainable investing and we strive to bring changes in our investees through active dialogue,” emphasises Varpula.
VER refrains from investing in industries that have socially questionable businesses. Its exclusion list includes sectors such as tobacco, controversial weapons and alcohol to mention.
The biggest challenge is not having a standard ESG marking system. VER, like many other investors, often have to seek third-party assistance to look into an investment’s ESG score.
“Different providers follow different scoring strategies. Some concentrate on environmental and social issues while others may emphasise corporate governance. Which means a company will have different scores depending on which scale it has been marked on,” explains Varpula.
Future of ESG
Another factor missing in ESG reporting is complete transparency. “Investors should have access to all ESG data points, both positive and negative, and not just the good deeds,” says Varpula. Also, currently, the data used for marking is based on past activities. Forward-looking data points are missing, which means making predictions about ESG is difficult.
Current discussions around ESG also include buzzwords like AI and data protection. Seminars have increasingly focused on labour well-being as well. However, Varpula believes the focus will remain on environment as “it still is the biggest discussion and the speed of actions in this direction need immediate acceleration”.