By Hamlin Lovell, NordicInvestor

The earliest ESG investment strategies probably date back to the 19th century, when religious groups, including Quakers and Methodists in the UK and US, started investing according to what was then called SRI (Socially Responsible Investment) rather than ESG. The mainly Lutheran religious groups in Scandinavia, including Church of Finland, were also early adopters.

When did Church Pension Fund start applying ESG to investing – since inception in 1991? How has the approach evolved?

We have invested ethically since the inception, but the first formalized “Ethical Investing Guidelines” were published in 1999. I was personally quite young back then, but when I started at the Pension Fund earlier this year, I read it through to understand how our approach has developed over the years. The first guidelines go deeper into the theory of how we should make investment decisions from an ethical point of view, but also offer concrete guidelines for example in terms of negative as well as positive screening. The themes themselves have not actually changed all that much in terms of screening, but for example environmental issues have a much stronger focus today. In terms of positive screening, you can find similar E, S and G related issues as are discussed today.

In the more recent versions, the traditional ethical point-of-view is still relevant, but the approach has developed, reflecting the overall change in the markets. That is, responsibility related aspects simply have to be taken into account in order to make good investment decisions.

Why is your Impact Investing only done through fixed income and alternative investments, and not through direct or external equity investments? Do you plan to eventually apply it to all asset classes?

I think the most important reason for “only doing” it through fixed income and alternatives is the measurability. If we categorize something as impact investment, that impact needs to be clearly measurable and significant from a social or environmental point-of-view. This is not always that straightforward for example within the listed equity strategies.

That said, we are seeing an increasing supply of products and methodologies in this space, so would not rule out us updating this part of the policy in the future. It is also worth mentioning, that the possible added “impact label” is not the determining factor for us when considering an investment. The definitions of impact investing within listed equity are diverse, but we have wanted to keep the definition in our policy as pure as possible.

Why does your sustainability theme apply only to equity and alternative investments, and not to direct equity or fixed income funds? Do you plan to eventually apply it to all asset classes?

Responsibility focus is applied across asset classes, but the “sustainability theme” mentioned in our guidelines is more related to thematic investing. For example, within listed equities, we have reserved an allocation for global thematic funds to benefit from structural trends related to sustainability.

Our direct equity exposure (still externally managed) on the other hand is currently limited to Finnish/European equities, which are more traditional equity strategies with a responsibility focus. Building a portfolio of thematic strategies there is not feasible.

How do you approach engagement?

Due to our size and resources we mainly engage through collaborative engagement in the global perspective, while doing direct engagement mostly in the Finnish market. In addition, we have extensively engaged with our asset managers over the years, for example helping to launch new funds, enhance screening criteria and investment strategy to more holistically take ESG-issues into account. We are always also open to work with our managers to develop their ESG approach and share best practice.

Do managers need to be active to implement ESG effectively? To what extent can passive managers eg index funds apply ESG?

This issue can be argued both ways depending on who you ask, but essentially depends on how strictly you define passive. Question can be for example, whether exclusion criteria or ESG-rating tilts count as active management. Incorporating measures to balance out the factor exposure (against a traditional benchmark) due to exclusions can also be seen to be an active decision. In addition, engagement can be considered appropriate for passive strategies, but can be argued to turn into an active decision if you decide to divest from a company.

Our index strategies track different indices than our own benchmarks, so you can argue that we do not have passive strategies per se. Our global index product, for example, has a tracking error of roughly 1% against MSCI ACWI. This tracking error is attributable to responsibility related aspects.

Do you vote your proxies and report this to your members? For external managers, do you still vote proxies, or ask the managers to do so according to your guidelines?

Within our direct equity mandates we work in co-operation with our asset managers when it comes to voting. When investing through funds, we track the engagement and voting for example through our annual ESG questionnaire, which was recently finished for this year. It is clear, that we expect our managers to take advantage of their shareholder rights.

You work with external ratings firms eg Impact Cubed? How useful do you find their reporting and why did you select Impact Cubed? How do they compare with other firms such as Sustainalytics, Trucost, Vigeo-EIRIS etc?

We work with a range of service providers when it comes to ESG-data, engagement, and screening. As the research has shown, the different approaches can lead to quite different outcomes, not only in terms of ESG ratings but also in for example norm-based screening.

We aim to use a range of different tools to tackle this issue. As mentioned, we have also used Impact Cubed. Their methodology looks at the portfolio from a relative perspective using established models of risk management, focusing on net impact. This can provide additional insight when, for example, comparing managers with a similar strategy. The main point is not necessarily to rank the managers on their level of responsibility, but to give another tool when assessing how the investment process actually translates into investment decisions.

You report to PRI. Do they rate you as they do for some asset managers?

Yes, we are signatory of the PRI. The PRI set the overall framework for our responsible investment activities and allow us to continue developing our practices. The assessment reports, as well as investor tools, are great resources to use when reflecting on where to put emphasis in terms of responsible investment development.

We were also chosen in the 2019 PRI Leaders’ Group, which consists of 47 asset owner signatories with leading responsible investment practices in terms of selection, appointment and monitoring of external managers. The Leaders’ Group is roughly equivalent to 10% of all asset owner signatories, and the idea is to spread examples of best practice in an easy to analyse format for other signatories to explore. As a recent joiner, I can only say that this truly highlights the extensive work the team has done over the years in terms of responsible investing.

You initiated a climate change strategy in 2016? What metrics do you report? Eg how does your carbon footprint compare with a broad equity index?

Our current climate change strategy was initiated in 2016 and will be updated next year. In the current strategy we have followed metrics such as the number of on-going climate related initiatives and discussions, percentage of green investments in the portfolio, carbon footprint, excluded companies and the share of low-carbon indices within our passive/index equity allocation.

It is interesting, how much the climate related aspects have developed in a rather short period of time. We very much welcome this crucial development and are looking forward to continue to contribute in this development.

We are currently starting our work on updating the climate strategy, which will be published next year. We will focus on trying to go deeper and more practical on climate related issues.

Do you use standard, or ESG specific, indices for performance benchmarking purposes?

We use a set of “standard indices” as of today. This has also partly reflected our desire to show, that investing responsibly can lead to better risk-adjusted returns. I would say that we will at some point move to “ESG specific indices”, but no concrete plan exists as of today. In addition, the EU Sustainable Finance Action Plan might give us new tools when considering for example the usage of low-carbon benchmarks.