Investing $20tn to change the world

How sovereign wealth and government pension funds can bring about a sustainable global economy

Investing responsibly, with strategic consideration of environmental risks, is moving from a nice-to-have feature to a critical consideration for success.

Last April, the California Public Employees’ Retirement System (CalPERS) sent a letter to 504 public companies with no women on their boards of directors. The $330bn pension fund asked, “that each company develop and disclose its corporate board diversity policy and implementation plan to address the lack of diversity.”

“Simply put, board diversity is good for business,” said Anne Simpson, CalPERS investment director, sustainability, at the time, in a news release. “It is essential in today’s global economy that boards avoid ‘group think’ and ensure there is the breadth of experience, skills and knowledge necessary to meet complex business needs.”

This type of action is becoming almost commonplace. It is not just related to gender diversity but to a whole range of environmental, social and governance (ESG) issues.

BlackRock, the world’s largest asset manager, recently made climate risk a top priority in engaging with corporations. It says that all directors of companies facing climate risk – such as mining and oil firms, for example – should “have demonstrable fluency in how climate risk affects the business.”(pdf) It has also openly opposed practices at Exxon Mobil over climate change – and it owned about 6% of Exxon stock at the time.

These are huge shifts. Board diversity and climate change are now fundamental to both CalPERS and BlackRock’s investment decisions – so much so that they are willing to put companies they invest in who do not meet their expectations on notice that they must change. This is starting to impact corporate priorities. But even they can’t drive this shift alone.

Staggering potential scale

So who controls the largest pools of capital? The last two decades have seen an extraordinary expansion of sovereign wealth and government pension funds. These include, CalPERS, Canada’s Ontario Teachers’ Pension Plan, Norway’s oil fund, South Africa’s and Korea’s sovereign pension funds, and China’s and Abu Dhabi’s sovereign wealth funds. Such funds’ assets totalled more than the entire European Union’s GDP last year.

These “asset allocators” are accountable to hundreds of millions of pensioners and citizens worldwide, who are the true owners of their assets. They hold over $20tn in assets, which means that their investment criteria can fundamentally change the direction of businesses and markets across the globe.

Sovereign wealth funds and government pension funds have investment horizons that span generations. This means that – as stewards of long-term capital – they are inherently concerned with anything that creates substantial risk for the value of their portfolios over the long-term. These risks include climate change – where there is a well-defined set of benchmarks for measuring and managing climate risk – to a range of ESG risks.

There are, for instance, looming threats to our “global commons”. The deterioration of our environmental commons – the land, seas, ice sheets and atmosphere we share, and the ecosystems and species they host – now topthe latest edition of the World Economic Forum’s Global Risk Report. This threatens not just the funds’ long-term returns, but the very citizens to which they are accountable.

Investing responsibly, with strategic consideration of these risks, is moving from a nice-to-have feature to a critical consideration for success.

“For stewards of long-term capital,” said Adrian Orr, CEO of the New Zealand Superannuation Fund, “the question is not can they afford to invest responsibly but, rather, can they afford not to?”

But there has been a crucial barrier to responsible investing thus far: the methodologies and standards that allow investors to account for the full range of ESG risks are still in the nascent stage. Many are complex and have significant reporting requirements: they are geared for use by specialised teams.

A new report seeks to bridge this gap. The Bretton Woods II Initiative, which has been making the case for responsible investing, late last year selectedThe 25 Most Responsible Asset Allocators (supported by analysis conducted by my firm Dalberg, and the Global Development Incubator). We worked with the asset allocator community to establish a set of common benchmarks – and ranked investors on how well they are addressing long-term sustainability risk in their portfolios. The resulting report sets out easy-to-understand guidelines to encourage greater adoption of responsible investment practices.

Leaders are emerging

The Bretton Woods II report shows that the most responsible asset allocators – controlling $5tn in assets – are already influencing the market in significant ways. Their strategies include: allocating parts of their portfolio to climate/renewable energy; using their votes to veto boards without women directors; and scrutinising labour practices in company supply chains.

These leaders have also recognised there is an incorrect assumption that investors have to choose between financial returns and social responsibility. In fact, considering the ESG performance of investments leads to higher returns and better management of long-term risk. A 2015 Harvard Business School study of 180 US companies over more than a decade, found that companies that scored well on ESG factors also achieved significantly higher returns.

This thinking is becoming increasingly mainstream. A survey (pdf) of 475 global institutions found that 80% of institutional investors now include ESG risks in their investment decision making process.

Stakeholders and the general public want to see (pdf) these long-term risks incorporated into their pensions and long-term savings funds, and this increases the pressure on big investors.

As stewards of long-term capital, major asset allocators are too big and too diversified to hide from global challenges. They hold the power to set standards and promote common methodologies for measuring risks. They are also large enough not to have to accept the world as they find it. If large institutional investors begin rigorously mitigating risks and investing towards the sustainable development goals they will create a massive incentive for companies and markets to follow.

The potential is for nothing short of building a robust, sustainable global economy that truly works for everyone. We hope more and more investors will lead the way.